Do our leaders know that the deficit is NOT unsustainable?

[cthulu2016]

Last edited Sun Mar 10, 2013, 05:36 PM - Edit history (8)

I really wonder. Does President Obama know that there isn't a deficit problem? Do Democrats in Congress? Do Republican leaders in congress?

We are not spending too much.
We are not taxing too little.
Our current policies are fine... or rather, they would be fine if we had a normal rate of GDP growth.

That part of our deficit/debt that is unsustainable (debt growth above rate of GDP growth) is currently caused only by the fact that the economy crashed circa 2008 and has grown only slowly since.

If we plug 2% inflation and 4% GDP growth into the CBO equations (meaning 2% real GDP growth on top of 2% inflation) we get a deficit growing at or below the rate the economy is growing. And that is a sustainable deficit in no need of cutting.

Because of inflation and growth we tend to view the defecit and debt relative to the whole economy. If we kept the debt the same and our economy doubled in size then our Debt/GDP ration would be cut in half. If our economy was cut in half then our debt/GDP would double. The sustainability of debt depends, in large part, on how fast your economy is growing.

Yes, at 1% growth going forward forever the deficit is unsustainable. True. But at 1% growth going forward forever the United States of America itself is unsustainable. At 1% the banking system is unsustainable, the housing market is unsustainable, employment and education and the freaking fire department is unsustainable.

If we assume the US will never recover from the crash of 2008 then the entire going concern we call America is unsustainable. In that scenario the deficit is the least of our worries!

And if we do expect to recover, in GDP growth terms, then there is nothing nuch wrong with our current laws and policies in deficit terms. With healthy but unextraordinary GDP growth we would be paying out less money (unemployent insurance, medicaid, food stamps) and taking in more money and the deficit would be growing slower than GDP, and a deficit growing slower than GDP is sustainable. (A literally balanced budget is a pointless and quite probably counter-productive goal. What matters is that the ratio of debt to the size of the economy not be growing.)

Our policy should be geared toward increasing GDP (and employment). That is the best way to fight a debt caused by low GDP and hgih unemployment.

The reason the deficit is unsustainable today is because of efforts to fight the deficit.

How could both sides have thought the stimulus in 2009 had to be balanced against the deficit... as if the two things were opposed rather than aligned? Are all our leaders just unable to take any problem seriously?

If the 2009 stimulus had been $2 trillion (my suggestion at the time) the deficit would probably be less of a problem today than it is. That huge magnitude of increased government spending would have been the fiscally responsible course in 2009... it was what an actual deficit hawk would have called for.

(The long-term deficit picture is a different matter, but that is entirely about healthcare costs and can only be solved with things pertaining directly to healthcare costs—most likely single-payer and the rationing of care that must attend single-payer.)

I do not expect people to believe that the deficit would disappear as a problem (as something growing faster than GDP) if all our policies stayed the same while GDP returned to normal, but it is true.

And don't take my word for it. Professor Krugman tries (for the umpteenth time) to explain it:

...it’s highly misleading just to focus on the raw deficit numbers (ONE TRILLION DOLLARS), for two reasons. First, fluctuations in the deficit tend to be driven by the business cycle; when the economy slumps, revenues fall and some kinds of expenditure, like unemployment benefits, rise. You want to take out these “automatic stabilizers” when assessing the underlying state of the budget.

Second, we don’t have to balance the budget to have a sustainable fiscal position; all we need is to ensure that debt grows more slowly than GDP.

So CBO is now out with its latest report on automatic stabilizers. It estimates that in fiscal 2013 these stabilizers will amount to $422 billion, accounting for just about half of a projected $845 billion deficit. So the cyclically adjusted deficit will be $423 billion.

How does this compare with the deficit consistent with fiscal sustainability? Well, there’s about $11.5 trillion in federal debt in the hands of the public. A reasonable, indeed fairly conservative guess is that nominal GDP will in future grow by 4 percent per year, half from real growth and half from inflation. This means that the sustainable deficit is 4 percent of $11.5 trillion, or $460 billion. Hey, we’re there!

...

http://krugman.blogs.nytimes.com/2013/03/09/gone-deficit-gone/

[abelenkpe]

1. "The only reason the deficit is unsustainable today is because of efforts to fight the deficit. "

This cannot be repeated enough. So very true.

