Economist's View

Trump Hasn’t Prepared Us for the Inevitable Economic Slowdown

Larry Summers:

Trump hasn’t prepared us for the inevitable economic slowdown, Washington Post: President Trump regularly and proudly takes credit for the U.S. economy’s strong performance. And with rapid growth during the second quarter, the stock market strong, the unemployment rate back below 4 percent and the midterm elections looming, Trump’s rhetoric and that of his supporters will probably escalate in coming months.

In fact, however, the president receives more of a boost from the strong economy than the other way around. This conclusion will only be reinforced if Trump’s current steps toward a trade war retard U.S. economic performance, as is increasingly feared. ...

Fiscal stimulus is like a drug with tolerance effects; to keep growth constant, deficits have to keep getting larger. Some combination of gathering foreign storm clouds, the end of growing fiscal stimulus and the delayed effect of tightening monetary policies may converge to slow or end the expansion. 

The choices this administration is making invite foreign retaliation against U.S. exporters and use up fiscal capacity — even as the economy is growing rapidly. Because of this, and because there is limited room for monetary policy, the country will not be in a position to respond strongly if a downturn comes. All the more reason, therefore, to avoid pulling demand forward. 

This is all quite dangerous. The president has taken credit for far more economic success than he deserves. He will disproportionately be blamed when the downturn comes. What follows will be a test of our democracy.

Paul Krugman: Fraudulence of the Fiscal Hawks

"...pretending to care about the deficit served several useful political purposes":

Fraudulence of the Fiscal Hawks, by Paul Krugman, NY Times: In 2011, House Republicans, led by Paul Ryan, issued a report full of dire warnings about the dangers of budget deficits. ... Citing the horrors of big deficits, Republicans refused to raise the federal debt ceiling, threatening to create financial turmoil and effectively blackmailing President Barack Obama into cutting spending on domestic programs.

How big were these horrifying deficits? In the 2012 fiscal year the federal deficit was $1.09 trillion. Much of this deficit, however, was a direct result of a depressed economy... The deficit fell rapidly over the next few years as the economy recovered.

This week Republicans, having just enacted a huge tax cut, cheerfully agreed to a budget deal that, according to independent experts, will push next year’s deficit up to around $1.15 trillion — bigger than in 2012..., but this time none of the deficit will be a result of a depressed economy.

Wait, it gets worse. In 2012 there were strong economic reasons to run budget deficits. The economy was still suffering the aftereffects of the 2008 financial crisis. ... By contrast, there is no comparable case for deficits now, with the economy near full employment and the Fed raising interest rates to head off potential inflation. ...

If anything, we should be using this time of relatively full employment to pay down debt, or at least reduce it relative to G.D.P. ...Republicans ... are providing more stimulus to an economy with 4 percent unemployment than they were willing to allow an economy with 8 percent unemployment.

There have been many “news analysis” pieces asking why Republicans have changed their views on deficit spending. But let’s be serious: Their views haven’t changed at all. They never really cared about debt and deficits; it was a fraud all along. ...

 However, pretending to care about the deficit served several useful political purposes. It was a way to push for cuts in social programs. It was also a way to hobble Obama’s presidency.

And I don’t think it’s unfair to suggest that there was an element of deliberate economic sabotage. ... Basically, they were against anything that might help the economy on President Obama’s watch.

Now Obama is gone, and suddenly deficits don’t matter. ...

No, this is all about Republican bad faith. Everything they said about budgets, every step of the way, was fraudulent. And nobody should believe anything they say now.

Paul Krugman: Republicans Are Coming for Your Benefits

"offsetting those deficits will require going after the true big-ticket programs, namely Medicare and Social Security":

Republicans Are Coming for Your Benefits, by Paul Krugman, NY Times: ...During the Senate debate over the Tax Cuts and Jobs Act, Senator Orrin Hatch was challenged over support for the Children’s Health Insurance Program, which covers nine million U.S. children — but whose funding lapsed two months ago... Hatch ... insisted that “the reason CHIP’s having trouble is because we don’t have money anymore” — just before voting for a trillion-and-a-half-dollar tax cut that will deliver the bulk of its benefits to the richest few percent....

He then went on to say, “I have a rough time wanting to spend billions and billions and trillions of dollars to help people who won’t help themselves, won’t lift a finger and expect the federal government to do everything.”

So who, exactly, was he talking about...?

Was he talking about food stamps, most of whose beneficiaries are children, elderly or disabled? ... Was he talking about the earned-income tax credit, which rewards only those who work? Was he talking about Medicaid, which again mainly benefits children, the elderly and the disabled, plus people who work hard but whose jobs don’t provide health benefits?

We can go on down the list. The simple fact is that big spending on people who “won’t lift a finger” doesn’t actually happen in America — only in Hatch’s meanspirited imagination.

Now, to be fair..., some people ... get lots of money they didn’t lift a finger to earn — namely, inheritors of large estates. ...Republican legislation would give these people ... billions and billions of dollars... How can this be justified if it’s supposedly hard to find money for children’s health care?

Well, Senator Chuck Grassley explained it all last week: “I think not having the estate tax recognizes the people that are investing, as opposed to those that are just spending every darn penny they have, whether it’s on booze or women or movies.” ...

The important thing to realize, however, is that the hypocrisy and contempt for the public we’ve seen ... is just the beginning..., budget deficits are going to soar... And offsetting those deficits will require going after the true big-ticket programs, namely Medicare and Social Security.

Oh, they’ll find euphemisms to describe what they’re doing, talking solemnly about the need for “entitlement reform” as an act of fiscal responsibility — while their huge budget-busting tax cut for the rich gets shoved down the memory hole. But whatever words they use to cloak the reality of the situation, Republicans have given their donors what they wanted — and now they’re coming for your benefits.

Trump’s Budget is Simply Ludicrous

Larry Summers:

Trump’s budget is simply ludicrous: Details of President Trump’s first budget have now been released. Much can and will be said about the dire social consequences about what is in it and the ludicrously optimistic economic assumptions it embodies. My observation is that there appears to be a logical error of the kind that would justify failing a student in an introductory economics course.

Apparently, the budget forecasts that US growth will rise to 3.0 percent because of the Administration’s policies—largely its tax cuts and perhaps also its regulatory policies. Fair enough if you believe in tooth-fairies and ludicrous supply-side economics.

