National Journal Expert Blog debate on fiscal sustainability
Posted by WARREN MOSLER on June 12th, 2009
What Is Fiscally — And Politically — ‘Sustainable’?
By James K. Galbraith
Professor of Economics, University of Texas
June 11th —Chairman Bernanke may, if he likes, try to define “fiscal sustainability” as a stable ratio of public debt to GDP. But this is, of course, nonsense. It is Ben Bernanke as Humpty-Dumpty, straight from Lewis Carroll, announcing that words mean whatever he chooses them to mean.
Now, we may admit that the power of the Chairman of the Board of Governors of the Federal Reserve System is very great. But would someone please point out to me, the section of the Federal Reserve Act, wherein that functionary is empowered to define phrases just as he likes?
A stable ratio of federal debt to GDP may or may not be the right policy objective. But it is neither more nor less “sustainable,” under different economic conditions, than a rising or a falling ratio.
In World War II, from 1940 through 1945, the ratio of US federal debt to GDP rose to about 125 percent. Was this unsustainable? Evidently not. The country won the war, and went on to 30 years of prosperity, during which the debt/GDP ratio gradually fell. Then, beginning in the early 1980s, the ratio started rising again, peaked around 1993, and fell once more.
Thus, a stable ratio of debt to GDP is not a normal feature of modern history. Gradual drift in one direction or the other is normal. There seems no great reason to fear drift in one direction or the other, so long as it is appropriate to the underlying economic conditions.
History has a second lesson. In a crisis, the ratio of public debt to GDP must rise. Why? Because a crisis – and this really is by definition – is a national emergency, and national emergencies demand government action. That was true of the Great Depression, true of war, and true of the Great Crisis we’re now in. Moreover, we’ve designed the system to do much of this work automatically. As income falls and unemployment rises, we have an automatic system of progressive taxation and relief, which generates large budget deficits and rising deficits. Hooray! This is precisely what puts dollars in the pockets of households and private businesses, and stabilizes the economy. Then, when the private economy recovers, the same mechanisms go to work in the opposite direction.
For this reason, a sharp rise in the ratio of debt to GDP, reflecting the strong fiscal response to the crisis, was necessary, desirable, and a good thing. It is not a hidden evil. It is not a secret shame, or even an embarrassment. It does not need to be reversed in the near or even the medium term. If and as the private economy recovers, the ratio will begin again to drift down. And if the private economy does not recover, we will have much bigger problems to worry about, than the debt-to-GDP ratio.
It is therefore a big mistake to argue that the next thing the administration and Congress should do, is focus on stabilizing the debt-to- GDP ratio or bringing it back to some “desired” value. Instead, the ratio should go to whatever value is consistent with a policy of economic recovery and a return to high employment. The primary test of the policy is not what happens to the debt ratio, but what happens to the economy.
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Now, what about those frightening budget projections? My friend Bob Reischauer has a scary scenario, in which a very high public-debt-to-GDP ratio leaves the US vulnerable to “pressure from foreign creditors” – a euphemism, one presumes, for the very scary Chinese. Under that pressure, interest rates rise, and interest payments crowd out other spending, forcing draconian cuts down the line. To avert this, Bob has persuaded himself that cuts are required now, not less draconian but implemented gradually. Thus the frog should be cooked bit by bit, to avoid an unpleasant scene later on when the water is really boiling hot.
With due respect, Bob’s argument displays a very vague view of monetary operations and the determination of interest rates. The reality is in front of our noses: Ben Bernanke sets whatever short term interest rate he likes. And Treasury can and does issue whatever short-term securities it likes at a rate pretty close to Bernanke’s fed funds rate. If the Treasury doesn’t like the long term rate, it doesn’t need to issue long-term securities: it can always fund itself at very close to whatever short rate Ben Bernanke chooses to set.
The Chinese can do nothing about this. If they choose not to renew their T-bills as they mature, what does the Federal Reserve do? It debits the securities account, and credits the reserve account! This is like moving funds from a savings account to a checking account. Pretty soon, a Beijing bureaucrat will have to answer why he isn’t earning the tiny bit of extra interest available on the T-bills. End of story.
