Peak fiscal indiscipline

For quite some time, I’ve been beating the drum on the reckless nature of fiscal policy, and now the media is getting on board.  Craig Torres and Liz Capo McCormick have an excellent piece in Bloomberg:

“Austerity is going to be on nobody’s platform for the foreseeable future,” said Lou Crandall, chief economist at Wrightson ICAP. Democrats and Republicans will push the U.S. toward “peak fiscal indiscipline” over the next couple of years, he said.

What both parties have learned is that, for now, the debt-carrying capacity of the economy appears to be high. One reason is the U.S. continues to be the world’s biggest provider of safe assets.

“We are the prettiest pig in the pig pen and we will be so for some time,” said David Beckworth, a senior research fellow at the Mercatus Center at George Mason University. “We have greater debt capacity than we thought we had.”

David’s right. Unfortunately it’s as if you told an alcoholic that they had more money in their bank account than they thought.  But now there’s a new concern; Congress is discovering that they passed a law back in 1978 that requires the Fed to engage in monetary offset:

Democrats soon to be in command of the House of Representatives are pushing for infrastructure spending and a wider distribution of gains to workers from a hot job market. Republicans want economic growth to accelerate from their tax cuts, deregulation and defense spending. Steadily rising interest rates can appear contrary to both goals. . . .

“On the House front, there will definitely be more criticism [of the Fed]. They will say clearly we have good outcomes, so what’s the hurry?” said Edward Al-Hussainy, a senior analyst for interest rates and currencies with Columbia Threadneedle Investments. “On the Republican side, the question will be, ‘If we roll out more stimulus, are you going to offset it? That doesn’t work for us.”

Offset!?!?  There’s that horrible word again.

I’m having a lot of trouble selling people on the idea of having the Fed self-evaluate past monetary policy decisions, and report the results to Congress.  People look on this as an ordinary public policy issue, where there are different points of view, different special interest groups, a CYA attitude among policymakers, etc. But monetary policy is nothing like ordinary public policy issues.  With a normal public policy issue, there might be a debate about whether higher interest rates are a good or bad idea, but at least both sides would agree as to what sort of policy produces higher interest rates.  In this case, Congress even lacks that basic knowledge.  Congress doesn’t have a clue as to how to evaluate monetary policy, and really does need help from the Fed.  I don’t doubt there are people in Congress who favor capping inflation at 2%, and who also want the Fed to engage in a pro-growth policy.

The Dems seem to think that easy money will raise real wage rates, as prices are more flexible than wages.  If anything, it would lower real wage rates in the short run.  Indeed real wage growth has slowed since Trump took office, partly because monetary policy has gotten easier.  The GOP seems to think that military spending will boost growth, which against seems very unlikely.  Although it’s especially difficult to figure out what the GOP believes, because their views seem to change radically from one year to the next.

During my first 7 years of blogging, I frequently pointed out that the GOP didn’t really favor small government, as when they finally took all three branches of government in 2001 they went on a deficit spending spree.  A number of commenters assured me that the Bush GOP was gone, and the party was now controlled by small government Tea Party types.  They were right in one respect, this is not the Bush GOP.  Deficit spending today is far higher than anything imagined by Bush, with the deficit expected to exceed $1 trillion next year, even as unemployment falls to 3.7%.  The Tea Party?  They love it, as long as Trump keeps trolling the liberals.

The Dems are deeply misguided on many economic issues, but at least the party still has tiny traces of idealism.  The idealists in the GOP are either dead (McCain), retiring (Ryan, Flake, Corker), or “changed” (Graham.)  No matter how cynical I get, I can’t keep up.

To be sure, there will be no immediate crisis.  The US has an enormous ability to borrow money, especially at these low rates:

Following the passage of the Republican’s Tax Cut and Jobs Act of 2017 — which rocketed projections for debt held by the public to 96.2 percent of gross domestic product by 2028 from 76.5 percent in 2017 — 10-year Treasury yields are hovering around 3.19 percent compared with 2.4 percent at the end of last year.

But keep two things in mind.  First, this trend is unsustainable.  Second, even this unsustainable path is the “rosy scenario”, assuming no recession in the next decade.  I’m actually more optimistic than the average economist on that score, but even I believe it’s unwise to base fiscal policy on that sort of optimistic assumption.