[JaneyVee]

2. Exactly. Unemployment is driving the deficit, not spending. Fewer jobs means slower economy and

smaller tax base. We ONLY have a jobs problem and a low tax rate problem. If we fixed those 2 things the economy would take off and the deficit would vanish. Which is why sequester is a TERRIBLE idea, the LAST thing we need right now are less jobs.

Gah! ETA: Meant to reply to OP.

[cthulu2016]

7. The OP suggests there is not a low tax rate problem, in *deficit terms*

We may have a low tax rate problem in terms of the structure of society (I would say we do) but we do not need to raise taxes to fix the deficit (intermediate term).

The deficit is (intermediate term) self-fixing at some level of GDP growth somewhere between 3-5%, at current tax rates.

That is not an argument that current tax rates are correct, or an argument against changing taxes for other purposes.

But raising taxes to address the deficit is dumb-lite. It is not quite as malicious as cutting spending to address the deficit, but it is the same general idea, and is a terrible idea.

[JaneyVee]

9. I meant raising top tax rate for the rich to help pay down debt while investing in America & jobs.

We could end high unemployment today if we really wanted to.

[cthulu2016]

15. I agree with all of that except "pay down debt"

Raising taxes to pay down debt that does not need to be paid down (the point of the OP) would be the same as Republicans thinking we need to cut spending to pay down debt.

There is no economic reason, at this time, for the government to do anything even slightly contractionary to pay down debt when the unsustainability of the debt is primarily caused by contraction.

This is an important economic point -- it is okay to tax the rich more today only if that revenue is spent on something more stimulative than what the rich person was doing with it.

Paying down the debt is not stimulative at all.

I am fine with raising taxes on the rich for almost any purpose other than paying down the debt. Paying down the debt is just about the only thing in the world even less stimulative than letting the rich keep their money.

Tax them to fix additional bridges that otherwise would not be fixed? Cool.

Just not to decrease the deficit.

[JaneyVee]

19. And investing in America & jobs.

[cthulu2016]

22. I agree with "investing in America & jobs"

Just take whatever you had penciled in for paying down debt and move that sum over to to investing *even more* in America & jobs.

Raising taxes on the rich to create jobs with the money is very good.

[dkf]

3. Debt Overhangs: Past and Present

Debt Overhangs: Past and Present
Carmen M. Reinhart, Vincent R. Reinhart, Kenneth S. Rogoff
NBER Working Paper No. 18015
Issued in April 2012
NBER Program(s): IFM ME

We identify the major public debt overhang episodes in the advanced economies since the early 1800s, characterized by public debt to GDP levels exceeding 90% for at least five years. Consistent with Reinhart and Rogoff (2010) and other more recent research, we find that public debt overhang episodes are associated with growth over one percent lower than during other periods. Perhaps the most striking new finding here is the duration of the average debt overhang episode. Among the 26 episodes we identify, 20 lasted more than a decade. Five of the six shorter episodes were immediately after World Wars I and II. Across all 26 cases, the average duration in years is about 23 years. The long duration belies the view that the correlation is caused mainly by debt buildups during business cycle recessions. The long duration also implies that cumulative shortfall in output from debt overhang is potentially massive. We find that growth effects are significant even in the many episodes where debtor countries were able to secure continual access to capital markets at relatively low real interest rates. That is, growth-reducing effects of high public debt are apparently not transmitted exclusively through high real interest rates.

http://www.nber.org/papers/w18015

[dkf]

4. Too Much Debt Means the Economy Can’t Grow: Reinhart and Rogoff

July 14 (Bloomberg) -- As public debt in advanced countries reaches levels not seen since the end of World War II, there is considerable debate about the urgency of taming deficits with the aim of stabilizing and ultimately reducing debt as a percentage of gross domestic product.

Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP. Nevertheless, many prominent public intellectuals continue to argue that debt phobia is wildly overblown. Countries such as the U.S., Japan and the U.K. aren’t like Greece, nor does the market treat them as such.

Indeed, there is a growing perception that today’s low interest rates for the debt of advanced economies offer a compelling reason to begin another round of massive fiscal stimulus. If Asian nations are spinning off huge excess savings partly as a byproduct of measures that effectively force low- income savers to put their money in bank accounts with low government-imposed interest-rate ceilings -- why not take advantage of the cheap money?

