Update 386 — FY 2020: Budgeting by Default
Has “Fiscal Policy” Become an Oxymoron?
The Federal budget-making process could fairly be described as broken. If it can fairly be described as a process at all.
There’s the law — the statutory deadlines, constantly being waived or disregarded by Congress. Then there’s practice — some assortment of appropriations bills and holiday ornaments jammed into an omnibus or Cromnibus pork-laden package, veto-threatened over minutiae and considered and voted on in a pell-mell rush out the door for Christmas.
The main casualty of this exercise is fiscal policy itself, now practically an oxymoron. Today, we look at the macroeconomic role of fiscal policy, theoretically and currently, and, therefore, at the cost of today’s inchoate, arcane, and opaque federal budget-making process.
Happy fiscal New Year, everyone. FY 2020 will be bigger than ever.
Last week, President Trump signed a continuing resolution funding the government through Nov. 21, obviating a government shutdown. Over the summer, the two parties struck a deal to add $324 billion to existing Budget Control Act spending caps, uncorking higher funding amounts for both defense and nondefense discretionary programs.
In total, defense spending in FY 2020 will be $738 billion, while non defense discretionary spending will be $621.5 billion. The Committee for a Responsible Federal Budget estimates that the deal adds $1.7 trillion to the federal debt over a decade.
Fiscal Policy by Default, Not Design
Federal fiscal policy today is practically an oxymoron. “Policy” implies premeditated, deliberated, evaluated and ultimately chosen courses of action, and — when needed — reforms. This doesn’t happen in today’s Congress and there is no affirmative fiscal agenda that achieves anything close to consensus.
Policy is not something you construct after the fact. But fiscal policy today is by default, not design. Wholesale budget proposals such as those submitted by the president or introduced by a House caucus are generally seen as policy blueprints or political statements. Even then, the fiscal policy is often only the sum of the tax and spending parts, with the fiscal whole ignored.
The macroeconomy has proven resilient, despite a completely dysfunctional Congress and a nonexistent fiscal policy. But the next recession is on the horizon. Early indicators, such as declining manufacturing output and weakening consumer and business confidence estimates, reveal vulnerabilities in the economy.
The yield curve, traditionally one of the most useful predictors of a recession, is a warning sign as well; in December 2018, the yield between 2 and 5 years inverted, and in August 2019, the yield between the 2 and 10 year treasury note inverted. As of yesterday, the 1-year Treasury offered a 1.73 percent return while the 10 year treasury note offered a 1.65 percent return. The New York Fed estimates a 31.4 percent chance of full-fledged recession in the next 12 months.
Next week, we will evaluate the recessionary indicators in greater detail. First, we will examine the prospects of pulling the fiscal lever: in the context of already-low interest rates and trillion dollar deficits, what options are available, and what constraints do policymakers face?
Interaction with Monetary Policy
The U.S. government employed two tools to combat the last recession: the Fed pursued an expansionary monetary policy and Congress adopted a Keynesian fiscal policy. Responding to rising unemployment in late 2007, the Fed aggressively cut its federal funds rate, lowering interest rates throughout the economy. The Fed lowered its rate more than 500 basis points (BP), from 5.25 percent to effectively zero from July to December. Along with its collateralized lending programs and large-scale asset purchases (quantitative easing), Fed policy helped halt and reverse the recession.
Today, the federal funds rate stands at two percent, following two 25 BP rate cuts in the past three months. In the event of a future recession, a 500 BP rate cut would not be an available option for the Fed; there simply isn’t monetary space to maneuver. Instead, we look to the federal government’s other recession-fighting tool: fiscal stimulus.
In September 2007, debt held by the U.S. public amounted to $5 trillion, about 35 percent of GDP and within the bounds of historical normalcy. Today, debt held by the public is $16 trillion, representing 79 percent of GDP. During the Great Recession, Congress approved The American Recovery and Reinvestment Act of 2009, a nearly $800 billion stimulus package to cut taxes, extend unemployment benefits, provide health and education services, and put Americans to work using federal contracts, grants, and loans. As in the aftermath of the GOP’s budget-busting tax overhaul in 2017, we may be running out of fiscal room to maneuver.
The Cost/Benefit of Deficits
“Fiscal space” refers to a government’s financial capacity to act in emergencies. While there is no consensus on what a magic number is in terms of a maximum advisable debt-to-GDP ratio, the U.S. government certainly is operating with less fiscal space than pre-2008.
But “fiscal space” is not an academic intangible. Countries have run out of fiscal space before. The problem arises when, having depleted the government coffers in stable economic times, a crisis emerges. Often, aggressive action is needed, whether it be financial rescue measures, such as bank bailouts, loan and deposit guarantees, and recapitalization of financial institutions, or conventional fiscal stimulus — tax cuts and spending increases. Countries with high debt-to-GDP ratios cannot respond forcefully to crises (even if a forceful response is called for) without risking fiscal stability. If they do, investors may push sovereign yields to prohibitive levels, or even refuse to lend. Debt servicing costs compound and crowd out other budget priorities, like spending on social programs.
As interest rates have remained low since about 2008, the cost of servicing U.S. debt hasn’t grown much, even as debt itself has grown exponentially. Though rates will not stay low forever, economic forecasting is auto-regressive — economists look to the rearview mirror to predict what will happen in the future. The Trump Administration’s monetary policy, however, is pushing for interest rates closer to zero. Debt servicing will become a major problem if and when interest rates start to rise again. Does this mean the Trump dump of debt doesn’t matter? Nyet.
Moderate and progressive Democrats take views with daylight between over the cost of deficits. Sixteen Democrats voted against the July budget caps deal, which raised the debt ceiling and increased spending despite an annual federal deficit of $896 billion at the time. Democrats who voted against the bill included several members of the Blue Dog coalition, as well as prominent senior Reps. Blumenauer and Kind. Most other Democrats advocate for increases in social programs that would boost spending significantly, supporting spending without worrying as much about balancing the books.
While monetary policy is decided by experts at the Fed, the next fiscal policy response to recession will be debated, voted on, and implemented by a bitterly divided Congress and a president facing impeachment. Members can’t seem to clear the low bar of passing a budget on time, hence the reliance on CRs. Since 2008, Congress has enacted an average of 5.3 CRs per fiscal year, with each CR lasting an average of just 38.8 days.
They do seem willing to incur opportunity costs arising from unpredictable budgeting. The Government Accountability Office found that between 2009 and 2014, CRs and shutdowns resulted in postponed contracts and grants, delayed hiring, and additional work for government employees, all of which amounted to forgone productivity gains.
The much-lauded budget caps deal forged earlier this summer was more of a return to normalcy after Congress self-imposed austerity measures. But what happens in the event of an actual recession, what if we must act quickly? Will fiscal paralysis prevent a response and exacerbate the next crash? And if the Federal Reserve is low on ammunition, does Congress have to tools or the will to be counted, if a coordinated fiscal policy is needed to cope with the next recession or crisis?