This week on Facing the Future, we talked with Ernie Tedeschi, Director of Economics at the Budget Lab at Yale, and author of a new study called “The Inflationary Risk of Rising Federal Deficits and Debt.” Concord Coalition Chief Economist Steve Robinson joined the conversation.
Tedeschi’s study looked at the inflationary risk of a permanent increase in budget deficits, excluding interest costs (i.e., the “primary deficit”), equal to one percent of the gross domestic product (GDP).
He explained that the reason to focus on primary deficits is not because interest costs are unimportant but because “interest costs are driven by the size of our overall debt, which is driven by both spending increases and tax cuts. So even though interest costs are a spending component of our budget, we can’t directly reduce interest costs unless we want to default, which we don’t want to do. Policy choices that we make on both the spending and the revenue side affect interest costs, so from a policy standpoint, they shouldn’t be thought of exclusively as a spending component.”
In Tedeschi’s scenario, using several different economic models, “the consistent message is that persistent high levels of government debt can have significant consequences for price stability, interest rates and overall economic performance.”
Tedeschi noted that Inflationary pressure from higher debt might not be fully experienced on prices if the “Federal Reserve reacted to this price pressure like they’re supposed to. So, they see this inflationary pressure and they raise interest rates. The inflation doesn’t happen, but interest rates go up.”
“What we found,” Tedeschi said, “is that interest rates would go up such that for a mortgage on the typical house in 2024, five years from now, interest rates would go up enough to add between $600 and $1,200 in interest costs on the typical mortgage. They would go up enough to add $1,000 just in five years on the typical small business loan. It would add $60 to the typical auto loan that people have.”
These are gross costs, not net costs. As the paper notes, “they do not incorporate the broader negative economic effects of debt on real income, nor do they include the positive effects of our illustrative policy.”
Nevertheless, Tedeschi said, “Those are real, tangible things that people will feel. And so, if our lesson from the pandemic, as I think it should be, is that cost-of-living needs to be a policy priority for Congress, for the President, for policymakers in general, then debt is a cost-of-living issue because, even if indirectly, debt affects cost of living even after just five short years”
In that regard, Tedeschi related his findings to a major issue currently before Congress.
“We found out later, as we were wrapping up work on the paper, that it just so happened that a one percent of GDP primary deficit is roughly the magnitude of fully extending the individual components of the Tax Cuts and Jobs Act (TCJA) without paying for anything. It’s actually a little bit more than a one percent of GDP primary deficit,” he said. “That was not intentional on our part, but one can read our paper, and get a fairly rough magnitude of what the gross costs over the medium to long term might be, depending on what the Fed does, of the debt consequences of a TCJA extension that is deficit financed.”
He noted that, “Obviously, deficit financing is not the only option on the table before Congress. They are considering policy changes to partially or fully pay for some of the things that they’re debating right now, and we can debate the merits of those pay-fors, but I think it’s at least laudable that they are considering pay-fors in this debate.”
Hear more on Facing the Future. Concord Coalition Senior Advisor Bob Bixby hosts the program each week on WKXL in Concord N.H., and it is also available via podcast. Join us as The Concord Coalition team discusses issues relating to national fiscal policy with budget experts, industry leaders, and elected officials. Past broadcasts are available here. You can subscribe to the podcast on Spotify, Pandora, iTunes, Google Podcasts, Stitcher, or with an RSS feed. Follow Facing the Future on Facebook, and watch videos from past episodes on The Concord Coalition YouTube channel.