Then the Administration asserts that it will propose revenue neutral tax cuts with the revenue neutrality coming in part because the tax cuts stimulate growth! This is an elementary double count. You can’t use the growth benefits of tax cuts once to justify an optimistic baseline and then again to claim that the tax cuts do not cost revenue. At least you cannot do so in a world of logic. ...

This is a mistake no serious business person would make. It appears to be the most egregious accounting error in a Presidential budget in the nearly 40 years I have been tracking them. ...

I have no doubt that there are civil servants in OMB, Treasury and CEA who do know better than this mistake. Were they cowed, ignored or shut out? How could the Secretary of Treasury, Director of OMB and Director of the NEC allow such an elementary error? I hope the press will ferret all this out.

The President’s personal failings are now not just center stage but whole stage. They should not blind us to the manifest failures of his economic team. Whether it is Secretary Mnuchin’s absurd claims about tax cuts not favoring the rich, Secretary Ross’s claim that the small squib of a deal negotiated last week with China was the greatest trade result with China in history, NEC Director Cohn’s ludicrous estimate of the costs of Dodd Frank, or today’s budget, the Trump administration has not yet made a significant economic pronouncement that meets a minimal standard of competence and honesty.

The Heartless Tradeoffs in the Trump Budget

I have a new column:

The Heartless Tradeoffs in the Trump Budget: As the bombshells continue to drop on the Trump administration, behind the scenes Trump’s first detailed budget proposal is being developed, and it has a few bombshells of its own, particularly for the poor. The budget proposal is not yet finalized, so the details could change, but according to what has leaked so far, the budget is a combination of tax cuts for the wealthy, reduced spending on social programs that serve the needy, and wishful thinking about tax cuts and economic growth. ...

Paul Krugman: The Priming of Mr. Donald Trump

"a delusion of truly Trumpian proportions":

The Priming of Mr. Donald Trump, by Paul Krugman, NY Times: Donald Trump has said many strange things in recent interviews. ... Over here in Econoland, however, the buzz was all about Trump’s expressed willingness, in an interview with the Economist magazine, to pursue tax cuts even if they increase deficits, because “we have to prime the pump” — an expression he claimed to have invented. “I came up with it a couple of days ago and I thought it was good.”

Actually, the expression goes back generations...

But why should anyone besides pedants care?

First, a mind is a terrible thing to lose..., that Economist interview was basically one long senior moment...

Second, we’re talking about some really bad economics here. ...

America may not be all the way back to full employment — there’s a lively debate among economists over that issue. But the economic engine no longer needs a fiscal jump-start. This is exactly the wrong time to be talking about the desirability of bigger budget deficits. ...

Which brings me to my third point: Trump’s fiscal delusions are arguably no worse than those of many, perhaps most professional observers of the Washington political scene.

If you’re a heavy news consumer, think about how many articles you’ve seen in the past few weeks with headlines along the lines of “Trump’s budget may create conflict with G.O.P. fiscal conservatives.” The premise ... is that there is a powerful faction among Republican members of Congress who worry deeply about budget deficits...

But there is no such faction, and never was.

There were and are poseurs like Paul Ryan, who claim to be big deficit hawks. But there’s a simple way to test such people’s sincerity:... when you see a politician claim that deficit concerns require that we slash Medicaid, privatize Medicare, and/or raise the retirement age — but somehow never require raising taxes on the wealthy, which in fact they propose to cut — you know that it’s just an act.

Yet somehow much of the news media keeps believing, or pretending to believe, that those imaginary deficit hawks are real, which is a delusion of truly Trumpian proportions.

So I’m worried. Trump may be not just ignorant but deeply out of it, and his economic proposals are terrible and irresponsible, but they may get implemented all the same.

But maybe I worry too much; maybe the only thing to fear is fear itself. Do you like that line? I just came up with it the other day.

Paul Krugman: The Scammers, the Scammed and America’s Fate

"The destructive effects of false symmetry in reporting":

The Scammers, the Scammed and America’s Fate, by Paul Krugman, NY Times: ...Mr. Ryan’s proposed Obamacare replacement ... is one of the worst bills ever presented to Congress.

It would deprive tens of millions of health insurance — the decline in the number of insured Americans would be larger than ... simple repeal of Obamacare! — while sharply raising expenses for many of those who remain. It would be especially punitive for lower-income, older, rural voters.

In return, we would get a small reduction in the budget deficit. Oh, and a tax cut, perhaps as much as $1 trillion, for the wealthy.

This is terrible stuff. It’s made worse by the lies Mr. Ryan has been telling about his plan. ...

Some people seem startled both by the awfulness of Mr. Ryan’s plan and by the raw dishonesty of his sales pitch. But why..., he’s still the same guy I wrote about back in 2010, in a column titled “The Flimflam Man.”

I wrote that column in response to what turned out to be the first of a series of high-profile Ryan budget proposals. ... It was a con job all the way.

So how did Mr. Ryan reach a position where his actions may reshape the lives of so many ... for the worse? The answer lies in the ... news media, who made him what he is.

You see, until very recently both news coverage and political punditry were dominated by the convention of “balance.” ... And this ... meant that it was necessary to point to serious, honest, knowledgeable proponents of conservative positions.

Enter Mr. Ryan, who isn’t actually a serious, honest policy expert, but plays one on TV. He rolls up his sleeves! He uses PowerPoint! He must be the real deal! So that became the media’s narrative. And media adulation, more than anything else, propelled him to his current position.

Now, however, the flimflam has hit a wall. ... The C.B.O. told the devastating truth about his plan, and his evasions and lies were too obvious to ignore.

There’s an important lesson here, and it’s not just about health care or Mr. Ryan; it’s about the destructive effects of false symmetry in reporting at a time of vast asymmetry in reality.

This false symmetry — downplaying the awfulness of some candidates, vastly exaggerating the flaws of their opponents — isn’t the only reason America is in the mess it’s in. But it’s an important part of the story. And now we’re all about to pay the price.

Debt, Diversion, Distraction

Paul Krugman:

Debt, Diversion, Distraction: ...So, about that supposed debt crisis...

Yes, the population is getting older, which means more spending on Medicare and Social Security. But ... quite a few baby boomers are already drawing on those programs; by 2020 we’ll be about halfway through the demographic transition, and current estimates don’t suggest a big budget problem.

Why, then, do you see projections of a large debt increase? The answer lies not in a known factor — an aging population — but in assumed growth in health care costs and rising interest rates. And the truth is that we don’t know that these are going to happen. In fact, health costs have grown much more slowly since 2010 than previously projected, and interest rates have been much lower. As the chart above shows, taking these favorable surprises into account has already drastically reduced long-run debt projections. These days the long-run outlook looks vastly less scary than people used to imagine. ...

