U.S. national debt and deficits: Expect a showdown

Capitol Hill
Capitol Hill
Photograph by Alex Wong — Getty Images

The results of the 2014 election may have signaled voters’ dissatisfaction with the economy, but one thing you didn’t hear a lot about was the federal budget deficit or the national debt.

This was a major issue in previous election cycles, but not so much this time around. You can see this quite clearly if you look at Google Trends data, which shows how people increasingly searched for the terms “national debt” and “budget deficits” in the run up to the the 2008, 2010, and 2012 elections. Interest in the topic was much less pronounced this time around.

The budget deficit has been shrinking, and fast. Here’s a chart from Jim O’Sullivan at High Frequency Economics, showing the trajectory of the deficit and the CBO’s projections for the future:

Screen Shot 2014-11-13 at 11.49.43 AM

As you can see, the CBO expects the budget deficit to bottom out next year and then begin to steadily rise from there. So, what does this mean for the economy? In the short run, it’s all positive. As O’Sullivan notes, much of the decline in the deficit in 2013 was due to budget deals in Washington which saw spending growth cut and taxes raised, but the decline in the deficit this year has been mostly a result of greater economic growth. In other words, we’re no longer seeing growth reduced by budget cuts, and we’re also seeing an increase in organic growth, which is raising tax receipts.

But how will budget deficits affect the economy going forward? Here’s O’Sullivan in a note sent on Thursday to clients:

While [an improving economy] is still pushing the deficit lower, the economy is almost back to full employment. Longer term, the trend will be up again as the population continues to age and retirement and healthcare costs grow. Similarly, the debt-to-GDP ratio will start moving up again within a few years. However that is for another time and another presidency. For now the budget deficit appears to have become a non-issue for financial markets.

Policymakers will, of course, have to enact legislation to reauthorize discretionary spending and federal borrowing, requiring some form of agreement between the Republican-led Congress and President Obama.

So there is a chance, then, that we will have another budget showdown in 2015, or government shutdown threats from Congress over hot button issues like immigration. But O’Sullivan, at least, believes that this won’t happen, writing. “Agreement is unlikely to come easily but we are not anticipating reenactment of the shutdown and debt-limit battles from recent years.”

Avoiding those pitfalls would be great for the economy, as analysts are pretty much uniformly in agreement that the shutdowns were bad for growth and confidence. But the above chart shows that we’re headed toward rising deficits and debt in the next few years, and economists are in less agreement about what that means for the economy.

Proponents of government spending during downturns argue that high levels of debt and deficits don’t matter when the economy is operating below full strength. Since the private sector isn’t spending anyway, government won’t “crowd out” investment by the private businesses. But as we get closer to full employment and the Fed raising interest rates, this argument holds less water.

Expect the debate over the relationship between debts, deficits, and economic growth to heat up again sometime next year.

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