Galbraith on federal debt sustainability

Is The Federal Debt Unsustainable?

By Professor James K. Galbraith

Excerpt

A more prosaic problem with the runaway-inflation scenario is that the “nonpartisan, professional” economic forecasters of the Congressional Budget Office (CBO), whose work is often cited as the benchmark proof of an “unsustainable path,” do not expect it to happen. The CBO baseline resolutely asserts that inflation will stay where it is now: around 2 percent. So one can’t logically cite the inflation threat and the CBO baseline at the same time. So far as I know, the CBO does not trouble itself to model the exchange value of the dollar.

What the CBO does warn is that, under their assumptions, the ratio of US federal debt (held by the public) to GDP will rise relentlessly, passing 200 percent by 2035 and 300 percent by midcentury. Correspondingly, net interest payments on that debt would rise to exceed 20 percent of GDP. This certainly seems worrisome, and the CBO warns about “investor confidence” and “crowding out” without actually building these things into their model. Indeed, in their model this remarkable and unprecedented ratio of debt to GDP goes right along with steady growth, full employment, and low inflation, world without end! Why one should care about mere financial ratios if they produce such good—and, according to the CBO model— “sustainable” results is another mystery the CBO does not explain.

Levy Policy Brief

The Levy Economics Institute of Bard College
Public Policy Brief
No. 103, 2009

FINANCIAL AND MONETARY ISSUES
AS THE CRISIS UNFOLDS
James K. Galbraith

Beginning page 9:

Warren Mosler picked up on the theme of human resource
utilization and full employment in a particularly useful way.
Mosler suggested that stabilization of employment and prices is
akin to a buffer stock—something to which surpluses can be
added when demand is low, and drawn down when it is high.
Normally, a buffer stock works on a price signal: the authorities
agree to buy when market prices are below the buffer and to sell
when they are above. In this way, prices stabilize at the buffer
price. The Strategic Petroleum Reserve is potentially a good
example, though political decisions have prevented it from being
used as it should be.

The problem with most commodity buffers is elasticity of
supply: create a buffer stock in wool, and suddenly it pays to raise
sheep. But this problem is cured if the buffer stock is human
labor, which cannot be reproduced quickly. A program that provides
a public job at a fixed wage for all takers functions exactly
like a buffer stock, stabilizing both total employment and the
bottom tier of the wage structure. People can move in and out of
the buffer as private demand for their services varies. Meanwhile,
the work done in the buffer—the fact that people are working
rather than receiving unemployment insurance—helps keep the
buffer “fresh.” Private employers like hiring those who already
work, and will prefer hiring from the federal jobs program rather
than from among those who remain unemployed.

The point is: the problem of unemployment is easily cured,
without threat of inflation. It is merely sufficient to provide jobs,
at a fixed wage, to whoever wants them, and to organize work
that needs to be done. Such work should be socially useful and
environmentally low impact: from child care to teaching and
research, to elder care to conservation to arts and culture. Where
possible, it should contribute to global public and knowledge
goods. It should compete as little as possible with work normally
done in the private sector; for instance, by serving those who
cannot afford private sector provision of teaching and care. The
point is not to socialize the economy but to expand the range of
useful activity, so that what needs doing in society actually gets
done. The barrier to all this is simply a matter of politics and
organization, not of money.

The effect, nevertheless, would be to raise all private sector
wages to the buffer-stock minimum (say, $8/hour in the United
States), while eliminating the reserve of unemployed used to
depress wages in low-skilled private sector industries. There will
be no pressure to raise wages above the buffer threshold, since private
employers providing higher wages can draw on an indefinitely
large workforce willing, for the most part, to move from the
buffer to the private sector in return for those wages. Hence, the
program is not inflationary. There is therefore no excuse for waiting
a year or two years on the assumption that unemployment
will cure itself, and every reason to believe that at the end of such
a policy of “hopeful waiting,” the discovery will be made that the
problem has not been cured.

deficits and future taxes


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(email exchange)

The latest noise is that today’s deficits mean higher taxes later.

Answer:

1. Taxes function to reduce aggregate demand.

2. A tax hike is never in order with a weak economy, no matter how high the deficit or how high the interest payments may be.

3. Future tax increases would be a consideration should demand rise to the point where unemployment fell ‘too far’- maybe below 4%.

