The United States, which has not yet been punished by bond vigilantes for its enormous public debt, is keeping fiscal stimulus policies intact for the short-term.
Many prominent economists, like Nouriel Roubini, co-founder of Roubini Global Economics, support fiscal stimulus in the short-run, even for highly indebted countries like the U.S., because withdrawing it may trigger a deflationary spiral and double-dip recession.
However, a key question is if the U.S. will be able to enact necessary fiscal austerity measures in the future.
Even before that, though, it needs to present a credible plan for future fiscal austerity and appear capable of achieving it. On this front, the U.S. faces major challenges. A key reason is the gridlocked Congress and the deep ideological divide between Democrats and Republicans.
Politicians from the two sides disagree sharply about how to accomplish fiscal consolidation, even if they do recognize the need for it. For example, many Republicans are against cutting defense spending and raising income taxes, while many Democrats do not want to cut welfare programs. And even if they did agree on the method, U.S. legislators may not have the political will to stomach popular reactions against tax hikes or spending cuts.
As a result, Washington is unlikely to come up with a fiscal solution voluntarily any time soon.
Roubini, in a Financial Times op-ed, said the mere realization that Congressional gridlock renders medium-term fiscal austerity impossible may trigger a U.S. sovereign debt scare.
But a sovereign debt scare, actually, may be the only thing that could push the U.S. government down the politically difficult path of fiscal austerity.
Austerity is generally forced upon countries. In recent memory, Greece is certainly a case of it, as with several other peripheral European countries. One can also make the case that U.K. politicians were pressured into austerity by sterling pound sellers and ratings agencies. The only notable exception is Germany, whose unique political climate and culture allowed the imposition of austerity without external pressures.
Now, Roubini thinks it may also take a sovereign debt scare to finally jolt the U.S. into fiscal austerity.
There may be a precedence for such a thing.
According to Princeton Professor Harold James, it was pressures from the capital markets that forced the Hoover administration in the U.S. in the 1930s into fiscal austerity.
Email Hao Li in New York at firstname.lastname@example.org.