The federal budget is on an unsustainable path, in which large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years.  But most important, deficits as a percentage of GDP in these simulations rise without limit.  Unless that trend is reversed, at some point these deficits would cause the economy to stagnate or worse.

A central bank cannot always offset the effects of government deficits on economic growth and stability. But the more credible the central bank's commitment to price stability, the less likely it is that an inflation premium will be built into market interest rates, and the less likely it is that rising inflation expectations will distort economic decisions.

Government policies such as budget-cutting or encouragement of private saving are unlikely, by themselves, to correct the current account deficit, much as they might be desirable for other reasons. Such policies probably do not address all or even most of the root causes of the current account deficit...[but] reducing our budget deficit can ease the adjustment process by releasing resources that can be channeled into higher net exports, so that a reduced trade deficit does not require a curtailment of investment.

The budget deficit has probably been only a small factor in the emergence of the large U.S. external imbalance. Of course, even if it does not narrow the current account deficit by much, reducing the budget deficit would be highly desirable for other reasons: It would free up resources for private investment, and it would reduce the burden on future taxpayers of repaying the federal debt.

It remains to be seen whether expansive fiscal policies can be reversed, and the federal budget can be returned to balance as we move through the expansion phase of the cycle. As an economist, I see the value of fiscal integrity, and this requires a cyclically balanced federal budget.

The overall environment for investment and innovation could be materially affected by the disposition of our fiscal and external imbalances and our exceptionally low net national savings rate.

Our fiscal deficit...is in the zone of unsustainability. Our external imbalance—the current account deficit—is...[at] a level without precedent in U.S. economic experience. Each of these imbalances magnifies the risk in the other.

Together, however, these imbalances [in the federal budget and current account] raise the potential for higher risk premia on U.S. financial assets and more uncertainty about future returns on claims on the United States. This in turn could reduce expected future investment, productivity growth and U.S. growth potential. This could reduce the willingness of the world’s savers to put their capital to work in the United States. And this could mean lower growth outcomes and slower growth in future incomes.

The U.S. fiscal deficit, although a problem, is a problem of manageable dimensions for the medium term, provided we deliver modest changes to the paths of expenditures and revenues. The more daunting problems we face of bringing our healthcare and social security commitments and resources into balance come later and are less acute than those facing most other large mature economies.

To mitigate the risks [resulting from large fiscal and current account deficits]...we can work to keep monetary policy credible, to preserve confidence we will act to keep inflation and inflation expectations stable at moderate levels.

The imbalances in our fiscal and external positions could be diffused gradually and smoothly. But the transitions to a more sustainable equilibrium could also bring greater volatility in asset prices, less stability in macroeconomic outcomes, slower growth and more uncertainty.

If we were to issue an economic report card, the nation would get great grades on its current performance, but would fail on what is necessary for the future—a strong rate of national savings. Households are barely saving at all, and the federal government is spending well beyond its means...This is one of the most important macroeconomic problems confronting the U.S.—its current and persistent low level of net national savings.

Unavoidable economic logic suggests that eventually this situation will prove unsustainable: our deficit and other countries’ surplus positions will come into better balance. The question is how...National savings need to grow. One way to increase savings is to cut the federal deficit...Another source of adjustment would be an increase in the personal savings rate...Rising productivity also could help us grow out of the problem...But it is likely wishful thinking to rely on faster productivity alone even if it is sustained at current levels...A strong case can be made to begin to address this issue sooner rather than later. And personally, I would start with the federal budget deficit.

In the long run, raising the low rate of national savings in the U.S. may be one of the best things that could be done to ensure lasting prosperity both here and around the world. Finding ways to curb the federal government deficit may be the best place to start on that laudable objective.

I believe that a thorough review of our commitments [in the federal budget]--and at least some adjustments in those commitments--is urgently needed.  The necessary adjustments will become ever more difficult and larger the longer we delay.  No changes will be easy.