05.31.2023 President Biden and House Speaker McCarthy shook hands over the weekend on a deal – reached through an old-fashioned bi-partisan compromise – to avert a US Treasury debt default. The fact that neither side is happy with the outcome is probably a good sign. Actually, the agreement doesn’t raise the debt ceiling; it suspends the borrowing limit for two years. Negotiations focused on capping non-defense, discretionary spending – in other words, just a slice of a slice of the budget that includes the environment, scientific research, the Department of Justice and the Internal Revenue Service. The framework keeps 2024 spending at the same level as 2023 and raises it one per cent in 2025. Defense spending was limited to a three per cent increase. Discretionary spending will likely shrink in real terms, however, considering inflation is currently running at five per cent.
The deal calls for more stringent work requirements for federal food aid recipients, raising the required working age from 49 to 54 for those with no dependents. It also claws back $400 million from COVID-related funds and cuts $10 billion from the $80 billion Congress approved for the IRS.
Some observers argue that, for the first time since the pandemic, monetary and fiscal policy will be rowing in the same direction, with both fiscal and monetary policymakers restraining growth. But any coordination between fiscal and monetary policy is coincidental. That’s because the federal government has been on a one-way spending spree since the financial crisis. Fiscal policy, through deficits and surpluses, was meant to be a counterbalance to the business cycle. John Maynard Keynes, the father of fiscal policy, recognized that economic growth (the sum of consumption, investment, government purchases and net exports) could be balanced with government purchases, allowing the government to run a surplus in good times and a deficit when times are tight.
Unfortunately, the idea of a government budget surplus disappeared in 1990, the same year in which hilarity ensued when Ferris Bueller took a day off from school. Since that time, the federal government, run by both Democrats and Republicans, has been running ever-widening deficits. Democrats claimed victory by expanding spending programs while Republicans pounded their chests over tax cuts. Sadly, both were right. While government spending helped cushion the blow of the financial crisis and the pandemic, spending the second time around got out of hand. Between January 2020 and November 2022, the Trump and Biden administrations distributed over $7 trillion in COVID relief. That was clearly excessive.
Handing out $7.2 trillion of checks to businesses and households at a time when production was hobbled sparked demand for goods that were not available, igniting the highest inflation America has endured in 40 years. Monetary policymakers raised interest rates to cool demand, yet the government kept right on spending, expanding the deficit by $1.8 trillion and embedding more persistent inflation.
Bottom Line: The debt ceiling debate may seem silly to many people. But negotiating a ceiling introduces a modicum of discipline to the legislative and administrative branches of government, which would otherwise gladly borrow today and kick that debt can down the road to the next generation. Eventually, the imbalances will need to be reconciled. Until then, let’s hope for high growth and low interest rates.