Tag Archives: debt

James Hamilton @ Econbrowser wonders whether our deficits will result in a looming fiscal ‘tipping point’:

It is important to recognize that we are not proposing that creditors will all of a sudden refuse to hold dollar-denominated assets. The question instead is whether demand for U.S. Treasury debt will continue to increase every year faster than the U.S. economy can grow.


Recall that the debt itself will be growing as a result of continuing deficits. A higher interest rate and growing level of debt would mean that the fraction of federal spending that is taken up by interest expenses will grow considerably over the next decade. The CBO anticipates that, under current law (that is, assuming for example that the recent “sequester” and planned future spending reductions remain in effect), federal net interest expense will grow to 3.3% of GDP by 2023. At that point (and again assuming that the spending reductions specificed under current law continue for the decade), interest expense would be higher than either the total defense budget or the total discretionary component of the nondefense budget.

I believe this argument misses the real chain of causality. This is an argument Scott Sumner has previously made. Here are a few reason yields are low:

  • No one wants to invest in anything (companies have loads of useless cash)
  • The Fed has been buying up assets because demand is lethargic
  • The market doesn’t expect yields to increase anytime soon (because they’re forward looking, and any serious such expectations would start to materialize now)
  • Other countries run a dollar trade surplus and have nothing else to do, creating a captive demand for dollar-denominated debt
  • Banks hold excess reserves
  • We’ve hit a zero lower bound

The post rightly wonders whether demand for this debt, determined by any amalgam of the above factors, will continue to rise, keeping our yields low. While Hamilton worries about this vis-a-vis rising interest rates, I think it’s rather obvious this is a good thing.

If demand for American debt can’t keep up, here are a few reasons why:

  • Our trade deficits are declining, as manufacturing picks up
  • Unemployment is down
  • Businesses got bored of cash and decided investment might pay off
  • Banks got bored of cash and decided to lend money (because people wanted it)
  • People expect more of this to happen in the future

That all sounds pretty good to me. Eventually, any of the above five options will result in robust (vis-a-vis today) economic growth. The same automatic stabilizers that increased our deficits will bring in greater revenue, bringing deficits down.

This better economy will also (hopefully) signal a less divided political climate, that can tackle the real challenge of future Social Security and Medicare outlays. Unfortunately, the market doesn’t expect this to happen, or we’d have seen rising yields.

One final point: none of this is to say that increasing the debt servicing to GDP ratio is a good thing, it’s not. And this is another problem that is eminently solvable if the US moves its debt towards longer maturities, or even perpetuities. We’re already in the process of rolling over our debt to 30-yr bonds. This will cushion any future increase in yields. It’s not a long-run solution to anything, but it is a (seemingly) smart stopgap in between.

h/t: Tyler Cowen

Edit: Dean Baker has some thoughts that echo my thoughts, perhaps in better words!

After the heated debate between Joe Scarborough and Paul Krugman, Jeffery Sachs and Scarborough co-authored an op-ed in the Washington Post, contending that “Deficits do Matter“. Paul Krugman replied with some good points and asks Sachs, what exactly he considers “crude Keynesianism”. To this, Sachs wrote a well-thought editorial in the HuffingtonPost.

I don’t think the attack on Krugman is fair – I’ll get to that later – but I also think Sachs’ argument fails to grasp the extent of cyclical (rather than structural) downturn, the extent to which ‘infrastructure’ can create immediate jobs, and external factors, like the European crisis. Ultimately, I think Sachs misrepresents his own (good) ideas under the guise of ‘debts are bad’. Infrastructure spending is smart, necessary and, yet, increases our structural deficit. Sachs is absolutely right that stimulus won’t solve long-term unemployment. Sweeping AS reforms, however, won’t be as quick to solve short-term unemployment. Skill atrophy will force long-term unemployment, in some measure, to be a function of short-term unemployment (though, WWII is a pretty good example to the contrary). There is no reason the US can’t both stimulate the economy with spending while at the same time overseeing broad, long-term, structural reforms.

So what is crude Keynesianism? According to Sachs:

(1) The belief in large, stable, and predictable multipliers on taxes and transfers;
(2) The belief that our problems are due overwhelmingly to a deficiency of aggregate demand, rather than to structural problems that need a long-term approach;
(3) The belief that a rapidly rising debt-GDP ratio is largely benign because interest rates are low today and will stay so indefinitely;
(4) The belief that “to a large effect, spending is spending,” thereby catering to waste and vested interests while ignoring America’s urgent investment needs.

I believe that all of these positions are misguided.