Although we agree that governments must exercise caution in gradually reducing crisis-response spending, we think it would be folly to take comfort in today’s low borrowing costs, much less to interpret them as an “all clear” signal for a further explosion of debt.

http://www.businessweek.com/news/2011-07-14/too-much-debt-means-the-economy-can-t-grow-reinhart-and-rogoff.html#p1

[cthulu2016]

5. This appears to be a confusion of correlation and causation

The fact that there is a magic threshold of 90% of GDP with no economic reason whatsoever why 100% should be very different from 80% suggests (almost to the point of stating) that the magic number is a magic number because people think it is a magic number.

It's like saying walking across the railroad tracks must be what makes you poor because everyone on one side of the tracks is poor and rich people seldom cross the tracks to go to the poor neighborhood.

National economies in crisis will incur more debt. True.

And people with cancer consume more chemotherapy drugs than people without cancer, and have a high rate of mortality from cancer. That doesn't mean that chemo drugs cause cancer death.

[dkf]

10. There are obviously economic theories on why this is so, but some food for thought:

Rogoff: When we started writing our book, we thought we would find that there were financial crises in Asia, Europe, the U. S. and elsewhere. What we hadn't quite anticipated was how similar these crises would be. It just shocked us, because these areas have different legal systems and different institutions. Carmen mentioned human nature. It is almost as if these institutions and these legal systems were forms of clothing and makeup, but inside the person is the same.

And

Rogoff: And, lastly, other things, like infrastructure and education spending, are important. This isn't all about austerity versus no austerity. Countries that are successful in dealing with these crises, such as Sweden, sometimes take them as an opportunity to change. We haven't.

http://online.barrons.com/article/SB50001424052748703961304578128861988425802.html#articleTabs_article%3D2

This is interesting too:

http://www.eurotrib.com/story/2011/2/26/4032/30282

I'm reading Reinhart's and Rogoff's This Time is Different, which is jam-packed with information about the economic history of defaults.

In it, there's a neat little box documenting the fact that no, countries don't actually grow out of debt.

To identify episodes of large debt reversals for middle- and low-income countries over the period 1970-2000, Reinhart, Rogoff, and Savastano selected all episodes in which the ratio of external debt to GNP fell 25 percentage points or more within any three-year period, then ascertained whether the decline in the ratio was caused by a decrease in the numerator, an increase in the denominator, or some combination of the two.

Of the twenty-two debt reversals detected in middle-income countries with emerging markets, fifteen coincided with some type of default or restructuring of external debt obligations. In six of the seven episodes that did not coincide with a credit event, the debt reversal was effected mainly through net debt repayments; in only one of the episodes (Swaziland, 1985) did the debt ratio decline principally because the country "grew" out of its debts! Growth was also the principal factor explaining the decline in debt ratios in three of the fifteen default or restructuring cases: those of Morocco, Panama, and the Philippines. Overall, this exercise shows that countries typically do not grow out of their debt burden, providing yet another reason to be skeptical of overly sanguine standard sustainability calculations for debt-intolerant countries.

Yes these are middle-income countries so its not apples to apples but fascinating anyway.

[cthulu2016]

13. If lenders had an inflexible 90% rule of thumb then

it would play out the same as if there were a real economic reason for 90% being a magic number. I grant that.

So it is possible for 90% to be a magic number in practical effect.

And I do not advise the USA blowing past 90%, either, except perhaps in a way calculated to best increase future tax revenues by GDP expansion.

(I am not an MMTer who thinks debt cannot matter. At some point it has to matter.)

But I do not think lenders are incapable of distinguishing between the USA at 90% and Greece at 90%. (They certainly do not treat Greece and Japan the same way -- Japan has a much larger relative debt than we do.)

I do not think we should plan to have a huge debt all the time. I think we should, however, try the experiment of kick-starting things with short-term but conventionally very "excessive" debt increase. (Rather than limping along like Japan, which just leads to Japan sized debt without frantic effect.)

[dkf]

16. There seems to be two levels of impact.

At the first level growth is inhibited. At the second level, interest rates increase and the debt becomes truly unsustainable.

The question to me seems to be if a large debt increase will bring us to that second threshold faster. That is the gamble and that is where the pain occurs.

Rogoff has made several comments that interest rates are often low prior to the crisis but interest rates can change with the wind.

So do we throw the dice?

