Saving For a Rainy Day

Oct 31, 2012 | Other Spending

As the East Coast and other communities affected by superstorm Sandy begin the work of rebuilding and assisting those who need help, the CRFB and Fix the Debt teams are keeping everyone in our thoughts. Just as there are preparedness lessons we can learn from Sandy, there are very important takeways for the federal budget too.

The storm can remind us that country's need the resources to be able to step in and respond to unpredictable disasters like hurricanes, tornadoes, or deep recessions. But of course, it isn't easy to predict these events, whick makes it very difficult to budget for. In order to maintain the ability of our country to respond to unpredictable events in the future -- be it a natural, international, or economic crisis -- we must have the budget flexibility and healthy levels of debt.

The breathing room to respond to crises before debt levels become suffocating is known as fiscal space, and it has been an important factor in allowing us to avoid making deep and abrupt spending cuts or tax increases to assuage our creditors during the recent downturn. Other countries did not have a sufficient buffer.

However, as a result of the economic downturn, the aging of the population, rising health care costs, and unsustainable policies enacted in the past, our fiscal space won't be what it once used to be. We previously discussed a study based on IMF data showing that the U.S. has a comparatively low level of fiscal space relative to other countries. The study looked at the projected debt to GDP path of the U.S. and compared it to the IMF's estimate of the point at which it would be impossible to get debt back under control without default. According to the study, we have similar levels of fiscal space to countries like Greece and Ireland, who have had debt troubles in the aftermath of the Great Recession and have been unable to respond with fiscal expansion. Reasonable people can disagree as to what the exact number level of debt will prompt a crisis, but it is clear that our current fiscal path would bring us to ever-increasing debt levels and an eventual debt crisis.

[chart:4083]

When disaster does strike, we need resources to deal with the damages that do occur. Having fiscal space can allow us to properly and adequately deal with rare and unpredictable events. In order to have that space we need to put the debt on a stable and downward path as a share of the economy. It's always better to prepare in advance and not wait until a crisis forces action.