Economically speaking, I think an economy growing as fast as ours can sustain a budget deficit in the neighborhood of 3% of GDP almost indefinitely. To be clear, I don't think we should sustain such a budget deficit--if we want programs, we should pay for them ourselves, not ask our kids to. But it is possible to run such a deficit without fiscal crisis or economic stagnation.
But three percent is around the ceiling of sustainable deficits. Six percent is well above that ceiling. At six percent, your debt service burden starts growing much faster than your tax revenues.
On the other hand, the markets don't seem to care, as Paul Krugman points out:
And right now, deficit-phobia has quickly congealed into the latest CW. You can see it in editorials (not from the Times, I'm happy to say, but almost everywhere else), in what the talking heads say, even in supposedly objective news reporting. Not a day goes by without my reading some assertion that "markets are anxious/jittery/worried about the deficit" -- an assertion based on no evidence whatsoever. (Long-term interest rates on US debt are near historic lows; CDS spreads show no concern about default.)
Matt Yglesias adds:
It's really maddening that at the same time preposterous idea like strong forms of the Efficient Markets Hypothesis continue to be respectable that people seem unwilling to trust financial markets to accurately convey the beliefs of participants in financial markets. I would add to Krugman's observations the fact that we have Cato's Chris Edwards blaming anticipating inflation for the lack of private investment when the TIPS spread shows that markets aren't anticipating inflation.
Right now economic conditions are bad. And the budget deficit is high. So I find it understandable if the man on the street chooses to conclude that the budget deficit is causing or contributing to the bad economic situation. But people writing about these matters ought to know better--interest rates are low and markets are assessing both default risk and inflation risk as low. So what about the deficit is supposed to be causing the problem?
I join with Messrs Yglesias and Krugman in a number of points:
- The current budget deficit is not causing our economic problems. There may be other administration policies that are contributing, but this is not one of them.
- Demand for government bonds is robust
- There are good and powerful reasons to run a deficit in the current recession
Nonetheless, I'm worried about our future budget deficits. And I think a number of market participants are also worried. Why?
For one thing, I don't think the TIPS spread tells us much, for reasons I've gone over before: as long as we have an independent central bank, default risk is greater than inflation risk. And since the market would treat any significant moves to abrogate the independence of the Fed as equivalent to actually inflating the debt away, the government can't regain control of the Fed without triggering the crisis that inflation is supposed to avoid.
As for the debt itself, America's debt right now has a number of idiosyncratic factors pressing on its price: dramatically heightened worries about the rest of the world's economies, and lower inflation expectations. So it's hard to say that the markets aren't pricing in default risk (though equally hard to argue that they are).
If not, why not? Well, a number of factors make US debt demand pretty sticky. The Chinese central bank, for example, wants to keep its currency from rising against the dollar, for reasons you've all heard a million times. That means it wants to buy a lot of US government debt (and quasi US debt, like--oops!--Fannie and Freddie securities). Regulated entities that need to buy securities which meet strict criteria. Unsophisticated and stodgy investors who pour their money into government bond funds.
The economic policy folks at the Bush administration had to spend a bit of time reassuring folks like the Chinese that really, nothing to worry about, we'll keep that deficit under control. I've no doubt the Obama administration is doing the same. And in truth, the prospect of a default is so horrendous that there's some reason to believe that of course we'll do something before it gets out of hand. I'd say, in fact, that this is more likely than not--though I don't know how much more likely.
What worries us doomsayers is that when you have that kind of sticky demand, it deludes you into thinking that everything is fine. Sticky demand can, and does, come unstuck eventually. When it does, great big chunks of demand for our debt will flow out of the market all at once. And when you have a lot of debt that you have to roll over every year, that's a bad thing.
Maybe I'm just a nattering nabob of negativism. But when I talk to professionals who invest in government bonds, they don't tell me they think everything is fine. They tell me they're worried about the deficit.
the market may reflect something in the short term, but that doesn't make it sustainable in the longer term.
In 1997 to 1999 -- lots of people were talking about the stock market being at levels that were unsupportable by fundamentals and relative to history. Yet it kept going up -- seeming to confirm those that pointed out "things are different now", the internet has created a new industrial revolution, etc, etc, etc. Yet -- by the end of 2001, the market had corrected and then some.
The "dont worry about the deficit" is a politically convenient argument -- coming from Krugman of all people. Apparently smaller Bush deficits matter, but much larger Obama deficits don't, because at least those are spent on things I agree with.
You could also ask anyone who bought a house in the last few years.