Politically, however, my argument is a loser.  The cost of a reckless fiscal policy, a reckless monetary policy, a reckless bank regulatory policy, a reckless global warming policy, and a reckless foreign policy, are not likely to occur until after the 2020 elections.  And to a politician, nothing after 2020 matters.

So how large a debt should we have?  I don’t know, but that’s not really the point.  Even if I’m wrong, and more US debt would be helpful in meeting the global need for “safe assets”, that is not a reason to run massive, irresponsible budget deficits.  Rather you’d want to create a sovereign wealth fund, and use the fund in later decades to meet the fiscal needs of retiring boomers. Of course we don’t have the foresight of a Norway or Singapore, and are becoming more banana republic-like by the day.

There’s a long historical record of populist economic policies, and in almost every case it hasn’t ended well.  Let’s hope Powell can withstand the pressure.



26 Responses to “Peak fiscal indiscipline”

  1. Gravatar of Todd Kreider Todd Kreider
    10. November 2018 at 14:56

    “As a friend said last night, we’ve become a banana republic with nukes” – Paul Krugman, 2008

    “[We] are becoming more banana republic-like by the day.” – Scott Sumnner, 2018

    “The U.S. is really, really about to slip into a banana republic!” -(this space open), 2028

  2. Gravatar of Benjamin Cole Benjamin Cole
    10. November 2018 at 17:21

    No matter how cynical I get, I can’t keep up.—Scott Sumner.


    But save some cynicism for the Federal Reserve. After all, regulatory agencies can be captured and the Fed is a regulatory agency.

    Really, what is the purpose of interest on excess reserves? And why are capital requirements so meager, even after the 2008 debacle?

    Why does the Fed, in its Beige books, constantly refer to “labor shortages” but never to regional housing shortages?

    Sunlight, transparency, accountability, clarity, simplicity— even in monetary policy, I posit these are the traits of good government.

    PS–As for the ever-soaring federal deficit, we can only hope that the US can do a Japan. The Bank of Japan has purchased back 45% of that nation’s huge pile of Japanese government bonds. The taxpayers of Japan now owe money to themselves and collect interest on the bonds that have been issued. Japan has managed to move to a 1% inflation rate, but that may be faltering. From the low side, that is.

    It is interesting that in the United States QE also did not lead to a round of inflation. Given that ballooning deficits are nearly a certainty, our best hope is that QE works as it has in Japan.

  3. Gravatar of postkey postkey
    11. November 2018 at 02:59

    Here is someone that didn’t think that US QE would lead to inflation?

    “this doesn’t create inflation
    29:33 some people thought at the time wow
    29:35 we’re gonna get hyperinflation now . . . ”

  4. Gravatar of H_WASSHOI (Maekawa Miku-nyan lover) H_WASSHOI (Maekawa Miku-nyan lover)
    11. November 2018 at 04:54

    I was very surprised that the Norway’s SWF are buying “value stock” of Japanese oil company.

  5. Gravatar of Michael Rulle Michael Rulle
    11. November 2018 at 06:20

    Ever since I exited business school all I ever believed and heard was how bad deficits are. Yet the entire Western world plus Japan and China have been and seemingly always will be massive deficit spenders. The largest percent of it is transfer payments (much of it from the people in the future to the people in the present). But somehow the material world keeps improving. I don’t know this, but I would bet that if in 1990 the world knew Japan’s debt would be 2.5 times its GDP they would have thought it would be more like Greece than Germany. You do write a blog called money illusion, so that could be part of my confusion——the illusion part. Maybe none of it matters at all. Maybe we create goods and services at an accelerated pace we do not know how to measure. Samuelson believed the need for balanced budgets was pure myth. So did Buchanan, except for pragmatic reasons of keeping the government small, but not for the usual reasons normally sighted. Having read enough of my comments it surely does not surprise you that I have no clue. But what I observe is very few seem to have a clue also—-not that I could tell.

