Second Guessing the Debt Debate: 5 Economists Judge Congress' Last-Minute Bargain

Second Guessing the Debt Debate: 5 Economists Judge Congress' Last-Minute Bargain

After a narrow vote, Congress agreed to raise the nation's debt ceiling. But was the debt-reduction plan too aggressive? Too timid? Focused on the wrong priorities? Five expert economists weigh in on the debate

Mohamed El-Erian: What Happens in Washington, Affects Everyone

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America debt ceiling debacle was a self-inflicted, home-grown crisis that President Obama righty warned could have sparked "a deep economic crisis — this one caused almost entirely by Washington." It was much more political than economic and financial. Yet, as the smoke clears, both America and the global economy now have to deal with the economic and financial hangover.

Unlike Greece and other peripheral European economies, America does not have an immediate debt and deficit problem. Yes the budget deficit is high, but there is ample funding available to the US Treasury at extremely low interest rates. And yes the national debt level is rising but, because of the special role that America plays at the core of the global financial system, the country has very patient creditors. (Gabrielle Giffords Makes a Debt Deal Appearance.)

What America has is a medium-term challenge — a festering policy issue that was aggravated by the aggressive use of government resources in 2008 and 2009 to avert an economic depression following the disorderly collapse of investment bank Lehman Brothers.

A legislative anomaly — the need for President Obama to get congressional approval for both an annual budget and a maximum amount of debt issuance - transformed a slow burning fuse into a grenade with its pin pulled and threatening to explode imminently. Political attempts to defuse this grenade exposed an extent of political dysfunctionality that has stunned many in America and abroad, and rightly so.

At the very last minute, this self-manufactured crisis was addressed through a messy compromise that has only a limited impact on the medium-term fiscal outlook. In the process, however, politicians have put at risk America's valuable AAA rating and inflicted damage on the American and global economy.

The debacle in Washington is a further hit to corporate, household and investor confidence. It will translate into lower US economic growth, higher unemployment and more volatile and fragile financial markets.

With the US at its core, the global financial system also faces considerable uncertainties. It is constructed (and operates) on the assumption that American politicians will safeguard the AAA status of US Treasuries (long-known as the global standard for a "risk-free" asset), and the related standing of the US dollar as the global reserve currency.

None of these headwinds to economic wellbeing will die down any time soon. Moreover, they come at a time when the western world is already hobbled by structural impediments that undermine economic growth, intensify income and wealth inequalities, make the unemployment crisis more protracted and ensure that this isn't our last debt scare.

With President Obama's signature on Tuesday of compromise congressional legislation, American politicians finished the chapter on how they fabricated a crisis and inflicted unnecessary pain on the innocent. But their writing is far from over. Their new chapter is entitled "how we undermined the world's AAA economic anchor."

Mohamed El-Erian is the chief executive and co-chief investment officer of investment firm PIMCO.

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Douglas Holtz-Eakin: Debt Deal Leaves Lots of Work Left Undone

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The debt ceiling debate is now behind America—at least temporarily. But the real threat—an explosion of debt—and the real work—entitlement reform—remains.

A river of red ink emanates from the U.S. social safety net entitlement programs. Social Security is running a cash-flow deficit of $49 billion that will explode to $211 billion annually in 10 years. Medicare's hospital program (Part A) has an annual cash-flow deficit of $66 billion, while the doctor program (Part B) and drug program (Part D) cost $216 billion more than is paid in premiums. Medicaid has no dedicated federal funding. In effect, each year our children are ponying up $405 billion in federal deficit-financed costs. Altogether healthcare entitlements will combine to form a crushing annual burden of $1.4 trillion by the end of the decade. The upshot is that these crucial safety net programs will implode without reforms. Liberals tout their defense of this status quo, when in fact business-as-usual is a callous political calculation that cruelly abandons future seniors and poor Americans without a durable safety net. (Top 10 Government Showdowns.)

