Archive for the Category Fiscal policy


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.

The Tea Party won

The Tea Party has finally achieved its objective.  The GOP is in control of all branches of government and Tea Party favorite Donald Trump was elected President.  They won.

But what exactly did they win?  Their big issue was the budget deficit, which as of 2015 was rapidly shrinking (as is generally the case during economic recoveries.)

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The recovery has since picked up speed, so the deficit should be falling especially fast right now.  Unfortunately, the FRED data site does not have updated figures, but the deficit is no longer falling.  Indeed it’s exploding, expected to reach $1.1 trillion in 2019.  Nothing like this has ever happened in America during a period of peace and prosperity.  There is such a firehose of spending that Washington is hardly able to shovel dollars out the door as fast as they are being appropriated:

The federal government is primed to spend as much as $300 billion in the final quarter of fiscal 2018 as agencies rush to obligate money appropriated by Congress before Sept. 30 or return it to the Treasury Department.

The spending spree is the product of the omnibus budget agreement signed six months late in March coupled with funding increases of $80 billion for defense and $63 billion for civilian agencies. The shortened time frame left procurement officials scrambling to find ways to spend the money.

Through August, defense and civilian agencies obligated some $300 billion in contracts. But to spend all the money appropriated to them by Congress, they may have to obligate well over $200 billion more in the final quarter of fiscal 2018, which ends in two weeks.

“It is not impossible for this to happen, but it is unprecedented for that high of a percentage to be obligated to contracts for a fiscal quarter,” David Berteau, president of the Professional Services Council, told Nextgov. “You’d have to spend almost 50 percent of the yearly total in three months.”

And yet the federal government may do just that.

This is what happens when you give the GOP full control over the government.

Hardly anyone is reporting this story, even though it’s one of the most bizarre things to have happened in America during my lifetime.  Perhaps this is because none of our “tribes” has an incentive to acknowledge these facts.  The GOP wants to tell voters that it’s a responsible, small government, conservative party, pushing back against the deficit spending of the Obama years.  The Dems want to tell voters that the GOP is a mean-spirited, small government, conservative party.  Both are lying.  The press plays along with this framing, because it lets the two tribes set the terms of the debate.  The GOP is actually a big government party.  Neither the NYT nor Fox News will tell you that.

To get a sense of the weirdness of this state of affairs, imagine the right-to-life movement were to get control of all branches of American government.  And then assume that they immediately proceeded to make abortion mandatory for all pregnancies involving unmarried women.  Because deficit spending is a dry economic issue, people don’t grasp the strangeness of what’s happened.

PS.  Off topic, this FT piece made me smile:

The US and Canada have been sparring over access to the protected Canadian dairy market, American insistence on scrapping a dispute settlement mechanism in the original pact, and Ottawa’s request for cultural exceptions to be maintained in the media sector. . . .

On Tuesday, Steve Scalise, a Louisiana Republican and the House majority whip, fired off a statement attacking Ottawa, saying there was growing “frustration” that Canada was not “ready or willing” to make a deal.

“Mexico negotiated in good faith and in a timely manner, and if Canada does not co-operate in the negotiations, Congress will have no choice but to consider options about how best to move forward and stand up for American workers.”

Good to see the GOP standing up for Johnny Depp, Brad Pitt, Robert Downey Jr., Tom Cruise, and other “American workers”.



Where the FTPL applies

The fiscal theory of the price level does not explain very much in the US.  Inflation often soars much higher during periods when the national debt is low and falling (the 1960s) and falls sharply when the deficit increases dramatically (the 1980s).  But the FTPL does explain the inflation dynamics of Argentina:

“The [peso] price action looks like a loss of confidence by foreign investors coupled with some form of “capitulation” by domestic investors,” he added. “Markets need to see a radical tightening in fiscal policy in order to stabilise the situation, and that includes cutting wage hikes in order to fight inflation.

There is also some data that sounds suspiciously NeoFisherian:

Argentina’s peso is again feeling the heat.

The currency has fallen to a new record low of 23 against the dollar after slumping 5 per cent in morning trade on Tuesday. . . .

The declines come despite massive intervention by the Argentine central bank, which hiked interest rates by an unprecedented 12.75 percentage points to 40 per cent in the space of just seven days last week.

As always, however, you need to keep in mind the correlation/causation distinction.  Most likely it’s the high inflation causing the high nominal interest rates, not vice versa.  (Or if you prefer, the budget deficits are causing both.)

What is demand stimulus?

This is a sort of follow-up to my previous post.  One can think of demand stimulus as policies that boost NGDP.  (There are of course other policies that boost RGDP, such as supply side reforms, which work even if NGDP doesn’t rise.  But demand stimulus boosts NGDP.)

We know from long run money neutrality that the long run trend rate of growth doesn’t matter, except for second order effects like hysteresis and menu costs and taxation of capital income—and these second order effects might be positive or negative.  If someone argues that a certain policy may be able to significantly raise the trend line for RGDP, they may be right, but they are almost certainly NOT talking about demand-side stimulus.