  6. Gravatar of Philo Philo
    11. November 2018 at 07:36

    If the U.S. government is going to issue a lot of debt, you want it to balance this by simultaneously piling up assets. Well, how much are the assets controlled by the U.S. government worth, and how has this (gross) amount changed over time, as the debt has been accumulating? In other words, how has the net worth of the U.S. government changed during the debt-binge period, the administrations of G. W. Bush, Obama, and Trump? You seem misguided in obsessing about the debit side of the ledger while completely ignoring the credit side.

  7. Gravatar of ssumner ssumner
    11. November 2018 at 08:40

    Postkey, Add market monetarists to that list.

    Michael, Deficits are not a problem, excessively large deficits are a problem.

    Philo, I’m not ignoring the credit side, it’s not enough to change the result.

  8. Gravatar of E. Harding E. Harding
    11. November 2018 at 09:03

    “For quite some time, I’ve been beating the drum on the reckless nature of fiscal policy,”


    “The idealists in the GOP are either dead (McCain), retiring (Ryan, Flake, Corker), or “changed” (Graham.)”

    Eh, no. None of these people ever supported small government, with the sole exception of Flake. McCain voted against Mulvaney due to Mulvaney’s willingness to cut military spending. Sasse, Cruz, Lee, and Paul are very much alive. Also, you yourself explicitly supported the defeat of one of the GOP’s great idealists on fiscal issues (Brat). Sadly, Sanford, another true fiscal conservative, was defeated by a moron Trumpist, who herself was defeated by a Democrat.

    “There’s a long historical record of populist economic policies, and in almost every case it hasn’t ended well. Let’s hope Powell can withstand the pressure.”


  9. Gravatar of Matthew Waters Matthew Waters
    11. November 2018 at 09:17

    Benjamin Cole,

    IOR is a very good policy outside of the zero-bound. The “shadow banking system” arose mainly because large bank accounts did not want 10% of their accounts to be 0%-yielding reserves. I would rather have IOR replace OMOs outside the ZLB.

    The beige books do show the pro-business bias of Fed Banks. The boards of these banks are mostly CEOs, of both banks and non-banks. So the bank employees talk exclusively with managers for what’s happening in the “real economy.” The perfect world for beige book seems to be excess demand but labor slack. Obviously this isn’t possible.

    IOR was implemented in 2008 because banks and MMFs would lose money otherwise for lack of interest-yielding assets. The Fed should not have cared. But now, outside of ZLB, IOR is a better policy tool than OMOs.

  10. Gravatar of Matthew Waters Matthew Waters
    11. November 2018 at 09:20

    In terms of debits vs credits, the deficit numbers are after taking account of most credits. A student loan for $10,000 increases liabilities of US gov by $10k. But only a percentage for default is counted as an expense.

  11. Gravatar of Jeff Jeff
    11. November 2018 at 13:45

    Debt held by the public is nearly $16 billion. If NGDP grows at 5 percent, you can run an $800 billion dollar deficit without increasing the debt-to-GDP ratio. That’s about what this year’s deficit is.

  12. Gravatar of Benjamin Cole Benjamin Cole
    11. November 2018 at 17:10

    Matt Waters:

    You make a good point, but on the other hand there is a bit of the USDA in the Federal Reserve IOER and regulation of the financial sector. That is, we are paying people to do nothing.

    You are correct that the procedure of the Fed Beige Books to determine “labor shortages” is to interview employers. Some Fed Beige Books have even referred to “worker shortages.”

    But the Fed is certainly aware of the exposure of the commercial banking system to property. There are never “housing shortages,” but there are strong and weak housing markets.

  13. Gravatar of Brian Donohue Brian Donohue
    12. November 2018 at 06:28

    5-year TIPS closed at a 1.17% yield on Thursday, the highest rate since 2009 (more than 9 years). Meanwhile, 30-year TIPS yield 1.32%.

    That’s a really flat TIPS curve. Self-inflicted wound ahead. Leave off the FFR hikes and accelerate unwinding of long-term QE instead. Basically, undo Operation Twist from 2011-12.

  14. Gravatar of Matthew Waters Matthew Waters
    12. November 2018 at 08:53

    Benjamin Cole,

    I think of reserves like one-day T-bills. They are funding about $2 trillion in debt on the other side of the Fed’s balance sheet.

