Part 4: Where Do We Stand?

October 18, 2011
Presentation (.pdf)

To help understand the current situation, Emmons explores several ways of looking at the total deficit and debt accumulated to date: the current deficit ($1.3 trillion), the total public debt ($14.9 trillion) and the debt held by the public ($10.1 trillion as of Oct. 13, 2011).


William Emmons: So first, where do we stand both today and then looking out into the future as best we can determine? This is a picture that shows year by year starting in 1930 the size of our federal budget deficit, and this is in each year compared to the size of the economy. So it's a constant comparable measure across all of these years. And so you can see gigantic deficits, 30 percent of GDP deficits. In today's terms, that would be on the order of $5 trillion. We had last year 1.3 trillion which was, of course, very large. But that peak deficit during World War II, the equivalent of $5 trillion.

Then deficits—there were surpluses in some years. Deficits though increasingly as we go through the 1960s, '70s, then chronically deficits in the 1980s and '90s. A return to surplus very briefly at the end of the '90s, and then a return to deficit throughout the 2000s and then, of course, the financial crisis in 2008, the recession in 2007, '08, '09 and all the responses that came along with that caused the deficits to go back to 10 percent which you can see very clearly is the largest deficit since World War II. And, in fact, we've just finished fiscal year 2011 in which we've had the three largest deficits since World War II. So this is an extreme situation of very large budget deficits.

And then the dashed line indicates to the left, these are historical numbers; to the right, these are projections. Inherently uncertain how that's actually going to play out. So what I'm going to talk about, spend really the bulk of my time, is talking about how do you think about where are we headed? And so I'm going to talk about two scenarios, and I'll explain those as we go. But just to give you kind of a sneak preview, there is a scenario under which the budget deficit will in fact improve, will get closer to balance within a fairly short period of time, within the next three or four years.

And then we would stay at relatively small budget deficits, on the order of 2 percent of GDP. So that's—and I'll explain this. This is the scenario if we follow along all the provisions that are currently in law and if the economy recovers and if we have a normal expansion throughout this period through 2021. It also includes all of the actions that have already been put in place by the August budget agreement of this year as well as the $1.2 trillion that the supercommittee is charged with identifying. So that's in that scenario. That's assuming that all happens.

There is another scenario, however—and I'll talk about this—under which, for various reasons, not all of those things happen. And if, in fact, suppose the supercommittee does its work, identifies those cuts, but if Congress chooses not to follow through on some of the other items that are currently envisioned, then we could have a somewhat different scenario, and that's this one shown by the red line where there would be some improvement primarily driven by an economic recovery but then a turn toward deterioration within the next three to four years as some of the longer-term issues start to really kick in. And that's including the aging of the population, the retirement of the baby boomers, the expansion of healthcare costs, and then as the debt rises, increasing interest payments on that debt. So we're going to talk about these two scenarios in particular, a fair amount, and then we'll talk later about other possibilities.

Okay. So I'm going to give you a table with a lot of numbers. You don't have to remember the numbers, but for those of you who really like the numbers, here they are. Facts about the deficit and the debt. The federal budget balance in fiscal year 2011 which just ended at the end of September was—you can read the number—$1.3 trillion. On a per capita basis, that's $4,146. So every man, woman and child in the United States could be mapped into a $4,000 shortfall in terms of the government's operations. Relative to the overall size of the economy, that's about 8.5 percent, which as I said is one of that string of three straight deficits that have had no precedent since World War II in terms of their size.

You might have noticed—or actually you wouldn't have noticed because I didn't mention it—I'm comparing this to gross national product rather than gross domestic product. They're very closely related right now. The numbers are not very different. But the CBO points out—the Congressional Budget Office—that as we look out into the future, the relevant measure for how much capacity we have to service the debt is the income of nationals, of those people resident in this country. So it's important that the CBO tracks that. That makes a bigger difference as we go further out in time. The size of our economy—and we'll be comparing things to the economy throughout—about $15.5 trillion this year; the population of the country about 313 million. So I just put those as reference points. And the gross national product per capita is close to $50,000. So that's something like average income. Per person was about $50,000.

Okay, so that's why, GNP. So that's the deficit, $1.3 trillion. And roughly speaking, that's how much was added to the debt. So the deficit is a flow measure, and the debt is a stocks measure. So the flow of deficit translates into an increasing debt. So at the end of—or actually, no, this was last week. You can get this information on a daily basis. The total public debt of the United States—this is the official debt, there's also some contingent obligations. For example, Fannie Mae and Freddie Mac are not reflected here, but that's sort of another question. The total official public debt, $14.9 trillion, which is $47,485 per person. It's almost the same size as GDP—96 percent.

There's a better measure though from economic terms, and that is the net public debt or the debt held by the public. The difference is debt that's been issued by the government and bought by the government primarily in the form of trust funds—Social Security trust funds, Medicare trust funds. The reason that debt held by the public is a better measure is that's the net exposure that the government, we all as taxpayers, have to pay the owners of those bonds. And that measure last week was $10.1 trillion which is about $32,000 per person in the United States. And that works out to about 65.6 percent of GNP.

All right. There's one more piece though. That's sort of the historical record. That's the historical accumulation of all the deficits run in past years. But what about the future? And that's really what we're talking about. How do you try to measure all of the future debt that's likely to accumulate? So I'm going to talk about ways to try to tackle that problem of getting a handle on that number. So here's a picture that shows the historical debt to GNP ratio. So this is year by year, how much debt held by the public—that second measure we talked about—relative to the size of the economy. And you can see because of those very large deficits in World War II, that pushed the cumulative debt very, very high—over 100 percent of GNP.

Then over the subsequent decades, that ratio fell. So that is to say that the debt was growing more slowly than the economy. That was partly because interest rates were very, very low. It was partly because the economy grew fast. We had a rapidly growing population, lots of productivity growth, lots of investments, so it was just a very favorable economic period. So that was one way to reduce the debt was for the economy essentially to grow out of the problem. So that's really what was going on through the '50s, '60s, '70s. Bottomed out in the '70s. Started to rise, so debt was now rising faster than the economy in the '80s and '90s. We had that period where we sort of turned a corner and moved back toward surpluses. That turned this debt measure down, so around 2000, stabilized in this last decade, and then you can see the spike at the very end which is the financial crisis and the recession.

So again, this is another way. It makes the same point that the last three years we've been through, in a financial sense, are the biggest shock to hit the economy since World War II. And it's reflected in a very rapid increase in the amount of outstanding debt relative to the size of the economy.