Building a stairway to heaven

In the early 2000s Paul Krugman was outraged by the Bush administration’s fiscal deficits, and rightly so.  Bush ran sizable deficits during the 2001 recession, which is appropriate.  And those deficits raised the ratio of public debt to GDP, which is also appropriate.  But what Bush failed to do is pay off those debts during the goods years that followed (2004-07).  The debt ratio merely leveled off during the expansion.  Then the debt ratio rose again during the 2008-09 recession, and the subsequent sluggish recovery.  With this sort of fiscal policy the ratio of debt to GDP looks like a sort of staircase stairway to heaven; flat stretches during good years, followed by steep increases during recessions.   You need to offset the increases in the debt ratio during bad years, with declines during good years.  Otherwise you end up like Japan, with an ever-increasing debt ratio.  Instead the US and Europe seem to be edging toward the Japanese model.

Here’s Paul Krugman on the current situation:

So, in fiscal 2012 (which ended September 30) we did in fact have a federal deficit of $1.1 trillion (pdf). The question is, however, whether this deficit represents, as everyone claims, a fundamental mismatch between what we want and what we’re willing to pay for — or whether it’s mainly just a reflection of the depressed state of the economy.

For starters, we need to be aware that we don’t need a balanced budget to have a stable fiscal situation; all we need is for debt to grow no faster than GDP. At the beginning of fiscal 2012, federal debt in the hands of the public was $10 trillion. Meanwhile, most estimates of long-run growth and inflation put them at a bit more than 2 and 2 respectively; so we can reasonably say that nominal GDP growth can be expected to be more than 4 percent per year. If debt grew at 4 percent, it would grow by $400 billion. So the deficit should be scaled down by that much.

I’d say it is a fundamental mismatch, partly because I am less optimistic than Krugman that programs like food stamps, unemployment compensation and disability will ever return to normal (I hope I am wrong.)  But mostly because I’m afraid we may become complacent if we eventually get to a stable debt/GDP ratio, with a $400b deficit.  Most likely that will occur many years into the recovery, and our “success” will be almost immediately followed by another recession, and another increase in the debt/GDP ratio.

Just to clarify, this isn’t so much a critique of Krugman’s overall views as a warning that we shouldn’t become complacent.  It’s true that some level of deficits are sustainable if NGDP is rising.  Ironically the country that this argument is most applicable to is Australia, as they seem to have decided not to have recessions.  (They lack our Puritanism.)  Yet they have a tiny national debt.  Nor do I disagree with Krugman’s view that the current budget deficit is not the big issue; it’s a lack of AD on the one hand, and a looming medical/demographic problem on the other.  And I’d add that I expect real interest rates to stay very low for many years to come.

On the other hand I expect countries with low national debts (Australia, Singapore, Switzerland, some of the Nordic countries) to do much better in future years than places like Japan and Italy, which have very large debts.  So we shouldn’t become complacent about a fiscal policy that barely reaches a stable debt/GDP ratio at the peak of the business cycle.

In conclusion, I’d rather not “scale down” the deficit by $400 billion, but rather work very hard to eliminate even that deficit, so that we can again see a falling debt to GDP ratio.  The best way of doing so?  Fiscal austerity plus a much higher NGDP target, level targeting.

PS.  Never once has anyone asked me whether I propose to target NGDP with monetary or fiscal policy.  Gee, I wonder why?

HT:  Clark Johnson


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55 Responses to “Building a stairway to heaven”

  1. Gravatar of marcus nunes marcus nunes
    15. December 2012 at 16:07

    Scott
    Krugman is fond of arguing that the Fed cannot manage to be “credibly irresponsible”, but the Federal Government somehow can, promising to lower deficits in the future.
    You just showed that that´s a “dream”.

  2. Gravatar of Bill Ellis Bill Ellis
    15. December 2012 at 16:19

    Scott said…
    “Never once has anyone asked me whether I propose to target NGDP with monetary or fiscal policy. Gee, I wonder why?”

    Either /or ? Just like a Keynesian you advocate targeting with a monetary and Fiscal policy… Monetary explicitly, fiscal implicitly.

    You have always advocated austerity to go along with your NGDPT.

  3. Gravatar of Ajit Ajit
    15. December 2012 at 16:21

    Its statements like these that really suggest PK isn’t a truth seeker or an academic, but a hardcore ideologue. And here I thought economists fashioned themselves as scientists, not demagogues.