...yes, it’s possible that we may at some point in the future have to cut benefits. But deficit scolds talk as if they offer a way to avoid this fate, when in fact their solution to the prospect of future benefit cuts is … to cut future benefits. ...

By putting the debt question aside, we are NOT in any material way making the future worse. And that is a total contrast with climate change, where our failure to act means pouring vast quantities of greenhouse gases into the atmosphere, materially increasing the odds of catastrophe with every year we wait.

So my message to the deficit scolds is this: yes, we may face some hard choices a couple of decades from now. But we might not, and in any case there aren’t any choices that must be made now. Meanwhile, there are genuinely scary things happening as we speak, which we should be taking on but aren’t. And your fear-mongering is distracting us from these real problems. Therefore, I would respectfully request that you people just go away.

Why Is the CBO Concocting a Phony Debt Crisis?

Lifted from Brad DeLong at Equitablog:

Why Is the CBO Concocting a Phony Debt Crisis?: Must-Read: Ari Rabin-Havt: Why Is the CBO Concocting a Phony Debt Crisis?: “The CBO assumes that Social Security and Medicare Part A will draw on the general fund of the US Treasury…

…to cover benefit shortfalls following the depletion of their trust funds, which at the current rate will occur in 2034. That would obviously lead to an exploding debt, but it’s a scenario prohibited by law. In the case of both programs, benefits must be paid either from revenue collected via payroll taxes or from accumulated savings in the programs’ trust funds. When those funds run out, full benefits will simply not be paid. ‘Because there is no borrowing authority, there is really a hard stop,’ said Goss.

Congress could pass a law saying that Social Security and Medicare Part A would begin drawing on the US Treasury general fund after 2034. Or, Congress could preemptively pass laws to avert the situation before the deadline; it could take the approach favored by progressives and increase revenue to the programs by lifting the payroll tax cap, or alternatively raise the retirement age and lower benefits. But the bottom line is the CBO projections disregard the actual law and assume a worst-case legislative scenario—and one that is politically unlikely, to boot…

'Budgetary Sleight-of-Hand'

Congress enjoys a "political free lunch," budgetary illusions that make it appear that tax cuts, new spending -- whatever -- will not require cuts in other spending, an increase in taxes, or change the deficit. Ben Bernanke reveals the trickery behind the latest attempt at deception:

Budgetary sleight-of-hand: The House voted Thursday to pay for planned highway construction by drawing on the Federal Reserve’s capital. The idea of using Fed capital to pay for government spending, which comes up periodically, is a bad one, for several reasons. ... More substantively—and this is what I want to focus on in this post—“paying” for highway spending with Fed capital is not paying for it at all in any economically meaningful sense. Rather, this maneuver is a form of budgetary sleight-of-hand that would count funds that are already designated for the Treasury as “new” revenue.

To see why, first note that the Fed, as a side effect of its other activities, is already a major source of revenue for the federal government. The Fed earns interest on its portfolio of securities. This income, less the Fed’s operating expenses and interest paid on Fed liabilities, is sent to the Treasury on a pretty much continuous basis. These remittances are large: Over the past half dozen years the Fed has sent nearly half a trillion dollars to the Treasury, funds which directly reduce the government’s budget deficit. ... The Fed’s capital account provides a buffer that absorbs any losses on the Fed’s portfolio and allows the payments to the Treasury to be smoothed over time.

Unlike the Fed’s remittances, which are real resources whose availability reduces the burden on the taxpayer, drawing down the Fed’s capital provides no net new funding for the government. ...

Legislators who care about the integrity of the budgeting process should not support this budgetary sleight-of-hand.

Paul Krugman: Austerity’s Grim Legacy

Austerity did not lead to prosperity:

Austerity’s Grim Legacy, by Paul Krugman, Commentary, NY Times: When economic crisis struck in 2008, policy makers by and large did the right thing. The Federal Reserve and other central banks realized that supporting the financial system took priority over conventional notions of monetary prudence. The Obama administration and its counterparts realized that in a slumping economy budget deficits were helpful, not harmful. And the money-printing and borrowing worked: A repeat of the Great Depression, which seemed all too possible..., was avoided.

Then it all went wrong. ... In 2010, more or less suddenly, the policy elite on both sides of the Atlantic decided to stop worrying about unemployment and start worrying about budget deficits instead.

This ... was very much at odds with basic economics. Yet ominous talk about the dangers of deficits became something everyone said because everyone else was saying it, and dissenters were no longer considered respectable...

Yet there’s growing evidence that we critics actually underestimated just how destructive the turn to austerity would be. Specifically, it now looks as if austerity policies didn’t just impose short-term losses of jobs and output, but they also crippled long-run growth. ...

What this suggests is that ... austerity had truly catastrophic effects, going far beyond the jobs and income lost in the first few years. In fact, the long-run damage ... is easily big enough to make austerity a self-defeating policy even in purely fiscal terms: Governments that slashed spending ... hurt their economies, and hence their future tax receipts, so much that even their debt will end up higher...

And the bitter irony ... is that this catastrophic policy was undertaken in the name of long-run responsibility, that those who protested ... were dismissed as feckless.

There are a few obvious lessons from this debacle. “All the important people say so” is not, it turns out, a good way to decide on policy... Also, calling for sacrifice (by other people, of course) doesn’t mean you’re tough-minded.

But will these lessons sink in? Past economic troubles, like the stagflation of the 1970s, led to widespread reconsideration of economic orthodoxy. But one striking aspect of the past few years has been how few people are willing to admit having been wrong about anything. It seems all too possible that the Very Serious People who cheered on disastrous policies will learn nothing from the experience. And that is, in its own way, as scary as the economic outlook.

'Defending The Bush Deficits'

This is telling, and kind of funny. This is how the National Review Online talks about budget deficits when a Republican is in office (this is from September, 2004 -- keep in mind that the recovery from the recession under Obama has been stronger than under Bush)

Defending The Bush Deficits, by Aman Verjee, NRO: It’s not hard to do if you look at the data.

Since President Bush took office in 2000, the economy has gone through at least three major shocks that were not of his making: a major terrorist attack that damped consumer confidence; the depression in business spending that followed the bursting of the stock market bubble; and a series of accounting scandals that afflicted some of the largest and most visible corporations in the United States.

