We might have just been saved from an immediate default on the national debt with all of its consequences. Senate Minority Leader Mitch McConnell late on Wednesday made a new offer to the Democratic-run Senate as lawmakers struggled to end a standoff over the federal borrowing limit.
Republicans will “allow Democrats to use normal procedures to pass an emergency debt limit extension at a fixed dollar amount to cover current spending levels into December,” McConnell, a Kentucky Republican, said in a statement.
But that only kicks the debt ceiling can down the road. Why should there be a congressionally mandated debt ceiling? If the U.S. congress was serious about putting a cap on public spending, then it would require that any new spending be paid for, as has been done in the past.
It is beyond silly to have have a debt ceiling, otherwise. Because the debt incurred is from past spending. But, alas, congress has not been able to agree on an acceptable formula for reinstituting what has been called pay-to-play budget resolutions.
The above FRED graph shows the amount of public debt as a percentage of GDP owed by the federal government is today. The largest growth in U.S. public debt occurred because of the last two recessions (gray columns in graph)—the Great Recession caused by lax regulation of Wall Street lenders that led to the housing bubble, and the COVID-19 pandemic, respectively.
The pandemic recession lasted just two months, and public debt soared mainly because of the $trillions in emergency spending passed by congress during the Trump and Biden administrations that wasn’t paid for. In fact, the Trump administration pushed through massive tax cuts on corporations and lowered the maximum tax rate on personal income in 2017. Some $7.8 trillion was added to the public debt during his term.
Even the current level of public debt ($22.7 trillion) is less of a danger to growth than the debate over raising the debt ceiling.
This is because as Josh Bivens of the Economic Policy Institute points out, and I have discussed in past columns, over the past 25 years debt service payments (required interest payments on debt) shrank almost in half, from 3.0 percent of GDP to 1.8 percent, as the nominal federal debt rose from $5 trillion to $22.7 trillion. And it has averaged 3 percent of GDP, historically.
The main danger to economic growth is that a debt ceiling exists at all. Fed Chairwoman Janet Yellen just warned that the U.S.could fall into a recession if the debt ceiling isn’t raised in congress by October 18.
“It is utterly essential that this be done,” Yellen said, in recent congressional testimony. She called Oct. 18 “the deadline.”
In fact, we are at the beginning of a new growth cycle. Doubts about the direction of growth after the pandemic arise from outdated economic models—models that can be lumped under supply-side, or more derisively, trickle-down economic theories.
Conservative economists tend to be stuck in what has been called the golden years of Reaganomics—or supply-side economics--when stimulating the supply of ever more goods and services by lowering government oversight and reducing taxes was the ticket to prosperity.
But explained simply, having excess aggregate demand, or effective demand, which we have today, stimulates greater growth rather than an excess of supply. And businesses are following that formula with record amounts of private and public investments in capital goods. Total capital expenditures in the second quarter are up 25 percent from a year ago, per the Federal Reserve Bank of St. Louis (FRED).
Lord JM Keynes understood this in the 1930s, which is why he thought it more important to stimulate greater demand with public investments when private investment disappeared during recessions. That was the lesson we learned from the Great Depression.
And it is the lesson we need to carry forward with the current infrastructure legislation winding its tortured way through congress that will stimulate a longer lasting growth cycle.
Then our debt will pay for itself.
Harlan Green © 2021
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