The river of entitlement red ink courses through a broken budgetary landscape. America is borrowing $58,000 every second—more than the median income of its households—and the gross debt already exceeds the level (90% of gross domestic product) that has historically been seen as toying with danger. Even worse, the federal debt promises to explode in the next decade, which will surely result in a Greece-style debt crisis. Erskine Bowles, co-chair of the President's fiscal reform commission has called it the "most predictable crisis in history."

When the crisis inevitably arises, the painful memories of 2008—panic; no credit; monthly job losses in the hundreds of thousands; Main Street businesses shuttering their windows and closing their doors; highly-qualified college graduates despairing of ever finding real work—will seem quaint and mild by comparison.

Now the focus should shift to solving the real problem of moving to a durable, fiscally-realistic social safety net that lifts the threat of a crushing recession from American workers. Some have argued that it is wrong to introduce such a debate during a Presidential election season. Nonsense. Nothing is more important than solving this problem. Nothing goes more to the heart of shaping America's future. Nothing is more meriting of a spirited public debate than the nature of the needed reforms.

It's time to get to work.

Douglas Holtz-Eakin is the president of right-leaning think tank The American Action Forum. He was John McCain's chief economic policy advisor during the 2008 presidential campaign.

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Simon Johnson: The Fiscal Progress Two Step

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The net effect of our debt ceiling debate is now clear — there will be large spending cuts, starting soon. Such an approach could make sense for some other economy or for the United States at another time. Unfortunately, the timing now could not be worse.

On July 29, the first quarter GDP growth number for 2011 was revised down to near zero, and the initial second quarter estimate barely qualifies to be called anemic. In part growth is weak because local and state governments have already been cutting. Most of them face restrictions on their ability to borrow.

In contrast, the federal government's obligations are in great demand around the world. When people say that the US dollar is a "safe haven," what they really mean is that individuals and organizations like to keep their rainy day funds in US Treasury debt. To be sure, this ability to borrow has been squandered in the past. But now, when it could be most helpful, we seem certain to pass up the opportunity to at least avoid destructive short-term cuts. (Gabrielle Giffords Makes a Debt Deal Appearance.)

Fiscal policy was too expansionary in the 2000s. The so-called "Bush tax cuts" were predicated on overly optimistic economic projections. They ended up making a significant contribution to current debt levels and they are a big part of the likely deficit going forward.

Now fiscal policy is about to become too tight while the political debate consistently misses both what brought us to this point and what are the main fiscal risks that lie ahead.

Almost no one in public life is discussing how the financial crisis of 2007-09 explains most of the recent sharp increase in government debt, by causing a deep recession in which tax revenues dropped sharply. Politicians need to feel more pressure to keep the financial system from getting out of control.

And hardly anyone is emphasizing that our future fiscal problems — for 2030 and beyond - are more about runaway health care costs than anything else. Let's focus on who will or will not dismantle Medicare and on what basis.

Simon Johnson is a professor of economics at the MIT Sloan School of Management. He is a former chief economist of the International Monetary Fund, and a co-founder of the influential blog Baseline Scenario.

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Alex Tabarrok: The Virtues of an Unbalanced Budget Amendment

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One thing is certain about the deal reached this week to raise the debt limit: Deficits aren't going away. Even if the deal is fully implemented it will not bring the US budget into balance. Deficits will continue to increase as will spending. Before the deal, the Congressional Budget Office was projecting federal government spending of $46.06 trillion over the next 10 years. With the deal, spending only falls to $43.66 trillion and that is assuming that future politicians follow through on the promised cuts.

The public is tired of repeated failures to put the U.S. financial house in order. A recent CNN poll showed that nearly three out of four Americans supported a constitutional amendment to balance the budget. If the politicians won't be virtuous then, so the thinking goes, we must substitute law for virtue.

The problem is that a recession is not the best time to raise taxes or cut spending, which is what you would be required to do every time you hit an economic rough patch if we had a balanced budget amendment. Keynesian economists believe that spending during a recession can stimulate the economy. But even if one is skeptical of this argument, its clear that taxes fall during a recession and spending needs rise, as more people need unemployment insurance and Medicaid. What's the point of unemployment insurance if it must be cut during a recession?

