Economists are playing a game of “can-you-top-this,” seeing who can ramp up their U.S. economic growth forecasts the most. (Those at JPMorgan now predict a 3.5 percent annualized rate for the current quarter, up from the measly 0.5 percent they expected at the end of July). Many are saying that the recession most predicted was imminent at the start of the year isn’t happening anytime soon. The White House says these are the fruits of “Bidenomics.” In reality, it’s more like a sugar high.
The hot economy may be getting all the attention, but the massive expansion in the federal budget deficit can’t be ignored. Back in May 2022, the bipartisan Congressional Budget Office projected a shortfall for fiscal 2023 ending Sept. 30 equaling 3.8 percent of gross domestic product. With two weeks left in the fiscal year, the actual deficit is 7.9 percent.
This isn’t the way President Joe Biden’s Rescue and Recovery Plan for the economy was supposed to work. The idea was that by spending money up front to stabilize the labor market the administration would ensure a strong economy, leading to higher tax revenues and thus a lower deficit. The first two parts of the plan worked out. Unemployment has been below 4 percent for 19 straight months, the longest stretch since the late 1960s, and last year tax revenues as a percentage of GDP were at a record high of just more than 10 percent. So, how did it go wrong on the deficit? The short answer is inflation.
Prominent economists such as former Treasury Secretary Larry Summers warned that Biden’s 2021 stimulus package could “overheat” the economy and cause inflation rates to soar. The White House chose to ignore those warnings because it worried about a repeat of the slow recovery that followed the Great Recession, when unemployment stayed elevated for years.
Summers turned out to be correct. Consumer prices rose at the fastest pace in 40 years. Higher rates of inflation lead to higher government spending because benefits such as Social Security receive annual cost-of-living adjustments.
Inflation also has an impact on the deficit indirectly through interest rates. As rates rise it costs more to finance the federal debt, with interest payments reaching an estimated $969 billion on an annualized basis in the second quarter. That compares with $719 billion in fiscal 2022 and $360 billion a decade ago.
Several factors overwhelmed the tendency for a strong economy to lead to narrower deficits. Biden’s economic team would argue that they would do it all over again. After all, the labor market is still strong and inflation has slowed over the last year.
Maybe so, but the U.S. economy only has so much “fiscal space.” That’s the phrase economists use to describe the maximum amount the government can borrow before additional borrowing restrains growth and starts to increase the risk of a financial crisis.
Jason Furman, Chairman of the Council of Economic Advisors in the Biden administration, estimated that the U.S. could accommodate a deficit of 3 percent of GDP over the long term. The CBO projects, however, that the narrowest deficit the U.S. can expect over the next 10 years is 5 percent of GDP. After that it only gets worse.
Although economists have pushed back their forecasts for an economic downturn, nobody is saying a recession will be avoided. Something will trigger a recession but we don’t know what will be the trigger. Perhaps it will be rising concern about America’s bloated debt and the resulting limited capacity to borrow without risking a repeat of rapid inflation. This is the price of economic policy designed to fight the last war and an unwillingness to heed warnings that the game has changed.
Karl W. Smith is a Bloomberg Opinion columnist.