When former politicians and bureaucrats get bored with golf …

What do you get when a bunch of former politicians who have an inflated sense of self-importance and cannot stay out of the public glare? Well one answer is nonsense. The related answer is the so-called Pew-Peterson Commission report Red Ink Rising, which was released in December 2009 with the by-line “A Call to Action to Stem the Mounting Federal Debt”. And with the Copenhagen climate change talks being the big public interest story of the week it was only a matter of time before soon goon started mapping the public debt-hysteria debate into the climate change debate to bring home the message to all of us that we are doomed unless we do something drastic. Its been quite a day down here!

So what is the Pew-Peterson Commission? Their home page indicates that there are three partners involved:

  • The Committee for a Responsible Federal Budget which is the parent organisation of the US Budget Watch Project – they say they are a “bipartisan, non-profit group committed to educating the public about issues that have significant fiscal policy impact” and is “made up of some of the most important budget experts in the country including many of the past Directors of the Budget Committees, the Congressional Budget Office, the Office of Management and Budget and the Federal Reserve Board.
  • Peter G. Peterson Foundation – set up by a private rich guy who made money in private equity buyouts and real estate – which is “dedicated to increasing public awareness of the nature and urgency of key fiscal challenges threatening America’s future, and to accelerating action on them”. Peterson himself has been raving on about the “large and growing budget deficits, dismal national and personal savings rates, and a ballooning national debt that endangers the viability of Social Security, Medicare, and our economy itself” (Source). So a fairly emotional chap by all measures.
  • The Pew Charitable Trusts – set up by the family of a rich oil baron it is less obvious than the previous two partners but it imbued with the raa-raa American-stuff – “Here, the door of opportunity has been kept open for every man, irrespective of creed, class or color. Here, men found that when they succeeded, they were rewarded in proportion to their achievements” (Source) and claims that its work is “nonpartisan and grounded in reliable data. It unites nationally recognized, and ideologically diverse, scholars, economists, social scientists and policy experts.”

Whenever I see big well-endowed foundations, trusts or committees emphasising how “non-partisan” they are I am immediately suspicious. Especially when it is followed by statements about “debt holes” and “ballooning national debt” and “large and growing budget deficits”.

Seems like something can be considered bi-partisan when retired Democrats and Republicans decide to combine to issue a joint report. But of-course the ideological bias of both sides of US politics (defining sides here as the main parties only) means that the economics they use is anything but bi-partisan.

Neither side of US politics ever present an alternative economics viewpoint. I wonder whether they consulted any modern monetary theory (MMT) proponents? I wonder whether any Post-Keynesians, Institutionalists, Marxists and whoever were consulted. As a result of this omission, I conclude that their claim to being non-partisan is ridiculous. They do not have that authority.

Just the language they use gives them away as having made their mind up without actually understanding very much about how the monetary system that they are pontificating about, in all their self-importance, operates.

What a gall they have to say that they are “committed to educating the public about issues that have significant fiscal policy impact”. Education is a process of enlightenment via knowledge and does not include brow-beating the population with fiction.

Anyway, the Report looks to me to be the work of a bunch of retired pollies and bureaucrats who are missing the limelight and who are being helped by some hot money from Peterson and Pew who are pushing their conservative barrows.

The release of the Report was given a massive press coverage. The headline in the Financial Times was Washington warned of crisis unless debt is stabilised and said:

The US is heading for a public debt crisis unless action is taken soon to stabilise debt relative to national income, a bipartisan group of former congressmen, White House officials and budget experts warned yesterday.

Public debt crisis? What the non-government sector is becoming too wealthy? The income flows from the debt are giving the recipients too much income?

In relation to the US, the Report says (page 3):

Without a dramatic shift in course, the debt will grow to unprecedented levels, breaking the 200 percent mark in 2038. Well before the debt approaches such startling heights, fears of inflation and a prospective decline in the value of the dollar would cause investors to demand higher interest rates and shift out of U.S. Treasury securities. The excessive debt would also affect citizens in their everyday lives by harming the American standard of living through slower economic growth and dampening wages, and shrinking the government’s ability to reduce taxes, invest, or provide a safety net.