Yet, the U.S. economy has outperformed that of every other G7 country since 2001. ... This remarkable record on the economy owes much to the pro-growth policies of the Bush administration. ...

Like Chicken Little, who caviled because she mistook a tumbling acorn for a crashing sky, President Bush’s critics are unjustified when they foretell of an impending economic doom. Alarmists who worry about the historical heights to which deficits have climbed need to review the historical data for some context. ...

At the end of 2003, federal debt stood at 36 percent of GDP. It is currently projected by the Congressional Budget Office to reach 40 percent of GDP by 2005 before it begins to decline again. By historical and international standards, these levels of debt are very modest. For instance, the debt burdens of Germany and France are over 60 percent of GDP; in Japan, debt is almost 150 percent of GDP. ... The president’s critics might suggest that economic growth should have been better in the low-debt years than in the high-debt years, but in fact, real GDP growth averaged 4.44 percent in the high-debt years and just 3.14 percent in the low-debt years. ...

Looking back at American history, it is apparent that economic prosperity can continue even if the federal government maintains a debt burden that is much higher than it is today as a percentage of GDP. ...

The lesson is clear: Economic prosperity can continue even if the federal government never balances its budget. ...

'Ornithology: What is a ''Deficit Hawk''?'

Bill McBride at Calculated Risk wonders how "deficit hawk" is defined:

Ornithology: What is a "deficit hawk"?, by Bill McBride, Calculated Risk: Nick Timiraos wrote yesterday in the WSJ: Debt, Growth Concerns Rain on Deficit Parade...

I'd like to see the definition of a "deficit hawk"!

I'd think a true deficit hawk would be truly concerned about, uh, the deficit. So they'd support both tax increases¹ and spending cuts to reduce the deficit. They'd oppose policies that increase the deficit (like the Bush tax cuts, and the war in Iraq). They'd also be concerned about policies that led to the financial crisis and a deep recession - since the deficit increases during a recession.

Maybe I'm talking my own position since I opposed the Bush tax cuts (that created a structural deficit). I opposed the Iraq war. I frequently talked to regulators about lax lending in real estate (and posted some of those discussion on this blog in 2005) that led directly to the financial crisis and large deficits. And I support both intelligent tax increases and spending cuts.

Unfortunately, my experience is that most people who claims to be "deficit hawks", are really pushing a different agenda.  I wish Timiraos would provide a few examples of deficit hawks!

Also the "red ink set to rise later this decade" is expected in increase the deficit from 2.5% of GDP to about 3.1% in 2020.

1 Note: Some people like to focus on "growth" to reduce the deficit, and they tend to focus on tax cuts to boost growth. However, all data and research shows that at the current marginal rates, tax cuts do not pay for themselves and lead to much larger deficits.

'GDP Growth is Not Exogenous'

Antonio Fatás:

GDP growth is not exogenous: Ken Rogoff in the Financial Times argues that the world economy is suffering from a debt hangover rather than deficient demand. The argument and the evidence are partly there: financial crises tend to be more persistent. However, there is still an open question whether this is the fundamental reason why growth has been so anemic and whether other potential reasons (deficient demand, secular stagnation,…) matter as much or even more.

In the article, Rogoff dismisses calls for policies to stimulate demand as the wrong actions to deal with debt, the ultimate cause of the crisis. ... But there is a perspective that is missing in that logic. The ratio of debt or government spending to GDP depends on GDP and GDP growth cannot be considered as exogenous. ...

In a recent paper Olivier Blanchard, Eugenio Cerutti and Larry Summers show that persistence and long-term effects on GDP is a feature of any crisis, regardless of the cause. Even crises that were initiated by tight monetary policy leave permanent effects on trend GDP. Their paper concludes that under this scenario, monetary and fiscal policy need to be more aggressive given the permanent costs of recessions

Using the same logic, in an ongoing project with Larry Summers we have explored the extent to which fiscal policy consolidations can be responsible for the persistence and permanent effects on GDP during the Great Recession. Our empirical evidence very much supports this hypothesis: countries that implemented the largest fiscal consolidating have seen a large permanent decrease in GDP. [And this is true taking into account the possibility of reverse causality (i.e. governments that believed that the trend was falling the most could have applied stronger contractionary policy).

While we recognize that there is always uncertainty..., the size of the effects that we find are large enough so that they cannot be easily ignored... In fact, using our estimates we calibrate the model of a recent paper by Larry Summers and Brad DeLong to show that fiscal contractions in Europe were very likely self-defeating. In other words, the resulting (permanent) fall in GDP led to a increase in debt to GDP ratios as opposed to a decline, which was the original objective of the fiscal consolidation.

The evidence from both of these papers strongly suggests that policy advice cannot ignore this possibility, that crises and monetary and fiscal actions can have permanent effects on GDP. Once we look at the world through this lens what might sound like obvious and solid policy advice can end up producing the opposite outcome of what was desired.

'Marco Rubio is Insisting That His Massive Tax Cuts Will Pay for Themselves'

Ezra Klein:

Why Marco Rubio is insisting that his massive tax cuts will pay for themselves, explained: On Tuesday, Marco Rubio told CNBC's John Harwood that his massive tax cuts — which estimates have found would blow a roughly $4 trillion to $5 trillion hole in the deficit — creates a surplus "within the 10-year window."

It is worth slowing down to make clear exactly what Rubio said there. Rubio's plan cuts corporate taxes, capital gains taxes, taxes on the rich, taxes on the middle class — it cuts taxes on everyone. The cuts are so large that the New York Times called it "the puppies and rainbows plan." And what Rubio is saying is that his massive tax cut is actually going to mean more tax revenue for the government — that two minus one will equal four. ...

Rubio's assurance will, to most tax analysts, sound like nonsense. And it is nonsense. A plan that massively cuts taxes isn't going to lead to budget surpluses. But it's nonsense that has been validated by an important conservative tax group, that shows the kind of candidate Rubio is looking to be, and that speaks to why the debate over taxes in Washington has become so dysfunctional. ...

 

The Path from Deficit Concern to Deficit Deceit'

The politics in the UK is so much better than here. Politicians in the UK would never think of using smokescreens like concern over the deficit to conceal their true intentions:

The path from deficit concern to deficit deceit, by Simon Wren-Lewis: ...A few days ago Lord Turnbull had the opportunity to question the Chancellor on his drive for further austerity. This is a part of what he said.