[dkf]

23. You make a good point here.

I wonder if what used to be a more random threshold will be changed to a more explicit one as the study spreads in the community.

Maybe in the end it will be a daisy chain of central banks buying everyone else's debt to keep it all stable. That doesn't depend on investors who may be leery of high debt levels.

[cthulu2016]

26. I would like to see the results adjusted for *total* debt in

an economy or a currency... or even the world.

I do not see any mechanism for our government debt today to restrict USA growth because total debt in the American economy is down. The people stopped spending more than the government started spending.

A debt caused by a consumer demand crash should play out differently than a debt caused by simple extravagance because in the later case the government might be competing for debt, which could inhibit growth in extremes.

But debt incurred to make up only a fraction of a larger drop in demand should not be inflationary, should not raise interest rates, and should not deter anyone from starting a business. (They will be deterred by a lack of customers, but not by the government debt.)

[dkf]

27. I've seen that type of data from them.

But I haven't read the book, just what I've found through google.

I have seen the comment that often in crises private debt ends up as public debt and I have a feeling they will need to clear out college loans at some point.

You should read more of what they have to say. For all I know you may be able to debunk the whole thing. I find it fascinating myself.

[cthulu2016]

29. What I have read about their book sounds interesting

I am big on the folly of the "It's different this time" mantra. And the authors are Keynesians.

What frustrates me about 2008-now is that it really was different while people refused to accept it.

We had never, since WWII, faced deflation as a real possibility in the USA. It really was (hopefully) a once-in-a-lifetime deal that defied conventional thinking.

Yet a housing bubble could emerge a couple years after a ridiculous stock bubble and the amnesia was almost total... "it's different this time."

[dkf]

30. You are right that a big stimulus was needed and if we had done the

The first time around we would be much better off.

Two things:

1). The stimulus was ineffectively designed. Geoffrey Sachs has made the point that not all stimulus dollars are the same and that is why they did not get the 1.5x bang they expected. Transfers to states did not add much as they mostly used it to reduce debt and similarly tax cuts didn't do much as many people saved it or reduced their debt.

2). Now that we have accumulated so much extra debt we may have entered that 90% threshold making more debt risky. It could be that if high debt already has implications on growth it will make the lift that much harder. In addition it may spook investors.

[Yavin4]

6. If the debt and deficits are so bad, then why won't Republicans advocate for higher taxes?

Funny, when Republicans take power all that we hear about is the urgent need to cut taxes.

[dkf]

11. I wish we could view this very analytically so that we could fix the structural problems.

But that's probably too much to expect from politicians. Why would they do the hard things that benefit the future if constituents insist on keeping what they have as is?

Until this country wakes up and realizes we need to change and yes, sacrifice, to make things better for the future, the politicians aren't going to move.

[Yavin4]

14. In 2000, the Deficit and the Debt problems were solved or

there was a framework in place for solving them. We made the hard choices in 1993. Once Bush took office, a huge clamor for tax cuts went out. Even Alan Greenspan testified that Bush's tax cuts were okay.

The public cannot tell true deficit hawks from those who use the deficit in order to push for more tax cuts.

[dkf]

18. I blame Greenspan for the housing bubble.

That was his baby and he didn't pull back when he needed to.

So irresponsible tax cuts and the housing bubble...what a record.

[cthulu2016]

20. Yes, but the bill for the internet bubble was going to be paid either way.

Greenspan's internet bubble was the largest bubble event ever at that time and it should have brought down the US economy in 2001... not as bad as 2008, but still the worst since the Depression.

Greenspan somehow managed to re-inflate it into an even bigger asset bubble, with an even bigger eventual burst... but kicked down the road until Greenspan was out of the picture.

[dkf]

21. Bush + Greenspan = recipe for disaster.

[Yavin4]

25. Greenspan not withstanding, It's very difficult for Americans to take discussions about the...

deficit/debt seriously when one party is fundamentally dishonest. When out of power, they cry to high heaven about the debt/deficit. Then they cajole a Dem president to make difficult hard spending cuts, and in some cases tax hikes.

Under both Clinton and Obama, overall federal spending declines as do the number of federal jobs.

Then, Republicans get elected and the first thing that they do is cut taxes.

I'm sorry, but I find this whole debt/deficit obsession to be the biggest scam going in politics today.

