Tuesday, February 15, 2011

US makes a "down payment" on fiscal consolidation

The US Administration has presented a Budget to Congress that represents, in the President’s own words, a “down payment” on fiscal consolidation. The Budget includes measures that are expected to reduce the deficit by US$1.1 trillion over 10 years. Despite this, the deficit will still be a record $1.6 trillion (10.9% of GDP) this year, $1.1 trillion in 2012 (7% of GDP). The deficit is projected to be $0.6 trillion (3.2% of GDP) by 2015.

We agree with the President’s assessment that this is a good start (I’m sure he’ll be relieved to know that). Fiscal consolidation was always going to be a difficult but necessary part of normalising post-GFC economic conditions in developed markets. However it was going to be necessary to strike an important balance: it is necessary to continue to support growth in the early part of the process. To that end, the Budget seems to strike a good balance.

Consolidation also means that fiscal policy can be relied upon to do some of the stimulus unwinding, which reduces the amount of work that interest rates will inevitably have to do.

It still remains to be seen the extent to which the very large Budget deficit this year – 10.9% of GDP – is split between its cyclical and structural components. Obama’s political opponents are arguing that he has not made any dent in the items that will really impact on the long-term fiscal outlook – Medicare, Medicaid and Social Security – which collectively make up about 40% of federal government expenditure.

We have made similar observations regarding New Zealand’s fiscal outlook. In last year’s Budget we gave the Government high marks for turning the deficit and debt trajectories around and for the growth-enhancing structural changes they made to the tax system.
However, we gave them low marks for not doing enough to tackle the big long-term structural issues like New Zealand Superannuation. The upshot is we think the pathway back to fiscal surplus will be more fraught than currently projected.

I think the same will prove to be the case in the US. The Administration expects the deficit to be back to around 3% of GDP by 2015, meeting the Toronto G20 commitments on fiscal policy. At this point, the projections seem to relying on much of that improvement being cyclical. That’s probably a tall order.

It seems to me that further structural work will be required. That means more tough decisions on spending and revenue to come. Doing that work also supports our view of only modest US economic growth ahead while the federal books get put back in order, on top of the good work already being done by households.