“I think what you are doing actually, is, the real argument is you want a smaller state and there are good arguments for that and some people don’t agree but you don’t tell people you are doing that. What you tell people is this story about the impoverishment of debt which is a smokescreen. The urgency of reducing debt, the extent, I just can’t see the justification for it.”

A former head of the civil service, who had initially supported Osborne on the deficit, was now accusing him of deliberate deceit. Big news you might have thought. And quite a turnaround in just 5 years.

Yet it is not surprising. Osborne’s fiscal plans really have no basis in economics. That leaves two alternatives. Either Osborne is just stupid and cannot take advice, or he has other motives. George Osborne is clearly not stupid, which leaves only the second possibility. It is therefore entirely logical that Lord Turnbull should come to agree with what some of us were saying some time ago.

What a strange world we are now in. The government goes for rapid deficit reduction as a smokescreen for reducing the size of the state. No less than a former cabinet secretary accuses the Chancellor of this deceit. Yet when a Labour leadership contender adopts an anti-austerity policy he is told it is extreme and committing electoral suicide. Is it any wonder that a quarter of a million Labour party members voted for change.

'Jeb Bush’s New Tax Plan: A Revenue-Eating Wolf in Sheep’s Clothing'

Jared Bernstein on the Bush tax plan:

Jeb Bush’s new tax plan: A revenue-eating wolf in sheep’s clothing: It seems like just yesterday we were pointing out that a) the arithmetic in Republican presidential candidates’ tax plans didn’t add up, and b) they were highly regressive.

Well, crank up the old calculator, because Jeb Bush’s new tax plan appears to have both of those problems, big time. ... I can confidently assert that the plan loses piles of revenue. Perhaps that’s the point, but if so, it’s a serious problem for our fiscal accounts, our economy, and the ability of our government to do what we need it to do. ...[some details of the plan] ...

These are just absolutely huge, regressive changes, far bigger than his bro’s, and really–what did we get for all of W’s supply-side cuts? Growth, jobs, and productivity had little to show for them, while after-tax inequality significantly worsened.

There are a few pieces I’ll note below that claw back some lost revenue, but this is really aggressive tax cutting. ... But didn’t I say something about sheep’s clothing?

There are a few ideas in the plan that tilt in different directions from the usual supply-side formula. To its credit, the Bush team expands the Earned Income Tax Credit for childless workers... They also expand the standard deduction, thereby significantly reducing the number of households with federal tax liability..., this pits Bush against the Romney “makers/takers” crowd...

[More details, both positive and negative] ... OK, that’s enough of the weeds. And I give the Bush team credit for presenting a fairly detailed plan at this early stage of the race. Also..., we’ll have to wait for a score by someone not associated with the campaign (rev up the hamster wheels, TPC!) to see the real extent of the revenue and distributional damage. But I’d be amazed—and I promise ... I will admit my mistake on these pages ... if I’m wrong—if this plan doesn’t blow a huge hole in the budget and make the federal tax code less progressive.

And those are two things we really, really don’t need right now.

'The Shrinking Deficit'

Bill McBride:

The Shrinking Deficit: From the WSJ: Budget Deficit Totaled $488 Billion For Year Ended July, Down 9% From Year Earlier...

The most recent CBO projection was for the fiscal 2015 budget deficit to be 2.7% of GDP. Right now it looks like fiscal 2015 will be under 2.4% (a significant improvement). ...

Is that a good thing?

'Is Deficit Fetishism Innate or Contextual?'

A quick one before hitting the road. Is deficit fetishism bullshit? This is from Simon Wren-Lewis:

Is deficit fetishism innate or contextual?: In a couple of interesting posts, Jonathan Hopkin and Ben Rosamond, political scientists from the LSE and Copenhagen respectively, talk about ‘political bullshit’. They use ‘bullshit’ as a technical term due to Princeton philosopher Harry Frankfurt. Unlike lying, bullshit tells false stories that pay no heed to the truth. Their appeal is more to common sense, or what Tyler Cowen calls common sense morality. At a primitive level it is the stuff of political sound bites, but at a slightly more detailed level it is the language of what Krugman ironically calls ‘Very Serious People’.

The implication which can then be drawn is that because bullshit does not reside in the “court of truth”, trying to combat it with facts, knowledge or expertise may have limited effectiveness. The conditions under which this might be true, and the extent to which information technology impacts on this, are fascinating issues...

In the case of fiscal policy, deficit fetishism as bullshit involves appeals to ‘common sense’ by invoking simple analogies with households, often coupled with an element of morality - it is responsible to pay down debts. The point in calling it bullshit (in this technical sense) is that attempts to counter it by appeals to facts or knowledge (e.g. the government is not like a household, as every economist knows) may have limited effectiveness. Instead it might be better to fight bullshit with bullshit...

I want to ask whether deficit fetishism will always be powerful bullshit, or whether its force is a symptom of a particular time, and what is more a time that may by now have passed. ...

At first sight deficit fetishism seems to be innate...

Paul Krugman: Zombies Against Medicare

Despite what you might hear from conservatives, Medicare is "eminently sustainable":

Zombies Against Medicare, by Paul Krugman, Commentary, NY Times: Medicare turns 50 this week, and it has been a very good half-century. Before the program went into effect, Ronald Reagan warned that it would destroy American freedom; it didn’t, as far as anyone can tell. What it did do was provide a huge improvement in financial security for seniors and their families, and in many cases it has literally been a lifesaver as well.

But the right has never abandoned its dream of killing the program. So it’s really no surprise that Jeb Bush recently declared that while he wants to let those already on Medicare keep their benefits, “We need to figure out a way to phase out this program for others.” ...

The ... reason conservatives want to do away with Medicare has always been political: It’s the very idea of the government providing a universal safety net that they hate, and they hate it even more when such programs are successful. But ... they usually shy away from making their real case...

What Medicare’s would-be killers usually argue, instead, is that the program as we know it is unaffordable — that we must destroy the system in order to save it... And the new system they usually advocate is ... vouchers that can be applied to the purchase of private insurance.

The underlying premise here is that Medicare as we know it is incapable of controlling costs, that only the only way to keep health care affordable going forward is to rely on the magic of privatization.

Now, this was always a dubious claim. .... In fact, Medicare costs per beneficiary have consistently grown more slowly than private insurance premiums... Indeed, Medicare spending keeps coming in ever further below expectations...

Right now is, in other words, a very odd time to be going on about the impossibility of preserving Medicare, a program whose finances will be strained by an aging population but no longer look disastrous. One can only guess that Mr. Bush is unaware of all this, that he’s living inside the conservative information bubble, whose impervious shield blocks all positive news about health reform.