  4. Gravatar of Bill Ellis Bill Ellis
    15. December 2012 at 16:34

    Scott says… “I am less optimistic than Krugman that programs like food stamps, unemployment compensation and disability will ever return to normal (I hope I am wrong.) ”

    My two cents… I am more optimistic. Once demand for employment strongly trends toward normal levels I believe that political pressure can and should be successfully applied to trim them back.
    Americans are fundamentally specious about those getting hand outs when there are jobs to be had.

    But what if unemployment finds a new, higher “normal” ?
    Are you pessimistic on long term unemployment?

  5. Gravatar of ssumner ssumner
    15. December 2012 at 16:53

    Marcus, Yes, it’s hard to reconcile those two views.

    Bill, You said;

    “You have always advocated austerity to go along with your NGDPT.”

    Not at all, only when the deficits are excessively large.

    I’m optimistic about employment if we boost AD and trim back programs that discourage work–but I don’t see much progress. I will admit, however, that I don’t follow this issue closely, and mostly rely on what I read in the media, or an occasional article by Casey Mulligan (who is very pessimistic).

    But you make a good point about Americans; the pessimism about the welfare state of the 1970s and 1980s was replaced by record levels of employment in the late 1990s. So maybe we can do it again.

  6. Gravatar of Philo Philo
    15. December 2012 at 18:28

    You already work hard enough, so I wouldn’t want to see you also “work very hard to eliminate [the U.S. federal] deficit.” But if you did work very hard toward that end, what, exactly, would you be doing? Do you potentially have a lot of influence over the size of the deficit, which you could exercise if you chose (though it would require very hard work)?

    For myself, I don’t worry about the deficit, because I don’t know of any activity of mine—easy or hard—that would have a noticeable effect on its size.

  7. Gravatar of Gene Callahan Gene Callahan
    15. December 2012 at 19:04

    Scott, I think you’re making an allusion, but then your post should be titled “stairway”!

  8. Gravatar of ssumner ssumner
    15. December 2012 at 19:35

    Philo, I want someone else to do that–I have enough on my plate right now.

    Gene, The only question is whether I’ll be able to stop blogging before I become completely senile. Of course you are right, and I just changed the title. What was I thinking?

  9. Gravatar of Benjamin Cole Benjamin Cole
    15. December 2012 at 19:40

    Agree that cutting the deficit is needed; like to see SS retirement age raised to 68, and 65 for all federal employees, whether in uniform, overalls or tie and coat. And cut the annual trillion dollars in Defense, Homeland Security and VA outlays in half. Or more.

    That said, there is the reality that the Fed has wiped out $2 trillion in federal debt recently. And is now on course to wipe out $1 trillion annually. (If the Fed buys MBS, if has to sell someday, or hold to maturity, resulting in reduction in federal debt as they transfer proceeds to Treasury)

    QE can’t last?

    Maybe. Japan went to zero bound, tried QE 2001-6, and suffered no inflation, quite the opposite. Still deflation.

    If we get trapped in zero bound—I think likely, given Fed timidity and the Japan model—then QE moves beyond default, and become a conventional policy.

    This suggests the Fed should be moved into the Treasury. It will be generating trillions in revenues for the US government. A Treasury function.

    Globally, we see sovereign yields heading towards zero.

    The next task for the economics profession is not wringing your hands over inflation, but what to do when the economy has slipped on the ice, and is in zero bound.That might be globally soon, thanks to central banker fixations on inflation.

    Deficit spending does not work, see Japan. Certainly not if passive tightening is the rule.

    And at zero bound, a central ban passively tightens, unless it conducts serious and sustained QE programs.

    The stairway to heaven is the the joy of monetizing debt with only positive effects.

    I know this is sacrilege, blasphemy to many.

    But explain Japan, Explain the USA since the Fed started QE. We are seeing the lowest reading on the Cleveland Fed Index of Inflationary Expectations ever. After $2 trillion in QE.

    The Fed should be targeting 2 percent inflation–as a floor.

    So should the ECB and Japan. See the chart on sovereign yields. The world is headed to zero bound while central banker pompously pettifog about inflation.

    And so far, no one has decided a real world lift-off from the zero bound.

    That is where the danger lies.

  10. Gravatar of Major_Freedom Major_Freedom
    15. December 2012 at 23:04

    Just to clarify, this isn’t so much a critique of Krugman’s overall views as a warning that we shouldn’t become complacent.