It's not a "politically convenient" argument. It's common sense. When the economy is strong and growing, running up deficits is a bad idea. Periods of growth should buffer against period of downturn. Bush was running "smaller" deficits when it was stupid to do so. Obama's running much larger deficits when it's very difficult not to. With inherited deficits and falling revenues, massive cuts were the only way to avoid a huge deficit, and that would be suicide.
Megan's right that 2019, or when things aren't so precarious in general, is the time to worry about deficits. We'll cross that bridge when we get to it, because God knows things will change by then. Focusing on it now is pure distraction.
lets differentiate between current deficits -- and the projected record deficits far as the eye can see
By the Obama administration's own estimates -- they will, after the repeal of the Bush tax cuts, still be running very large deficits long after the economy returns to growth (and even robust, unrealistic growth).
That is an issue, and one Krugman appears quite sanguine about.
I just find the hypocrisy of your side breathtaking. $400 billion deficits under Bush were "horrific" and "evil", but $1.4 trillion deficits "aren't enough" now.
I assume you've sourced and attributed "horrific" and "evil" to members of my "side", whatever the hell that means.
The bottom line is: in the near to short term, deflation and high unemployment pose much greater risks to the long term health of the US economy than the increasing federal debt. And if we don't tackle these issues now, the economy will never be strong enough to pay down the debt. Everyone knows this. Overinflating the risk of the deficit is a transparent tactic of the current Republican party.
Read Megan's agreement bullet points again. Deficits aren't causing problems now, but they're justified in the current recession, especially because demand for bonds is strong.
Most of the deficit arguments are rolled up in the healthcare debate right now. In other words, arguing about it now will have a fairly big impact on 2019 deficits. Hardly "distraction".
The future deficit numbers are unknowable. If Buffet's Burlington Northern bet on a resurgent US economy proves precient, and if we can keep spending down a little and let the AMT hit a few more people then boom, 2.5% deficits for ever.
We don't need to know just that things can break. We need to know what to do about it. How do we prevent deficit growth or is it inevitable?
For example, what should we do about health care instead of lie about the cost of federalizing it? The current system doesn't seem sustainable (either).
Thinking outside the box: Maybe it's okay to let things go bang if all the other countries in the world end up even worse off? The globalist co-prosperity regime we've all been assuming may not be realistic. So what is? The last great burst of US prosperity was a follow-on to WWII. Do we need to break the rest of the world to do well?
We need to know what to do about it. How do we prevent deficit growth or is it inevitable?
Historically the best option would be for Republicans to return to power in the House and Senate along with 7 more years of Obama and we'd be good to go.
Should I find it amusing/ironic that folks who found CDSs bad 8 months ago are relying on CDS data to back up their claims?
Lolololol.
I see great irony in watching you affirm market failures to try to fill the hole in your argument using bricks from its foundation. If the market is so ineffective at evaluating risk, one wonders why you put so much faith in it in the first place.
These spreads are not instantaneous. They are an estimate of future risk. The 10 year spread should be incorporating all relevant information to price the of risk in 10 years.
If you really wanted to make your point, concisely, clearly, and without undermining your overall ideological position, you should just post three graphs. The 5-year TIPS spread, the 10-year TIPS spread, and the 20-year TIPS spread. If you are right, the spreads should currently be ascending.
Also, to end your post with a claim that bond investors agree, doesn't do anything to affirm your point. If they really agreed they would put their money where their mouths are and drive up the price of TIPS. So either their statements to you do not accurately reflect their beliefs, or the people you are talking about are in the extreme minority, or it is time for you to get out of the pro-market-ideology business.
Beyond the throw-away at the end, you identifying a couple of factors with out getting quantitative says nothing. There is no way to know if your list is exhaustive, or what the relative importance of these factors is.
Again, TIPS measure inflation risk, not default risk. And given that I was talking about the stock market bubble in 2000, and the housing bubble in 2004, it's hardly some crazy departure for me to say that prices can get a little crazy.
The Federal deficit funds net private sector savings. A higher deficit just means that the private sector is de-leveraging, and increasing its savings. Not a bad thing considering how over indebted it had become.
Given our high unemployment rate, the deficit is still too low. Japan shows how crazy high a deficit can get and STILL not be big enough to fund the private sector's demand to put more cash in the bank.
As for TIPS, well, the default risk is zero so not a big deal that it does not measure that. Well, maybe it does. Impossible to tell either way!
True dat.
We saw something similar in WWII. Sure, the money we were borrowing was necessary to crush the enemy. But a lot of it found its way into a vast increase in personal income (in the form of wages for people like factory workers and GIs). Given the presence of rationing, a lot of that personal income in turn wound up in the bank. So, one way to look at WWII is that it was one gigantic program whereby the US government helped improve the balance sheets of American households.