Its all there folks! Everything – inflation, depreciation, crowding out, insolvency … the US running out of money … then pestilence and we all feel sorry for America the once great nation which drowned in bits of paper that are 100 per cent guaranteed by a national government which has the sole authority to issue the currency units that are written on the bits of paper.

Alcoholics have to commit to a 10-step plan, but the Report only requires the US government to commit to a 6-step plan:

Step 1: Commit immediately to stabilize the debt at 60 percent of GDP by 2018;

Step 2: Develop a specific and credible debt stabilization package in 2010;

Step 3: Begin to phase in policy changes in 2012;

Step 4: Review progress annually and implement an enforcement regime to stay on track;

Step 5: Stabilize the debt by 2018; and

Step 6: Continue to reduce the debt as a share of the economy over the longer term.

In fact there are 10-step plans everywhere if you Google them. So here are some extra points they might logically have asked to be included:

Step 7: Ensure all these fiscal adjustments continue without the slightest regard for the state of capacity utilisation in the US;

Step 8: Ignore any labour market dynamics that accompany the cut back in net government spending including persistently high unemployment;

Step 9: Completely disregard the saving intentions of the private sector in the US and squeeze them so badly that they will be forced to increase indebtedness to maintain spending;

Step 10: empower the financial engineers with more freedom to ensure Step 9 is accomplished.

The extra steps will be required if they are to succeed (temporarily with the first six steps).

Delving into the Report in more detail – yes, my research life is one of misadventure … dead-ends … and total tedium … but someone has to do it – you find some explanation for the all important Step 1:

The 60 percent debt threshold is now an international standard – regularly identified by the European Union (EU) and the International Monetary Fund (IMF) as a reasonable debt target.

Yes, identified by the crippled Eurozone system and the neo-liberal IMF which systematically impoverishes the most disadvantaged citizens in the world.

The only discussion you get on the 60 per cent rule appears on Page 15 of the Report – this is as close as you get to a justification:

From a financial perspective, the United States must persuade credit markets that it is serious about debt reduction. Global markets are more likely to embrace a plan if the goal has international credibility. The 60 percent debt threshold is now an international standard. In the EU, under the requirements of the Maastricht Treaty and the Growth and Stability Act, EU countries must satisfy a benchmark target of 60 percent of GDP for debt and 3 percent for annual deficits. Likewise, the IMF has singled out the 60 percent debt target as a reasonable benchmark. Given the significant risks of high U.S. debt, a less aggressive target might be insufficient to reassure the markets.

I particularly like the reference to “an international standard” – who determines that? The EU or the IMF? Who says that global markets think that 60 per cent is credible? How can global credit markets place any restrictions on the US government that it doesn’t wish to have?

Anyway, take the 1992 Maastricht Treaty 1992 for example which set up the final phase of the EMU. The treaty stipulated that countries seeking inclusion in the Euro zone had to fulfill amongst other things the following two requirements: (a) a debt to GDP ratio below 60 per cent, or converging towards it; and (b) a budget deficit below 3 per cent of GDP.

Where did these rules come from? The Delors Report (1989) was the first major report leading up to the final phase. It was the output of the Committee, chaired by Mr Jacques Delors, then President of the European Commission which had the “task of studying and proposing concrete stages leading towards this union”. It didn’t say anything about the 60 per cent rule nor provided any economic theory which might have led a conclusion that the rule was “optimal”.

The specifics did not emerge until these two reports (which I cannot find links to – I have hard copies):

  • European Commission (1990) ‘One Market, One Money’, European Economy 44.
  • European Commission (1994) ‘Towards Greater Fiscal Discipline’, European Economy – Reports and Studies, No. 3.

However, none of these publications provide any solid (derived) theoretical justification for the 60 per cent threshold. Try as you might you will not find any economic rationale for these fiscal criteria in the literature that is robust. They are made up.

You will find a lot of articles that model stock-flow adjustment paths and play cute games with the rules to conclude that one country or another is doomed or will adopt some fancy accounting to meet the rules. But you won’t find a coherent argument why it is 60 per cent rather than 20 or 50 or 71 or 89 or any other number that someone could write on a bit of paper.

