Apr 16, 2020

Quick Reads: COVID-19 Shows Why We Should Have Gotten Our Fiscal House in Order

A high debt-to-GDP ratio like the US has maintained is strongly associated with lower economic growth
Jack Salmon Staff Writer, Veronique de Rugy Senior Research Fellow

People of virtually every political stripe have been talking about controlling the federal government’s profligate spending habits for decades. Institutions have issued warnings, too: the Congressional Budget Office (CBO) has warned time and again that the insane trajectory of our growing federal debt would eventually limit our ability to respond to the next crisis. Well, that crisis is here, and we’re about to test the consequences of ignoring these warnings.

Other governments took the lessons of the financial and debt crises of 2008 seriously and took action to get their fiscal houses in order while they could. In Germany, Chancellor Angela Merkel noted that “all of us have to stop spending more than we earn every year.” In the United Kingdom, former Chancellor of the Exchequer George Osbourne implemented a budget surplus law, arguing that the nation must “act now to fix the roof while the sun is shining.”

These governments moved to patch up their fiscal houses because they understood that they would need to staunch up debt to be prepared for the next rainy day.  This shift toward fiscal responsibility found support in a burgeoning academic literature that stressed the negative effects of a large and growing debt burden on economic growth.

Unlike other countries, the US government did not fix our leaky roof while the sun was still shining. Now that we need financial cover more than ever, our federal shelter is riddled with holes.

The storm of the COVID-19 pandemic is upon us, so the federal government felt pressed to quickly pass a record-breaking $2 trillion spending package to alleviate the distress of an evolving economic crisis. This response may be well justified, as the US economy is likely to be in a recession by July. Our current fiscal situation, however, is not: $1 trillion annual deficits are already the norm, and our outstanding debt of $24 trillion is on track to surpass $26 trillion by the end of the year.

Our recent research for the Mercatus Center analyzes a decade of research on the relationship between government debt and economic growth. Every single study except two finds a negative relationship between government debt and economic growth. According to the empirical evidence, there is little doubt that large government debt has a negative and, in many cases, worsening impact on the growth potential of a debt-burdened economy.

Given our dire debt trajectory, these findings should be of grave concern for American policymakers and the public. Diminished economic growth rates will have significant negative impacts on living standards for average Americans over time. With total outstanding federal debt at 105 percent of GDP in 2019, the US fiscal condition is almost certainly already having a deleterious impact on our growth potential. At a time when the COVID-19 pandemic is threatening to knock off several or more percentage points from quarterly GDP projections, we need every bit of secular economic growth we can muster. Heavy government debt burdens basically make this impossible.

Maybe the large fiscal packages recently signed into law are indeed necessary to lighten the blows of a systemic economic meltdown. This aid will likely only patch an already threadbare financial awning: it would have been much better if we were already on a solid fiscal foundation. By not balancing our budget and curtailing our debt levels during the past decade, we have now put ourselves in the excruciatingly difficult position of having to forgo future economic opportunity in order to stave off this current crisis.

Photo by Branimir Balogović on Unsplash

If you are interested in speaking with Veronique de Rugy and Jack Salmon about their research, please reach out to media@mercatus.org.

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