Deficits only finance private savings if you assume that peoples only way to save money is to buy treasury bonds. Some might find other investments to use for savings.
Also, you seem to be confusing deficits and debt, in the case of Japan. But I could be wrong.
Ken Magalnik: Not at all. People save by keeping money in the bank. That must be funded by Federal deficit spending at a sector level.
At a national level, deficit is per period, debt is sum of all deficits. No confusion there either.
TIPS spread measures inflation risk, CDS spreads measure default risk. Between Yglesias and Krugman both are addressed, both refute your claims.
If there was an increasing belief in default risk, we'd also see a decrease in demand for both TIPS and Fixed Rate.
So again, the if your claim was true, it would be in the numbers. You can't just wish yourself into a world where the data refuting your claims don't exist.
p.s. Insofar as crazy prices. Prices were crazy a year ago. It is much harder to say that one year later, for 2001,2004,or 2008
Beyond that, I for markets to be reasonably functional in a rational actor sense, you'd have to believe that the market fluctuations reflect the rapid availability of new information and not flights of fancy amongst investors. As soon as there isn't any additional model breaking data, there shouldn't be any reason to distrust large scale aggregates.
I'm not a strong EMH advocate. I never was. You're beating the snot out of a straw man.
The CDS spreads are more compelling--but the CDS market is less worried about very long default risk. I'm not worried about default in the next five years; I'm worried about increasing default risk raising rates and forcing fiscal problems. Since I'm not a strong EMH advocate, I don't need prices now to be high for that to be a risk.
Aren't we talking about default on debt by the US government?
Are there any CDS' being sold to cover that eventuality? If so, I would suggest that people are considering the unthinkable.
As for the market being an accurate guage of risk, the market has been incapable of forseeing major events in the past.
And with the unprecedented liquidity pushed into the market by the Fed, and the tacit support to all the large player's liabilities, the free market is non existent. Any prices we are seeing now have no relation to reality.
Derek
Megan,
First off, CDS are available at a variety of maturities insuring a variety of assets. For example, 10 year contracts covering 30 year US Treasuries. Overall, their price has been declining not increasing.
Second, before you say anything, these contracts have plenty of volume. Stodgy institutional investors(the ones with lots of $$$) have the strongest incentive to insure their sizable investments by buying CDS's even if the probability of default is quite low. So China's(and the rest of asia's and the world's) interest in our securities provides a good reason to believe that the likelihood of default(therefore the price of CDS's for US securities) are as carefully considered as anything in economics.
Third, the same logic applies to the TIPS spread and inflation. Big investors will consider the ratio of fixed securities to inflation indexed securities very carefully.
Fourth, you are making a logical mistake with your strong emh straw man argument. It is true, the TIPS(or CDS) not pricing risk and inflation implies a failure of strong emh, but it also refutes much weaker claims.
US treasury investors are some of the most risk averse and best funded investors on this planet. If they can't get the most important variables right, it suggests that no one can get economic decisions right. If that were the case, I would wonder about the wisdom of your constant policy recommendations favoring market based solutions.
Fifth, TIPS and CDS spreads don't have to do a perfect job pricing risk to be a useful indicator of future behavior. In the context of this discussion, all that they need to do is indicate future risk better than your laundry list of factors that may-or-may-not matter. Until you've at least done a back of the envelope calculation on these factors' significance, your claim can't be directly assessed at all.
Much like your claims in the health care debate, the best they can do is cast doubt; not make a positive case for your position.
Seems like we are pricing in perfection again, leaving no room for the unexpected. A natural disaster, a new war somewhere, another act of terrorism or another downturn in the economy (here or anywhere else) could all kick over the house of cards.
Aren't we kind of vulnerable to interest rate increases right now?
Pretty funny to hear these two insisting the market is right.
But I have to agree. I think the danger from the deficit isn't so much inflation as creeping socialism. We are not yet at the point where we can afford to have the government misallocating 50% of the economy, regardless of whether it gets there via tax or debt. As a minarchist I shudder at the hundred-odd new bureaucracies in the House Obamacare bill.
There was an article today saying India could have saved 14.5 million lives had they adopted free market policies 10 years earlier.
It is absolutely offensive that someone like Matt actually is speaking on EMH. Go back to studying philoposhy and constructing sentences as a journalist. He has no basis for commenting on EMH, much less anything on the market anticipating inflation.
As he said, people should know better. He should know better to shut up. Typical drivel. The idiot leading the blind.
And krugman has long given up unbiased intellectual thought and become a political hack.
All the markets price is the risk of default, not the risk of fiscal crisis.
You can believe that the federal government will cut loose all non-political-connected groups and raise taxes to pay you when it runs into problems and therefore conclude that the risk of default is low.
