THE BLOG

The Current Budget Gridlock

07/20/2011 04:07 pm ET | Updated Sep 19, 2011
  • Nake M. Kamrany Professor of Economics, University of Southern California

It is axiomatic that the congressional debate over the current budget gridlock was disingenuous and a partisan game on the American people. Because the politicians know, or should have known, the following facts about the annual budget and the national debt and not cause consternation of an impending decline in U.S credit rating that would be very injurious to the economy.

First, all nations in the world sustain annual budget deficits and have accumulated national debt. At the end of the fiscal year, the budget books are cleared and the deficit is moved up to national debt where it accumulates. The U.S. national debt relative to its gross domestic product (GDP) is about in the middle among the rich industrialized nations. U.S. national debt now stands at about 93% of the GDP. By comparison, advanced rich countries' debt to GDP ratios is: Japan 226%, Italy 118%, and France 84%.

Second, the major causes of annual budget deficit and national debt are wars and recessions. Currently the U.S .is engaged in three wars (Iraq, Afghanistan and Libya) and it sustained a great recession during 2007-2008 that is still lingering. War has to finance wars for national security reasons, although the current three wars that we are in did not pose much of a national security threat upon us. There were no weapons of mass destruction in Iraq, no Osama bin Laden in Afghanistan, and no clear objectives in Libya. Nevertheless, wars would have to be financed with borrowing, which adds up to national debt. These wars cost us plenty. Recession has to be fought also with counter-cyclical measures, i.e., deficit financing to promote our economic interests. Recessions inflict economic damages such as high unemployment. The cost of recessions is the loss of GDP largely due to high unemployment. Currently the U.S. unemployment rate is at 9.2%, as compared to Italy 8%, United Kingdom 7.6% and China 4%.

Third, whether we get into wars is a decision that is ultimately made by the President. Economic management of the country is in the hands of the Federal Reserve Board (the FED) who manipulates the supply of money by mini-managing the movement of the economy. Unfortunately several recessions over the last couple decades were brought upon us by the FED when it set the interest rate very high and squeezed the supply of money in the economy. Also, the Fed's lifting of many controls contributed to the great recession. The private sector also contributed to recession due to undue speculation, greed, and high risk-taking, as was exemplified in the 2007 -2008 great recession as well as in the major crash of 1929 and the ensuing depression.

Fourth, the major burden of national debt is the annual interest on the debt that has to come out of the annual budget plus the fact that the burden of debt is passed on to the future generations. The benefit of the debt is that it creates assets and values when it gets rid of recessions and gets the economy (GDP) to grow and reduce unemployment.

Fifth, economic policy prescription during any recession, as we are in now, is to increase government expenditures and reduce taxes. The politicians are intent to do the reverse, i.e., reducing government expenditures and raising taxes on some people. The result of such a policy would lock the economy into a high unemployment rate in the range of 9%-11% instead of a range of 3%-6%; as was the case prior to 2007. And it will add more people into poverty and permanent unemployment.

Sixth, if the U.S. credit rating is downgraded as a result of the budget gridlock, it will cause the interest rate to rise on government borrowing. The additional interest cost would put more pressure on the budget which means more deficit and higher national debt.

In conclusion, the current political jockeying on the budget and national debt may prove counterproductive. It may further reduce the growth rate of the GDP, depress stock prices, increase unemployment, prolong the recession and add more people to the rank of poverty.

This is an illustration and a typical case of "the tragedy of the commons" wherein each politician is trying to promote his/her personal /individual agenda at the cost of public good, i.e., when measured collectively it would cause a breakdown of the system.