An Age of Austerity is probably on the way

It's not the 2010s anymore.

Photo by Towfiqu barbhuiya on Unsplash

I still remember watching the 1992 presidential election as a kid — the first election I was really aware of. The biggest issue was the federal budget deficit; Bill Clinton and independent candidate Ross Perot were demanding fiscal austerity after 18 years of persistent government borrowing. Incumbent George H.W. Bush lamely called the Democrats the party of tax-and-spend, but his protests rang a bit hollow after 12 years of don’t-tax-but-spend-anyway (Bush had tried raising taxes, but faced a revolt from within his own party). In the end, Clinton won, and enacted an austerity budget in 1993 that raised taxes and cut spending, and by the end of the decade the federal budget was in surplus. Most of the country and the national news media hailed this as a great victory. Progressive economists who worked for the Clinton administration, such as my podcast co-host Brad DeLong, argued that austerity lowered long-term interest rates and helped fuel the economic boom of the 90s.

It’s pretty crazy to think back to a time when austerity was such a popular policy. By the early 2020s, popular thinking had undergone a dramatic reversal. The Great Recession made “austerity” a dirty word. When we say “austerity” now, we think of the huffy Germans who deepened the Eurozone crisis by refusing to bail out Greece, or the misguided conservatives who railed against U.S. stimulus spending in 2009. More than a decade spent in a liquidity trap, where austerity only compounded the shortfall in aggregate demand, taught many of us that government deficits are something to be welcomed rather than feared. And when Covid came around, we applied that lesson, taking out unprecedented amounts of government debt in order to protect people and businesses from economic ruin in 2020 and 2021. The strong recovery that began in 2021 seems to vindicate that decision. Big Deficit won the day.

But what changed once can change again. And there are two big reasons to think that the Age of Stimulus we’ve been living in since 2008 is going to give way to a new Age of Austerity fairly soon. These reasons are 1) higher interest rates, and 2) the aging of the U.S. population.

Borrowing isn’t free anymore

Interest rates are the most immediate worry. The Fed has raised rates from around 0% to over 5% in order to combat the post-pandemic inflation. That’s starting to raise the interest costs that the federal government has to pay on its debt every quarter:

Looking at this chart, you can pretty easily see why Americans wanted austerity back in 1992; interest payments were devouring a historically large percent of the federal budget. By the 2000s and 2010s, thanks to Clinton’s austerity, continued economic growth, and low interest rates, interest was much less of a burden.

Now the line is shooting up again, thanks to rate hikes. It’s not yet nearly as high as it was in 1992, because many of the bonds that the U.S. government is paying off were issued back when rates were low. But the average maturity of U.S. government debt is only a little over 6 years, meaning it has to be rolled over fairly frequently. So if rates don’t drop back to a low level very soon, we can expect the federal government’s interest costs to continue to rise steeply.

In fact, the line could go much higher than it was in 1992. The reason is that the federal government’s outstanding stock of debt is about twice as high now as it was then, relative to the size of the economy: