James Pethokoukis

Politics and policy from inside Washington

Obama’s deficit commission and the politics of crisis

April 27, 2010

Good luck to the Obama deficit commission. In my heart, I do not believe Congress will pass huge entitlement cuts (preferable)  or tax increases without a  crisis.  (There needs to be a focus on boosting economic growth.) To quote Milton Friedman in Capitalism and Freedom:

Only a crisis—actual or perceived—produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.

Here is one crisis scenario, as outlined by the Committee for a Responsible Federal Budget:

If low interest rates lead to continued debt accumulation and then suddenly, creditor preferences shift, we could experience a “catastrophic budget failure” as set out in a recent paper by Len Burman of the Maxwell School at Syracuse University and his colleagues at the Tax Policy Center.

Under this scenario, at some point financial markets or foreign lenders decide we are no longer a good credit risk, possibly due to debt affordability concerns. They conclude the United States cannot escape basic economic and financial “laws of gravity” forever. They stop buying our debt securities or demand dramatically higher interest rates due to increased perceived risk. With the sudden shift and large rise in interest rates, the economy goes into a severe recession. (“The longer it takes for the crisis to occur, the worse it will be.”) Unlike the past two years, we cannot, however, borrow to stimulate the economy because the crisis was caused by excessive debt and lost confidence. “In the extreme case, the U.S. may not be able to borrow at any interest rate.” Creditors concerned with hyperinflation or even default will not buy U.S. debt.

Comments

wait!
What happens after that? The Road Warrior – Hilly Have Eyes scenario?

Seriously. What would the landscape look like after the “unthinkable” happens? I’m curious.

Posted by bryanX | Report as abusive
 

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