I read an article in the Financial Times earlier this week (September 23, 2023) -…
I have given some further consideration to the Co-Chairs Draft Proposal from the US National Commission on Fiscal Responsibility and Reform, which was released on Wednesday (November 11, 2010). This was in the context of reading an article over the weekend that said the the co-chairs’ report reads like a document from Mars. I can’t say I know much about Mars but I thought this description was a bit unkind to any life forms that might exist there. Does the author of that comment have any insights about Mars that we do not have? Given my propensity to be hopeful rather than assume the worst I prefer to think of the unknown Mars as being occupied by nice, thoughtful, smart, considered and above all realistic people. They would never produce such a silly document as the co-chairs have had the audacity to inflict on the public policy debate. Martians are (probably) better than this.
But in maligning the Martians, the author did get something right. The co-chairs report is ignorance personified:
… the economy’s current problem has nothing … to do with deficits. Its problem is a lack of demand. If there were more demand, more people would be employed. The government is the only force capable of creating demand right now, since the housing bubble wealth that had been fueling the economy has largely disappeared. This means that if our commission co-chairs had ever bothered to look at the current deficit in the context of the economic crisis, they would be complaining that the deficit is too small rather than too large.
Context is always crucial when you are appraising government policy positions. You cannot just get a spreadsheet out with columns describing government outlays and revenue by year and then make the numbers go so as you get deficits and debt levels falling. That completely ignores the fact that fiscal outcomes are largely endogenous.
That funny word (which economists like me us to sound erudite) just means “determined within the system” rather than “imposed on the system”. In other words, the government can try as it likes to set some artificial target budget outcomes and alter discretionary spending and revenue settings to match their “static” spreadsheet formulas, but if the other sectors (foreign and private domestic) have other intentions then the government will fail to meet their targets.
After government policy settings are in place it is the other two sectors (which comprise the non-government sector) that determine the budget outcome.
I often say when I am giving a talk to private sector interests that if they don’t like the deficit they can do something about it immediately. Blank stares follows. The answer … invest more in productive capacity and see the deficit plunge as the automatic stabilisers, driven by the growth, increase public revenues and decrease public welfare outlays. It is your hands baby!
Remember: spending equals income. Taxation revenue rises within income as does employment growth. Government net spending set up the conditions whereby the budget outcome will fall as private income growth accelerates. It is as simple as that.
In considering the co-chairs’ proposal I hasten to add that some of the individual ideas they have advanced may have merit. For example, they propose cuts in military spending and also reducing some of the more pernicious aspects of “high-income-wealth” welfare (for example, the elimination of mortgage-interest tax deductions). In isolation, these measures seem reasonable targets for reforming the composition of the US government’s budget (or any national government budget).
But in macroeconomics we cannot operate in isolation tanks. The composition of the budget is one thing and I would never reduce its significance but from a macroeconomic perspective the main game is about systems and multipliers. Spending equals income whether it is public spending on tanks and missiles or private spending on golf-course developments or public spending on better schools and hospitals and job creation programs.
So there are two different debates. First, how much net public (deficit) spending is required to support the economy given the saving desires of the non-government sector and the degree of capacity utilisation in the economy? Second, what is the best composition of that net spending for the society (and the world at large)?
On the second, I would dramatically cut US military spending – the world would be a much better place. That is my opinion and is not derived from my understanding of the economic impacts of such spending. Clearly, if the military spending is cut then if there is still idle capacity in the economy it has to be replaced by alternative spending.
The problem of the co-chairs’ proposal is that they ignore the context. They assume that they can just alter numbers in columns (headings of which are years) of a spreadsheet draw fancy graphs and everything else will be equal. It won’t be equal that is for sure and you also have to understand the starting point – hence the Martian reference.
The Mars author (so-called progressive Dean Baker) also buys into the intergenerational debate. He says:
Over the longer term, the country is projected to face a deficit problem, but this is almost entirely attributable to the projection that private sector health care costs will continue to grow at an explosive rate. More than half of our health care is paid for by the government, so this projected growth rate of health care costs would eventually lead to serious budget problems in addition to leading to enormous problems for the private sector. However, the underlying problem is the broken health care system, not public sector health care programs.
First, note he concedes that the “deficit problem” exists and is related to an explosive increase in private sector health care costs which will “eventually lead to serious budget problems”.
I do not see this as a budget problem. It is always going to be a political problem but is not a financial problem which is inferred here.
Second, what exactly is the problem that Baker and the co-chairs propose? They say it is about private sector health costs? So more people will be demanding health care services in the future because the population is getting older. That tells me that less people will be demanding early childhood care and educational services, secondary school education and whatever.
