Tax Analysts Blog

Lost in Fiscal Space

Posted on Mar 16, 2011

"Fiscal space" is a term you hear mostly in Europe as governments there try to figure out if they have the borrowing capacity to provide stimulus and to lend to huge failing banks. Nobody really knows how much government debt is "too much." Some economists say gross government debt should not exceed 90 percent of GDP, but I wouldn't bet the house on it.

In today's Washington Post Steven Pearlstein points out calamities now seem more common than ever. The trendy jargon for calamity is an event with "long-tail risk"--that is, a high-negative impact, low probability event. The terrorists attacks of 2001, Hurricane Katrina, and the Japanese earthquake are examples. Another example is the financial collapse of 2007-09.

When disaster occurs, economics and politics require the government to respond with expensive, assertive action. Our government does not have significant reserve funds to deal with these types of disasters. We just assume--based on historical experience--that we can borrow to meet any contingency. As our borrowing capacity continues to shrink, this is an increasingly dangerous assumption.

Of course natural disasters will always occur. But if our borrowing capacity is shrinking we will need to be more careful to prevent those that are man-made. Unfortunately, while the federal government did an excellent job of propping up our failing financial system, it did little to reform it. So we can have another financial crisis a decade from now but by then we will be more like Greece than Germany. And by then, maybe only the Chinese will have the fiscal space to bail us out.

Read Comments (1)

Gabriella CiocanskyMar 22, 2012

well..you spoke my mind! I live in Europe and i had the "chance" to see how
Greece for example is sinking and with it the economy of other EU's countries
too...economy is such a delicate subject and you never know what happens next
no matter what decisions they make.

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