Meanwhile, what the rest of us need to know is that Medicare at 50 still looks very good. It needs to keep working on costs, it will need some additional resources, but it looks eminently sustainable. The only real threat it faces is that of attack by right-wing zombies.

'Debt Miracle: Why the Country that Borrowed the Most Industrialized First'

"When we consider the dangers of debt in today’s world, we should keep an eye on its potential benefits as well.":

Debt miracle: Why the country that borrowed the most industrialized first, by Jaume Ventura and Hans-Joachim Voth, Vox EU: Towering debts, rapidly rising taxes, constant and expensive wars, a debt burden surpassing 200% of GDP. What are the chances that a country with such characteristics would grow rapidly? Almost anyone would probably say ‘none’.

And yet, these are exactly the conditions under which the Industrial Revolution took place in Britain. Britain’s government debt went from 5% of GDP in 1700 to over 200% in 1820, it fought a war in one year out of three (most of them for little or no economic gain), and taxes increased rapidly but not enough to keep pace with the rise in spending.

Figure 1 shows how war drove up spending and led to massive debt accumulation – the shaded grey areas indicate wars, and they are responsible for almost all of the rise in debt. Over the same period, Britain moved a large part of its population out of agriculture and into industry and services – out of the countryside and into cities. Population grew rapidly, and industrial output surged (Crafts 1985). As a result, Britain became the first country to break free from the shackles of the Malthusian regime.

Figure 1. Debt accumulation and government expenditure in the UK, 1690-1860

Until now, scholars mostly thought of the effect of government borrowing on growth as either neutral or negative. One prominent view held that investment in private industry would have been higher had Britain fought and borrowed less (Williamson 1984). Another argument is that private savings decisions undid the potentially negative effects of massive borrowing – because debt eventually has to be repaid, private agents anticipated rising taxes in the future and neutralized the effects of debt accumulation (Barro 1990).

The revolution that wasn’t

In a recent paper, we argue that Britain’s borrowing binge was actually good for growth (Ventura and Voth 2015). To understand why massive debt accumulation may have accelerated the Industrial Revolution, we first consider what should have happened in an economy where entrepreneurs suddenly start to exploit a new technology with high returns. Typically, we would expect capital to chase these investment opportunities – anyone with money should have tried to put their savings into new cotton factories, iron foundries and ceramics manufacturers. Where they didn’t have the expertise to invest directly, banks and stock companies should have recycled funds to direct savings to where returns where highest.

This is not what happened. Financial intermediation was woefully inadequate – it failed to send the money where it should have gone. As one prominent historian of the British Industrial Revolution argued:

“the reservoirs of savings were full enough, but conduits to connect them with the wheels of industry were few and meagre … surprisingly little of [Britain’s] wealth found its way into the new industrial enterprises ….” (Postan 1935).

There were many reasons for this, but deliberate financial repression by the government was one of them. Usury limits, the Bubble Act, the Six Partner Rule that limited the size of banks – all of them were designed to stifle private intermediation, in part so as to facilitate access to funds for the government (Temin and Voth 2013).

Without effective intermediation, new sectors had to self-finance – rates of return stayed high because so little fresh capital entered to chase the sky-high returns. Allen calculated that the profit rate for capital rose from 10% in the 1770s to over 20% by the 1830s – capital’s share of national income more than doubled (Allen 2009).

Why debt helped

The inefficiency of private intermediation is crucial for debt to play a beneficial role. By issuing bonds on a massive scale, the government effectively pioneered a way – unintentionally – to put money in the pockets of entrepreneurs in the new sectors.

How did it do that? Before the availability of government debt, Britain’s rich and mighty – the nobility – overwhelmingly invested in land and land improvements. Status was closely tied to land, but improving it was not a profitable enterprise. Many forms of investment yielded a return of 2% of less. No wonder that noblemen were disenchanted with landed investment: By the 1750s, the first nobles were switching massively out of land and into government debt. The Prime Minister Sir Robert Peel advised: “every landowner ought to have as much property (as his estate) in consols or other securities…” (Habbakuk 1994). Many nobles obliged, shifting into an asset with a superior risk-return profile. As Lord Monson put it: “What an infernal bore is landed property. No certain income can be reckoned upon. I hope your future wife will have consols. . . ” (Thompson 1963).

The shift from investing in liming, marling, draining, and enclosure into government debt liberated resources – labor that could no longer be profitably employed in the countryside had to look for employment elsewhere. Because so much of English agricultural labor was provided by wage laborers, the switch to government debt pushed workers off the land. Unsurprisingly, wages failed to keep pace with output; real wages, adjusted for urban disamenities, probably fell over the period 1750-1830. What made life miserable for the workers, as eloquently described by Engels amongst others, was a boon to the capitalists. Their profit rates continued to rise as capital received an ever-larger share of the pie – while the share of national income going to labor and land contracted. Higher profits spelled more investment in new industries, and Britain’s industrial growth accelerated.

By putting debt at the center of our interpretation of the Industrial Revolution, we can provide a unified explanation for a number of features that have so far seemed puzzling. Growth was relatively slow, especially in the beginning (Crafts 1985) – but technological change was probably quite rapid (Temin 1997). Government borrowing slowed capital formation on impact – but structural change was rapid over the period as a whole. Rates of return were high in industry, but little capital chased these returns. Wages failed to keep up with productivity despite the rapid move out of the countryside and into the cities. By emphasizing how government debt issuance ‘healed’ the negative consequences of financial frictions, we can jointly explain rapid structural change and slow growth; rapid technological change and poor wage growth; massive government borrowing and the first take-off into sustained growth.

Good-bye to Downton

The issuance of government debt also accelerated social change – the rise of the capitalists and the decline of nobility. Without it, rates of profit in industry would have been less, and the decline and fall of the nobility as a dominant economic force would have taken much longer.

The solution that would have ensured the fastest growth – a much better financial system – would have preserved England’s social hierarchy entirely. Financial investment from the nobility would have flowed into new sectors via banks and the stock market, allowing the top 1% to earn high returns. The rise of the capitalists would have been long-delayed or been avoided altogether.

The bigger picture

How much of the situation in industrializing England has any relevance for the world as it is now? Is this a tale from a distant island and period of which we know little – to paraphrase Chamberlain – or does it hold lessons for the present? Financial frictions are still very prominent even in the most developed countries today; changing the profitability of revolutionary sectors should have first-order effects on the long-run rate of growth. The issuance of government debt may still crowd out investment that is, overall, inefficient.