Why is that a problem in a market system? If the problem they foresee is that the US will run out of titanium for knee joint replacements and the technology hasn’t discovered a reliable substitute then that is a problem. The government or any other sector cannot purchase goods and services that are not available for sale. In a market system, then rationing takes place. There are only so many Ferraris made and most of us cannot afford the price (even if we wanted one).
Okay, so then the argument is that health care is a right not a preference and so we cannot let the market system allocate these resources freely. I agree within reason – I exclude a manner of procedures and interventions that are exploited largely by the high income/wealthy set which are not based on any deep-seated medical or psychological need. But my exclusion zone is not the issue and has nothing much to do with economics anyway.
So if the public sector is to provide these services at affordable prices as the demand for them rises then there is going to have be a political debate about resource allocation and the design of the health system. I agree with Baker that the US health system is broken. From a person who lives in a publicly-provided universal health care system which means that anyone can get access to first-class health care most nearly always the US system is archaic and comical.
But that is the problem and has very little to do with the “deficit”. The US government will always be able to buy any medical goods and services that are available for sale in the market place. It will never face a reduced capacity to do this. Trying to imply that the issue is public solvency when the real issues are political (what should be purchased and at what level) and real (will there be enough medical resources available) doesn’t help anyone.
In fact, by trying to make it into a government spending issue and then using mis-informed political pressure to cut that spending in the hope that the problem will be reduced in 20 or 30 or so years will probably worsen the real issues. If I was the boss of government I would be making outlays now on R&D and technology innovation in health care to ensure that the chances of there being a shortage of resources which would necessitate a harsher political debate (more trade-offs between resources uses) are minimised.
But each generation ultimately (and eventually) chooses what resources will be out laid and commanded by the public sector. This is done via the ballot box and via political lobbying. None of that has anything to do with the sovereign government’s capacity to spend. That capacity is infinite (minus one cent).
Again … do not infer I think the government should spend to an infinity minus one cent. It certainly should not but it has that nominal capacity to do so.
In that sense, the political debate should be on how much of that nominal capacity the government chooses to exploit. That would lead to a better appraisal of what we mean by public purpose and an exploration of community values. I would bet that most communities would vote for higher employment rather than persistently high unemployment if they really appreciated that either was possible.
That is, there is nothing fatalistic about persistently high unemployment. The US government is choosing to allow nearly 10 per cent of its willing workers lay idle in unemployment. They can say what they like but the government could eliminate all but the frictional component of that unemployment overnight if they wanted – via a Job Guarantee.
But you see the way the debate is twisted. The starting point is that the government has some sort of financial constraint and less is better. All manner of disasters are outlined by the conservatives (and many progressives) if the government runs continuous deficits etc. So from that perspective a host of non-issues then get oxygen.
If the government can run out of money, then it will have to close hospitals as demand rises.
If the government can go broke, then we might not be able to afford to defend the country with a well-equipped military.
Etc and etc. All these statements – and the entire co-chairs’ positioning is based on that false starting assumption. So you never get a debate about the preferred size of the deficit which would educate the citizens on what the deficit is and what it does.
The false starting point just inculcates a fear – a loathing – and we cut off our noses to spite our faces. Yes we are idiots for allowing the economics profession to run these smokescreens.
This is why the co-chairs’ proposal is so damaging – it reinforces the entrenched wrong starting point and assumptions. Once you start in the wrong place the logical conclusions are obvious – pages and pages of expenditure cuts.
Further, the context is also important. The co-chairs’ proposal reads as if the US economy is operating at full capacity and inflation is about to surge. This is the martian reference.
What do the two co-chairs see when they examine the data? How do they think the private economy is going to react as their incomes contract further and their capacity to reduce their disturbing debt levels via saving diminishes. What do they think will happen to the investment plans of firms who see their orders falling again and inventories rising?
Their report is bereft of any detail at all in this respect.
Anyway, then I stumbled on a New York Times Op-Ed article (November 11, 2010) by one David Brooks – National Greatness Agenda which was his take on the co-chairs’ proposal. See also the response by Baker a few days later.
If the world was as Brooks thinks it is then I must have been very blind for many years. (Please don’t write in and tell me that you have known that all along! Well Ray can – he is exempt!)
Brooks says that:
Elections come and go, but the United States is still careening toward bankruptcy. By 2020, the U.S. will be spending $1 trillion a year just to pay the interest on the national debt. Sometime between now and then the catastrophe will come.