    It’s always amusing when advocates of the moral hazard infused central banking system “warns” about political complacency. It’s almost as amusing as Krugman “warning” about a housing bubble in 2005 after screaming for one in 2002.

    Inflation has an inherent moral hazard associated with it. MMs (and Keynesians and MMTers) cannot understand this.

  11. Gravatar of Rajat Rajat
    16. December 2012 at 00:39

    Australia IS becoming complacent. We have gone from a budget surplus of more than 1% of GDP to deficits reaching >4% the last 4 years even without a recession. Funnily enough, the Labor government is maintaining its objective/promise to come back to surplus this FY even though most commentators think the government is too fixated with it and should ease up. But the government’s grandiose plans for extra disabilities and schools funding suggest they don’t intend to stay in surplus for long, even if they get there.

  12. Gravatar of fiscal conservatism « Thought du Jour fiscal conservatism « Thought du Jour
    16. December 2012 at 03:38

    [...] Sumner, “Building a stairway to heaven“, TheMoneyIllusion, 15 December [...]

  13. Gravatar of Niko Niko
    16. December 2012 at 04:15

    “Australia IS becoming complacent. We have gone from a budget surplus of more than 1% of GDP to deficits reaching >4% the last 4 years even without a recession. Funnily enough, the Labor government is maintaining its objective/promise to come back to surplus this FY even though most commentators think the government is too fixated with it and should ease up. But the government’s grandiose plans for extra disabilities and schools funding suggest they don’t intend to stay in surplus for long, even if they get there”

    Australia was experiencing a downturn so the RBA cut rates and the government spent money to avoid an actual recession. This is called counter-cyclical fiscal policy mate.

  14. Gravatar of Yaron Yaron
    16. December 2012 at 04:21

    There is a simple way to reduce debt/GDP ratio. Let the central banks cancel the government bonds they hold. Nothing is going to change except for one thing – the debt/GDP ratio will look much less scary.

  15. Gravatar of Michael Michael
    16. December 2012 at 05:29

    Why was it appropriate to have big deficits in 2001? The Fed Funds rates was above 2% until the recession was all over, so the zero lower bound was not binding and it seems we could have left things to monetary policy even by Krugman’s standards, doubly so by Sumner’s.

  16. Gravatar of ssumner ssumner
    16. December 2012 at 07:31

    Ben, But you could argue that they’ve merely replaced one form of debt (T-securities) with another (interest earning ERs.)

    Michael, I should have clarified that I was opposed to discretionary fiscal stimulus in 2001, but I favor “automatic stabilizers” during a recession. So yes, the deficit was bigger than it should have been–Krugman might well agree.

  17. Gravatar of Saturos Saturos
    16. December 2012 at 07:56

    Here is Adam Posen on Britain: http://notthetreasuryview.blogspot.com.au/2012/12/what-is-wrong-with-uk-economy-guest.html

  18. Gravatar of Saturos Saturos
    16. December 2012 at 08:00

    Here’s some fun – Robert Reich on the Fed’s new policy: http://www.moneynews.com/StreetTalk/Reich-Fed-rates-unemployment/2012/12/14/id/467762

  19. Gravatar of Steve Steve
    16. December 2012 at 10:42

    Saturos, are you trying to depress me?

    Reich: “But the sad fact is near-zero interest rates won’t do much for jobs because banks aren’t allowing many people to take advantage of them. If you’ve tried lately to refinance your home or get a home equity loan you know what I mean.”

    I don’t think Reich has a sufficient job history these days to meet the agency standards. The banks would be at risk of government putbacks if Reich decided to walk away from his mortgage.

  20. Gravatar of flow5 flow5
    16. December 2012 at 11:16

    We’re close to seeing the real power of OMOs. R-gDp is likely to accelerate earlier & faster than anyone now expects. The roc in M*Vt before any new stimulus is already above average. With low inflation (given some deficit resolution), Jan-Apr could be a zinger.

  21. Gravatar of Steve Steve
    16. December 2012 at 14:29

    Nouriel “Dr Doom” Roubini said we are moving from inflation targeting to NGDP targeting in a Bloomberg interview. Some people have said he got lucky in predicting the financial crisis; others think he is visionary. We shall see.

  22. Gravatar of JSeydl JSeydl
    16. December 2012 at 15:41

    If you think rates are going to stay low for a while, then I’m not sure why you’re upset about the deficit. As a percentage of GDP, the interest burden is at a post-war low.

