Will the US Debt Ceiling Deal Derail the Pandemic Recovery?

In this Strategic Analysis, Dimitri B. Papadimitriou, Michalis Nikiforos, Giuliano T. Yajima, and Gennaro Zezza discuss how the current state and structural features of the US economy might affect its future trajectory. The recent recovery after the pandemic has been remarkable, when compared to previous cycles, and offers evidence of the efficacy of fiscal policy. Moreover, the inflation rate has been finally decelerating as the problems in global value chains that emerged after the pandemic are resolving and the price of commodities and oil, which spiked after the pandemic and the war in Ukraine, are stabilizing. Yet despite the recent success of fiscal policy in promoting output and employment growth, the recent debt ceiling deal--culminating in the 2023 Fiscal Responsibility Act—risks putting the US economy on the austerity path of the previous decade. And given the structural weaknesses of the US economy--including its high current account deficits, high level of indebtedness of firms, and overvalued stock and real estate prices--this projected fiscal policy tightening, combined with the impacts of high interest rates, could lead to a significant slowdown of the US economy. The US economy, the authors contend, is in need of a structural transformation toward modernizing its infrastructure, promoting industrial policy, and investing in the greening of its economy and environmental sustainability. A necessary condition for achieving these goals is an increase in government expenditure; they show that such an increase could also have positive demand effects on output and employment.