June 21, 2011
I spoke last week with a group of reporters who gather regularly for breakfast at the invitation of the Christian Science Monitor. The conversation touched on a number of issues, but I would like to focus on three of those.
Defaulting on government obligations would be a dangerous gamble. It is difficult to know exactly what would happen if the federal government were to default on its debt because we do not have any recent experience of a federal default. However, a government that owes as much as ours does, and will need to borrow as much as ours will need to borrow, cannot take the views of its creditors lightly.
Even a slight increase in the perceived risk of U.S. government securities would raise interest payments a lot: For example, if Treasury rates were pushed up by one-tenth of a percentage point, the government would pay $130 billion more in interest over the next decade, given CBO’s projected path of revenues and non-interest spending under current law.
CBO expects economic recovery to be slow but steady. CBO and other forecasters expect the economy to continue to expand at a modest pace in the next few years. Unfortunately, that pace is not likely to bring down the unemployment rate very rapidly. We expect the unemployment rate to be around 8 percent at the end of next year and not to fall below 6 percent until 2015. Therefore, a lot of the pain from the recent recession and the slow recovery remains ahead of us.
Tax increases or spending cuts in the short-term would slow the economy, while increases or cuts in the medium- or long-term would boost it. Our analysis implies that cuts in government spending or increases in taxes during the next few years would, by themselves, reduce economic activity and employment relative to what would otherwise occur. At the same time, credible steps to narrow budget deficits in the medium and long run would tend to boost economic activity and employment in the next few years by holding down interest rates and enhancing business and consumer confidence. Therefore, the short-term economic effects of deficit reduction depend on the balance between changes in taxes and spending that take effect right away and those that will take effect in subsequent years. In any case, deficit reduction would tend to boost economic activity in the long run, because it would free up private saving for investment rather than just meeting the government’s current bills.
Indeed, deficit reduction is required relative to current policies for taxes and spending, because under those policies, the debt will rise in an unsustainable way.