Trillion-dollar deficits and the largest debt load since World War II will not be enough to stop the U.S. from supporting the economy with fiscal stimulus (should it be needed).
Traditional roadblocks, including bond vigilantes, inflation concerns and a fiscally conservative Republican Party, no longer appear to stand in the way of ramping up government borrowing, leaving a divided Congress as the only hurdle to some combination of tax cuts and higher spending should the U.S. economy look like it might slip into recession.
Bond vigilantes, once the guardians of fiscal responsibility, have been sidelined by an increasingly dominant Federal Reserve that has kept U.S. borrowing costs near record lows since the financial crisis. Inflation risks have been on the downside for the past decade as the Fed has struggled to meet its 2% target, and Republicans have all but abandoned any claim to be concerned about the deficit after enacting tax cuts in 2017 that are projected to add roughly $1.5 trillion to the Federal budget shortfall over 10 years.
"In a sense, you don't have to worry about fiscal space in the U.S. and certainly not worry about fiscal space in the case of an economic downturn," Gregory Daco, chief U.S. economist at Oxford Economics, said in an interview. Low borrowing costs and the "exorbitant privilege" that comes with owning the world's reserve currency mean the U.S. doesn't have to worry about a lack of demand for Treasurys any time soon, he said.
The Fed gets a break
Access to fiscal stimulus means the U.S. would not have to lean so heavily on monetary policy in the event of a slowdown, making it less likely that the economy will get stuck in the low rates trap that is ensnaring Europe as it struggles to boost growth while hamstrung by debt accumulated in the aftermath of the global financial crisis. However, racking up debts now will reduce the ability for the U.S. to tackle economic challenges further down the road.
The latest estimates from the Congressional Budget Office have the total federal budget deficit for fiscal 2019 at $960 billion, $63 billion more than it estimated in May. The CBO now estimates that the federal budget deficit will average $1.2 trillion between 2020 and 2029, reflecting an estimated $809 billion increase since May.
Federal debt is predicted to reach 95% of GDP by 2029, up from 79% today and compared to 39.5% of GDP at the end of 1966, according to data from the Federal Reserve. Federal debt has averaged 42% of GDP over the past 50 years, according to CBO data.
U.S. federal debt levels are not currently particularly high compared with its Group of Seven peers, but many of them are in the process of trimming debt levels. Net government debt in the U.K. was 77.5% of GDP in 2018 after peaking at 79.3% in 2015 and will fall to 70.9% by 2024, according to International Monetary Fund projections.
Germany's was 41% of GDP last year and will drop to 28.4% by 2024, while Canada's was just 27.9% and will be 23% in 2024, IMF data shows. The highest net government debt load in the G7 is Italy's at 120.1% of GDP in 2018, a figure that the IMF expects to rise to 127.8% in 2024.
Opinions about the health of the U.S. economy vary. Mark Yusko, CEO of Morgan Creek Capital Management, said the U.S. will probably enter recession next year, citing declining 10-year Treasury yields, Brent crude, LME copper prices and the Korea Composite Stock Price Index as warning signs. The National Association for Business Economists, or NABE, said this week that most of its members see the economy contracting by 2021.
Speculation about a downturn prompted President Trump to suggest on Aug. 20 the U.S. could implement a payroll tax cut if needed, but he had changed his mind by the following day, insisting that the U.S. economy is "the strongest in the world by far."
His confidence is supported by solid job growth — the U.S. economy added 164,000 jobs in July and the unemployment rate remained unchanged at 3.7% — while naysayers might point to the recent yield-curve inversion that saw 2-year Treasury yields climb above those on 10-year notes.
About half of the economists surveyed by NABE said current U.S. fiscal policy is already "too stimulative," and 59% of respondents said the federal government should reduce its spending to address the deficit.
In the event of a recession, political fissures between the parties in Congress could prevent lawmakers from agreeing on what kind of fiscal stimulus is most appropriate.
If lawmakers try to address a recession through tax cuts, for example, Democrats would likely require a package with direct benefits to the middle class and increased taxes on the rich and businesses, putting them at odds with Republicans who voted to pass a corporate tax rate cut in 2017, said Megan Greene, a senior fellow at the Mossavar-Rahmani Center for Business and Government at Harvard University. The size and scope of a potential downturn could also affect lawmakers' willingness to work together.
"If it's just kind of a run-of-the-mill couple quarters of contraction that's mild and short, then I don't think that policymakers will be galvanized to reach across the aisle and come up with something big," Greene said in an interview. "If it's another financial crisis, which I don't expect at all, then I think policymakers would be more likely to do something."
That kind of action can come with its own intra-party fighting, however. When President George W. Bush signed the Emergency Economic Stabilization Act in 2008, the bill passed both the House and Senate with comfortable margins, albeit with dissent from members of Bush's own party. Then-Rep. Michele Bachmann, R-Minn., voted against the bill and said before the vote the bill did not "address the fundamental problem of the credit crisis" and "we may rue the day that this passed," according to National Public Radio.
That sort of friendly fire was not reserved exclusively for Bush. In November 2009, liberal economist and New York Times columnist Paul Krugman wrote that President Barack Obama's American Recovery and Reinvestment Act was too small to address the breadth of economic problems the U.S. needed to overcome during the financial crisis, predicting many years of high unemployment unless something changed.
Political pressure could convince members of Congress to pass a stimulus package, even if it is larger than it needs to be, according to Douglas Holtz-Eakin, an economist and president of the American Action Forum, a center-right think tank in Washington, D.C.
"In a downturn, I'm pretty sure [lawmakers] all panic. Their collective jobs are at stake," he said. "They will then spend money, probably more of it and more inefficiently than otherwise we would need to."