The second risk is the long-term fiscal position of the United States. Recognizing that fiscal policy is the domain of the executive and legislative branches rather than the Federal Reserve, I would emphasize several points. For one, the current U.S. fiscal position is far worse than it was at the end of the last business cycle. For example, in fiscal year 2007, the budget deficit was 1.1 percent of GDP; in fiscal 2017, it was 3.5 percent of GDP. Similarly, federal debt held by the public was 35 percent of GDP in fiscal 2007, and 77 percent in fiscal 2017. Additionally, three factors will undoubtedly cause these budgetary pressures to intensify over time: the tax legislation will push up the federal deficit and federal debt burden; debt service costs will rise as interest rates normalize; and entitlement outlays will increase as the baby boom generation retires. Let me discuss each of these in turn. With respect to the tax legislation, the Joint Committee on Taxation estimates the cost at around $ trillion over the next 10 years.9 This estimate takes into consideration the likelihood that the legislation will boost the productive capacity of the U.S. economy somewhat—raising the economy’s potential growth rate—and that this incremental growth will generate additional tax revenues. To me, this seems like a reasonable estimate, recognizing that with any complex tax legislation, there is a high level of uncertainty about its impact on longer-term growth and revenues.
While this does not seem to be a great concern to market participants today, the current fiscal path is unsustainable. In the long run, ignoring the budget math risks driving up longer-term interest rates, crowding out private sector investment and diminishing the country’s creditworthiness. These dynamics could counteract any favorable direct effects the tax package might have on capital spending and potential output. Favorable near-term outlook Turning to the near-term outlook, the prospects appear favorable for another year of above-trend growth. Consumer spending should continue to grow at a moderate pace, supported by solid fundamentals. Household income is being bolstered by faster compensation growth and continued healthy employment gains. Moreover, the aggregate household balance sheet remains in good shape, due in part to rising home prices, a strong stock market, and only moderate growth in household debt. Over the past year, home prices have risen by about 7 percent on a national basis, and the S&P 500 equity index has risen by nearly 20 percent. In contrast, household debt has risen about 4 percent over the past year, only slightly higher than the growth in personal income. Further, the household debt service burden is low, reflecting the extended period of low interest rates. Of course, the aggregate figures mask some underlying problems. Two issues worth highlighting are the persistent growth in income and wealth inequality and the burden of rising student loan debt.2 Many people of more modest means don’t directly benefit from rising home and stock prices.