Some have tried to justify them on the grounds that there are two types of government – those that are disciplined and those that are not. For the monetary system to run smoothly the latter group have to be eliminated but first they have to be identified. The rules identify them clearly (according to this perverted logic). The debt rule then “attempts to distinguish disciplined from undisciplined governments according to the magnitude and persistence of those deficits, as reflected in the level of public debt” (Source).

Others claim there is an optimal size of government which is determined using very flawed econometric models whereby tax elasticities are estimated and related to the point where private spending is meant to decline after some tax threshold is reached. I won’t go into the econometrics of this literature but I can assure you it is as bad as it gets.

Conceptually, the literature also assumes without question that national governments are budget constrained and have to raise tax revenue to balance budgets over time. While the econometric gymnastics that are used to derive the “optimal” size are without credibility, the underlying theory which drives the empirical work is just wrong.

Further, such a debt threshold tells you nothing at all about fiscal displine. Imagine an economy faced with a sequence of aggregate demand failures due to private sector pessimism. Without any change in fiscal parameters, the government would see its deficit increasing and because it voluntarily ties net spending to debt-issuance, the former will also rise. You can easily construct circumstances where the debt/GDP ratio could skyrocket without any discretionary change in fiscal policy at all.

In a 2006 book I published with Joan Muysken and Tom Van Veen – Growth and cohesion in the European Union: The Impact of Macroeconomic Policy. In that book, we show that it is widely recognised that these figures were highly arbitrary and were without any solid theoretical foundation or internal consistency.

The rationale of controlling government debt and budget deficits were consistent with the rising neo-liberal orthodoxy that promoted inflation control as the macroeconomic policy priority and asserted the primacy of monetary policy (a narrow conception notwithstanding) over fiscal policy. Fiscal policy was forced by this inflation first ideology to become a passive actor on the macroeconomic stage.

As a result of the establishment of the European Central Bank (ECB), European member states now share a common monetary stance. The The Stability and Growth Pact (SGP) was designed to place nationally-determined fiscal policy in a straitjacket to avoid the problems that would arise if some runaway member states might follow a reckless spending policy, which in its turn would force the ECB to increase its interest rates.

Germany, in particular, wanted fiscal constraints put on countries like Italy and Spain to prevent reckless government spending which could damage compliant countries through higher ECB interest rates.

Aided by the growth period following the 1991 recession, the fiscal constraints were met by all aspiring member states. Emboldened by this success, and more alert because the date for the Euro introduction was approaching, the Euro countries decided in the 1997 Amsterdam Treaty that the rules should be sharpened.

The deficit should be either zero or in surplus, and when it threatened to reach 3 per cent of GDP, countries should take appropriate measures. This requirement, formalised in the SGP, was criticised by many economists.

Even economists operating from within the so-called orthodox deficit dove paradigm argued that there is no rationale for zero government debt, which a zero deficit would imply in the long run. While the doves work within the government budget constraint framework which is clearly flawed when MMT is understood these economists still argue that it is more fruitful to concentrate on stimulating economic growth, than it is to anxiously guard government deficits

From the dove viewpoint, public borrowing is constructed as a way to finance capital expenditures. Since government invests a lot in infrastructure and other public works, those investments should at least allow for a deficit. This was already recognised by the classical economists as a golden rule of public finance.

So even within an orthodox public finance model, the stipulations of the SGP were difficult to justify.

From a MMT perspective, economists who advocate the SGP fail to comprehend the basis of government spending and in imposing these voluntary financial constraints on government activity, deny essential government services and the opportunity for full employment to their citizenry.

The requirement that budget deficits should be zero on average and never exceed 3 per cent of GDP not only restricts the fiscal powers that governments would ordinarily enjoy in fiat currency regimes, but also violates an understanding of the way fiscal outcomes are effectively endogenous.

Any economist with even the simplest understanding of the way in which automatic stabilisers operate will see the lack of wisdom in the SGP rule. A sharp negative demand shock which causes an economic downturn will reduce tax receipts and increase benefits, automatically increasing the deficit.

