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What To Do With The Surplus: Fiscal Policy And The Coming Recession

The United States has enjoyed a Goldilocks economy since the early 1990s: robust growth, low unemployment, and low inflation. After much debate, many resolutions, historic budget agreements, and a strong equity market, the federal government finally managed to balance its fiscal 1998 budget (indeed, ran a surplus) for the first time in more than a generation. Predictably, a new debate--over "what to do with the surplus"--has emerged. Some policymakers favor tax cuts, others prefer debt reduction, and the president has advocated the rescue of Social Security. We argue that the budget surplus will be short-lived as the coming worldwide recession slows growth in the United States and lowers tax revenues. In our judgment the deficit reduction during the 1990s played a significant role in depressing aggregate demand, which was offset only by unsustainable private sector borrowing. As the private sector in the United States becomes cognizant of declining equity markets, the spread of financial crises from Asia to Russia and Latin America, and falling world demand, it will be forced to reduce borrowing and repay loans. This will cause an economic downturn in the United States. While we applaud the Federal Reserve's recent timid moves to lower interest rates, we do not believe that monetary policy alone can stabilize the U.S. economy. Rather, substantial fiscal stimulus will be required. Although well-targeted tax cuts may do some good and should be considered, the stimulus should be supplied mainly in the form of an increase in the federal government's budget.