Attention: Deficit Disorder

There’s good news and bad news about the United States’ ongoing deficit and debt problems, according to high-profile economists who discussed the subject recently at Massachusetts Institute of Technology (MIT).

The good news is that the country’s long-term debt is a less pressing economic problem now than much of the political debate about the issue would indicate, at least according to some members of the panel.

The bad news is that a variety of policy options that could create jobs and economic growth—and in the process, reduce the country’s annual deficits and cumulative debt— are unlikely to advance in a political climate that has largely produced budget-cutting measures in 2011.

“The United States has an unemployment crisis and a debt problem, but many people in Washington are behaving as if we have a debt crisis and an unemployment problem,” said Peter Diamond, Institute Professor emeritus at MIT.

To be sure, the federal debt is “on a trajectory that’s unsustainable” in the long run, Diamond said. But, he noted, “we’ve got a decade before we’ve got any problem, maybe more,” meaning that “what we should be looking for are not things that cut spending this year or next year.”

Instead, Diamond emphasized, job creation should be an immediate priority. “We’ve got a lot of evidence that when you’re unemployed for a year, your future labor market prospects get significantly worse,” he said. “It’s bad for workers and their families, and it’s bad for the economy.” As a remedy, Diamond said, “We need significant fiscal stimulus…. Doing it now rather than later is going to be cheaper.” That would include, he suggested, more spending on infrastructure, education, and scientific research.

The panel discussion, “The Federal Budget Deficit: Causes, Consequences and Potential Remedies,” featured economists who have served in key White House positions, as well as Nobel laureates Diamond and Robert Solow, also an Institute Professor emeritus at MIT.

Jeffrey Liebman, a professor at the Harvard Kennedy School who worked in the Office of Management and Budget from 2009–10, joined Diamond in making the case for more government spending on jobs.

The country still needs “fiscal stimulus as big as the American Recovery and Reinvestment Act, but this time with it all being stimulus,” Liebman said, referring to the $787 billion stimulus bill passed in 2009, which included tax cuts. In Liebman’s view, those cuts did not create growth as effectively as more spending might have.

Liebman also presented sobering numbers for those anticipating a recovery. While U.S. growth in gross domestic product (GDP) has stagnated recently—it grew by 1.3 percent during the second quarter of 2011—it would take a full year of 4.5 percent growth in GDP to lower the unemployment rate from its current level of roughly 9 percent to 8 percent, he said. To lower unemployment to 7 percent would require two straight years of 4.5 percent growth.

Others on the panel expressed more concern about the U.S. debt situation. Deborah Lucas, a professor at the MIT Sloan School of Management and former economist in the Congressional Budget Office, said she was “less sanguine” about the hazards involved, which she said could include “panic” by investors. “We don’t have to solve [the debt level] tomorrow, but I think the risks are greater than other people think,” she said.

Health care concerns

Harvard economist Gregory Mankiw noted that bond markets have kept the costs of U.S. debt servicing low; a higher yield on bonds would indicate more concern by investors that the United States would not repay its debts. But like others on the panel, Mankiw pointed to rising health care expenditures as a major driver of government debt.

“I’m really quite pessimistic about health care costs,” Mankiw said, “and the reason is that I think the main driver of health care costs is technology, which over time [gives] us better and better ways of saving lives, but at greater and greater costs.”

Mankiw, a professed skeptic of the 2009 stimulus bill, suggested a few ways that the government could try to rebalance its revenues and spending, including a gasoline tax of $2 per gallon and elimination of the mortgage-interest tax deduction for homeowners. But, as Mankiw noted, those policies are easier to back when you “don’t have to run for office every two years.”

A challenge to economists

Indeed, the difficulty of finding political backing for policy prescriptions was a major talking point among the panelists. The U.S. political system, Liebman suggested, is “built well for inertia,” but has a harder time responding during crises.

In his remarks, Solow was considerably more critical of Washington, terming this summer’s debt-ceiling negotiations a “disgraceful” performance on the part of Congress.

“To call it a banana republic would be an insult to Central America,” Solow said, producing a wave of laughter from the audience.

In Solow’s view, government deficit spending has had a significant benefit, by compensating for reduced private-sector spending since the financial crisis hit in 2008. On the other hand, he noted, the presence of large amounts of U.S. government debt—traditionally a safe haven for investors —means that less money is directed toward, say, somewhat riskier corporate bonds, which fuel private investment.

Still, panel participants agreed it was necessary to keep talking publicly about the fiscal outlook. Given the “failure to come to grips with some of the basic realities” on the part of Washington, said James Poterba, MIT’s Mitsui Professor of Economics, who moderated the panel, economists “have a very important challenge ahead… trying to communicate more effectively how some of the basic moving parts fit together, and what is and what isn’t a feasible way of trying to tackle some of these basic problems.”

Article by Peter Dizikes. Reprinted with permission of MITnews.

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