  23. Gravatar of Benjamin Cole Benjamin Cole
    16. December 2012 at 19:43

    Yaron:

    In effect, when the Fed prints cash and buy Treasuries, they are “canceling” those bonds. The interest from the bonds, and the value of the bonds (at maturity) is transferred to the Treasury. It is a huge deleveraging of taxpayers.

    Printing money to buy and wipe out the federal debt is a fascinating operation, and taboo-verboten in economic circles. We are talking blasphemy, sacrilege, and perhaps bestiality all wrapped in one.

    Yet the reality is, the Fed is on course to wiping out $3 trillion in debt this recession, and we have the Cleveland Index of Inflationary Expectations heading towards zero, and we are still trapped at zero bound. Globally, sovereign debt yields are headed towards zero.

    THe Fed should wipe out another $3 trillion in debt and see what happens…..

    The threat today is not inflation, but global zero-bound perma-recession.

    And the threat is that due to economic shibboleths—that monetizing the public debt is profane—the globe may head towards zero-bound perma-recession.

  24. Gravatar of Yaron Yaron
    16. December 2012 at 22:37

    Benjamin, Thank you for your response. It makes sense to me.

  25. Gravatar of Suvy Suvy
    16. December 2012 at 22:50

    There’s a difference between running fiscal deficits when you have 12 million people unemployed versus some minor recession where far fewer people are unemployed. The 12 million people we have unemployed right now is a waste of resources that isn’t being used by the private sector. We could easily be producing more and more production used in the right way could easily pay for itself with interest rates being at zero right now.

    Usually, fiscal policy is counterproductive as it just takes away resources that can be used by the private sector for more useful purposes; however, now is not one of them. This is the stupidity of fiscal policy we’ve had over the past 30 years. We’ve run deficits in the biggest debt bubble in US history and when we need to run deficits and have 12 million people out of work; we don’t have the money to do it. Talk about idiots in charge.

  26. Gravatar of Suvy Suvy
    16. December 2012 at 22:52

    I would also like to add that government expenditures on things like infrastructure and public works are far more useful than things like Social Security which do nothing to improve the productive capacity or capital stock of a country. We need to make sure that government spending is used in productive ways rather than just government handouts to people(mainly in things like Social Security and Medicare).

  27. Gravatar of Benjamin Cole Benjamin Cole
    17. December 2012 at 00:43

    Suvy-

    I am glad for the federal government to so what is in the province of government, such as improving infrastructure.

    But that is separate from stimulating the economy.

    The Fed could be match better at that, through aggressive and sustained QE.

    My observation is that the Fed has done or is on course to to do $3 trillion in QE, and we see sinking expectations of inflation. See the Cleveland Fed Index of Inflation.

    So we have wiped out $3 trillion in taxpayer debt. And the door is wide open for a lot more….

  28. Gravatar of Saturos Saturos
    17. December 2012 at 01:48

    Robin Harding’s very important new piece in the FT: “Central Bankers Give Voice to a Revolution”

    http://www.ft.com/intl/cms/s/0/cbfae4f4-45e0-11e2-b7ba-00144feabdc0.html#axzz2FIj2XqZi

  29. Gravatar of RebelEconomist RebelEconomist
    17. December 2012 at 02:16

    Benjamin / Yaron “when the Fed prints cash and buy Treasuries, they are “canceling” those bonds.”

    Wrong. It is just an asset swap – floating rate interest reserves for fixed interest goverment bonds. No state debt has been cancelled at all. In fact, I dare say it has been increased, since most of the bonds will have been bought above par.

    At the moment, market short-term interest rates are low, so the reserves are willingly held, but they won’t be if market rates pick up and the Fed does not increase the interest paid on reserves. That is when the Great Inflation Showdown begins.

    As MF points out (in one of his shorter comments, which I therefore read), inflation generates moral hazard, which an objective, scientific analysis would suggest is bad for the economic system; nothing to do with blasphemy or sacrilege, let alone bestiality. My guess is that Benjamin’s irrational antipathy towards hard money derives from having a coin dropped on his head when he was in his pram.

  30. Gravatar of RebelEconomist RebelEconomist
    17. December 2012 at 03:29

    By the way, a reader of this blog from the UK frequently gets adverts for investing in postage stamps. Is this a sign that the advertiser considers this blog to be a nest of inflationists?

