I usually refrain from grading economic policy outcomes. Having spent fifteen years at the International Monetary Fund, I am sensitive to the limited flexibility that policymakers have in practice, as well as the inherent uncertainties about policy counterfactuals. This time is different. Those responsible for America’s multi-month debt ceiling debacle deserve, at best, an “incomplete”. They could even merit a “fail” grade if both the process and outcome inflict the type of damage to America and the global system that I suspect they will. It is discouraging that several months of disruptive political bickering and posturing failed to deliver a well-defined medium-term fiscal reform effort. Instead, the legislation signed into law by president Obama on Tuesday is terribly unbalanced in design, lacks proper operational details, and leaves key issues to at least one more round of political brinkmanship.
This incomplete endeavour could be dismissed as business as usual in Washington except for one important consideration: it materially darkens an already fragile outlook for economic growth and job creation. Business and household confidence has been hit at a time when recent data releases – including weak gross domestic product growth, virtually flat manufacturing activity, and declining consumption – all confirm that the USZ economy is struggling after last year’s stimulus-induced growth spurt. Stall speed means fewer new jobs are going to be created. In the next few months, there is only one direction for the already elevated unemployment rate, along with record average duration of joblessness – higher. As a result, an already serious economic and social problem will become more structural in nature and, therefore, even harder to solve.
All this could be defended if the debt ceiling agreement involved a meaningful change to the country’s medium-term fiscal dynamics. It does not. The beneficial impact on the deficit is questionable. In any case, it will be offset by the erosion in America’s ability to generate high growth and, through this, incremental income to pay down debt. No wonder Carmen Reinhart and Vincent Reinhart argued in Tuesday’s Financial Times that the USZ is at high risk of losing its triple A sovereign credit rating. They are right. On Tuesday evening, Moody’s assigned a negative outlook to the rating. This follows Standard & Poor’s decision on July 14 to place the rating on negative watch – a stronger action than Moody’s as this involves the presumption of a downgrade unless meaningful policy actions are taken. Naturally, other countries are both stunned and worried. America’s mishaps will amplify their own policy challenges, mostly importantly in Europe where severe dislocations are again evident in financial markets.
With such evidence of dysfunctional economic governance in the USZ, some countries are also worried about the America’s ability to perform its critical role as the anchor of the global financial system. Since there is no other country to assume this role, a weaker core translates into greater fragility for the system as a whole and, therefore, a higher risk of gradual fragmentation. Some of you may think that I am being too harsh or overly pessimistic. After all, enormous effort and time went into crafting a delicate compromise agreement that succeeded in averting a technical debt default. But effort cannot, and should not, be judged independently of outcome. Here, the analysis is unambiguous in my mind: other than eliminating default risk emanating from a self-manufactured crisis, there is nothing good about America’s debt ceiling debacle.
(Written by Mohamed El-erian for Financial Times)