4. That is a scenario of prosperity and an economy growing so fast that it might be causing inflation which might need a tax hike or spending cut to cool it down.

So when someone states that today’s high deficit mean higher taxes later, he is in fact saying that today’s high deficits might cause the economy to grow so fast that it will require tax increases or spending cuts to slow it down.

Sounds like a good thing to me — who can be against that?

And, of course, the government always has the option to tax interest income if interest on the debt is deemed a problem at that time.

>    On Fri, Jun 12, 2009 at 8:46 AM, James Galbraith wrote:
>   
>   A comment in the National Journal, on the ever-green deficit alarmism that so preoccupies
>   people in Washington, to no good effect.
>   
>   Also, my June 5 lecture in Dublin, at the Institute for International and European Affairs, on the
>   crisis.
>   
>   With Q&A
>   
>   And a small postscript, reprising the old story of Eliza in Cuba, which I’ve promised her I
>   will now retire
>   
>   Jamie


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National Journal Expert Blog debate on fiscal sustainability


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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.

*****

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.

****

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.

****

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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On the floor of the Senate today


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From the last two paragraphs it looks like another fiscal package is on the way?

Interesting how little damage to the real economy it takes to trigger a fiscal response – GDP last printed at 3.3% and the relatively modest job losses are not nearly enough to have triggered a fiscal response in the past from either party?

So it seems behind the rhetoric the Democrats in Congress are in fact reacting more to financial sector needs.

Probably because, like the Republicans, most of their constituents are also shareholders.

The move to broaden shareholdings has had profound political ramifications that has undercut the previous agendas of both parties.

A few months ago the far left in Congress was congratulating the Fed chairman for keeping inflation expectation well contained even as other prices were rising, after it was explained that this meant keeping wages in check.

Since when doe the ‘far left’ praise a Fed chairman for suppressing wages, especially when the cost of living is on the rise???

Having a nation of shareholders seems to have redirected overall public purpose?

The 30% corporate income tax means the government already ‘better than ownes’ 30% off all the US based equity- it’s the direct pipe, and easily increased or decreased by decree.

Equity held at this level has very different political effects than individual ownership of shares.

Yet there is no discussion of any of this, anywhere in the public debate.

Meanwhile, crude seems to be acting like the ‘Master’s inventory liquidation’ may have run its course and the Saudis are again moving prices back up as demand for their output remains firm and their excess capacity is too thin for comfort.

This drives down the USD, making our stocks ‘cheaper’ to foreigners, so look for more foreign takeovers, which will be spun as the US ‘needing’ foreign borrowers and being ‘rescued’ by them.

Reid: While Financial Markets Reel, Bush-McCain Republicans Call For More Of The Same

Washington, DC—Senate Majority Leader Harry Reid made the following statement today on the floor of the U.S. Senate. Below are his remarks as prepared for delivery:

“On the morning of October 30, 1929, President Herbert Hoover awoke the day after the biggest one-day stock market crash in American history, surveyed the state of the U.S. economy and declared, ‘The fundamental business of the country, that is production and distribution of commodities, is on a sound and prosperous basis.’

“In the coming weeks and months, President Hoover remained in an economic bubble, unaware of the extreme suffering of ordinary Americans – even declaring that anyone who questioned the state of the economy was a ‘fool.’ For Herbert Hoover, ignorance was bliss. And it wasn’t until the American people replaced this out of touch Republican president with a Democrat, Franklin Roosevelt, that our nation’s economic recovery began.

“Yesterday, nearly 80 years after the Hoover Administration took America with blissful ignorance into depression, the Dow Jones Industrial Average dropped more than 500 points – the biggest one-day decline since trading opened after the attacks of 9/11. With one major investment bank headed for bankruptcy, another sold at a bargain-basement price, and one of the world’s largest insurance companies teetering, investors rushed to sell their shares.

“With our financial markets reeling, the American people are wondering whether they will lose their jobs, whether they will be able to pay their child’s next tuition bill, whether their pension and retirement savings will be safe.

“There is no reason to think we are headed into an economic depression. There is no reason to panic. Yet one Senator – John McCain – woke up yesterday morning, surveyed the state of the U.S. economy, summoned the ghost of his fellow Republican, Herbert Hoover, and declared, ‘The fundamentals of our economy are strong.’