The only thing the scary foreign creditors can do, if they really do not like the returns available from the US, is sell their dollar assets for some other currency. This will cause a decline in the dollar, some rise in US inflation, and an improvement in our exports. (It will also cause shrieks of pain from European exporters, who will urge their central bank to buy the dollars that the foreigners choose to sell.) The rise in inflation will bring up nominal GDP relative to the debt, and lower the debt-to-GDP ratio. Thus, the crowding-out scenario Bob sketches will not occur.
I’m not particularly in favor of this outcome. But unlike Bob Reischauer’s scenario, this one could possibly occur. And if it did, it would lower real living standards across the board. This is unpleasant, but it would be much fairer than focusing preemptive cuts on the low-income and vulnerable elderly, as those who keep talking about Social Security and Medicare would do.
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Now, it is true, of course, that you can run a model in which some part of the budget – say, health care – is projected to grow more rapidly than GDP for, say, 50 years, thus blowing itself up to some fantastic proportion of total income and blowing the public finances to smithereens. But this ignores Stein’s Law, which states that when a trend cannot continue it will stop, and Galbraith’s Corollary, which states that when something is impossible, it will not happen.
Why can’t health care rise to 50 percent of GDP? Because, obviously, such a cost inflation would show up in – the inflation statistics! – which are part of GDP. So the assumption of gross, uncontrolled inflation in health care costs contradicts the assumption of stable nominal GDP growth. Again, the consequence of uncontrolled inflation is… inflation! And this increases GDP relative to the debt, so that the ratio of debt to GDP does not, in fact, explode as predicted.
I do not know why the CBO and OMB continue to issue blatantly inconsistent forecasts, but someone should ask them.
Further confusion in this area stems from treating Social Security alongside Medicare as part of some common “entitlement problem.” In reality, health care costs and haphazard health insurance coverage are genuine problems, and should be dealt with. Social Security is just a transfer program. It merely rearranges income. For this reason it cannot be inflationary; the only issue posed is whether the elderly population as a whole deserves to kept out of poverty, or not.
Paying the expenses of the elderly through a public insurance program has the enormous advantage of spreading the burden over all other citizens, whether they have living parents or not, and of ensuring that all the elderly are covered, whether they have living children or not. A public system is also low-cost and efficient, and this too is a big advantage. Apart from that, whether the identical revenue streams are passed through public or private budgets obviously has no implications whatever for the fiscal sustainability of the country as a whole.
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What is politically sustainable is nothing more than what the political community agrees to at any given time. I have been surprised, and pleased, by the political community’s acquiescence in the working of the automatic stabilizers and expansion program so far. The deficits are bigger, and therefore more effective, than many economists thought would be tolerated. That’s a good sign. But it would be a tragedy if alarmist arguments now prevailed, grossly undermining job prospects for millions of the unemployed.
Let me note, in passing, that Chairman Bernanke should please read the Federal Reserve Act, and focus on the objectives actually specified in it, including “maximum employment, stable prices and moderate long-term interest rates.” He does not have a remit to add stable debt-to-GDP ratios or other transient academic ideas to the list. One might think that the embarrassing experience with inflation targeting would be enough to warn the Chairman against bringing too much of his academic baggage to the day job.
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June 12th, 2009 at 8:46 am
You have taught him well! In the past, I’ve always thought he had a pretty shaky grasp of monetary operations – but he really seems to be completely “in paradigm” now. Now, if he could only get it across when he appears on CNBC…
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Dave Begoka Reply:
June 12th, 2009 at 9:30 am
The Central Intelligence Agency owns everyone of any significance in the major media.â€â€”-William Colby, former CIA director
Nothing gets said unless they let it be said!
http://www.youtube.com/watch?v=mZ55zegkV6Q
I think we are not looking at core of the problems
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Keynes Liquidity Fetish Reply:
June 12th, 2009 at 11:06 am
“940 through 1945, the ratio of US federal debt to GDP rose to about 125 percent.”
At this point I call BS. The world was engulfed in global destruction, you cannot compare the mobilization of resources and labor then, and the resulting prosperity for us winning the war and having no mass destruction on our mainland to events today, completely different environment. I am surprised such a distinguished economist would try and hoodwink us with this sillyness.