Reducing government expenditures in that situation to meet the rule will worsen (prolong) the recession, which is then likely to involve the country in further SGP rule violations. The vicious circle of spending cuts implied is unsustainable and amounts to fiscal vandalism. In other words, fiscal policy becomes pro-cyclical under the SGP rule violating any sensible ambitions that are the ambit of responsible fiscal management.

Another problem relates to the bias in the way fiscal adjustment is conceived. In particular, it is automatically assumed that discretionary actions to reduce the budget deficit will involve spending cuts rather than increasing taxes. This leaves the impression that some politicians are not primarily concerned about the size of the budget deficit, but covet the 3 per cent rule as a welcome excuse to force their ideological predilection for small government.

In other words, the ideological bias against public activity, particularly in the social security sphere, is dressed up as prudential economic management to give the crude religious zeal an air of authority and respectability.

The SGP rule cannot be seen in isolation of the acceptance by EU countries of the voluntary monetary policy straitjacket that the ECB acceptance imposes. While the ECB now has a monetary policy monopoly across the EU countries, it is not politically responsible for its actions.

The EU countries have voluntarily allowed the ECB to be an unelected and independent body whose sole aim is to control inflation. The fundamental democratic principle that the citizens have the ability to cast judgement on the policies of their representatives at regular intervals has been abandoned in this setup.

This voluntary monetary policy straitjacket suggests that countries have to use fiscal policy to react to economic shocks which affect the real economy. However, the SGP has imposed an inflexibility on this discretion and stagnant economic outcomes have been the norm.

It is often said that the European economies are sclerotic, which is usually taken to mean that their labour markets are overly protected and their welfare systems are overly generous. However, the real European sclerosis is found in the inflexible macroeconomic policy regime that the Euro countries have chosen to contrive.

The rigid monetary arrangements conducted by the undemocratic ECB and the irrational fiscal constraints that are required if the SGP is to be adhered to, render the nation states within the Eurozone incapable of achieving low levels of unemployment and increasing income growth.

In terms of ideology the IMF takes the cake in the fiscal sustainability area. I particularly liked this opening slide which came from an IMF regional workshop presentation on debt where sovereign default was discussed. Pick the ideological bias and theoretical flaw in relation to any sovereign government?


Yes, the household which uses the currency is not remotely like a government which issues the currency. The house burning is meant to bring the flawed but powerful household analogy into play.

At least they could be a bit more subtle about it, no?

Anyway, we shouldn’t ignore the important Pew-Peterson Report which was written by a host of important people. In the Report, you read statements such as:

The economy is expected to recover, but the federal budget may not …

What does that mean? It is obvious that we can make unambiguous assessments about the state of the economy. We know when the economy is in trouble. High unemployment; sluggish growth in output, productivity, wages; high inflation etc. All those things have meaning and can be mapped back into our lives in a direct manner.

But what does a budget deficit that is 10 per cent of GDP mean in isolation? Is it worse than one that is 5 per cent? From the logic of the Report it is twice as bad.

However, MMT tells us that the 10 per cent deficit might be better or worse than the 5 per cent depending on the state of the real economy that determined the accounting outcomes. You could have a fully employed economy with a budget deficit of 10 per cent of GDP (driven by discretionary policy choice) supporting private saving yet also have a budget deficit of 5 per cent (driven by automatic stabilisers) where mass unemployment was high and GDP growth stagnant.

Which one is better? Well the answer is clear. Further, if the government took the 5 per cent outcome and expanded the deficit to 10 per cent it might get the economy into the shape described by the former situation.

The point is that these mindless statements about fiscal health based on comparing numbers and asserting that a big number is bad and a small number is good is without any foundation and should be ignored.

On Page 11 of the Report you get the “kitchen sink” of horror stories. This is high comedy. The headings and snippets below are indicative:

The economic consequences of too much debt – Excessive debt can hurt a country, its citizens, and its economy in many ways. It can harm the economy by pushing up interest rates – something that would be particularly dangerous as we are coming out of a recession.

… it deprives the country of the fiscal flexibility to respond to future crises and new national priorities as they arise.

Living standards decline. As debt increases, interest rates are likely to rise since the government will have to pay more to attract capital. This can “crowd out” private investment, and make it more costly to borrow for everything from housing to education to business investments.

