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The fiscal outlook for the United States "is not good," according to Goldman Sachs, and could pose a threat to the country's economic security during the next recession.
According to forecasts from the bank's chief economist, the federal deficit will increase from $825 billion (or 4.1 percent of gross domestic product) to $1.25 trillion (5.5 percent of GDP) by 2021. And by 2028, the bank expects the number to balloon to $2.05 trillion (7 percent of GDP).
"An expanding deficit and debt level is likely to put upward pressure on interest rates, expanding the deficit further," Jan Hatzius — Goldman's chief economist — wrote Sunday. "While we do not believe that the U.S. faces a risk to its ability to borrow or repay, the rising debt level could nevertheless have three consequences long before debt sustainability becomes a major obstacle."
Legislators passed a package of corporate and individual tax cuts in December, a two-year budget deal in February and a massive spending bill in March that boosted government expenditures on both domestic and military programs.
In light of the big spending and easier tax burden, the Congressional Budget Office – Capitol Hill's nonpartisan financial scorekeeper – in April projected that debt could equal GDP within a decade if Congress extends the tax cuts, a level not seen since World War II.
Economic growth should jump above 3 percent in 2018 thanks to the stimuli, the CBO said, but the acceleration will likely prove brief, and debt held by the public will soar to $28.7 trillion by the end of fiscal 2028.
That could create a precarious situation for Congress if the economy faces an economic downturn in the near term, Hatzius wrote, hampering legislators' ability provide additional fiscal stimulus.
"Lawmakers might hesitate to approve fiscal stimulus in the next downturn in light of the already substantial budget deficit," the economist said. "While we would expect some additional loosening of fiscal policy during the next downturn, there is a good chance in our view that it would be less aggressive than it was in the last few recessions."
But even if the debt and deficit levels don't prevent lawmakers from approving countercyclical fiscal stimulus during the next recession, a political desire to stabilize the debt level would likely arrest growth during the next recovery, the Goldman team explained.
"The current fiscal expansion ... must at some point give way not just to a neutral stance, which we expect by 2020, but to a tightening of fiscal policy that could restrict growth," Hatzius wrote.
Finally, the economist explained that regardless of how much longer the current expansion persists, increasing deficits and debts naturally put upward pressure on interest rates, expanding the deficit further.
According to estimates by Goldman Sachs, a 1 percentage point increase in the budget deficit raises the 10-year Treasury yield by roughly 20 basis points when the economy is at or beyond full employment, as it appears to be currently.
"Surprises are clearly possible in both directions, but we believe the risks are tilted in the direction of larger deficits than projected," Hatzius concluded. "While we expect Congress will eventually address the widening budget gap, it also seems quite likely to take longer than most market participants might expect."