  31. Gravatar of Benjamin Cole Benjamin Cole
    17. December 2012 at 03:53

    Rebel–

    I think you are mistaken.

    Reserves held in a bank are not debts owed by taxpayers. They cannot mature and thus require repayment by taxpayers.

    The Fed is choosing now to pay interest on reserves, and Scott Sumner and I disagree with that policy. But that is lot different from being obligated to honor a lump sum at maturity. The Fed can unilaterally choose to not pay interest on excess reserves.

    My antipathy to hard money is based upon the results in Japan and the deflation they have endured since 1992. If ever there was a nation that tight money would work, it was probably Japan. It did not work, it was a disaster.

    For me, the key thing is real economic growth, not price stability.

    There are some costs to inflation; but the Internet has rapidly cut down those minor costs. Investment would rise if we could generate growth and inflation at this time. Indeed, I think we would have a long road of growth before we hit any moderate inflation. Unit costs per output generally go down when production rises from a recession, due to heavy fixed costs.

    Unit labor costs have been falling or flat for years. There is no inflation baked into the cake as in the 1970s. Trade is one third of the economy, the private sector has all but deunionized since the 1970s.

    My disco pants still fit, but not much else from the 1870s is worth re0doing, trust me.

    If you look at the Cleveland Index of Inflationary Expectations, it has been falling steadily or five years—QE has done nothing to reverse that.

    The Fed could probably buy another $3 trillion in Treasuries, and still have modest impact on inflation. We could a big impact on growth.

    And it would have wipe out $6 trillion in taxpayer debt.

  32. Gravatar of Saturos Saturos
    17. December 2012 at 05:18

    When the Fed makes a permanent increase in the money supply, as it regularly does, this means a permanent increase in its balance sheet. It is committing to roll over debt indefinitely, to permanently maintain a higher stock of outstanding liabilities. Sure, the Fed might be holding millions of baskets of goods in an underground bunker somewhere, but the fact is that people are quite happy to accept central bank liabilities as irredeemable debt, purely for its value as a medium of exchange. This also accounts for the theoretical difference between temporary and permanent helicopter drops, which the literature says should have quite different effects. (Nick Rowe has great posts on this, but I can’t be bothered hunting them down right now.)

  33. Gravatar of Saturos Saturos
    17. December 2012 at 05:19

    So point being, permanent OMOs which grow the money supply over time are monetization.

  34. Gravatar of Major_Freedom Major_Freedom
    17. December 2012 at 06:14

    Saturos:

    So point being, permanent OMOs which grow the money supply over time are monetization.

    “Permanent OMOs” is bad verbiage, because all OMOs are finite actions, and not permanent. They last as long as the Fed takes to send money to the primary dealers. Even if OMOs were temporary (using your verbiage), and even if the aggregate money supply was falling as the OMOs are made, OMO would still be “monetization.” Monetization is the act of turning claims to future money, into new present money, via legalized counterfeiting (or what others call “monetary policy”, “OMO”, “inflation”, etc. If private debt claims are deflating, which when combined with the Fed’s reserve activity adds up to negative aggregate money supply growth, it wouldn’t change the inherent nature of the OMO itself, thus aggregate changes should not be considered as factors that would determine whether or not monetization is taking place.

  35. Gravatar of Major_Freedom Major_Freedom
    17. December 2012 at 06:18

    Every single time the Fed sends money to a party in exchange for X, that is a “monetization” of X.

    Yes, this implies the Fed has been monetizing debt for generations. The more pertinent questions are how much of it they engage in, who they engage it in with, for what, and how that affects others (of course MMs falsely believe their preferred rate of monetization has gains greater than the costs, because they also do not understand that gains and costs are subjective and cannot be lumped together to form single monolithic “social gain” and “social cost”)

  36. Gravatar of RebelEconomist RebelEconomist
    17. December 2012 at 06:21

    Benjamin, I agree that irredeemable base money is arguably not formally a liability, but the key is that its performance (in terms of real value) has been guaranteed by its supplier – ie via the Fed’s mandate and now inflation target. Now you will probably say that this does not amount to a formal promise and can be broken, but the point I try to make to you is that broken promises – even perceived promises – tend to cost a lot in the long run, because your counterparties build in an insurance premium to account for your unreliability. It might be called MORAL hazard, but in reality it is just impersonal portfolio optimisation. It would be wiser to treat base money as a state liability, just like Treasury debt.

