Now that we have the recovery, we will have to pay for it. The question is did we take the appropriate measures or did we overspend.
On Thursday, the CBO estimated that the federal deficit in 2011 will reach nearly $1.5 trillion. That’s up from nearly $1.3 trillion last year. Three years after the financial crisis many had hoped what were supposed to be temporary budget deficits would be shrinking by now. That’s especially true because early bailout measures like TARP ended up mostly paying for itself.
So why is the deficit still rising? It’s because the recession has turned out to be weaker than many expected, and unemployment has stayed high. The tax cut passed late last year, which some called a second stimulus, will alone add $400 billion to the debt this year. Here in Davos, where business and political leaders are meeting for the World Economic Forum, there are two views on debt that are being expressed. And at least one of them seems to suggest the recent run up in US deficits aren’t that bad. Here’s why:
The first view on debt is the obvious one. Perhaps, in part, because the World Economic Forum is located, conversations here and panel discussions are dominated by the European fiscal crisis. And the situation in Europe seems bad. Greece, Ireland and others have borrowed so much that many are worried they won’t be able to pay back their debts. The UK’s austerity measures may be causing that country to slip back into recession. Some are saying the Euro will have to be abandoned.
On that backdrop, the US debt seems bad. At a dinner of economists on Wednesday night, economist Carmen Reinhart predicted that the US was headed toward a crisis where we would be forced to cut many of our social services. Raghuram Rajan, a former chief economist at the IMF, said that the measures that the UK were making to deal with their deficit right now were a good move. He said we too should deal with our fiscal problems now, rather than putting them off.
But not everyone thinks the US debt problem is so dire. While the total deficit is larger this year than last year, it is slightly smaller as a percentage of GDP than last year. What’s more, the US many have more ability to borrow than other countries because of the dominant role of the dollar in the world economy. The fact that our dollars are so widely seen as a safe asset gives America the ability to borrow more than say Greece or Ireland before hitting the breaking point. Nobel prize winning economist Joseph Stiglitz, who is also at Davos, said that while he is worried about some of the US states debt problem, he thinks debt may not be as bad as some people think. In fact, Stiglitz would even be for increasing our debt even more. As long as it was spent on things like infrastructure and education, which can produce jobs, and boost incomes. So there is a debt cliff, but the US may not be there yet.