So instead of a balanced budget amendment I propose a better idea might be an unbalanced budget amendment. Like now, an unbalance budget amendment (unBBA) would allow the government to run a deficit during a recession. But unlike now, the unbalanced budget amendment would require the government to run a budget surplus in good times. So although unBBA allows for deficit spending on things like unemployment and food stamps during a recession, it would have similar effects to a balanced budget amendment over time because surpluses in good times would be spent in bad times. The surpluses, however, would come when we can most afford them, during a boom and the deficits would come when we most need them, during a recession.

The idea of an unbalanced budget amendment is not new. Sweden's government has been required since 2000 to budget for a 1% surplus over the business cycle. Since implementing their unBBA, Sweden has successfully brought their budget into balance and created a surplus.

Even more ancient sources are supportive of an unBBA. In the Bible, Joseph doesn't advise the Pharaoh to balance the budget instead he tells the Pharaoh, save during the seven fat years so you are prepared for the seven lean. An unbalanced budget amendment reflects this simple and ancient wisdom.

Alex Tabarrok is an economics professor at George Mason University and a research director for The Independent Institute, a think tank. He is also a co-author of the popular blog Marginal Revolution.

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Stephen S. Roach: So Much for the Kindness of Strangers

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Washington overlooked a critical issue in the deficit and debt debate: Global imbalances are a key aspect of the problem. They must be addressed if the United States is to put its fiscal house in order.

The global connection is underscored by America's voracious appetite for foreign credit. Overseas investors now hold about $4.5 trillion, or 48%, of all U.S. Treasury securities. In late 2008, China surpassed Japan as America's largest foreign lender and now accounts for nearly 30% of Treasuries owned overseas.

America's addiction to foreign capital did not come out of thin air. It stems from a chronic shortfall of saving — an imbalance that was deeply embedded in a culture of excess and bubbles. Aided and abetted by reckless policies, Americans became convinced that open-ended housing appreciation had become a permanent source of wealth. Consumers no longer came to rely on the income they earned at their jobs to produce their retirement nest eggs and emergency accounts. Instead, they became hooked on credit and the ability extract purchasing power from the housing bubble.

Lacking in saving, the United States borrowed other nation's surpluses in order to keep growing. That's where China came into play — the economy with the biggest imbalance on the other side of the equation.

The excesses of bubble-dependent American consumers provided high-octane fuel for China's export machine. As export-led Chinese growth surged, so did its saving surplus. China recycled that surplus back to the U.S. in order to keep America's consumption bonanza alive. It bought dollars — especially Treasuries — enabling the United States to keep spending and sustain an ever-larger shortfall of savings. China, the lender, was seemingly the perfect match for America, the debtor. The imbalances in both economies fed on each other.

But then the music stopped. For China, the fiscal crisis and Great Recession was a wake-up call — a signal to rebalance away from unsustainable external demand toward untapped internal consumption. Such efforts now appear to be underway. And that's where it comes full circle. China, the world's biggest surplus saver, gets it. It will now save less and consume more. Conversely, the United States, with world's biggest savings deficit, doesn't get it. At least, that's the message to take from the disappointing outcome of the debt ceiling debate.

What face us in America are tough questions. Absent the Chinese buyer of Treasuries, who will step up and fill the void? And on what terms? That latter point is key. With increasingly skittish foreign lenders now likely to require concessions in the form of a weaker dollar and higher U.S. interest rates, there will be new pressures on U.S. inflation and growth.

Steeped in denial and drawing a false sense of security from the dollar's status as the world's reserve currency, Washington continues to take foreign capital for granted. That is a serious mistake. As Tennessee Williams put it, ultimately, there is little consolation in the "kindness of strangers." America's free ride on the deficit and debt cycle is over.

Stephen S. Roach is the non-executive chairman of Morgan Stanley Asia, and a former chief economist of the investment firm. He is the author of The Next Asia.

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