Fiscal policy will matter

Challenge, Jan-Feb, 1998 by Wynne Godley, George McCarthy

Some Strategic Implications

The question we now have to ask is where growth over the medium-term future - over, say; the next five years - will come from. It seems out of the question that the rise in net lending will continue much longer. Household debt now comprises more than 90 percent of disposable income, a record proportion far in excess of the 84 percent reached just before the credit crunch. There is no way of knowing when the next peak will be reached, and it has often happened in the past that credit booms in interaction with rising asset prices have fed on themselves, persisting for years longer than anyone could have anticipated. These normal uncertainties about saturation are compounded because borrowing and lending habits, along with the associated financial institutions and instruments, are all in a state of rapid evolution. One thing is certain, however; the rise in the debt-income ratio has to come to an end sometime within the next five years.

To provide a positive impulse, net lending would have to go on growing. The mere ending of the rise, as debt-income ratios reach a plateau, would be enough to deprive the economy of the main stimulus it has enjoyed during the past six years. This conclusion is reinforced by the prospects for nonresidential investment, which has risen at an average rate of nearly 10 percent a year during the past five years. Such a rate of growth over a five-year period has occurred only very occasionally in the past and has never continued for a period much longer than this.

Could net export demand come to the rescue? Anything is possible, but the prospect is not encouraging. Foreign trade performance has actually been falling relative to GDP during the past few years, as Figure 4 shows. There has recently been a substantial fall in import prices relative to domestic prices as a result of the strong dollar, with the possible implication that penetration of U.S. markets by foreign goods and services will continue to grow rapidly. Meanwhile, the prospects for growth in the economies of the main U.S. trading partners are not, at the moment, particularly favorable.

Prospects for the Fiscal Stance

The CBO produces conditional ten-year forecasts for the U.S. economy. Its most recent publication (September 1997) presents dramatically revised projections based on a legislated plan of action that seems to command universal enthusiasm, particularly regarding the federal fiscal stance. The revisions were inspired by two bills passed by Congress during the summer of 1997: the Balanced Budget Act of 1997 and the Taxpayer Relief Act of 1997. The former bill mandates that discretionary spending be held at 1999 nominal levels through the year 2002. The latter bill includes changes in tax laws that will reduce revenues. Revenues are projected to fall until 2000 and begin rising thereafter. The CBO projects a fall in the real value of discretionary spending of around $60 billion by 2002, a draconian and difficult path to follow, as noted by the CBO in its recent report (CBO 1997, chap. 2, p. 8):