The upshot of all of this is that there is only one coherent way to think about demand-side policies.  When should AD be more expansionary than average and when should it be less expansionary than average? It’s incoherent to say, “I think demand side polices should always be stimulative.”  That doesn’t even mean anything.  It’s like saying, “I believe all Americans should earn above average incomes.”  Any demand-side strategy should either call for stable AD growth, or else specify when aggregate demand should be more expansionary than average and when it should be more contractionary than average.

If you are advocating demand stimulus during a period of low unemployment, then (whether you know this or not) you are implicitly suggesting that demand-side policy should be more contractionary than average during a recession.  Not good.

A corollary of this is that terms like ‘hawks’ and ‘doves’ don’t have the meaning that almost everyone thinks they have.  If you have a 2% inflation target, exactly how do you implement a “dovish” policy?  A “hawkish” policy?

What if we turn to fiscal policy; does that change things?  Not at all.  The government’s national debt is constrained by the fact that the debt must be serviced in the long run.  This budget constraint means that budget deficits that are larger than average during certain periods must be offset by deficits that are smaller than average during other periods–to keep the debt manageable.  It makes no sense for someone to say, “I generally favor a more expansionary fiscal policy than what is favored by Sumner.”  It’s not even a coherent statement.  If you say that you favor a more expansionary fiscal policy that what I currently favor, you are implicitly saying, “and at some future date I prefer a more contractionary fiscal policy than what Sumner will favor at that point in time.”  I worry that the insights of Robert Lucas are being forgotten.

It’s not just about big government

The recent budget deal is even worse than I imagined.  Here’s Ravi Smith, from the previous comment section:

By repealing IPAB, which is essentially a cap on Medicare spending, the Republicans have massively increased the size of government. In the long run, that will probably be more important for sustainability than any of the tax changes or immediate spending items.

Conservatives used to try to argue that while the GOP would not cut spending, at least they would not increase it as fast as the Democrats.  But even that is no longer true, and the reason is that the GOP is no longer either a small government or a big government party; they are something much worse, the party of crony capitalism.  They are the party that forces the Pentagon to spend money on weapons that ever single military expert says are unneeded.  They are the party that wants to shovel more spending into the insatiable medical industrial complex, even when every health expert tells us the spending is utterly worthless.  They want to shovel more money to big agriculture, even though every economist will tell you it does nothing to prevent agriculture from becoming increasingly dominated by big farmers.

The Democrats also want to spend a lot of money on providing health care, but at least they have a slightly defensible reason, providing health coverage for the needy.  The GOP would rather double spending on Medicare and gut spending on Medicaid, as long as it enriched wealthy people in the healthcare industry (while denying coverage for the poor.)

One thing the left and right seem to agree on is that the GOP is the small government party.  That explains why the media are paying little attention to this fiasco.  But they are both wrong.  The GOP is the party of crony capitalism–small vs. big government plays no role in the modern political debate between the right and the left.  America has become a European country.  If it’s stupid bigots vs. stupid utilitarians, I’m with the stupid utilitarians.

The right used to mock the Democratic Party claims that high government spending does not hurt the economy.  Now I see conservatives engaging in “magical thinking” that would put 1960s-era liberals to shame.  All this orgy of spending is not a problem (we are told) because the GOP won’t pay for it with higher taxes.  Instead we’ll just borrow the money!  I’m not surprised that Trump thinks this way, he’s never had the slightest interest in reality.  But I am sort of surprised by the number of conservatives drinking the kool-aid.

So let me make it really simple.  There’s a pie.  The GOP is about to give the government sector a much bigger slice of that pie.  That means the private sector will get a smaller share of that pie.  And no amount of deficit spending will change that fact, unless you believe that pouring hundreds of billions of dollar into ships and airplanes with no military purpose, and into an out of control medical sector, will magically cause “the pie” to grow.

Here’s the National Review:

Republican congressional leaders have announced a deal with Democrats to bust discretionary spending caps by nearly $300 billion over the next two years. Appropriations will rise by 13 percent this year. . . .

[That 13% growth is in contrast to NGDP, which will rise by about 4.5%.  Think slices of the pie.]

The Republican Congress that aggressively pushed President Clinton on spending then turned around and rubber-stamped President Bush’s domestic spending spree. Now the GOP Congress that admirably fought President Obama’s spending agenda is set to bust the budget caps under President Trump.

So let’s see, we only get spending restraint when we have a GOP Congress and a Democratic President.  Pity Hillary didn’t win. Seriously, I think things would actually be about the same if Hillary had won.  The GOP would have done a deal of no repeal of Obamacare and a massive domestic spending increase in exchange for corporate tax cuts.  (That was my prediction before the election, and I’m even more convinced today.)  The only difference is that we wouldn’t have an embarrassing buffoon in the White House, with his finger on the nuclear trigger.

Hey Tea Party, how’s your support for Trump working out?