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Employment gains in May jumped up materially from the already robust levels of the prior two months. This, along with recent data on strong gains in personal consumption and business investment outlays affirms expectations of a marked acceleration in the economy going into the second half of the year.
President Trump recently proposed rescinding $15.4 billion in spending that would otherwise go unspent. If enacted, these rescissions would reduce federal spending by less than 0.4%. In Washington, this qualifies as a “big lift,” which goes a long way to explaining why the annual federal deficit is approaching $1 trillion. Though the deficit today dwarfs expressions of concern – the proposed rescissions notwithstanding – the budget hawks won’t be ignored indefinitely.
A rescission is a simple device often used in years past that – if approved by Congress – cancels previously enacted budget authority. The rescission package may seem small, but one has to start somewhere. Its modest size motivates a curious criticism that $15.4 billion in rescissions are not worth the effort. True, such small cuts represent a puny 2% of the current budget deficit, but those who object to doing so little are typically counted among those who refuse to offer more substantial deficit reductions.
This is indeed a classic instance of political prestidigitation. Propose a modest solution and critics will carp on its inadequacy just to avoid having to act. But propose a substantial remedy, those same critics insist the solutions go too far, are unworkable, or are just “unfair.” As long as inaction is the result, any criticism against reining in government spending has currency.
Not so long ago, members of both political parties overwhelmingly insisted on a sound fiscal policy. Fiscal rectitude reflected responsible behavior toward future generations. Deficits might surge during a recession or times of war, but normally at most only modest deficits were tolerated. Then the notion took hold that deficits during recessions were not only tolerable but beneficial, and so, in the immortal words of the Doobie Brothers, “what once were vices now are habits.”
Financial markets, normally expected to provide painful disciplinary reminders for fiscally wayward policymakers, also played a substantial role in this cultural shift. These reminders are missing today. In recent years the federal government doubled and doubled again its outstanding debt, yet the 10-year Treasury bond rate hovers around 3%, and barely touches 1% after inflation.
Low interest rates have also helped keep federal net interest costs in check, another typical concern associated with budget deficits. The Congressional Budget Office (CBO) projects about $316 billion in net interest expense in 2018, about 8% of total spending.
Consequently, and at least for the present, it appears fiscal deficits truly do not matter much either to interest rates, investment levels, or in constraining other federal spending. In the absence of painful economic or fiscal consequences, and in light of repeated urgings to allow the deficit to increase during downturns, steadily but inexorably fiscal hawks found themselves on the endangered species list.
These low interest rates won’t last forever. CBO projects the 10-year Treasury note will rise about 1.1 percentage points, to 4.1%, in a couple years, suggesting CBO believes base real interest rates will soon return to more normal levels. Consequently, CBO projects federal net interest payments will reach $915 billion in 2028, at which point net interest will account for about 60% of the overall budget deficit.
Modern accepted norms reinforced by abnormally low interest rates have combined to make unsustainable budget deficits economically and politically palatable. This will not last indefinitely. Interest rates will surely normalize eventually, possibly rising much further than normal given the rise in federal debt. The economic and budgetary pain will be substantial when we learn the budget hawks were right all along.