The Shrinking Budget Deficit And The Slowing Growth of Federal DebtCommentary by Bob McTeer
October 11, 2015
The U.S. budget deficit for the fiscal year 2015, which ended in on September 30, was $435 billion, according to the Congressional Budget Office. The 2015 deficit was lower than the $483 deficit in 2014, and much lower than the trillion dollar plus deficits of 2009-2012. The deficit has declined from 10% of GDP in 2009 to about 3% in 2015. Recent progress in reducing the deficit has been boosted by the spending sequester and tax increases of 2013.
Even smaller annual deficits still add to the accumulated national debt, however. Gross federal debt has risen to about 103% of GDP. About 75% of that debt is held by the public or non-governmental agencies while the remainder is held by the Social Security Administration and other government agencies. The debt held by the public is the traditional way of measuring the burden of sovereign debt. The 75% estimate is up from the 60’s prior to the financial crisis and great recession.
Debt held by the public includes debt held by foreign entities, including governments. Much has been made in the past of the large quantity of treasuries held by China, and much is now being made of recent reductions in these holdings. However, rather than reflecting a loss of confidence in U.S. Treasuries, a more benign and likely explanation is that foreign dollar reserves are being used to support weakening foreign currencies, including China’s.
Budget deficits affect the economy and are affected by the economy. As economic activity weakens, certain government spending programs increase automatically and tax revenue intake slows down. The growing deficit automatically adds stimulus to the economy. In a strengthening economy the opposite tends to happen, with tax revenues growing faster and certain spending programs slowing down. Thus, to some extent, the budget balance acts as an automatic stabilizer of the economy.
However, most economic textbooks suggest not relying only on the deficit as an automatic stabilizer. Instead, they recommend deliberately increasing the deficit with tax and/or spending measures to combat a slowing economy and deliberately reducing the deficit as economic growth is restored. Ideally, deficits should be run in weak times offset by surpluses in strong time.
Fiscal policy has traditionally focused on the deficit rather than the level of debt. However, in recent years, the level of the debt has received increased attention, with higher and higher levels of debt being thought to inhibit economic activity. Certainly, as debt grows, interest payments on the debt take a larger portion of tax revenues and crowd out other government expenditures. Recently, however, the Federal Reserve’s monetary policy, by lowering interest rates over a prolonged period, have reduced the cost of servicing the growing debt. In addition to that, the Fed’s larger balance sheet caused by more Treasury security holdings, have directly reduced the burden of federal debt since Fed earnings on its holdings are repatriated to the Treasury. Some worry that those benefits will reverse when interest rates are normalized and if and when the Fed sells of its portfolio of Treasury securities.
Whatever the burden of the federal debt, it grew rapidly during the 2009-2012 period when annual deficits exceeded a trillion dollars per year. In more recent years, even though the debt has continued to rise, it has risen more slowly relative to the size of the economy, and its burden has increased little or none. It would take annual budget surpluses to reduce the debt, which are hard to come by. A more doable approach would be to take measures to stimulate economic growth and tax receipts.