  37. Gravatar of Saturos Saturos
    17. December 2012 at 06:23

    Not sure if he’s kidding, but I actually like this idea: http://www.washingtonpost.com/business/economy/to-solve-our-debt-problems-lets-sell-alaska/2012/12/14/1c63c1d6-4352-11e2-9648-a2c323a991d6_story_1.html

    MF, I understand you oppose the Fed’s monopoly on money creation, but why would that make it counterfeiting? It’s not pretending to be something it’s not. (Well actually it is – it’s pretending to be a bank, and it’s not.)

  38. Gravatar of Saturos Saturos
    17. December 2012 at 06:32

    Okay, read to the end of that article. He was kidding. But I still think China could get more value out of Alaska than the US would. It’s a Pareto improvement.

  39. Gravatar of RebelEconomist RebelEconomist
    17. December 2012 at 06:34

    Saturos, I would be wary of the term “permanent OMOs”. Practically every asset bought by the Fed is a self-cancelling debt asset. In other words, when that asset matures, the Fed has to accept the return and effective cancellation of base money. There are of course coercive ways round this, such as enforcing tax liabilities in state money, but I am not sure that many would want to live in a country like that (eg like Argentina, where people try to hold as few assets denominated in domestic currency as required for foreseeable transactions).

    (I think this might be what MF is getting at in his reply to you).

  40. Gravatar of Saturos Saturos
    17. December 2012 at 06:49

    Scott, very interesting and important new post by Arnold Kling (but WordPress won’t let me link to it, so check the blogsite).

    Rebel, do you deny that the Fed has been growing its balance sheet over the past century, steadily increasing the outstanding base money supply?

  41. Gravatar of ssumner ssumner
    17. December 2012 at 06:55

    Steve, After what’s happened since 2009, surely there’s no one who still views Roubini as a “visionary?” He’s been consistently wrong about the stock market and the economy.

    Rebeleconomist, The ads are tailored to the reader’s interests, not the blog content.

  42. Gravatar of RebelEconomist RebelEconomist
    17. December 2012 at 06:58

    Saturos, I used to suggest years ago on Brad Setser’s blog that the US sold Alaska – eg here: http://blogs.cfr.org/setser/2007/03/30/almost-unimaginably-large-2006-global-reserve-growth/ (see comment at 5.27am on 1st April; and I was not entirely joking!). Hawaii too. Good blog, Brad Setser’s.

  43. Gravatar of RebelEconomist RebelEconomist
    17. December 2012 at 07:00

    Jeez Scott, I am now getting payday loan adverts (Quick Quid). What does this thing know?!

  44. Gravatar of RebelEconomist RebelEconomist
    17. December 2012 at 07:07

    Saturos, I should have written 5.32am (as if anyone cares). You may also find this old Macro Man blog post amusing: http://macro-man.blogspot.co.uk/2008/07/modest-proposal.html (another classic blog).

  45. Gravatar of RebelEconomist RebelEconomist
    17. December 2012 at 07:17

    @Saturos

    “Rebel, do you deny that the Fed has been growing its balance sheet over the past century”

    No, but that does not mean that the Fed has not stood ready to contract the stock of money if its inflation target required. For years, this has been largely a moot point (although it is the case in the UK at least, the base money stock has long been contracted quite sharply after Christmas), but the recent massive balance sheet expansion under QE has made this a live issue. I hope these have not been “permanent” OMOs!

  46. Gravatar of Mike Sax Mike Sax
    17. December 2012 at 09:18

    “I’d say it is a fundamental mismatch, partly because I am less optimistic than Krugman that programs like food stamps, unemployment compensation and disability will ever return to normal (I hope I am wrong.)”

    You’re pessmistic that the automatic stabilizers will go down if the economy more fully recovers or are you pessmistic the economy will fully recover?

    “In conclusion, I’d rather not “scale down” the deficit by $400 billion, but rather work very hard to eliminate even that deficit, so that we can again see a falling debt to GDP ratio. The best way of doing so? Fiscal austerity plus a much higher NGDP target, level targeting.”

    Krugman recently posted a chart that showed that most of teh structural deficit is driven by the Bush tax cuts and the off balance sheet wars. The wars have ended/are ending. The Bush cuts will be scaled back for the rich. True no one-including me-wants to end them for the middle class and poor.

  47. Gravatar of cucaracha cucaracha
    17. December 2012 at 11:52

    “The best way of doing so? Fiscal austerity plus a much higher NGDP target, level targeting.”

