Our Insane Government Spending Will Hurt Our Response To Ukraine

It is wise to maintain a sound fiscal house before an emergency strikes. Inflation will rise further due to Russia’s brutal invasion of Ukraine, and West’s reaction. Home, you can expect more spending by the government to support Ukraine’s defense and help us Americans deal with supply disruptions. No matter what legislators do, their past fiscal failures will hinder them.

Due to excessive COVID-19 relief spending, and substantial Federal Reserve accommodation added onto existing large deficits, the United States now has an unprecedented inflation rate. The result is that government debt has reached 100 percent gross domestic product and the fiscal year 2020 deficit will reach $1.4 trillion. Our high level of debt, if Congress doesn’t have any interest in repaying it, will be more troubling than the lack of Congress. A Fed increase in interest rates will quickly translate into increased government payments, and greater deficit spending.

Although we can’t ignore the Fed’s inability to predict inflation, it’s worth mentioning that the trendiest idea is that government debt could be increased while maintaining fiscal sustainability. For years academics have suggested several ways that increasing our debt does not threaten our fiscal well-being. Two main types of scenarios are the best.

This first assumption is based upon the belief that historically low real interest rates will continue to be so for some time. The government could therefore have high levels of debt without concern about sustainability. This is especially true if higher amounts are used to make productive and sensible investments.

It is foolish to expect interest rates to remain low for an indefinite period. This scenario also requires great faith that legislators will spend money in ways which produce sustained economic growth. Research has shown that these spending often outweighs healthy private-sector spending.

The second and more interesting scenario argues that in countries where real interest rates are lower than the real rate of economic growth, a one-time deficit increase—even a large one—won’t have any cost over time. The new idea is an extension of the old belief that debt can be outpaced by economic growth if conditions are favorable. Let’s say the Treasury borrowed $3 trillion to fund the Next Build Back Better Plan. If all Congress does is allow the Treasury to borrow new money to pay interest on the debt—and as long as interest rates stay below the rate of GDP—then debt will grow, but the ratio of debt to GDP (a key metric reflecting our ability to absorb the borrowing) will fall slowly.

This scenario is not possible for the country, despite how appealing it may sound. Jack Salmon (my Mercatus Center friend) and I have a new study that explains why. The scenario works only with a one-timeThere has been a dramatic increase in the deficit, followed by decades of tax increases that were large enough for us to afford our spending. The “primary deficit”, as economists refer to it, is the difference between current fiscal deficits and the interest payments for previous borrowings. It must be balanced over many years.

This is an essential condition if growth is to surpass interest payments. Unfortunately, it won’t be found in current or future U.S. budgets. The Congressional Budget Office’s analysis reveals decades worth of significant primary deficits and increasing debt-to-GDP ratios. These are mostly due to the explosion in spending for programs such as Social Security and Medicare. If the next round is of emergency spending occurs without any real repayment plan, this outlook will only get worse.

There is a lot to be blamed politically. All political parties have long since stopped worrying about the growing debt and ballooning spending. The moment that former President Donald Trump made the announcement that he won’t be touching Social Security and Medicare was especially revealing for Republicans.

However, even during turbulent times, the truth is that our debts matter. John Cochrane of the Hoover Institution noted that large borrowing should be followed up by severe consequences, such as tax rises, spending cuts, inflation and worse, a major debt crisis. You will have greater difficulties responding to crises like the one in Ukraine.

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