Interest payments rise and squeeze out other priorities. Greater levels of debt and higher interest rates mean rising interest payments for the government. As interest payments become a larger share of the budget, they squeeze out other important tax and spending priorities.

As the government relies more on foreign creditors … relying on foreign capital means that the interest and dividends from these investments go overseas and it also leaves the United States more dependent on and vulnerable to changes in international lenders’ investment preferences.

As international investors become more concerned about U.S. fi scal stability, the dollar may no longer be the foundation of global economic transactions.

Future generations pay the price. In addition to experiencing lower living standards, future generations will be left

No theoretical model is presented to justify any of these claims. Probably an old tattered copy of Mankiw was hanging around and some assistant was given the job of copying sections of it out for the Report. But then any mainstream macroeconomics textbook would have probably been fine for their task.

By the way, after the Second World War the British public debt exceeded 300 per cent of GDP without any significant issues. The children who grew up in the 1960s and 1970s were considerably better off as a consequence of the public infrastructure created and services provided.

It is clear that the Report wants the US government debt retrenchment process to provide for “fundamental tax reform” (tax cuts for the rich); “improving labor force incentives” (more onerous welfare-to-work rules and a loss of welfare provisions); “and protecting productive investment spending” (hand outs to the rich) – these reforms “should be given special consideration when crafting a plan”.

They also suggest that major spending cuts have to be made in the areas that are driving the deficits – “such as health and retirement programs, are the most likely to produce compounding savings, which not only help stabilize the debt in the medium term but keep it from growing again over the longer term”.

I read nothing at all about the need to ensure full employment is created and that workers, who have been enduring years of near zero real wages growth while the Wall Street bullies made of with the booty, get some semblance of distributional equity.

I read no analysis at all of how the deficit contraction proposed would sit with the saving desires of the non-government sector. There is a lot of nonsense about the US government needing to draw on savings – as if they are finite and not generated by the deficits in the first place. But no understanding is provided of the role that the deficit plays in a modern monetary economy.

There is no analysis of essential financial market reforms – banks, investment banks, derivative trading, etc – that might reasonably be made to ensure that financial markets serve public purpose as a true public-private partnership rather than undermine the real welfare of millions through the imprudent and illegal casino-like behaviour of a few.

The Report is just a mindless rehearsal of the notion that a big number on the deficit is bad per se and a lower number is better. There are only so many ways that you can make that point but the Report manages to include all of them.

Finally, after asserting that the US government was constrained fiscally by all the competing demands on the budget – no analysis provided to justify this – the Report then proposed:

There needs to be a mechanism to help keep any plan on track once it is adopted. Simply pledging to meet certain targets may not reassure financial markets – there have been too many past examples of empty promises and budget gimmickry.

The Commission recommends enacting a “debt trigger”, which would take effect if an annual debt target were missed. Any breach of the target would be offset through automatic spending reductions and tax increases. The Commission recommends that the trigger apply equally to spending and revenue. There would be a broad-based surtax, and all programs, projects, and activities would be subject to this trigger.

So doesn’t matter whether there is high unemployment or failing industries – pull the trigger and do your bit for the nation.


The only thing going for the Report is its colour layout – a nice blue with white backing. Very soothing on the eyes.

Then we get to climate change

But that is a story for tomorrow perhaps unless something else comes along that requires attention.

This Post Has 10 Comments

  1. “But of-course the ideological bias of both sides of politics (defining sides here as the main parties only) means that the economics they use is anything but bi-partison.”

    Reminds me of the redneck bar in “The Blues Brothers”: “Oh, we play both kinds of music here – country AND western!”

  2. Bill,

    Off topic for this post, but Menzie Chin is out with a post today entitled, “Teaching macro, after the Great Recession.”

    Looks to me like its following down the same wrong track, but it’s beyond my ability to critique. I’d be interested in hearing your take, if you think it would be of interest to the other readers of this blog.

    Thanks for your attention,

  3. Tom,

    I read that link you posted. I got as far as the discussion on the “Consumption Function” and burst into uncontrollable laughter to the point whereby I could no longer continue.

