« Spending on Infrastructure Can Reduce Our Expected Debt | Main | Links for 01-30-2013 »

Tuesday, January 29, 2013

'Trillion Dollar Deficits are Sustainable for Now – Unfortunately'

John Makin and Daniel Hanson of the conservative American Economic Institute talk sense on the deficit. Now if we could just get them over their inflation fears -- the source of the "unfortunately" part of the title -- we might be able to get somewhere in addressing our biggest problem right now, high and persistent unemployment, and enhance our long-tern growth prospects at the same time:

Trillion dollar deficits are sustainable for now – unfortunately, by John H. Makin and Daniel Hanson, Commentary, FT: An abrupt spending sequester at a rate of about $110bn per year ($1.1tn over 10 years) scheduled to begin March 1 could cause a US recession, coming as it does on top of tax increases worth about 1.5 per cent of GDP enacted in January. The April deadline for a continuing resolution to fund federal spending could lead to a fight that shuts down the government, placing a further drag on growth.
These ad hoc measures, aimed at creation of an artificial crisis, will fail to produce prompt, sustainable progress towards reduction of “unsustainable” deficits because deficits have been, and will continue to be for some time, eminently sustainable. The Chicken Little “sky is falling” approach to frightening Congress into significant deficit reduction has failed because the sky has not fallen. Interest rates have not soared as promised... Trillion-dollar federal budget deficits have continued to be sustainable because the federal government is able to finance them at interest rates of half a per cent or less. Two per cent inflation means that the real inflation-adjusted cost of deficit finance averages −1.5 per cent...
The real danger facing American policy makers is ... the current sustainability of trillion-dollar deficits, thanks to very low borrowing costs relative to GDP growth. Eventually, the Federal Reserve’s QE programme of large government debt purchases at a current rate of $800bn per year, largely aimed at sustaining the growth of outlays on entitlements that do not support economic growth, will cause inflation to rise. The Fed’s latest move to target the unemployment rate with more quantitative easing only adds to the threat of inflation because the only way monetary policy can affect growth or employment is by engineering a higher-than-expected rate of inflation.
Despite the current absence of rising inflation, Washington is flirting with a debt trap, where abrupt austerity forced by the sequester and/or a government shut down would actually boost the ratio of debt to GDP by depressing growth too rapidly. That outcome will be far more costly in terms of forgone income and unemployment than moving preemptively to reduce American primary deficits to about 3 per cent of GDP over a half decade. ...
By 2018, once the debt-to-GDP ratio has stabilised under such a programme, reducing the primary deficit to 2 percent a year (given a growth rate of 3 percent above borrowing costs) will reduce the debt-to-GDP ratio gradually by 1 per cent a year. That is the meaning of sustainable long-run reduction of government debt relative to income, which will ensure moderate deficit financing costs for decades to come.

I can't let this pass:

the Federal Reserve’s QE programme of large government debt purchases at a current rate of $800bn per year, largely aimed at sustaining the growth of outlays on entitlements that do not support economic growth...

That's NOT what Fed policy is aimed at. There is no third part of its mandate that says it needs to sustain the growth of entitlements. (And the casual, but empirically unsupported claim that entitlement spending is anti-growth is troublesome as well.)

    Posted by on Tuesday, January 29, 2013 at 10:23 AM in Budget Deficit, Economics, Inflation | Permalink  Comments (29)

          


    Comments

    Feed You can follow this conversation by subscribing to the comment feed for this post.