“Then, when the private economy recovers, the same mechanisms go to work in the opposite direction.”
LOL! What an assumption. That after the potholes are filled, we are going to re-educate GM workers who screwed in bolts in door panels on an assembly line to be bio science engineers! I don’t think we can do it, I think it is a pipe dream. I have provided articles where our education policy and rising education prices are not helping the situation either. Then there is the whole cultural, societal problems of putting football and baseball scholarships at the top while china puts science and engineering at the top. In the words of Mogambo Guru, we are FREAKING DOOMED.
“The reality is in front of our noses: Ben Bernanke sets whatever short term interest rate he likes. ”
That is PURE GARBAGE and I am ashamed galbraith is LYING like this. Bernanke went to china and told them things they didn’t like and he got BANNED from their country. So now giethner, who studied there and speaks chinese, is begging them (the people that make our stuff) what can we do to make them happy. Galbraith is a liar if he says we are not already HEAVILY influenced from chinese politics and policies, they already exert too much influence over me I feel, I can’t vote on their leaders. Chinese Lobbyists and chinese payoffs to the clintons aside from over a decade ago, they already have influencd so many things I have lost great respect for Galbraith lying like this.
“This will cause a decline in the dollar, some rise in US inflation, and an improvement in our exports.”
No, he shows a fundamental misunderstanding of the REAL WORLD up in his ivory tower. The CIA will not allow oil to be traded in anything other than US fiat, they cannot allow it and have the USA maintain thier current standard of living. Exports will not increase, I don’t see princess leaving the shopping mall and going to work on the factory line making shoes and orange juice – she will just sit down and bitch how awful the current times are. Wage inflation WILL NOT HAPPEN, and therefore inflation in so many other prices will not happen either. There is too much labor chasing too little global work.
“A public system is also low-cost and efficient, and this too is a big advantage”
Another FLAT LIE, as a disabled vet who is very experienced with the VA healthcare system, it is a total disaster and nightmare. http://www.vawatchdog.org for daily horror stories. The worst way to screw up efficiency in many things is to bring in lots of useless government administrators and thier costs to administrate. Kudlow freaked out last night how all these CZARS paid hundreds of thousands of dollars to obama. Talk about crony capitalism.
Right now on Cspan GM dealers are bitching to congress why are they being closed when they were profitable. Sometimes the government way – using a nuclear bomb to swat a fly – is VERY inefficient and wasteful.
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Keynes Liquidity Fetish Reply:
June 12th, 2009 at 11:58 am
I want Galbraith to address one of the BIG problems with strong big powerful central government, namely that it can then be exploited by EVIL interests to do EVIL things. A weak decentralized government may not can do big GOOD things, but it can’t do big BAD things either. Why is philip morris supporting the new tobacco leglislation?:
The U.S. Senate on Thursday struck the most devastating legislative blow in history to Big Tobacco, giving the Food and Drug Administration (FDA) authority over the industry. The new bill, which passed in the House in April, includes tough new restrictions on advertising like allowing only black-and-white text ads in magazines with substantial youth readerships, mandates that manufacturers prove or stop using claims like “light” and “low tar,” bans flavored cigarettes (except menthol) and makes provisions for large, graphic warning labels. So why, then, is tobacco giant Philip Morris, unlike its industry brethren, celebrating the unprecedented oversight?
When Senator John McCain introduced FDA regulatory legislation in 1998, the company spent a reported $100 million successfully fighting it. But since then, Philip Morris has had a crucial realization. With 50% of the U.S. tobacco market already safely in the company’s pocket – and more than 50% of 18- to 25-year-old smokers loyal to its top brand, Marlboro – restrictive legislation will effectively lock in its market dominance, preventing any competitors from taking a bite out of Philip Morris’ very lucrative business. (See vintage cigarette propaganda.)
The company’s main rival, R.J. Reynolds, manufacturer of Camel cigarettes, is still in dismay over Philip Morris’ reversal from regulation opponent to champion, and the third largest cigarette manufacturer, Lorillard, has labeled the legislation the Marlboro Monopoly Act. Both argue that as the new restrictions cut off most remaining avenues available for advertising and ban marketing stunts like free-sample cigarette giveaways, the companies’ ability to “communicate” (i.e., gain market share) with potential and existing smokers about their products will be blocked. In addition, the administrative costs of complying with FDA regulations favor large manufacturers over smaller ones.
