The US economy and financial system appear to be rebounding from their worst crisis since the Great Depression. Fiscal and monetary authorities took unprecedented steps to address the crisis and their efforts seem poised to reap their intended benefits. Yet, their actions have many wondering whether the cure may be worse than the disease. The rapid increase in public debt and the corresponding explosion of the budget deficit have become significant concerns.
We reviewed public debt, budget deficits, and GDP from 1977 forward. While earlier data is available, the government has used various fiscal years throughout our history. Prior to 1842 the fiscal year coincided with the calendar year and from 1842 through 1976 the government’s fiscal year ran from July through June. Since then it has run from October through September. Therefore, to maintain consistency of data, we began with fiscal year 1977. From October 1977 though July of this year, public debt has increased more than 16 fold, from just under $699 billion to nearly $11.67 trillion (Chart 1).
Our next chart depicts the percentage increase in debt outstanding from one fiscal year to the next. Generally, debt increased at double-digit rates from the early 1980s through the early 1990s. The growth in public debt slowed dramatically from the early 1990s through the early 2000s as budget deficits declined and ultimately became surpluses. However, public debt began to rise more rapidly again after 2001, rising dramatically over the last two years (Chart 2). During this time the country once again ran budget deficits.
Public debt rose 16.5% from October 2008 through the end of July and will likely increase 20-22% this fiscal year. While this is an enormous increase, it is in line with the 20.59% increase in fiscal 1983. From October 1980 to September 1989 public debt more than tripled from just over $900 billion to just over $2.85 trillion, increasing at least 9.80% each fiscal year and increasing more than 14% each year from 1982 through 1986. Not surprisingly, the government ran large budget deficits in the 1980s. In 1983, the budget deficit was 6% of GDP, the largest deficit as a percentage of GDP of any year from 1977 through 2008. The deficit, which was 4% of GDP or more in only seven years from 1977 through 2008, was 4% or higher every year from 1982 through 1986 (Chart 3).
Despite rapidly rising debt levels and historically high deficits as a percentage of GDP, US economic growth was robust from 1983 through 1989. The economy grew at least 3.4% each year, growing 4.1% or more in four of those years.
Now, compare that period to the seven years from 1994 through 2000. Public debt grew far more slowly, never increasing by more than 6.38% in a single fiscal year. The budget deficit declined from 1994 through 1997 and the government ran surpluses from 1998 through 2000. GDP grew between 3.7% and 4.5% each year with the exception of 1995, when it rose a more modest 2.5%. Despite greater fiscal restraint, the economy grew less, on average, than it had over the seven years ending in 1989 (Chart 4).
We are not suggesting that rapidly rising public debt and large budget deficits portend strong economic growth. Rather, we applaud the fiscal restraint of the latter period in this analysis. Additionally, the budget deficits we now face dwarf those of the 1980s. The Congressional Budget Office predicts that the deficit in the current fiscal year will skyrocket to a heretofore unimaginable 13% of GDP. Rising debt and budget deficits, double those of the 1980s, will place significant pressure on the US Dollar, which in turn will place upward pressure on commodity prices and inflation. This poses a significant threat to the nascent economic recovery. Unfortunately, severe economic crises are similar to critically ill patients; the cure can be as deadly as the disease itself.
Yet it is inaccurate to suggest that rising government debt automatically harkens economic disaster. Fiscal stimulus results in the expansion of debt and rising deficits because it is implemented to combat economic weakness. As a result, spending increases as tax receipts decrease. Additionally, the size of the stimulus should be proportionate to the severity of the recession. Therefore, in the face of the most severe economic crisis since the Great Depression, rapid, large increases in public debt and historic budget deficits are not surprising. Yet fiscal stimulus, intelligently implemented and removed in a timely fashion, need not result in continually rising deficits and years of economic malaise, although we fully admit that this is a delicate balance not easily achieved.
Despite the fact that higher deficits do not automatically presage economic weakness (the 1983 deficit was a record at that time), we do not expect the recovery to be anywhere near as robust as that which began in 1983. At that time, the US economy had struggled for nearly a decade to realign itself to changing economic realities. Conversely, we have just begun the long, arduous process of again realigning and restructuring the US economy. This process will take many years and economic growth is likely to be modest and uneven over the next three to five years. The current debt levels and deficits are an unavoidable, and unenviable, result of the current crisis; a crisis which was years in the making. Whether they develop into long-term problems will largely depend on the discipline America exhibits in addressing the hard choices currently confronting it.