WASHINGTON, September 9, 2014 — Representative Marcia Fudge, D-Ohio, spoke at the Akron Roundtable luncheon and asked, “Why is it so important to have a balanced budget? We haven’t balanced the budget but one time in the last 50 years.”
We had budget surpluses in 1998, 1999, 2000 and 2001, but her question is a good one.
Economist are of three philosophies on fiscal policy, that is, government tax and spending policies. Conservative economists say that the budget should be balanced every year, perhaps making exceptions for extreme conditions like war. They argue that monetary policy can provide sufficient flexibility to offset business cycles and provide economic stability.
While most people believe that balanced budgets make sense on a personal level, that view may not extend to the federal budget. The public believes that the federal government has the ability to raise unlimited amounts of capital by selling bonds, or that the Federal Reserve can, as it has been doing for a number of years now, simply increase the money supply to buy government debt.
Because of this popular view, a second economic philosophy has some influence. This is sometimes known as functional finance. It asserts that although the budget could be balanced, there is never a reason that it must be balanced. Simply set the level of government spending and taxation necessary to reach the economic goals of growth, low unemployment and low inflation. If the budget balances that’s great. If it doesn’t, that’s OK too.
The result of this philosophy, which has driven policy since 1962, is that the federal government budget has been in deficit 48 of the last 52 years. The total public debt is approaching $18 trillion dollars which is greater than annual GDP of about $17 trillion. Even at historically low interest rates, the annual interest payment is about $450 billion.
The problem with never balancing the budget and allowing debt to accumulate, is that there is no plan to ever repay it. Unless there is a budget surplus, the annual deficit is financed mostly by selling long term bonds. When the bonds mature and must be paid, the government sells new bonds to repay the maturing bonds. This is known as rolling over the debt. The result is that we pile this ever increasing debt burden onto future generations.
And that is really the answer to Rep. Fudge’s question. Annual interest payments will take away from productive government spending, especially as the public debt doubles in the next 15 years or so. Eventually, when interest rates rise, the burden will be heavier.
In addition, as the public debt grows, it may crowd business and consumer borrowers out of the market as investors buy government bonds instead of private securities. This will reduce economic growth and raise the borrowing cost to consumers who which to finance new homes or new cars.
Maybe the worst of the negative consequences is that it sets a tone that state and local governments, where allowed by law, seem to follow. Even average Americans believe that it is OK to spend more than you earn every year. This creates problems with household budgets and eventually leads to financial distress.
What about the third budget philosophy?
The third view calls for a cyclically balanced budget. This position says that is acceptable to run deficits during recessions or early in a recovery, if the budget is in surplus during the expansion years. The surplus in the expansion years would be approximately enough to repay the deficits during the recessionary years, so that the budget is balanced over the business cycle. This allows for the use of Fiscal Policy to offset economic fluctuations while avoiding an ever increasing public debt.
Because of the more compelling problems facing the U.S. today, reigning in government spending and reducing deficits are not being discussed. Eventually we will have to deal with this issue. For our children’s and grandchildren’s sake, let’s hope we do it soon.