Snowpocalypse Doesn’t Stop Announcement Effect Club from Growing

Feb 12, 2010 | Economics

Fearless economists braved the Washington snow this week to walk through the doors of the Announcement Effect Club via their testimony before the Senate Budget Committee on “The Economic Outlook and Risks to the Federal Budget and Debt.”

Carmen Reinhardt of the University of Maryland testified that, based on her extensive research of financial crises and their fiscal implications, markets eventually react to oversized debt.

While the exact mechanism is not certain, we presume that at some point, interest rate premia react to unchecked deficits, forcing governments to tighten fiscal policy.

She concludes that the U.S. must develop a credible fiscal plan now in order to stave off higher interest rates.

To be sure, this is not the time to exit. It is, however, the time to lay out a credible plan for a future exit. The sooner our political leadership reconciles itself to accepting adjustment the lower the risk of truly paralyzing debt problems down the road, the likes of which we are seeing in Europe right now. Although most governments still enjoy strong access to financial markets at very low interest rates, market discipline can come without warning. Countries that have not laid the groundwork for adjustment will regret it.

Also at the hearing, Club member Donald Marron affirmed his membership by stating “a credible plan to reduce future deficits is not just about the future. If we do it well it will help keep long-term interest rates low today, thus strengthening our current recovery.”

A lot of discussion at the hearing centered on how the U.S. could avoid a deep economic crisis. That topic will be addressed at a conference -- "Avoiding a Government Debt Crisis" -- convened by the Peterson-Pew Commission on Budget Reform on Tuesday, February 16 that will feature experts such as former Comptroller General of the U.S. David Walker and Federal Reserve Bank of Kansas City President Thomas Hoenig.