[99Forever]

8. I hear what you are saying.

However, what is actually unsustainable, is never ending "growth." That is the downfall of capitalism. This is a finite planet, with finite resources, most of which are already stretched to, or beyond the breaking point. The results are all around for anyone who wants actually honestly look to see.

A more equitable distribution of the existing resources is the only way we will survive. The likelihood of that happening becomes more remote with each passing day.

[dkf]

12. Growth doesn't necessarily mean using resources. It could be services.

[Tierra_y_Libertad]

17. If they were reprentatives rather than "leaders" they would know.

[MadHound]

24. Sooner or later the debt has to be addressed, that is a fact.

However that time is not now, not with our economy in such a fragile recovery(if you can even call it a recovery). Obsessing on the debt, to the point where the government is imposing austerity programs, is going to crash what is left of our economy. What needs to be done now, especially with the cost of borrowing so low, is to institute a serious WPA type stimulus, something on the order of a trillion dollars. It would put people to work, and upgrade our infrastructure(an investment in the future that needs to be made if we want to remain competitive globally). As more people are put to work, the economy will start to grow, and revenues will come in and we can pay our way, grow our way out of our debt.

Do our so called leaders know this, certainly, it is basic Econ 101. But our government is basically bought and paid for by corporate America, and corporate America wants an economic crash, because they view that as a buying opportunity. Furthermore, corporate America wants a slack labor market, because that means that with people desperate for jobs, they can pay a pittance to their employees, who are just grateful to have a job, no matter the pay. This keeps labor costs low and profits high.

[talkingmime]

28. Bingo. It's primarily a lack of revenue problem. The F-35 could be considered a waste of spending.

But the point is that we need more revenue to sustain a stable economy. If they simply eliminated the cap on FICA we'd be in good shape. I have to pay 15.whatever percent of my income on self-employment income and 7.6 or so on salaried income. Why doesn't everyone have to do that? If you're making millions of dollars, $110K or whatever it is doesn't mean squat. It's like dropping a penny when you take out your car keys and leaving in the parking lot for some kid to find. Taxes on the highest incomes are at or almost at the lowest rate they've ever been.

And yes, the sustainable deficit is in an acceptable range, but making the ultra-wealthy pay their fair share could very possibly eliminate it completely and not just get us to an anual surplus like Clinton did for two years but put money in our long-term coffers. Congress is owned by the robber barrons.

Edit: I changed my mind. The F-35 can't be considered a waste of spending. It simply is one.

[taught_me_patience]

31. I love how Krugman completely ignores debt held by the trust fund

in order to make his numbers work.

[cthulu2016]

32. ??? (revisit what was being calculated)

You are right that the total debt is closer to 16.5 Trillion than 11.5 Trillion, counting the trust fund.

But leaving the trust fund out of the debt figure is nessecary because including it would make the sustainable deficit being calculated larger.

4% of 16.5 trillion is larger than 4% of 11.5 trillion.

What would have been eye-brow raising would be if he had NOT excluded the trust fund, which is a genuine fiscal concern but not something that adds or subtracts from the annual deficit.

How does this compare with the deficit consistent with fiscal sustainability? Well, there’s about $11.5 trillion in federal debt in the hands of the public. A reasonable, indeed fairly conservative guess is that nominal GDP will in future grow by 4 percent per year, half from real growth and half from inflation. This means that the sustainable deficit is 4 percent of $11.5 trillion, or $460 billion. Hey, we’re there!

[former9thward]

33. The normal rate of growth, 3%-5%, will not return.

That was the average rate of growth after WW II because the U.S. alone reached the end of the war with its infrastructure intact and a healthy educated and skilled labor force. Europe got its infrastructure reconstructed, Asia and S. America built theirs. Everyone's labor force was recreated and educated. This meant scores of nations could produce what the U.S. could. Now we compete against the world. We can't grow at the rates the OP would like because there is just not room in the world economy for it. We will be lucky if we stay at 1%. Most likely we will slide into a Japanese/European no growth economy.

[cthulu2016]

34. That is possible, but if we are planning for that in one sense (deficit) then

we should be planning for that across the board... in all policy contexts.

(Like building the Soylent Green factories)

[former9thward]

35. We should but neither party will tell the truth.

They have to have a motivation to get the voters to vote for them so they say 'things are improving' if they are in power and 'we can do better' if they are out of power.