After the Recession, What?

Canada had the good fortune to enter this economic downturn not only with a balanced budget, but a decade long record of substantial surpluses. Not so our dominant trading partner. There, the Bush government used regressive tax cuts during good times to place the American economy at huge risk when bad times came.

The result is that when the rescue of the financial system and the creation of fiscal stimulus necessary to allay a deep recession are tallied up, public debt in the U.S. will be at historic highs. As Paul Krugman among others has noted, this is currently offset by a precipitous decline in private borrowing, so that overall debt levels remain relatively constant.

But as Willem Buitner suggested in a recent Financial Times op-ed, beyond the short term, the outlook becomes a good deal more troubling for two reasons. First, at some point the recession will end, and when it does, private borrowing will increase. And when it does, levels of total debt may become unmanageable. More important for Buitner is the additional burdens that will be placed on public finance over the next decade or so, first by the ambitious programs envisioned by the Obama administration, but also by unfunded liabilities for Social Security and Medicaid.

This, of course, is an argument that has been going on between left and right in the U.S. at least since the Clinton adminstration, and each side has well-rehearsed if very tired talking points. For Buitner, however, it is this seemingly eternal politcal impasse that is at the heart of the problem. As he describes it

My fears about the sustainability of the US public finances is based on my belief that the US public believes there is a Santa Claus: that you can have the higher benefit levels and higher-quality provision of public goods and services without paying the price in the form of higher taxes or user charges. The US polity is so polarised, that it is not likely that a compromise will be achieved in the years and decades to come, on how to raise the additional revenues or how to cut public spending by enough to restore public debt sustainability. Exaggerating slightly, the Democrats will veto any future public spending cuts and the Republicans will veto any future tax increases.

Faced with this impasse, he believes, an administration of whatever stripe will choose what it views as the only way out: inflation. Thus

The markets are slowly waking up to the threat of inflation as a solution to fiscal unsustainability in the US. The fact that, in the short run (say for the next 3 years or so) deflation is much more likely than inflation does not help, as markets are hopelessly myopic. But once we get more than 3 years into the future, and certainly more than 5 years, the risk of high inflation (between 5 and 15 percent, say) is a material one. Only if Obama manages to put together a new coalition, based on a new national consensus, about the level of public spending and the distribution of its funding burden, will there be a non-inflationary way out of the debt dilemma. Such a major political realignment is possible, but not likely.

So Buitner is not counseling a retreat from expansionary policies now. But he is warning that problems post-recession may be even more difficult than those we face now.