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An Update on the Economic Crisis and the Fiscal Crisis: 2009 and Beyond
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This paper reviews recent economic events and their impact on U.S. fiscal performance and prospects. We highlight the historic nature of the 2009 budget outcomes, the unsustainability of plausible ten-year budget projections, and the increasingly dire long-term fiscal problem. These conditions leave federal policy makers with difficult choices. Over the next several years, as the recession ends and the economy recovers, policy makers will face a delicate balancing act between encouraging economic recovery and establishing fiscal sustainability. Even if a successful recovery ensues, however, medium-term and long-term fiscal problems have become increasingly urgent.
At the beginning of this decade, the U.S. fiscal picture was bright. After running deficits every year from 1970 to 1997, the federal budget was in surplus in fiscal year 2000 for the third year in a row, and the surplus was an all-time high - $236 billion, or 2.4 percent of GDP. Future fiscal prospects looked strong as well. The Congressional Budget Office (2001) projected rising surpluses over time, totaling $5.6 trillion over the succeeding 10 years. Despite the well-known shortfalls in Medicare and Social Security finances, estimates of the long-term fiscal outlook showed the government as a whole in manageable shape, at least for the succeeding 70 years (Auerbach and Gale 2000). A key fiscal concern was the prospect of paying off all redeemable public debt, which was expected to occur by the middle of the decade.1 In the absence of a market for Treasury debt, leading policy makers and academics were concerned with how monetary policy would be conducted and where investors would find safe assets.
Looking at the situation in 2009, fears that the United States would run out of Treasury obligations have vanished. Concerns about the conduct of monetary policy and the ability of investors to find safe assets now relate to both the conduct of economic policy since 2001 and the severe downturn in the economy since last fall. In many respects, the current fiscal situation couldn't be more different from that at the beginning of the decade. The budget outlook at every horizon is troubling: the fiscal-year 2009 budget is enormous; the ten-year projection is clearly unsustainable; and the long-term outlook is dire and increasingly urgent. These general trends are punctuated by a number of specific highlights that illustrate the U.S. fiscal problem. The Medicare Trust Fund is now projected to be exhausted by 2017. Credit default swap markets now imply a non-negligible probability of default on senior U.S. Treasury debt in the next five years. A top Chinese official has publicly questioned the security of U.S. Treasury obligations.
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