Should We Watch Wile E. Coyote Go Off the Cliff?
For generations, one of the great joys in life has been watching Roadrunner cartoons, during which the Roadrunner always manages to find a way to trick Wile E. Coyote into running off a massive cliff. Sadly, it seems as though in the bizarre cartoon political world we now live in, the Roadrunner has become the U.S. government, and “We the People” have become Wile E. Coyote.
It turns out when you’re the Coyote, running off the cliff isn’t nearly as funny or entertaining.
In 2018, Ben Bernanke, the former chairman of the Federal Reserve, stated that fiscal stimulus “is going to hit the economy in a big way this year and next, and then in 2020, Wile E. Coyote is going to go off the cliff.” Bernanke was referring to the return of trillion-dollar deficits added on top of the $21 trillion national debt that the federal government has already accumulated.
What most elected officials refuse to admit is that we have a structural deficit that is not sustainable. The expectation is that in the next recession the federal government will bail out financial institutions, corporations, and state and local governments, as it did during the recent financial crisis. Yet what Bernanke and most economists are saying is that even the most prudent monetary policies are being undermined by deficit spending. As debt continues to accumulate, we are watching the federal government slowly go over a fiscal cliff -- and without a safety net.
The debt crisis is a relatively recent phenomenon in the United States. For two centuries, elected officials adhered to what economists refer to as the “old time religion” of balanced budgets at the local, state, and national levels. Under the old model, yes, the government might incur deficits and accumulate debt in periods of war, but in peacetime, it was expected politicians would balance the budget and use surplus revenue to pay down the debt.
This “old religion” was practiced well into the post-World War II period. During World War II, debt increased to levels exceeding our national income. However, in the following three decades that ratio was reduced below 40 percent. In those days, the United States’ economic growth rates averaged about 3 percent per year, which allowed the government to pursue a countercyclical economic policy without accumulating unsustainable levels of debt in the long run.
Unfortunately, the U.S. government seems to have abandoned the vestiges of the “old time fiscal religion.” In other words, deficits don’t matter anymore, at least according to elected officials. With the exception of a few years in the 1990s, the government has consistently incurred massive deficits and accumulated a mindboggling national debt. Over the next decade, the debt held by the public is projected to again exceed national income, and continue to increase to more than 150 percent of national income over the next three decades
In recent years, higher levels of debt have been accompanied by stagnant economic growth. As debt levels have soared, the fiscal room to pursue countercyclical fiscal policy has disappeared. The United States recently experienced the worst financial crisis since the Great Depression, and it is now exposed to even greater economic instability.
To understand why the government has abandoned the “old time fiscal religion” of balanced budgets, it is important to understand the sources of deficit spending and debt accumulation over the past half-century. Unlike much of U.S. history, the cause of our recent deficits is not related closely to military spending. In fact, even during the Cold War, defense spending was not the primary source of deficits and debt. Defense spending as a share of the total federal budget declined over most of the period, and in recent years has reached an all-time low.
The major source of deficits and debt over the past half-century has been income transfers. Since the Great Society programs were enacted during the 1960s, income transfers have continuously increased as a share of the total federal budget. Mandatory expenditures for Social Security, Medicare, and Medicaid now exceed the entire amount spent on discretionary programs. Over the next three decades, these mandatory expenditures are projected to engulf more than two-thirds of the federal budget.
These troubling trends in debt-financed spending helps to explain why the country continues to pursue unsustainable fiscal policies. Throughout most of our history, there was a consensus supporting the “old time religion” of balanced budgets. Citizens understood that during wartime the federal government could not finance military spending by raising taxes. Elected officials incurred debt to finance military spending, knowing all the while that in peacetime spending would be reduced. Citizens expected elected officials to balance the budget in the near term and pay down debt in the long term.
The growth in income transfers over the past half-century has replaced commonsense fiscal policies. As spending for mandatory entitlement programs has displaced spending for other federal programs, including defense spending, political parties have become increasingly polarized. The Republican Party fights to restore defense expenditures, while the Democratic Party defends expenditures for domestic programs and entitlements. Game theorists describe this as a negative sum game in which the political parties are trapped in a prisoner’s dilemma. The failure to reach consensus on the budget leaves the government trapped with suboptimal fiscal policies.
However, we don’t need to watch Wile E. Coyote go over the cliff this time around. Other countries have shown that with effective fiscal rules in place, the government can balance the budget and reduce debt to sustainable levels. In our research, we propose similar fiscal rules for the U.S. government. Stabilizing the debt-to-GDP ratio at current levels is not a sufficient condition for a sustainable fiscal policy. In the long term, the goal of this simple approach to fiscal policy must be to reduce the debt-to-GDP ratio to historic levels, i.e. less than 50 percent. At these lower levels of debt, the country can restore higher rates of economic growth and also provide fiscal space to pursue countercyclical economic policies. At that point, the fiscal rules would create the conditions necessary for a cyclically balanced budget, with surplus revenue in periods of economic expansion offsetting deficits in periods of recession. Fiscal rules can restore this “old time religion” of balanced budgets.
John Merrifield (email@example.com) is professor of economics at the University of Texas-San Antonio. Barry Poulson is emeritus professor of economics at the University of Colorado-Boulder. They are the authors of Restoring America’s Fiscal Constitution’ New York, Lexington Books, 2017.