Okay, at least we have a sort of a prediction with an estimation interval (sometime between now and then). Now, I am not going to deny the possibility of a catastrophe between now and 2020. Niagara Falls might do something funny and flood houses. One of the Bay bridges in San Fran might fall apart. A hurricane could come along (and certainly will).
But exactly what would be catastrophic about a $1 trillion a year interest income being received by the non-government sector?
I sought further explanation from the Brooks (the clairvoyant).
The next bit of information was that:
It will come with amazing swiftness. The bond markets are with you until the second they are against you. When the psychology shifts and the fiscal crisis happens, the shock will be grievous: national humiliation, diminished power in the world, drastic cuts and spreading pain.
F…ing hell! That is bad. What are the historical precedents for this in US history under a fiat currency system? Answer: none. The national humiliation that the US faces is already clear – they have a legislature that is dysfunctional, they cannot “win” wars they start (and their intervention only seems to make things worse) and as the richest nation in the world they allow millions of their citizens to remain idle – unproductive and sinking into poverty.
That is humiliating.
Does Brooks understand that the US Federal Reserve could buy whatever volume of government debt the US treasury issued whenever it wanted to? What have bond markets got to do with anything really if the government doesn’t want to party with them? Please read my blog – Who is in charge? – for more discussion on this point.
The rest of Brook’s article is a bit patriotic-rah-rah-America for my liking. Apparently, America will be saved by a “love of country” which will allow the pain of fiscal austerity to be shared and sacrifices made.
The problem dear David is that love of country does not alter the economics of spending equals income. Yes, you might find a tolerance for increased poverty in the name of country in the way the Irish seem to be going at present (although social upheaval is coming there too). But when the poverty will be concentrated among the more disadvantaged cohorts and spreads into the middle class as their property ownership dreams collapse then I wonder whether the flag will be enough to stop rising crime rates; an epidemic of drug and alcohol abuse; increased incidence of family breakdown; rising incidence of mental and physical illness; amidst the falling income levels and rising bankruptcies.
You might get the “flag” effect tolerating some harsh cutbacks – but just wait for the impacts of those cutbacks and see where your society is in several years from now having lost a decade of prosperity for no good reason other than the government was captured by a pack of neo-liberal bullies who knew how to extract as much real income for themselves from a system even during times when that real income was falling.
In Dean Baker’s response to Brooks he says that “Mr. Brooks’ scary interest burden will be equal to about 4.1 percent of GDP … The interest burden peaked at 3.3 percent of GDP in 1991, so we would not be in hugely different territory than we were during the Bush I presidency”. So not very catastrophic is the point.
But both Brooks and Baker seem to want to play with numbers – one says the estimates are too high, the other says they are not that out of whack with the historical experience. Neither case hits the mark. They both explicitly (Brooks) or implicitly (Baker) suggest that solvency is the issue.
A sovereign government like that in the US is never revenue constrained because it is the monopoly issuer of the currency. There is never any solvency risk. That extends to paying back the debt upon maturity or servicing the debt with interest payments. The US government can always afford to honour all liabilities that are expressed in the US dollar (which they issue exclusively).
So is there any issue to be considered in the context of these rising interest payments? Answer: Certainly! The rising interest payments represent income to the non-government sector. So the increase of income may increase aggregate demand which could at some point place a strain on the capacity of the economy to respond by increasing output.
And ladies and gentleman you know what happens next – demand-pull inflation.
Baker recognises this point and says:
The Fed currently holds much of the federal debt and it is actually increasing its share. This is what QE2 is all about. Given the massive amount of excess capacity and unemployment, coupled with the trend towards disinflation, there is no reason that the Fed should not continue to hold this debt. (It can take other steps, such as increasing reserve requirements, to ensure that an increase in reserves in the banking system does not lead to inflation in future years.) If the Fed holds the debt, then it poses no burden to the government. The Treasury pays interest on the debt to the Fed and then the Fed refunds the interest to the Treasury. Last year the Fed refunded $77 billion in interest to the Treasury, nearly 40 percent of the net interest paid out by the Treasury.
Clearly, demand pull inflation (excessive nominal aggregate demand growth pulling up prices) is not a danger in the US in the foreseeable future.
This is not the same thing as saying that there are no inflationary threats in the world economy looming. The most obvious sources will be on the supply-side as world competition for finite energy resources increases courtesy of the on-going economic expansion of China and India. It is clear that over the next decade and more a major realignment of energy usage will occur and poorer Americans (and Australians) will have less capacity to use “cheap” energy relative to the past squandering behaviour.