    In a nutshell – much ado about nothing.

    cheers, Alan

  4. The Pew Charitable Trusts are a big public radio advertiser. To some of us out here in the US, they are known as the “FEW” Charitable Trusts. It makes listening to their ads a little easier to take.

    I think the burning house is supposed to represent the level of public services we can expect once we impose “sound debt” management.

    And would it be so hard to create a corresponding private lending metric equivalent to the public budget deficit? If these buffoons can create concepts such as unfunded liabilities and NPV on an infinite horizon, we need a valid, easily understood metric to measure the gap in private spending. A snappy name wouldn’t hurt either.

    And even if crowding out were not a bogus concept, why wouldn’t we want some of the idiotic private spending of the past quarter century to BE crowded out. You mean, the Dubai Disneyland might have been crowded out if we had been spending more on public services? What a horrible thing! We need to have our celebrities well taken care of in a gated city in one of the most impoverished areas of the planet to demonstrate our ethics to the rest of the world. Just think what other monstrosities we could avoid if we can crowd out that spending – more public deficit, please!!

  5. LBOs were allowed to have leverage of 5-10 and with similar crazy income/debt coverage. Can it be somehow compared to public debt? Is GDP a good approximation of company equity?

  6. Sergei,

    The comparison of public debt to a company is not a good one for the same reason that the comparison of a government budget to a household one is not a good one. As Bill notes in this post, households and businesses are users of the currency, while governments are monopoly issuers of currency (at least in countries like the US, UK and Australia which have fiat currencies and flexible exchange rates).

    Even if you did want to make the comparison as a diverting evercise, GDP is the annual product of the country not the value, so it would be more analogous to earnings. If we assumed a price=to-earnings ratio of, say, 10 times then we could loosely impute a value of 10xGDP to the national economy. Then even a public debt of 200% would only represent debt of 10% of the “value” of the country, small beer in comparison to the 5-10x leverage ratios you mention in LBOs.

    So, if the analogy was meaningful, the public debt would still look small, but we don’t even have to worry about in those terms as the analogy does not in fact hold.


  7. So if I understand this article correctly, it’s perfectly okay – even good – for the government to make promises it can’t keep?

  8. Bill, I think I understand your formulation that rubbishes the “one deficit-to-GDP ratio fits all” idea. However, ideas such as those you’ve given us here are being used by others right now also to rubbish the idea that America should use ANY fiscal discipline whatsoever, to keep us from running deficits comparable to the PIGS I countries. I think that this shows no appreciation for the fact that we are no longer the America of 1950, on the gold standard, or of 2001, where our dollar was buoyed by Asian central banks repatriating funds to buy US Treasury bonds.

    In cutting loose from any worry and saying, to paraphrase some French movie, “No deficit spending is wrong if it feels good,” people have not defined ANY ceiling at which either 1) rates we must pay are too high, or 2) the volume of debt we take on is too high to service it. You say the 3% ceiling wasn’t backed up by any model. Fair enough. But what of YOUR model? Surely you’re not saying that any loan-shark rates are hunky-dory, and that ANY debt level is sustainable? What levels, then, must concern us for rates or volume of debt?

    You complain that no model is used to justify the claim that

    “Greater levels of debt and higher interest rates mean rising interest payments for the government. As interest payments become a larger share of the budget, they squeeze out other important tax and spending priorities.”

    Who on earth needs a model for that? It’s simply a fact that if one defaults on one’s debt, one doesn’t get any more credit. So one pays one’s debts as the highest priority. Individuals may declare bankruptcy, and forget their debts; but a government that does that is in trouble, deeply. Nor, now that China has cut its holdings of US treasuries by $34 billion in December ($45 billion since last May), is it strange, nor is a model needed, to think that:

    “As international investors become more concerned about U.S. fi scal stability, the dollar may no longer be the foundation of global economic transactions.”

    That, too, is simple, and requires no mathematical model. It’s simply creditors behaving the way creditors do. And China has worried aloud and publicly for years about our deficit spending jeopardizing the worth of its treasury securities. Now they’re pulling out, and since last spring, the world as a whole has divested from our securities more than it’s cut.

    Forgive me if I’m misunderstanding you somehow, but please advise.

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