By Kate Davidson and Jon Hilsenrath
A big question hangs over Janet Yellen this week at her
confirmation hearing to become U.S. Treasury secretary: How much
debt is too much?
In the past four years, U.S. government debt held by the public
has increased by $7 trillion to $21.6 trillion. President-elect Joe
Biden has committed to a spending program that could add trillions
more in the year ahead. At 100.1% of gross domestic product, the
debt already exceeds the annual output of the economy, putting the
U.S. in company with economies including Greece, Italy and
Japan.
When Ms. Yellen served in the Clinton administration as
Chairwoman of the White House Council of Economic Advisers, she was
among those who pushed for a balanced budget. Today, she has
joined, cautiously, an emerging consensus concentrated on the left
that more short-term borrowing is needed to help the economy, even
without concrete plans to pay it back. Central to the view is the
expectation that interest rates will remain low for the foreseeable
future, making it more affordable to finance the borrowing.
The Biden administration will now contend with progressives who
want even more spending, and conservatives who say the government
is tempting fate by adding to its swollen balance sheet. Ms.
Yellen's challenge, if confirmed, will be to keep Democrats
together and persuade some Republicans to come along.
Ms. Yellen, who will be a top economic adviser to Mr. Biden, is
scheduled to testify Tuesday before the Senate Finance Committee,
which will vote on her nomination. She served as chairwoman of the
White House Council of Economic Advisers in the 1990s and Federal
Reserve chairwoman in the 2010s. Confirmation of Ms. Yellen as
Treasury secretary would make her the first person to achieve such
a trifecta of economic leadership roles.
Ms. Yellen would be managing the nation's debt when the economic
consensus has flipped. In the 1990s, economists argued that
surpluses would push down long-term interest rates and encourage
private-sector borrowing and investment. Government borrowing, this
view held, crowded out the private sector. The strategy seemed to
work. The U.S. saw an economic boom, with the longest expansion on
record at the time, fueled by technology investment.
After years of low inflation and interest rates near zero, more
economists say the government should be borrowing to keep the
economy going because the private sector isn't. With borrowing
costs expected to remain low and the pandemic-stricken economy
still weak, temporary increases in deficits aren't only tolerable
but desirable if they help strengthen the recovery, the thinking
goes.
In past times, the Fed carried the load by cutting short-term
interest rates, allowing the private sector to borrow cheaply. But
it has already cut rates to zero.
"There is really a strong need at this point to continue support
for the unemployed," Ms. Yellen said in an October interview.
"There is a huge amount of suffering out there. The economy needs
the spending."
The strongest advocates of this view are center-left economists,
including former Treasury Secretary Lawrence Summers. Republicans
have implicitly embraced the idea when in power. President Trump
ushered in spending programs and tax cuts that pushed debt sharply
higher even before the coronavirus crisis. George W. Bush also
raised spending, cut taxes and grew deficits. In the minority, the
GOP has tended to revert to fiscal conservatism.
Mr. Biden is embracing the view, as well. On Thursday, he
proposed a $1.9 trillion aid package that includes $1,400 stimulus
payments to individuals, expanded jobless benefits and paid work
leave, aid for schools and hard-hit small businesses and a national
vaccination program. Mr. Biden hopes it will be the first in a
two-step program, with the second to focus on longer-term
investments, such as in green energy and infrastructure.
"Economic research confirms that with conditions like the crisis
today, especially with such low interest rates, taking immediate
action -- even with deficit financing -- is going to help the
economy," Mr. Biden said after a Labor Department report this
month. It showed that employers cut jobs in December, ending seven
months of employment gains. A growing economy will make debt more
manageable, he said.
Unaddressed are the twin questions of whether there is a ceiling
on the U.S.'s debt load and how the country will pay it back,
concerns heard mostly on the right. "At some point we'll start
paying a price for this, " said Michael Boskin, a Stanford
University economist. He served as chairman of the Council of
Economic Advisers under President George H.W. Bush in the early
1990s, the last time a Republican administration cut deficits.
Mr. Boskin agrees that low interest rates and a weak economy
help make the case for limited federal support. He said he favored
tax cuts over government spending and warned that immense deficits
can't be carried on without limit. "Eventually rates will rise," he
said.
Mr. Summers said economists have been predicting rising rates
for decades, and yet they kept falling. Even today, he said, rates
are as likely to go down as up; in Europe and Japan they are
negative.
Some economists have worried that a shock to the U.S. economy
could drive investors away from government bonds. Yet, through
economic shocks in the past 20 years, investors have flocked to
Treasury securities, seen as a haven in times of trouble. With the
help of Fed interest-rate cuts and bond purchases, not only are
U.S. short-term interest rates near zero, the government's
borrowing cost for newly issued 30-year debt is below 2%.
While U.S. debt is growing faster than the economy, the level of
debt "is far from unsustainable," Fed Chairman Jerome Powell, a
Republican who served in the George H.W. Bush Treasury Department,
said Thursday.
Despite a $4 trillion increase in debt last year, a 25%
increase, interest payments on that debt declined by 8%. The
Congressional Budget Office projects rates will stay low for much
of the next decade, and that interest costs as a share of GDP will
be lower than it forecast before the pandemic.
In an Aug. 13 briefing with Mr. Biden and Vice President-elect
Kamala Harris, Ms. Yellen made the case that ultralow interest
rates and low inflation gave the government the capacity to keep
borrowing to fight the pandemic's economic fallout.