But there’s another key reason Philip Morris lobbied hard for FDA regulation, aligning itself with strange bedfellows like the Campaign for Smoke-Free Kids, the American Lung Association and longtime antismoking crusaders Senator Ted Kennedy and Representative Henry Waxman. “Philip Morris wants the public-health community to join them in finding the holy grail: the safe cigarette,” says Gregory Connolly, a tobacco expert and professor at the Harvard School of Public Health. Simply put, figuring out how to produce a less harmful tobacco product and getting an FDA seal of approval could open up a whole new, potentially huge consumer market.
http://news.yahoo.com/s/time/20090612/us_time/08599190425000
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June 12th, 2009 at 7:43 pm
Jamie’s about perfect here, the blatherings (I assume they are blatherings, though I stopped actually reading them several weeks ago) of this site’s resident dissenter notwithstanding.
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June 13th, 2009 at 12:38 am
Scott, as one of this sites resident cheerleaders, you could follow my example, attack some of the points I make. I have stated in the past I like galbraith better than many others. What specifically in my blatherings above do you think are utterances from an ignorant uncomprehending fool and why? Debate is good for everyone. What you just admitted you DID though, shutting your eyes and ears to dissenting comments, and then just attacking the messenger, makes me lose a lot of respect for your debating prowess.
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Dave Begoka Reply:
June 13th, 2009 at 8:18 am
TMI
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June 13th, 2009 at 11:17 am
1933 short film claiming “inflation will save us!” Fascinating!
http://www.businessinsider.com/henry-blodget-inflation-will-save-us-inflation-will-save-us-1933-propaganda-film-2009-6
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June 13th, 2009 at 12:17 pm
Sorry, not getting sucked in anymore. There are enough dissenters that actually want to engage to waste time and energy.
Best,
Scott
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TMI Reply:
June 13th, 2009 at 10:52 pm
Scott can you point out these other dissenters here to me, I mostly only see cheerleaders here like you. I don’t recall anyone else coming here regularly that do not get brown on their nose. You will not debate the points, I think you can do better. Specifically Galbraith said when the private economy recovers – Was Japan so long ago? Then Galbraith talks about government efficiency. If you have ANY appreciation for the veterans of wars that keep your rights protected from enemy forces, then you owe them the time to at least educate yourself on the issues affecting them. What a disgrace these men give lives and limbs for people and no one even cares to learn of their struggles back home.
The website I provided above http://www.vawatchdog.org gives daily corruption, fraud, waste, and abuse in the VA system that services our wounded warrios, Galbraith is wrong.
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Scott Fullwiler Reply:
June 13th, 2009 at 11:55 pm
Going against my own rule here . . . probably will regret it.
1. Jamie’s talking about the efficiency of a government transfer system. Every analysis out there will show you that a government transfer system like SS functions at a lower cost than similar private systems. That’s VERY different from the government providing an actual service, like healthcare. As usual, you’ve missed the point he was making. On a side note, I am a veteran . . . USMC . . . but it doesn’t really “count” (at least in my mind) since I was injured before I could actually join the fleet. I did, however, spend the better part of 2 months in a VA hospital, and I do have a healthy respect for sacrifices made. Again, though, that’s not the point Jamie was making in the first place.
2. Randy Wray has said that there are at least 100 really good policy ideas out there. But like him, I only have expertise in a few of them (though he has expertise in more of them than I do), so those are the ones I talk about here, and they are usually the ones under discussion by others here. Your comments here (the ones I have read, anyway, since I don’t anymore) generally refer to (a) the other 95 or more good policy ideas, (b) a complete misinterpretation of the ideas presented here, or (c) some combination of a and b.
3. My reference to other dissenters was not necessarily about this site. This very much is a site in which people discuss a certain core of ideas, and judging from the comments here and the ones I have received privately, many find it useful. As such, there are few dissenters here, for sure. There are some repeat commenters, besides yourself, that appear to disagree (like Curious, perhaps), but they generally engage directly and appropriately. In that case, disagree away, just as I do on other sites not so amenable to my own views.