These efficiency-enhancing effects of government debt may be all the more important in developing countries. There, the added benefits of debt that we did not discuss – such as providing a safe store of value, and a certain source of liquidity (Holmstrom and Tirole 1998) – may tilt the overall scoresheet even more in favor of government borrowing. None of this is to say that debts may not become excessive (Reinhart and Rogoff 2009) – but when we consider the dangers of debt, we should keep an eye on its potential benefits as well.

References

Allen, R (2009), “Engel’s pause: A pessimist’s guide to the British Industrial Revolution”, Explorations in Economic History 46 (2): 418–35.

Barro, R J (1987), “Government spending, interest rates, prices, and budget deficits in the United Kingdom, 1701–1918”, Journal of Monetary Economics 20 (2): 221–47.

Crafts, N F R (1985), British Economic Growth during the Industrial Revolution, Oxford: Oxford University Press.

Habakkuk, H J (1994), Marriage, Debt, and the Estates System: English Landownership, 1650-1950, Clarendon Press.

Holmstrom, B R, and J Tirole (1998), “Private and Public Supply of Liquidity”, Journal of Political Economy 106(1): 1-40.

Postan, M M (1935), “Recent trends in the accumulation of capital”, The Economic History Review 6 (1): 1–12.

Temin, P (1997), "Two views of the British industrial revolution", The Journal of Economic History 57(1): 63-82.

Temin, P and H-J Voth (2013), Prometheus Shackled: Goldsmith Banks and England’s Financial Revolution After 1700, Oxford University Press.

Thompson, F M L (1963), “English landed society in the nineteenth century”, English Landed Society in the Nineteenth Century.

Reinhart, C M, and K Rogoff (2009), This Time is Different, Princeton University Press.

Williamson, J G (1984), "Why was British growth so slow during the industrial revolution?" The Journal of Economic History 44(3): 687-712.

Ventura, J and H-J Voth (2015), “Debt into growth: How government borrowing accelerated the Industrial Revolution”, CEPR DP No. 10652.

'Boosting Growth Without Raising the Deficit'

I have been neglecting to post the things I write for MoneyWatch:

Boosting Growth Without Raising the Deficit: One of the lessons of the Great Recession is that monetary policy alone isn't enough to offset the effects of a massive economic downturn. Pushing the Federal Reserve's target interest rate as low as it can go, as monetary policy authorities did early in the recession, helped limit its severity.

But once interest rates are near zero, the Fed's power to stimulate the economy diminishes considerably. That means the Fed cannot, by itself, offset and overcome the forces pushing the economy into a severe recession. To accomplish that goal, fiscal policy also has to play a role.

Attempts to use fiscal policy, however, run into a big stumbling block: objections to the large increases in the deficit that come with tax cuts or additional government spending needed to stimulate the economy.

Even though the economics of large deficit increases to finance, say, infrastructure construction are supportive (worries that an increase in the national debt will cause interest rate spikes or other problems appear to be unfounded), the political will needed to pursue deficit spending on infrastructure or anything else simply isn't there.

But one message that did not come through very strongly in public discussions of economic policy during the Great Recession is that stimulative fiscal policy doesn't necessarily require an increase in the deficit. ...[more]...

Blow Up the Tax Code and Start Over???

Here we go again with the flat tax proposals. This time it's Rand Paul:

Blow Up the Tax Code and Start Over, by Rand Paul: Some of my fellow Republican candidates for the presidency have proposed plans to fix the tax system. These proposals are a step in the right direction, but the tax code has grown so corrupt, complicated, intrusive and antigrowth that I’ve concluded the system isn’t fixable.

So on Thursday I am announcing an over $2 trillion tax cut that would repeal the entire IRS tax code—more than 70,000 pages—and replace it with a low, broad-based tax of 14.5% on individuals and businesses. I would eliminate nearly every special-interest loophole. The plan also eliminates the payroll tax on workers and several federal taxes outright, including gift and estate taxes, telephone taxes, and all duties and tariffs. I call this “The Fair and Flat Tax.” ...

He might call it that, but even he admits the rich will pay a lower rate:

The left will argue that the plan is a tax cut for the wealthy. But most of the loopholes in the tax code were designed by the rich and politically connected. Though the rich will pay a lower rate along with everyone else, they won’t have special provisions to avoid paying lower than 14.5%.

Why not just get rid of the special provisions? Why is a flat tax more equitable than taxes based upon ability to pay (i.e. a progressive structure)?

And, of course, this won't provide enough revenue to fund government. How does he solve this? With two pieces of magic. First, magic budget cuts that he leaves unspecified (because proposing what it would actually take to close the budget gap would require severe cuts to social programs that people want to retain), and second, magic economic growth.

On the budget cuts, we get: 

my plan would actually reduce the national debt by trillions of dollars over time when combined with my package of spending cuts.

That's it. Somehow, the spending cuts will magically occur (and since we are imagining, guess who they would fall on?). But the biggest magic is the effect on the economy. It's an "economic steroid injection"!!!:

As a senator, I have proposed balanced budgets and I pledge to balance the budget as president.

Here’s why this plan would balance the budget: We asked the experts at the nonpartisan Tax Foundation to estimate what this plan would mean for jobs, and whether we are raising enough money to fund the government. The analysis is positive news: The plan is an economic steroid injection. Because the Fair and Flat Tax rewards work, saving, investment and small business creation, the Tax Foundation estimates that in 10 years it will increase gross domestic product by about 10%, and create at least 1.4 million new jobs.

And because the best way to balance the budget and pay down government debt is to put Americans back to work, my plan would actually reduce the national debt by trillions of dollars over time when combined with my package of spending cuts.

I bet it would almost be as good for the economy as the Bush tax cuts. Oh wait...

'Congressional Budget Plans Get Two-Thirds of Cuts From Programs for People With Low or Moderate Incomes'

The true goal of Republican's "deficit fetishism":

Congressional Budget Plans Get Two-Thirds of Cuts From Programs for People With Low or Moderate Incomes, by Richard Kogan and Isaac Shapiro, CBPP: The budgets adopted on March 19 by the House Budget Committee and the Senate Budget Committee each cut more than $3 trillion over ten years (2016-2025) from programs that serve people of limited means. These deep reductions amount to 69 percent of the cuts to non-defense spending in both the House and Senate plans.