He continues:

The belief in stable, predictable, and large multipliers is belied by both theory and evidence. Households and local governments might simply use a temporary tax cut or temporary transfer, for example, to pay down debts rather than to increase spending, especially because the tax cut or transfer is seen to be temporary. Businesses, concerned about the buildup of public debt, might hold back on business investment in the face of large deficits, anticipating higher taxes in the future.

That families might use stimulus checks to pay down debts is incorporated into any calculation of a multiplier which is inversely proportional to the marginal propensity to save. Sachs might argue that the method in which multipliers are calculated is incorrect, which might well be the case, but is not in itself a criticism of Keynesian policy. The rational expectations argument has a lot of appeal, but is ultimately predicated on the idea that much of our deficits are structural. If deficits are primarily cyclical, a government can impose a one-time high tax that would have no effect on future investment (whether this is subgame perfect or not is another story).

Key to Sachs’ argument is that we face a looming structural deficit:

These structural components are not susceptible to a Keynesian diagnosis or to a Keynesian remedy. They require a long-term public investment response that has not been forthcoming.

Second, Krugman seriously and repeatedly downplays these structural changes occurring in the U.S. economy. He repeatedly emphasizes that we suffer a demand shortfall, pure and simple, one easily remedied by more stimulus. Yet it’s increasingly hard to reconcile many features of the U.S. economy with this view.

Unlike the Great Depression, which Krugman repeatedly uses as his reference point, U.S. profits are soaring. Unlike the Great Depression, the world economy is growing rather rapidly (3 to 4 percent per year) so that more rapid U.S. export growth is feasible. Unlike the Great Depression, vacancy rates are recovering even as unemployment is stuck. (Technically, the Beveridge Curve has shifted to the right.)

I completely agree that the US is ripe for vast reinvestment in infrastructure and public works projects (oh, and, Krugman does too). However, that much of our deficit is structural is plain false:


When we consider deficits as a proportion of potential GDP, the deficits are coming down. Sachs and Scarborough don’t acknowledge that CBO estimates a flat debt-GDP ratio over the next decade. We have a long-run spending problem which, again, has nothing to do with a criticism of short-run stimulus. CBO budget projections are pretty accurate in the short-horizon, and at this rate cyclically-adjusted (or structural) deficits will fall below 3% this year. This is eminently feasible, at current growth rates.

This rides in well into his third criticism of of ‘crude Keynesianism’ – that it suggests a rising debt-GDP ratio is somehow okay. Krugman certainly doesn’t think so. And while long-term problems are better solved today, their existence doesn’t somehow void the need for short-run stimulus. For this reason, this sounds like an unfair argument:

Third, crude Keynesians like Krugman believe that we don’t have to worry about the rising public debt for many years to come, perhaps well into the next decade. This is remarkably shortsighted. The public debt has already soared, from around 41 percent of GDP when Obama came into office to around 76 percent of GDP today (and with no lasting benefit to show for it). If Krugman had his way, and deficits were not restrained, the debt-GDP ratio would already be above 80 percent by now and would be rising rapidly towards 90 percent and above (as shown in the recent CBO alternative scenario).

For one, ‘has increased’ is wildly different from ‘is increasing’ – not the least that the former is true while the latter is not. Furthermore, so long as growth projections outpace structural deficits, there isn’t something magical about a 90% debt-GDP ratio. Indeed, growth would have picked up faster, and fewer people would be unemployed, and even fewer permanently unemployable. A self-proclaimed progressive like Sachs should care about this. A lot.

Most of the shortfall this recession has been due to demand-deficiency. While supply-side reforms are crucial, we’re not experiencing any severe cost-push inflation. We have time to implement a well-thought infrastructure plan that would invigorate our power grids in an environmentally and economically sustainable fashion.

Further, Obama has tried to leverage global growth to the greatest extent he can. While Sachs might argue Krugman hasn’t ‘quantified’, the effect of the European crisis is pretty obvious. Sluggish European demand has widened our trade deficit and, for the first time, the greatest trade growth in developing countries has come from other developing countries. China is now the largest trade partner for most countries. It’s not as easy to ‘tap in’ to global recovery as it once was. Obama is pursuing a European free-trade deal that would hopefully spur job growth. Both the United States and Europe are in dire need for homogenized regulations, we have good reason to believe the President can pull this off.

Sachs’ interpretation of future interest rates is also questionable:

It’s true that we’ve not paid heavily so far for this rising debt burden because interest rates are historically low. Yet interest rates are likely to return to normal levels later this decade, and if and when that happens, debt service would then rise steeply, increasing by around 2 percent of GDP compared with 2012. Many people seem to believe that we can worry about rising interest rates when that happens, not now, but that is unsound advice. The build-up of debt will leave the budget and the economy highly vulnerable to the rise in interest rates when it occurs. The debt will be in place, and it will be too late to do much about it then.

