Growth is the key to US fiscal recovery
The Obama deficit commission has its first meeting next week. And when the panel finally releases its report after the election, I am sure it will contain an unsurprising mix of tax increases and spending cuts as a way of dealing with the deficit. But a new report from the wealth management group at UBS looking at public sector debt dismissed that policy prescription:
Although fiscal discipline is important, on its own it has rarely been enough to lower a country’s debt ratio. Fo example, since 1980 some 30 countries have undergone exercises in fiscal discipline and many of them have achieved significant reductions in their debt-to-GDP ratios.
However, the overall level of debt hardly ever diminished. At best, fiscal austerity helped to slow down the increase in debt, the actual reduction of the debt ratio was in practically all cases attributable to higher economic growth (often helped by falling interest rates and privatizations). Unfortunately, the growth outlook for the advanced economies is anything but encouraging over the medium to longer term, especially in comparison with the past two decades.
Now the UBS piece argues that the US will try to inflate its way out of its debt problems. Yet I think the report too easily dismisses the prospect for faster-than-expected economic growth. Remember that all those scary CBO deficit forecasts assume long-term growth of around 2 percent, less than two-thirds its historical average. That ability to generate high growth (or hinder it) is the lens though which every new government policy needs to be examined.