The net effect of our debt-ceiling debate is now clear: there will be large spending cuts, starting soon. Such an approach could make sense for some other economy or for the U.S. at another time. Unfortunately, the timing now could not be worse.
On July 29, the first-quarter GDP-growth number for 2011 was revised down to near zero, and the initial second-quarter estimate barely qualifies to be called anemic. In part, growth is weak because local and state governments have already been cutting. Most of them face restrictions on their ability to borrow.
In contrast, the federal government's obligations are in great demand around the world. When people say the U.S. dollar is a "safe haven," what they really mean is that individuals and organizations like to keep their rainy-day funds in U.S. Treasury debt. To be sure, this ability to borrow has been squandered in the past. But now, when it could be most helpful, we seem certain to pass up the opportunity to at least avoid destructive short-term cuts.
Fiscal policy was too expansionary in the 2000s. The so-called Bush tax cuts were predicated on overly optimistic economic projections. They ended up contributing significantly to current debt levels, and they are a big part of the likely deficit going forward.
Now fiscal policy is about to become too tight, while the political debate consistently misses both what brought the U.S. to this point and what main fiscal risks lie ahead.
Almost no one in public life is discussing how the financial crisis of 2007–09 accounts for most of the recent sharp increase in government debt by having caused a deep recession in which tax revenues dropped sharply. Politicians need to feel more pressure to keep the financial system from getting out of control.
And hardly anyone is emphasizing that America's future fiscal problems — for 2030 and beyond — are more about runaway health care costs than anything else. Let's focus on who will or will not dismantle Medicare and on what basis.
Simon Johnson is a professor of economics at the MIT Sloan School of Management. He is a former chief economist of the International Monetary Fund and a co-founder of the influential blog Baseline Scenario.