If a vedic astrologer told me that rates would be ‘normal’ later this decade I would be thrilled. It means businesses aren’t hoarding cash, private investment is increasing, unemployment is falling and, as automatic stabilizers start slowing, decreasing deficits. Alas, this is not the case. Markets are forward looking, and any expectation of future growth or rise in interest rates would result in a discounted increase today, which is not the case. Yields capture the macroeconomy. Furthermore, we’ve rolled over a lot of our debt on longer maturities. The effect of increasing yields will be slow to cause rising deficits.

There also seems to be an unfair criticism of Krugman vis-a-vis his former positions:

Krugman, an economist and New York Times columnist, agreed not so long ago with our position that demographic challenges demanded fiscal restraint. In 2001, he wrote that deficits mattered as he inveighed against President George W. Bush’s tax cuts. With the gross federal debt then at a mere $5.6 trillion, Krugman nervously declared that balancing the budget “is mainly a matter of preparing for the fiscal consequences of an aging population.” But these days, Krugman tends to be a bit more dismissive about the dangers of long-term debt despite America’s aging population and the addition of another $10 trillion of debt in the past 12 years.

In fact, Krugman’s argument is highly consistent. If the economy is in the gutter, it’s okay to spend more. It’s a pretty terrible idea to run deficits when it’s expanding. Krugman isn’t arguing for structural deficits that outpace growth, only the need for cyclical stabilizers. This is both economically and morally sound.

However, I completely agree with Sachs on his policy recommendations, as well as his dissatisfaction with Obama’s first-term economic team:

(1) Decade-long public investment programs in renewable energy, upgraded public infrastructure, fast rail, job training and the like;
(2) Adequate fiscal revenues (including tolls on infrastructure) to pay for these investments over the course of a decade, including a downward path of the debt-GDP ratio;
(3) Increased revenues through taxation on high net worth, financial transactions, high incomes, capital gains and carried interest, offshore corporate earnings, and carbon emissions, and a stiff crackdown on tax havens and phony transfer pricing.

All of this would have been much easier if Obama had started down this long-term path in 2009, and had never conceded the permanence of the Bush-era tax cuts for almost all households. Instead, he followed a populist and shortsighted policy of “stimulus” and tax cuts.

Green investment will be a crucial and also empowering driver for not just economic growth, but America’s standing as a hub of real innovation and moral agency. As a recent San Francisco Fed paper argues, infrastructure spending isn’t mutually exclusive with short-run stimulus, as is sometimes thought:


While most of the gains come 6-8 years after increase in investment, there is a not insignificant increase in immediate activity. Indeed, ARRA included just under $30 billion in highway grants.

I found this paragraph to be very important (and apparently Tyler Cowen does too):

This approach is disastrous both politically and economically. Progressives like myself believe strongly in the potential role of public investments to address society’s needs – whether for job skills, infrastructure, climate change, or other needs. Yet to mobilize the public’s tax dollars for these purposes, it is vital for government to be a good steward of those tax dollars. To proclaim that spending is spending, waste notwithstanding, is remarkably destructive of the public’s trust. It suggests that governments are indeed profligate stewards of the public’s funds.

However, as a progressive I ultimately disagree that short-term spending is misguided. Much of the stimulus and cyclical deficit was directed in financing unemployment insurance and transfers for the relatively poor. By virtue of a flat dollar reimbursement and nature of the tax holiday, the largest beneficiaries of this scheme are those who earn the least. While Sachs approaches this spending from a merely artificial economic angle, there is a deeply human element, namely the funds provided by the recovery allowed many Americans to make end’s meet. This is a terrible way of achieving that necessary goal, but an important achievement nonetheless.

Ultimately, all of Sachs’ great ideas will require us to run greater structural deficits. Official estimates suggest the US government can invest about $80 billion a year more on infrastructure and see positive gains. Do I think we should spend that much? Yes. I just don’t think it’s politically feasible without deficit spending.

Unfortunately, Sachs can’t have the luxury of being both an advocate of public infrastructure and investment while simultaneously fearing our short-run deficit.

In his recent blog post, Noah Smith gives full life to a point I think Paul Krugman has been subtly making for a while – at a political level, the best policy is very irrelevant: 

This means that politics’ response to policy is highly nonlinear – give the enemy an inch, and they take a mile. It also means the response is highly path-dependent; precedent matters.