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TMI Reply:
June 14th, 2009 at 11:27 pm
“1. Jamie’s talking about the efficiency of a government transfer system.”
I keep hearing on C-span interviews the biggest problem with 3rd world freedom and prosperity is inefficiency in the governments from waste, fraud and abuse. From iraq to afghanistan to pakistan. All our soldiers giving lives to reform the governments there and it isn’t getting the desired results. The latest equipment being shipped to hospitals, but no one knowing how to use it. Pat Tillman’s family getting lied too, etc etc
Erin Burnett is on doing a special right now on the richest african nations eaten up with so much corruption that none of the aid makes it to the people.
Arnold Kling argued our own government is hurt by this and we need to break up the USA into 250 states.
Experiencing the government from inside the military and outside of it, I see lots of problems, gross inefficiencies everywhere.
“Every analysis out there will show you that a government transfer system like SS functions at a lower cost than similar private systems.”
I hear Obama and orzag say SS is broke going forward and needs to be restructured. Greenspan tried to do that in 80′s and just kicked the can down the road didn’t he? Middlemen in transfer schemes become too costly a drag sometimes. These analysts you speak of, are they government paid employees or receiving grants who have incentives in keeping the government in place?
“On a side note, I am a veteran .”
Salutes.
“but it doesn’t really “count†(at least in my mind) since I was injured before I could actually join the fleet.”
I know several vets who fell out of their bed in boot camp after being in only a week or 2 who are now getting PTSD disability at or over 50%, are you saying thier service doesn’t count because they didn’t actually get to their operating theater and was only in service a few days perhaps? They have many disability attorneys who would argue with you.
“I did, however, spend the better part of 2 months in a VA hospital, and I do have a healthy respect for sacrifices made.”
I recently had a wheelchair ramp installed from the HISA grant, a grant to help with handicap modifications to homes. I was required to get several quotes and submit, I did this. My social worker also did this for me without my knowledge through a different prosthetics representative. The HISA committee approved both grants because it came from different prosthetics workers in 2 different offices, they should not do this. One ramp got installed, then a couple weeks later another contractor came to install his ramp. He sees my ramps already installed and says what is this, he said the VA wouldn’t screw up like this, you have done something fradulent. I laugh at him and say he obviously hasn’t been through the VA “machine” for long, screwups like this are common. The left hand never knows what the right hand is doing. They brought Ross Perot to the Tampa VA, he said it was the finest run healthcare he had ever seen. I was there that week, they didn’t let him talk to all the vets who are very upset and bitter about all the waste, fraud, and abuse. They have a shredding scandal were 10′s of thousands of vets paperwork was shredded so their benefits would not get approved, certain officers were given bonuses to shred this. So not only do these vets get victimized by the enemy, but then their own government victimizes them all over again. Have you read about Patton and McArthur running over the bonus army in washington, nothing ever changes.
“(b) a complete misinterpretation of the ideas presented here, or (c) some combination of a and b.”
Closing yourself off to aligned groupthink doesn’t give anyone a chance to influence and learn from each other. I am very jaded from my experiences in the military and dealing with so much red tape from too much administration, from the army to IBM to many state and local governments. I see some of that same frustration IN Warren ridiculing the 1984 Ministry of Truth garbage that Art Laffer keeps spewing. I can relate to that, I can relate to you disagreeing with my comments, perhaps your life experiences and mine give us very different perspectives on this world. What I can’t relate too is open communications being shut down and dissenting comments being censored because you don’t want to hear other people’s views when the site says “comments encouraged”
June 14th, 2009 at 11:46 pm
“I know several vets who fell out of their bed in boot camp after being in only a week or 2 who are now getting PTSD disability at or over 50%”
Good for them (benefits, not injuries, obviously). I wasn’t so fortunate (20% for a few years, then revoked even though every doctor I visited agreed the injury was permanent. 20 years later, can’t swing a baseball bat, golf club, or tennis racket without my knee popping out).
“are you saying thier service doesn’t count because they didn’t actually get to their operating theater and was only in service a few days perhaps?”
Absolutely not. It was a self-deprecating comment, but I see your point. Agreed.
I appreciate your closing comments. Let’s see if we do better going forward.
Best,
Scott
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