How bad can it get if the U.S. government fails to get its debts under control? If you believe a new paper published by the International Monetary Fund, Americans could be worse off to the tune of about $2.6 trillion.
The paper's authors, Bertrand Gruss of the IMF and Jose Torres of the University of Maryland, subject a model of the U.S. economy to various fiscal scenarios. In one, they assume legislators do no more than they already have to reduce deficits over the next 20 years. In another, they implement fiscal reforms similar to those proposed by the Simpson-Bowles deficit reduction commission.
Result: In the world with no fiscal reforms, interest rates end up being 4.6 percentage points higher, and the U.S. suffers a permanent economic loss equal to 17.1 percent of annual output. In today's terms, that amounts to about $2.6 trillion. And that's assuming there won’t be a nightmare scenario in which concerns about government debt levels trigger an investor strike and financial meltdown.
These results should be taken with a healthy dose of skepticism, as they depend on a kind of economic modeling that, while commonly used, is increasingly under debate. For one, the model assumes that people are extremely rational and will always act in a way that maximizes their utility. This, together with estimates of such parameters as risk tolerance, helps determine how fiscal policy affects economic activity in the model.
Still, the overall message is clear: When it comes to getting the government's long-term finances in order, sooner is a lot less expensive than later.
(Mark Whitehouse is a member of the Bloomberg View editorial board.)