This discussion is a response Krugman’s take on Miles Kimball’s piece here. There’s a beautiful essay by Margaret Levi in this compilation. The better analogy, she claims is a tree, not a path: 

Path dependence does not simply mean that “history matters.” this is both true and trivial. Path dependence has to mean […] that once a country […] has started down a track, the costs of reversal are very high. There will be other choice points but the entrenchments of certain institutional arrangements obstruct an easy reversal of the initial choice. Perhaps the better metaphor is a tree […] From the same trunk, there are many different branches […] Although it is possible to turn around […] from one to the other – and essential if the chosen branch dies – the branch on which a climber begins is the one she tends to follow

Noah tackles the path dependence from a behavioral perspective, that technocrats like Kimball offer solutions that will ultimately be rejected by a public that thinks debt is bad: 

In other words, finding optimal, first-best technocratic solutions might be far less important than simply embedding “AUSTERITY = BAD!!!” in the public consciousness. 

The more salient point, one that Krugman makes, is that the political will doesn’t exist to mold to a more adept public. That is, Osborne and Cameron are highly averse to real stimulus because their careers have been staked on the virtue of austerity. Keynesians aren’t any better (except in that they are probably right). Krugman’s reputation would be forever stained if Eurozone austerity suddenly kickstarted private demand for investment, churning with it economic growth. 

Levi makes a striking point, “it is possible to turn around form one to the other, and essential if the chosen branch dies”. Embedding the idea that austerity is bad within the public conscious won’t do anything, precisely because his own point that politics are path dependent. More importantly, convincing the public that deficits are okay for now is a lot harder than it seems. The reason for this, of course, is many politicians and pundits have a reputation predicated on deficits being bad. So long as they are the source of information for much of America, much of America will never be convinced otherwise. This idea is here to live, because we can’t kill that branch

Now for the economics. 

The question at hand was the worthiness of so-called federal lines of credit, or FLOCs. The idea that government will lend to consumers directly, ensuring that every dollar is spent unlike ARRA. Noah’s concern is valid – FLOCs would increase only aggregate demand, government investment in infrastructure and education would have huge supply-side pay dirt too.  

I also think it’s highly presumptuous that the whole dollar would be spent by the borrower. This policy, as Mike Konczal notes, is clearly not intended for AmEx cardholders. The demographic that would benefit most from federal credit is likely in serious debt already. Chances are, beneficiaries would be paying insane interest on credit card debt (or even moneylenders), which would just be rolled over to the government. 

Another example of socializing financial sector risk. 

Now, FLOCs will stimulate the economy without increasing deficits assuming defaults are controlled for (more on that later). However, the government would have to initially allocate the funds for credit, for which it will have to sell bonds. So from a political perspective, spending still increases (and from an economic perspective we know short-run cyclical deficits aren’t a bad thing but, as Noah points out, no one cares about the economic perspective). There is also the very murky issue of ensuring repayment.

The government, unlike any bank, can ensure repayment. There is also the moral issue that it shouldn’t do so. Doing so could imply freezing of assets and use of its monopoly on law enforcement. It can have you fired, it can do what it wants. This would be highly immoral, as the social risk falls to the neediest.  

However, it would be equally immoral to lend out money knowing full well that you are not ensuring its return. This, in turn, would encourage mass default. I also highly doubt there is any civic responsibility, anymore, to repay a loan (especially when you see the inequality all around you) to a government that, according to you, is doing a disservice.

If default becomes publicly acceptable, FLOCs become glorified stimuli, which will be no different from ARRA. I take issue with Konczal’s assertion that the burden of this scheme would be unfairly felt by the poor and needy. This would be true if, but only if, the government became a repo man. However, it’s a false dilemma to compare a federal line of credit with progressive taxation: 

This means that as the bottom 50 percent of Americans borrow and pay it off themselves, they would bear all the burden for macroeconomic stability through fiscal policy. Given that the top 1 percent captured 93 percent of the income growth in the first year of this recovery, that’s a pretty major transfer of wealth. One nice thing about tax policy, especially progressive tax policy, is that those who benefit the most from the economy provide more of the resources. This would be the opposite of that, especially in the context of a “”relatively-quickly-phased-in austerity program.”

If the program works as intended, this would help the people with highest credit bills the most. However, spending and progressive taxation are a false dilemma. That 93% of income goes to 1% of the people is a structural flaw of our recovery, and will exist so long as income inequality grows the way it does. I fully support policies to avert this trend, but that’s another story. Investing in the Northeast Corridor would also help our Beltway elite the most. 

Noah’s right, we should probably spend more on infrastructure, but Kimball tries to suggest a policy that wouldn’t require long-run spending. But there is no way a government with a monopoly on law and military can extract deficit in a moral way.