Please read my blog – Be careful what we wish for … – for more discussion on this point.
The point is that you don’t attack a supply-side inflation by restricting demand. Then you get stagflation which we first encountered in any severity in the period following the first OPEC oil shock in the 1970s.
But reflect back on Baker’s soothing message. He suggests that “Mr. Brook’s apocalypse story” is not warranted because “there is no reason that the Fed should not continue to hold this debt”. That is an incorrect summation.
The fact is that it is irrelevant who holds the debt. The point about the central bank’s capacity to purchase the debt is that it snookers the “bond markets will move swiftly and devastatingly to invoke a fiscal crisis” argument.
He further says that if the central bank “holds the debt, then it poses no burden to the government”.
Let’s think this through. Say if the central bank purchased all new debt issued by the Treasury and via QEX bought all existing outstanding debt. Would the government be paying the interest on this debt?
Answer: clearly as long as the monetary policy target was non-zero. Why? Because the debt-issuance would only be mirroring (by voluntary arrangement) the on-going net public spending (deficits). These deficits would create increased bank reserves every day and if there was no support rate paid on excess (overnight) reserves by the central bank then the competition in the interbank market would bid the overnight rate down to zero!
This means the central bank effectively loses control of monetary policy. So if the central bank wanted to keep the overnight rate at a non-zero policy rate level then it would have to pay interest on the excess reserves overnight at a rate equivalent to the policy target.
This is just a replay of the old “monetisation” issue. The central bank cannot “monetise” a deficit and keep a non-zero policy rate unless it is offering a support rate on the reserves or is selling debt to the private sector at volumes commensurate with that required to drain the excess reserves.
Either way the government pays interest on the reserves. The trick here is to recognise that the government is a consolidated entity comprising the central bank and the treasury. Please read the blog – The consolidated government – treasury and central bank – for more clarification of the significance of this.
The point is that there is nothing cosy about knowing that the central bank pays the treasury the interest back. The fact is that the government still has to pay interest on the bank reserves unless it is prepared to run a zero interest rate policy.
With a zero interest rate policy, the non-government sector would be largely indifferent to holding bonds and/or cash reserves. And clearly, any interest payments that the government faced would fall to zero should the central bank decide buy the debt each issue.
But what a long-handed way of proceeding. The issue of the size of the interest payments bill each month is not about debt at all. It is about the monetary policy rate target which arises because the government net spends (and adds to reserves) rather than because it issues debt.
We have seen that the government would still have to pay interest (on reserves – via the central bank) even if it didn’t issue any debt. So it all comes down to what the central bank wants the short-term rates to be. It can always keep the interest payments down to minimal levels by keeping the short-term rate at or around zero.
Getting back to the humiliation of the USA, I liked Baker’s conclusion:
Of course, if Brooks really wants to tell a story of national humiliation, he just has to look around beyond the streets and restaurants that he and his friends frequent. The country has more than 25 million people who are unemployed, underemployed or who have given up work altogether. Tens of millions of people are underwater in their mortgages and millions face the imminent prospect of losing their home through foreclosure.
This might not be the apocalypse, but it should be humiliating to the nation, especially since this suffering is entirely due to incompetent economic policy and therefore was and is entirely avoidable. And, Brooks doesn’t even have to wait for 2020 to talk about this picture.
Absolutely! That is humiliation par excellence.
So there is no apocalypse coming. Just a very messy and protracted recession/tepid recovery all self-imposed by the government on its citizens. It is totally unnecessary and incredibly damaging. But try telling that to the co-chairs of the Fiscal Commission who probably have nice warm offices and secure salaries.
Advertising segment: Annual CofFEE Conference – December 2-3, 2010
Each year my research centre – The Centre of Full Employment and Equity (CofFEE) hosts the annual Path to Full Employment Conference. For many years it has also been combined with the National Conference on Unemployment (which began in the aftermath of the 1991 recession as a venue to discuss ideas about the persistently high unemployment that remained for some years after that downturn.
This year we are hosting the 12th Path to Full Employment/17th National Unemployment Conference at the University of Newcastle (NSW, Australia) from Thursday, December 2 to Friday, December 3, 2010.
It is a chance to meet a lot of the Modern Monetary Theory (MMT) developers and to participate in debates. Newcastle is beautiful at this time of year – sunny and warm with great surf beaches.
The conference is accessible for all interested parties and is not overly academic. A lot of government officials and workers from relevant sector organisations attend as well as academic researchers.
So register and come along if you would like a nice few days in Newcastle.
That is enough for today!