“For whom are the fundamentals of our economy strong? Not for the 606,000 Americans who have lost their jobs this year alone. Not for the commuters and truckers who are sending more and more of their hard-earned dollars to pay for fuel. Not for all those struggling to make one pay check last until the next, with record hme heating prices looming in the coming winter months. Not for cities and towns that have been forced to cut back on police, schools and firefighters because their tax base is shrinking. And certainly not for the millions of families who have or may soon lose their homes, or for the tens of millions who are seeing their home equity plummet.

“No matter what George Bush, John McCain or the ghost of Herbert Hoover may think, this economy is not strong, and the American people deserve better.

“This is not a time for panic. But it is a time to look back on the past eight years of Bush-Hoover-McCain economics and figure out what brought us to this point so that we don’t repeat the same mistakes. And the tragic truth is that this disaster was avoidable. In its palpable disdain for all things relating to government, the Bush/Cheney Administration willfully neglected the government’s most important function: to safeguard the American people from harm.

“In their simplistic philosophy of ‘big business equals good, government equals bad,’ the Administration and the Republican Congress failed to conduct oversight and let the financial sector go wild. Without anyone regulating their actions, market excess destroyed the financial prudence that allowed a firm like Lehman Brothers to prosper for 158 years. Vast fortunes were made virtually over night, and now vast fortunes have been lost literally over night.

“The unfortunate irony is that the Bush Administration’s zeal to favor big business has now crippled it – and left the American people to pay the price. President Bush did nothing to stop this disaster, and now it’s clear he’ll leave the mess to the next president.

“Now our nation must decide who is better suited to end Bush-Hoover economics and return sanity and security to our economy. Senator McCain says the economy is not his strong suit, so he went searching for an economic advisor who could bolster his weakness. Who did he choose? Former Senator Phil Gramm. The same Phil Gramm who, as a Senator, was responsible for deregulation in the financial services industries that paved the way for much of this crisis to occur.

“A respected economist at the University of Texas, James K. Galbraith, said that Gramm was ‘the most aggressive advocate of every predatory and rapacious element that the financial sector has’ and that ‘he’s a sorcerer’s apprentice of instability and disaster in the financial system.’

“It was Phil Gramm who pushed legislation through a Republican Senate that allowed firms like Enron to avoid regulation and destroy the life savings of its employees, and it was Phil Gramm’s legislation that now allows Wall Street traders to bid up the price of oil, leaving us to pay the bill. Warren Buffet called the result of Gramm’s legislation ‘financial weapons of mass destruction.’ And now, the architect and leading cheerleader for every mistake and neglect that created the Bush/Cheney financial nightmare is whispering into the ear of John McCain – who says he doesn’t know much about the economy.

“Whether you call it Hoover economics, Bush economics, or McCain economics, it is not a recipe for change – it’s a recipe for more of the same.

“For all of the college students worried about finding a job, the working families who don’t know how they’ll pay the bills, and the fixed-income senior citizens trying to figure out how to pay for medicine, we must do better.

“We can’t afford another Republican president who will follow his party’s ghosts down the path of recession, depression and more suffering. We desperately need a president who understands that working people, not industry titans, are the backbone of our economy. We need a president who will cut taxes for working people and senior citizens; end the windfall profits of oil companies and put that money back into the pockets of those who are paying record prices at the pump; and put millions of Americans back to work by investing in jobs on Main Street, not Wall Street.

“In November, we can elect that President who will break from the past and invest in the future. Until then, the Senate should pass a second economic stimulus plan that funds infrastructure projects that will create jobs; prevents cuts in desperately-needed state services; and invests in renewable energy, expanded unemployment benefits for victims of the Bush-McCain economy, and helps working people and senior citizens afford the costs of energy.

“I expect the House of Representatives to pass a stimulus bill in the coming days. When it arrives in the Senate, I hope it will be embraced by Senators from both parties as a critical first step on the long road from economic ruin toward economic recovery.”


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A surge of a different type


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Government spending kicking in with 2007 spending that was delayed to 2008:

Topical article: The GOP’s December Surprise by James K. Galbraith

Durable Goods Orders Rise Unexpectedly

by Michael M. Grynbaum

A separate report showed that orders for big-ticket items rose last month, beating economists’ expectations. A surge in export orders and *investment in military-related products* sent durable goods orders up 0.8 percent in June from a revised 0.1 percent in May, the Commerce Department said. Excluding orders for military-related goods, orders were up only 0.1 percent.


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