President-elect Joe Biden has named the leaders of his economic policy team. His most important nominee — Janet Yellen, for Treasury secretary — is an especially wise choice, for her breadth of experience and expertise, and for the respect she commands across the political spectrum. The rest of the lineup — which includes Cecilia Rouse at the Council of Economic Advisers, Neera Tanden at the Office of Management and Budget, and (according to people familiar with the matter) Brian Deese as head of the National Economic Council — is shrewdly chosen to combine needed skills with support from different parts of the Democratic Party coalition.
These officials, once confirmed, will have their work cut out. Their task will be nothing less than to develop a substantially new approach to fiscal policy.
The coronavirus crisis has put extreme demands on economic management everywhere. Budget deficits have soared and many central banks have cut interest rates close to zero. For the moment, attention is rightly focused on coping with the resurgence in COVID cases, and on the further fiscal support it requires. Biden's team will need to address this short-term issue urgently. But it will also need to think farther ahead, and ask whether the traditional rules of fiscal prudence should be relaxed even after the disease is defeated and normality returns.
A rethink is indeed called for. This doesn't mean that fiscal prudence is passe. Even in a world of persistently low inflation and interest rates close to zero, fiscal recklessness is still possible, and still involves costs. But sound fiscal policy now allows — indeed requires — more flexibility in budgeting and a more nuanced understanding of the mechanics of public debt than the old orthodoxy recommended.
The crucial change is the seeming persistence of very low interest rates. This is not solely the result of expansionary monetary policy since the recession of 2008 (though 12 years of monetary stimulus stretches anybody's definition of "temporary"). Long before the crash, starting in the 1980s, real interest rates began trending downward. The underlying causes seem to involve a combination of higher worldwide saving (partly for demographic reasons), slower growth, and fewer opportunities for profitable investment. The upshot is a persistent excess of global savings, driving down the price of capital.
This shift has enormous implications for fiscal policy.
First, it makes runaway growth in public debt less likely. When the real interest rate is less than the rate of economic growth, the existing stock of debt shrinks over time in relation to the economy as a whole. This means that budget deficits, if kept within bounds, don't necessarily have to be financed by higher future taxes.
Second, concerns that public borrowing will "crowd out" private investment are less pressing. It's still true, on plausible assumptions, that higher public debt implies a smaller stock of private capital — but the economic cost of that reduction in private capital is smaller when rates of return are low. Moreover, if budget deficits are used to increase public investment (as opposed to financing tax cuts or higher current spending) and those investments are well chosen, the net economic gain will be all the bigger.
Third, persistently low interest rates strengthen the case for relying more heavily on fiscal policy to support demand when the economy falters. You might say there's no choice: With interest rates close to zero, and central banks' bond-buying programs facing diminishing returns, fiscal policy needs to carry more of the burden of economic stabilization regardless. But the point is, it can do so more readily — meaning with less risk and at a lower long-term cost — than the traditional thinking allowed.
To be sure, in the midst of the coronavirus emergency, budget deficits in the U.S. and many other countries are exceptionally large — so big that, without eventual corrective action, they'll drive ratios of public debt to output sharply higher even if interest rates stay low. The longer that goes on, the greater is the risk that investors will think the debts are insupportable, which would cause the cost of public borrowing to surge. Governments also need to keep in mind that many longer-term trends in public finance point to mounting fiscal stress. For instance, aging populations mean higher public spending on health care and pensions, and a higher ratio of dependents to taxpayers.
Debt still needs to be kept under control, and seen to be kept under control. For this reason, once the COVID crisis has abated, governments should lean toward growth-promoting public investment and away from expanded transfer programs financed by borrowing rather than taxes. Good investments can pay for themselves, especially with interest rates so low. Current spending unsupported by taxation risks creating deeply rooted structural deficits.
All that said, the balance of pros and cons has changed. The calculation has shifted toward greater reliance on fiscal stimulus as a remedy for too little demand, and in favor of patience, as opposed to peremptory action, when it comes to restoring fiscal control in due course. It isn't about throwing caution to the winds. It's a matter of recognizing that fiscal prudence is more complicated than it used to be, and that smart public borrowing has a new role to play in sound economic management.
Editorials are written by the Bloomberg Opinion editorial board.
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