    If you have an NGDP target, you probably you need some easing to go after this target. Central Banks do this easing mostly by buying public debt.

    And if Central Banks eventually buy private bonds to “ease”, that corresponds to a fiscal deficit, too.

    On one hand, in a zero lower bound situation like the current one, and zero fiscal deficit, buying more public debt won’t make any difference, because you are exchanging (again) money for money. The total amount of money does not change.

    On the other hand, Central Banks buying private debt to put more money in the market is equivalent to increasing the deficit. It’s fiscal policy made by Central Banks.

    Which means that an effective NGDP in the current situation needs both QE and fiscal deficits.

  48. Gravatar of ssumner ssumner
    17. December 2012 at 12:49

    Cucaracha, No, the Fed doesn’t need to buy bonds to make this work, and if they do it doesn’t imply a fiscal deficit.

  49. Gravatar of cucaracha cucaracha
    17. December 2012 at 14:50

    Scott,

    I mean:

    1- Central Bank buys government bonds = does not raise the budget deficit, but this isn’t effective without a budget deficit (from the Treasury) in a zero lower bound;

    2- Central Bank buys private bonds: it may be effective (really pumps more money into the market) but it generates a fiscal deficit.

    Why buying government bonds is monetary policy and buying private bonds is fiscal policy ? Because when CBs buy public debt, they increase the amount of money (strict meaning) and reduce the amount of public bonds in the market. The amount of money (strict meaning), which is public debt itself, plus government bonds in the market remains unchanged – This is monetary policy. But when CBs buy private debt, the total amount of money + government bonds, ceteris paribus, increases – government debt (Treasury + Central Bank) is consequently higher – this is fiscal policy working…

  50. Gravatar of ZHD ZHD
    17. December 2012 at 16:22

    Scott,
    Why should we be concerned with deficit reduction when there’s still a large negative output gap and inflation is extremely low?

    Is there even a problem with running a perpetual deficit? Isn’t sovereign debt an asset to the private sector? As long as fiscal policy isn’t crowding out skilled labor demands then why is everyone so concerned over debt?

  51. Gravatar of ssumner ssumner
    18. December 2012 at 06:31

    cucaracha, That’s wrong, it makes no difference who they buy from.

    ZHD, More debt means more future tax liabilities, which slows growth.

  52. Gravatar of ZHD ZHD
    18. December 2012 at 10:35

    I fail to see the connection between debt and tax liabilities. Tax liabilities are a claim to real assets, just because there is more debt doesn’t mean that claim must increase.

  53. Gravatar of Doug M Doug M
    18. December 2012 at 10:42

    “You’re pessmistic that the automatic stabilizers will go down if the economy more fully recovers or are you pessmistic the economy will fully recover?”

    Pessimistic that after unemployment breaks below 6%, there will still be a segment of the popluation that is “chronicly unemployed” and 99 weeks of unemployment insurance becomes the new normal.

  54. Gravatar of Doug M Doug M
    18. December 2012 at 10:59

    Cucaracha,

    “Central Bank buys government bonds = does not raise the budget deficit, but this isn’t effective without a budget deficit (from the Treasury) in a zero lower bound;”

    The budget defecit it what ever it is, regarless of the stance of the Fed. If the Fed buys Treasury bonds it neither increases nor decreases the defecit. It may change the supply of publicly avaible government debt. If the Fed buys private debt, again, it does nothing to the defecit.

    Strictly speaking it doesn’t matter if the Fed buys government debt or non-government debt. Both make the same injection of money into the banking system. One way to think about money supply is as the quantity of assets on bank balance sheets — Deposits, plus loans — loans to the Government (T-notes), loans to corporations (both loans and bonds), and loans to individuals (MBS, Autos, and credit cards).

  55. Gravatar of cucaracha cucaracha
    19. December 2012 at 03:12

    Doug,

    “If the Fed buys Treasury bonds it neither increases nor decreases the defecit.”

    We don’t disagree on this. What I said is that the Fed buying Treasuries in a lower zero bound without a budget deficit from the Treasury would tend to be ineffective.

    “If the Fed buys private debt, again, it does nothing to the defecit.”

    Probably you don’t share my view that money itself is government debt and the issue of money on current spending or on the purchase of any other asset other than government debt itself implies on fiscal spending that contributes to increase the fiscal deficit.

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