The President-elect's spending plans represent a major shift
from the 1990s, when Ms. Yellen was Mr. Clinton's top economic
adviser, and Mr. Biden was a senator supportive of the president's
fiscal policies.
Back then, inflation was still seen as a threat. Yields on
10-year Treasury notes exceeded 6% for most of the 1990s, as did
borrowing costs for even the most creditworthy companies. Large
government debt and deficits, the thinking went, would push rates
higher and crowd out private investment.
The Clinton administration restrained spending and raised income
taxes on wealthy households, balancing the budget in 1998 for the
first time since the 1960s. Fiscal discipline helped produce "a
strong, investment-driven recovery," Ms. Yellen wrote in 1999.
New lesson
Starting under President George W. Bush, something unexpected
happened. Deficits and government debt rose because of increased
spending and tax cuts, but interest rates kept falling.
"I spent most of my career worrying about the effects of
government debt, and as I've been doing that, interest rates have
been falling point by point by point," said Douglas Elmendorf, who
worked with Ms. Yellen at the Council of Economic Advisers in the
late 1990s.
There are different theories about why that happened. One is
that China's emergence as an economic power, and the growing wealth
of its citizens, created a surge in global saving. Former Fed
chairman Ben Bernanke called it a global "saving glut." Global
savers put aside 26% of their money in 2020, up from 24% in 2000,
according to the International Monetary Fund. Much of the trillions
of dollars in new saving flowed into the U.S. Treasury market.
At the same time, U.S. private-sector investment slowed for
reasons economists are still sorting out. Explanations include an
aging population and diminishing investment in big machinery as the
economy became more service oriented and factories moved to China.
In the 1980s and 1990s, private-sector U.S. investment grew 4% a
year on average, adjusted for inflation. Since 2000, as interest
rates tumbled, private investment growth averaged 2% a year.
By the time Ms. Yellen became Fed vice chairwoman in 2010,
battles over large budget deficits consumed Washington once again.
Tea Party Republicans, alarmed by surging debt levels, pushed for
strict spending curbs as the U.S. recovered from the 2007-2009
financial crisis.
"The challenge for U.S. policy makers will be to craft a
strategy that puts our fiscal policy on a sustainable path in the
longer term while helping support the recovery in economic activity
in the near term," Ms. Yellen said at her 2010 confirmation hearing
for Fed vice chairwoman.
Washington went in the opposite direction. Discussions about the
long run went nowhere. Short-term spending cuts helped tame
deficits for several years but weighed on growth by pulling money
from the military and public projects.
Ms. Yellen and others concluded austerity came too soon,
stunting the recovery and keeping unemployment higher than it
needed to be. Aside from a fracking boom that kicked off in energy
states, private investment sagged.
Free lunch
The pandemic has pushed Washington's tolerance for debt to new
levels. Congress last year authorized trillions of dollars in new
spending to combat the virus, pushing deficits well beyond records
set in the last recession.
Some economists point out that in the long run, interest rates
tend to be lower than the economy's growth rate. The IMF studied
data for 55 countries over 200 years and found that more than half
of the time, interest rates were lower than growth rates, on
average, by 2.4 percentage points in advanced economies and even
more in developing economies. That suggests most countries can run
modest budget deficits and still reduce the cost of servicing that
debt as their economies grow.
Among the skeptics is Valerie Ramey, an economist at the
University of California San Diego. She said some economists see
the gap between interest and growth rates as a "free lunch,"
enabling more borrowing, but that it was more like a "free snack."
The gap tends to be relatively small over time, and now it is
trivial compared with the growth of U.S. debt.
"What we are having here is just gluttony in terms of what the
government is doing," she said.
The IMF study's authors have another warning about running large
deficits. Fiscal-policy crises that push interest rates sharply
higher tend to come out of nowhere, even when rates are low.
"Market expectations can turn quickly and abruptly," the authors,
Paolo Mauro and Jing Zhou, concluded.
While economists on the left and right acknowledge the
government has more capacity to borrow than once thought, there is
still no consensus on the limits of borrowing over the medium- to
long-term, which is a key question facing Ms. Yellen and the Biden
administration.
Mr. Summers and Jason Furman, who served as chairman of
President Obama's Council of Economic Advisers, said policy makers
should focus on the cost of borrowing rather than debt levels. The
U.S. can afford to borrow more as long as net interest payments on
the debt are expected to stay below 2% of output over the next
decade, they argue. In the most-recent fiscal year, interest
payments totaled 1.6% of output. By comparison, in the early 1990s
the payments hovered around 3%.
Long-run challenges remain. Even before a new spending plan is
launched, U.S. debt is on track to double to nearly 200% of GDP by
2050 because of soaring Social Security and Medicare promises,
according to the CBO. Ms. Yellen has said such high levels can't be
sustained.
Mr. Biden has proposed tax increases on high-income households
to pay for some of his economic policy proposals, which include
investments in clean energy and health care. But there is little
appetite in Washington for cuts to Medicare or Social Security.
Write to Kate Davidson at kate.davidson@wsj.com and Jon
Hilsenrath at jon.hilsenrath@wsj.com
(END) Dow Jones Newswires
January 18, 2021 13:33 ET (18:33 GMT)
Copyright (c) 2021 Dow Jones & Company, Inc.