As a result of the pandemic, U.S. general government debt (federal, state, and local obligations combined) has surged above 130 percent of GDP, more than double what it was in 2007. And, recent U.S. experience is far from unique. Looking at the G20, average public debt rose from 52% of GDP in 2007 to 74% in 2019 and is projected to reach 91% next year.

Unsurprisingly, as government debt increases, the debate over public spending heats up. Are these high debt ratios sustainable? Should we be cutting spending and raising taxes to reduce what will otherwise be a large financial burden on future generations?

In this post, we emphasize that not all government spending is created equal. Investment in physical infrastructure, as well as in education and health—especially for children—can boost future GDP. Moreover, delaying inevitable outlays can boost long-run costs. As a result, a failure to make productive, self-financing investments due to concerns about the debt would be not only tragic, but counterproductive….

Steve Cecchetti and Kim SchoenholtzDecember 9, 2020Public investment, Depreciation, Infrastructure, Human capital, Public debt, Fiscal sustainability, Government debt, COVID-19, Pandemic, Crowding out, State and local government

COVID-19 Economic Downturn: What do cyclical norms suggest?

Business cycle downturns come in many forms. Some are big, others small. Some are long, others short. Some result from policy errors or euphoric booms, while others are the consequence of external events.

Nevertheless, downturns have some common features and regularities. Among those that have been reasonably stable over much of the past half century are the relationships among unemployment, activity and federal budget deficits. Using these, we explore the impact of the U.S. COVID-19 economic downturn that began last month.

To sum up, recent labor market developments already make clear that we are in the midst of the deepest recession since the 1930s. In fact, the coordinated shutdown of a large swath of the American economy has made this plunge more rapid than that of the Depression. Whether we are at the start of a second Depression depends greatly on how long we keep the economy in a state of suspended animation.

If the lockdown extends from weeks to months, the short-term pain will turn into long-term scarring. The longer it takes to reopen businesses safely, the more damage we will do to the many linkages and networks (including lender-borrower, supplier-user and employer-employee relationships) that make up the fabric of the economy. As the wave of bankruptcies grows, damage to the financial system will increase, as will the resulting harm to the economy’s productive capacity….

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Money, Banking, and Financial Markets