    The real issue is that access to the reserves are guarded. You have to get an OCC or state charter. Then the Fed has to agree to a Master Account Agreement. The Fed is statutorily required to give access to any chartered bank, but they’ve slow-walked the application for TNB for a year.

  15. Gravatar of Doug M Doug M
    12. November 2018 at 11:47

    If you are a politician, there really is nothing good about cutting spending. It might be good to talk about cutting spending, but the dollar not spent has no influence behind it.

    People run for office because there is $4T dollars to distribute, there is a lot of status associated with being one of the people who can direct some of that flow. And people spend good money to get “their guy” into office so that their politician can direct that flow to the correct patrons.

    Putting money into the piggy bank isn’t sexy.

    When re-election rates are at all time highs, and satisfaction is at all time lows, you know that congress is doing its job.

  16. Gravatar of msgkings msgkings
    12. November 2018 at 12:26

    @Brian D: Your idea seems very strong, almost obviously so. How do you and I see this but the actual people at the Fed, who presumably know more about it than we do, not see it? Genuinely curious, is there something wrong with the idea that we don’t see?

  17. Gravatar of ssumner ssumner
    12. November 2018 at 15:09

    Jeff, So we’ll never have another recession? And RGDP will keep growing at 3%?

  18. Gravatar of Carl Carl
    13. November 2018 at 07:10

    We have no check and balance in our system that protects those not yet able to vote and those not yet born. So, we foist our debts onto them. I don’t know how to change the system to eliminate the disparity, but I think it would help if some politicians starting raising the fact that people who are complaining about austerity are partly, at least, complaining that they can’t put our bills on our grandkids’ credit cards.

  19. Gravatar of foosion foosion
    13. November 2018 at 08:54

    “We have no check and balance in our system that protects those not yet able to vote and those not yet born. So, we foist our debts onto them.”

    The debt is owed to the same generation that has to pay it (or rolling it over by future borrowing). Creditor and debtor side net to zero.

    There are distributional issues.

  20. Gravatar of Jeff Jeff
    13. November 2018 at 09:14

    Scott, surely you understand that budget projections are almost always wrong. And in any case, the true burden of government is how much it spends and how many decisions it takes out of the private sector. The deficit doesn’t actually matter that much.

  21. Gravatar of Carl Carl
    13. November 2018 at 09:45

    “The debt is owed to the same generation that has to pay it”

    That would only be true if we never rolled over our debt.

  22. Gravatar of Carl Carl
    13. November 2018 at 10:16

    One clarification. My statement that we have no check and balance is over simplified. Bond buyers have to be willing to purchase the debt. Voters have to be willing to endure the inflation that will occur if we start monetizing the debt.

    That said, because we can rollover our debt, much of our debt will get rolled over to our grandchildren who have had no say in accruing it. And, I would guess that they would say no if someone asked them whether they wanted to start their lives paying off debt accrued to overthrow Saddam and to pay for grandpa’s viagra,

  23. Gravatar of Wonks Anonymous Wonks Anonymous
    13. November 2018 at 13:45

    Your reference to McCain & Graham as idealists reminded me of Paul Krugman’s tweet that only the neoconservatives on the right turned out to have genuine principles, to which Tristan Severs responded “Technically he is correct, it’s just that those principles are evil.”

  24. Gravatar of ssumner ssumner
    13. November 2018 at 15:58

    Jeff, I said:

    “Second, even this unsustainable path is the “rosy scenario”, assuming no recession in the next decade.”

    And then you replied:

    “Scott, surely you understand that budget projections are almost always wrong.”

    I guess people have lost the ability to read.

  25. Gravatar of Weekend Reading: Why This Isn’t “THE” Bear Market…Yet | Real Patriot News Weekend Reading: Why This Isn’t “THE” Bear Market…Yet | Real Patriot News
    16. November 2018 at 13:39

    […] Peak Fiscal IN-Discipline by Scott Sumner via The Money Illusion […]

  26. Gravatar of DJ DJ
    21. November 2018 at 21:45

    I’m 45 years old. In my adult life I haven’t seen the Democrats enact any reckless fiscal policies at the Federal level. Not sure why you would assume they will now.

    Also, as long as we have substantial wealth inequality we’ll continue to have plenty of buyers of debt – and financial volatility.

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