1. Bond interest is robust. By whom? Mostly central banks- including the fed and their QE program. Central Banks =! Market participants.
2. Credit default swaps are low. So what? Default swaps are paid out in dollars- if the US is in a position to default on its debt to a significant extent (you don't insure things because your worried about a 3-5% loss) What is going to happen to the dollar? It would get murdered. Just like every other currency that defaulted on its debt. In other words if you default occurs you get paid in a currency that lost a large chunk of its value right before you got paid- this dramatically mitigates the value of swaps. If we were talking about how CDSs were trading on Mexican debt that were denominated in dollars, that would mean a lot more.
3. Fear is RELATIVE, not absolute. Low bill rates mean that you think these investments are less risky- not absolute low risk- than other options. Typically people say it represents absolute risk because you could always hold cash instead of those investments. Only we have Fiat currencies- which are currently very volatile and not at all a source of security right now.
Yes let's run trillion dollar deficits as far as the eye can see because hacks like Krugman say it's A-ok to! In fact let's up the deficit to 20% of GDP!
Why not do a real stimulous.
Mail a check for $1,000,000 to every person in country, funded by bonds bought by the Fed.
That would finally get US Back on Track!!!
There is balance, and then
there is equivocation.....
If things are this variable
why not just say: I don't know ?
Me, I think the State is doing its
interpretation of that amazing pep-talk
which stopped the bank run in
"its a Wonderful Life",
not to be confused with
"Its a Good life",
which probably gives a more accurate
explanation of the motivation of the
Experts; They do not dare even to think
what they truly believe. :>
LMAO! Interest rates today are telling us the deficits are no problem? Really? What the hell were the rates telling us 2 years ago? How did that prediction turn out?
Let me ask you this- how high would the government's interest costs today be if the Federal Reserve hadn't been buying a trillion and half dollars of government bonds and MBS? The debt is rolling over more often and in bigger waves with respect to the economy's size. This is dangerous. Absolutely nothing makes the US fundamentally different from other countries in this regard. The debt isn't a problem until it is a problem. These sorts of crises tend to come on suddenly, and just after periods when it appears no one was worried about it.
The deficit is a political issue. If politicians can spend more than they can tax, they will, and they will give that money away unproductively.
If they can spend $1.4 trillion more than they tax, then there is more money to give away unproductively.
If the world doesn't end if they borrow $1.4 trillion, why not $2 trillion?
It's a bubble mentality, and it will end like all bubbles do.
Derek
The main problem with the deficit spending is that the government massivley misallocates capital. This would be bad if it were taxed, but deficit spending avoids accountability.
With a debt you can either pay it off or default (keeping it the exact same size until the heat death of the universe can be constructivley viewed as a default). Nobody really wants it paid off since that would involve sacrifice, and at this point defaulting is probably the thing to do.
Since an outright default would involve some degree of said accountability, government officials will probably want to inflate it away. While the fed can control certain interest rates in its current form, it won't always be able to control inflation. Keep in mind most such officials don't look beyond the next 4-year presidential cycle.
I don't believe current economic conditions are a temporary emergency, so much as they represent the consequences of nearly 100 years of irresponsability. I expect them to continue until such time as the default occurs. Since all the privatley held wealth is worth maybe 40 trillion you can probably expect that within 20 years. The real question is what happens after that point?
deficit spending and borrowing money = more taxes in the future = more deadweight loss = lower productivity = lower GDP = higher structural unemployment = lower standard of living = europe
get it?
Should I Learn to Stop Worrying and Love the Deficit?
Depends; Is this the Deficit Bomb ?
http://www.ft.com/cms/s/9a5b3216-c70b-11de-bb6f-00144feab49a,Authorised=false.html?_i_location
=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F9a5b3216-
c70b-11de-bb6f-00144feab49a.html&_i_referer=
People speak of "Jumping the Shark";
Perhaps the metaphor about the stationary shark
is more apt; How long can the US economy
stop moving before it dies ?
US treasury investors are some of the most risk averse and best funded investors on this planet. If they can't get the most important variables right, it suggests that no one can get economic decisions right. If that were the case, I would wonder about the wisdom of your constant policy recommendations favoring market based solutions.
This is classic. Good point about imperfect knowledge; too bad what logically follows is the exact opposite of your conclusion.
Should we also consider interest payments as a percentage of the budget?
Interest on the national debt in fiscal year 2009 was $383,363,826,680.60.
It was $451,154,049,950.63 in fiscal year 2008. When the economy recovers and interest rates go back up so will interest payments.
Aren't we borrowing in part to make interest payments on our debt?