The US confronts huge challenges, at home and abroad. Its fiscal position is not one of them. This is a highly controversial statement. If one judged by the debate in Washington, one would conclude that the federal government is close to bankruptcy. This view is false. Yes, the US does confront fiscal challenges in the long term. But these are largely caused by the soaring costs of its inefficient healthcare. Yes, the US is engaged in a fierce debate on fiscal policy. But this is due to philosophical disputes over the role of the state. Yes, the US has been running large fiscal deficits in the short run. But these are a result of the financial crisis.
Start, then, with the medium-term prospects. In a widely cited piece, published this month by the Center on Budget and Policy Priorities, Richard Kogan argues that “policymakers can stabilize the public debt over the coming decade . . . with $1.4tn in additional deficit savings”. The explanation for this improved medium-term outlook is a combination of economic recovery and policy measures, particularly the Budget Control Act of August 2011 and the American Taxpayer Relief Act enacted this month. Moreover, because of savings on interest payments, policy makers could achieve this amount of deficit reduction with just $1.2tn in further savings. That would be just 0.6 per cent of prospective gross domestic product, even on the pessimistic assumption that nominal GDP grows at an annual rate of just 4 per cent.
Under these assumptions, the ratio of debt to GDP would stabilise at about 73 per cent (see chart). Would this be unbearable? No. At current real interest rates, the cost would be zero. Even if real rates of interest were to rise to, say, 3 per cent, the fiscal cost, in real terms, would be a mere 2 per cent of GDP. That is perfectly manageable.