The Deficit Endgame

In 2009, the federal deficit will be 13 percent of GDP. This is the highest it has been since the four year period during World War II, when deficits averaged about 20 percent of GDP. The long-term budget outlook is equally troubling. The CBO projects that under the Obama Administration, the cumulative deficit for the period 2010-2019 will be approximately $9.1 trillion. In other words, the average deficit per year will approach $1 trillion. In adjusted estimates, we project the deficit under more realistic assumptions, and also factor in the possible costs of health care reform. Our adjustments add at least another trillion dollars to budgetary costs over the next ten years-a total deficit of nearly $10.2 trillion.

Countries with deficits this high have historically proceeded down three divergent paths. Some have chosen fiscal consolidation, others have chosen to attempt to inflate away the debt, and others have simply defaulted, if not intentionally, because of the failure to pursue either of the first two strategies.

In this paper, we discuss the historical evidence along each of these three paths, and compare the current U.S. situation to past experiences. We find that the most successful policy responses to high deficits have mimicked that adopted by the U.S. following World War II, that is, successful consolidations have generally reduced spending. Failure to do so exposes the U.S. government to significant default risk that could, if history is a guide, emerge as a factor in financial markets without significant notice.

Click here to view the full text of this working paper as an Adobe Acrobat PDF.

Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI. Desmond Lachman is a resident fellow at AEI. Aparna Mathur is a research fellow at AEI.

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About the Author

 

Kevin A.
Hassett
  • Kevin A. Hassett is the State Farm James Q. Wilson Chair in American Politics and Culture at the American Enterprise Institute (AEI). He is also a resident scholar and AEI's director of economic policy studies.



    Before joining AEI, Hassett was a senior economist at the Board of Governors of the Federal Reserve System and an associate professor of economics and finance at Columbia (University) Business School. He served as a policy consultant to the US Department of the Treasury during the George H. W. Bush and Bill Clinton administrations.

    Hassett has also been an economic adviser to presidential candidates since 2000, when he became the chief economic adviser to Senator John McCain during that year's presidential primaries. He served as an economic adviser to the George W. Bush 2004 presidential campaign, a senior economic adviser to the McCain 2008 presidential campaign, and an economic adviser to the Mitt Romney 2012 presidential campaign.

    Hassett is the author or editor of many books, among them "Rethinking Competitiveness" (2012), "Toward Fundamental Tax Reform" (2005), "Bubbleology: The New Science of Stock Market Winners and Losers" (2002), and "Inequality and Tax Policy" (2001). He is also a columnist for National Review and has written for Bloomberg.

    Hassett frequently appears on Bloomberg radio and TV, CNBC, CNN, Fox News Channel, NPR, and "PBS NewsHour," among others. He is also often quoted by, and his opinion pieces have been published in, the Los Angeles Times, The New York Times, The Wall Street Journal, and The Washington Post.

    Hassett has a Ph.D. in economics from the University of Pennsylvania and a B.A. in economics from Swarthmore College.

  • Phone: 202-862-7157
    Email: khassett@aei.org
  • Assistant Info

    Name: Emma Bennett
    Phone: 202-862-5862
    Email: emma.bennett@aei.org

 

Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
  • Phone: 202-862-5844
    Email: dlachman@aei.org
  • Assistant Info

    Name: Emma Bennett
    Phone: 202.862.5862
    Email: emma.bennett@aei.org

 

Aparna
Mathur
  • Aparna Mathur is an economist who writes about taxes and wages. She has been a consultant to the World Bank and has taught economics at the University of Maryland. Her work ranges from research on carbon taxes and the impact of state health insurance mandates on small firms to labor market outcomes. Her research on corporate taxation includes the widely discussed coauthored 2006 "Wages and Taxes" paper, which explored the link between corporate taxes and manufacturing wages.
  • Phone: 202-828-6026
    Email: amathur@aei.org
  • Assistant Info

    Name: Hao Fu
    Phone: 202-862-5214
    Email: hao.fu@aei.org

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