Each budget plan derives more than two-thirds of its non-defense budget cuts from programs for people with low or modest incomes even though these programs constitute less than one-quarter of federal program costs. Moreover, spending on these programs is already scheduled to decline as a share of the economy between now and 2025.[1]

The bipartisan deficit reduction plan that Alan Simpson and Erskine Bowles (co-chairs of the National Commission on Federal Policy) issued in 2010 adhered to the basic principle that deficit reduction should not increase poverty or widen inequality. The new Congressional plans chart a radically different course, imposing their most severe cuts on people on the lower rungs of the economic ladder. ...

'Controlling the Past'

Simon Wren-Lewis:

Controlling the past: In his novel 1984 George Orwell wrote: “Who controls the past controls the future: who controls the present controls the past.” We are not quite in this Orwellian world yet, which means attempts to rewrite history can at least be contested. A few days ago the UK Prime Minister in Brussels said this:

“When I first came here as prime minister five years ago, Britain and Greece were virtually in the same boat, we had similar sized budget deficits. The reason we are in a different position is we took long-term difficult decisions and we had all of the hard work and effort of the British people. I am determined we do not go backwards.”

In other words if only those lazy Greeks had taken the difficult decisions that the UK took, they too could be like the UK today.

This is such as travesty of the truth, as well as a huge insult to the Greek people, that it is difficult to know where to begin. ...

The real travesty ... is in the implication that somehow Greece failed to take the ‘difficult decisions’ that the UK took. ‘Difficult decisions’ is code for austerity. A good measure of austerity is the underlying primary balance. According to the OECD, the UK underlying primary balance was -7% in 2009, and it fell to -3.5% in 2014: a fiscal contraction worth 3.5% of GDP. In Greece it was -12.1% in 2009, and was turned into a surplus of 7.6% by 2014: a fiscal contraction worth 19.7% of GDP! So Greece had far more austerity, which is of course why Greek GDP has fallen by 25% over the same period. A far more accurate statement would be that the UK started taking the same ‘difficult decisions’ as Greece took, albeit in a much milder form, but realized the folly of this and stopped. Greece did not get that choice. And I have not even mentioned the small matter of being in or out of a currency union. ...

Paul Krugman: Trillion Dollar Fraudsters

Why do Republicans use "magic asterisks" in their budget proposals?:

Trillion Dollar Fraudsters, by Paul Krugman, Commentary, NY Times: By now it’s a Republican Party tradition: Every year the party produces a budget that allegedly slashes deficits, but which turns out to contain a trillion-dollar “magic asterisk” — a line that promises huge spending cuts and/or revenue increases, but without explaining where the money is supposed to come from.

But the just-released budgets from the House and Senate majorities break new ground. Each contains not one but two trillion-dollar magic asterisks: one on spending, one on revenue. And that’s actually an understatement. If either budget were to become law, it would leave the federal government several trillion dollars deeper in debt than claimed, and that’s just in the first decade. ...

The modern G.O.P.’s raw fiscal dishonesty is something new in American politics... And the question we should ask is why.

One answer you sometimes hear is that what Republicans really believe is that tax cuts for the rich would generate a huge boom and a surge in revenue, but they’re afraid that the public won’t find such claims credible. So magic asterisks are really stand-ins for their belief in the magic of supply-side economics, a belief that remains intact even though proponents in that doctrine have been wrong about everything for decades.

But I’m partial to a more cynical explanation. Think about what these budgets would do if you ignore the mysterious trillions in unspecified spending cuts and revenue enhancements. What you’re left with is huge transfers of income from the poor and the working class, who would see severe benefit cuts, to the rich, who would see big tax cuts. And the simplest way to understand these budgets is surely to suppose that they are intended to do what they would, in fact, actually do: make the rich richer and ordinary families poorer.

But this is, of course, not a policy direction the public would support... So the budgets must be sold as courageous efforts to eliminate deficits and pay down debt — which means that they must include trillions in imaginary, unexplained savings.

Does this mean that all those politicians declaiming about the evils of budget deficits and their determination to end the scourge of debt were never sincere? Yes, it does.

Look, I know that it’s hard to keep up the outrage after so many years of fiscal fraudulence. But please try. We’re looking at an enormous, destructive con job, and you should be very, very angry.

'Tax Cuts Still Don’t Pay for Themselves'

I get tired of saying that tax cuts don't pay for themselves, so I'll turn it over to Josh Barro:

Tax Cuts Still Don’t Pay for Themselves: Last week, I wrote about the new tax plan from Senator Marco Rubio and Senator Mike Lee... It calls for big tax credits for middle-income families with children, corporate tax cuts and complete elimination of the capital gains tax — and as a result would cost trillions of dollars in revenue over a decade.

Or would it? The Tax Foundation released a report last week arguing the Rubio-Lee plan would generate so much business investment that, within a decade, federal tax receipts would be higher than if taxes hadn’t been cut at all. ...

I discussed the Tax Foundation report with 10 public finance economists ranging across the ideological spectrum, all of whom said its estimates of the economic effects of tax cuts were too aggressive. “This would not pass muster as an undergraduate’s model at a top university,” said Laurence Kotlikoff, a Boston University professor whom the Tax Foundation specifically encouraged me to call. ...

[T]he House adopted a rule in January that requires “dynamic scoring” of tax bills... In principle, dynamic scoring is fine. Tax policy really does affect the economy... But as the Tax Foundation report shows, dynamic scoring can be misused: You can get essentially any answer you want ... by changing the assumptions...

The crucial thing to watch, in the guts of future C.B.O. reports that rely on dynamic scoring, will be whether the new dynamic assumptions are more reasonable than zero — or whether, like the Tax Foundation assumptions, they take us farther away from accuracy, and make unsupportable promises of tax cuts paying for themselves.

Monetary and Fiscal Policy in a Post-Inflation World

Alice Rivlin:

Thoughts about monetary and fiscal policy in a post-inflation world, Brookings: ... Why are we still so focused on fighting inflation? Why are so many people in this room devoting so much time and attention to guessing when the Federal Reserve will start raising short-term interest rates and get back to its “normal” job of protecting us from inflation? Is inflation an important threat to our economic well-being? Is when to raise interest rates the most urgent question facing the Fed at the moment? Or are we suffering from cultural lag?

Collecting linguistic evidence of cultural lags is a minor hobby of mine. I smile when I catch myself referring to the refrigerator as the “ice box,” because that was what my mother called it... I am amused when young people tell me their phones are “ringing off the hook.” Have they ever used a phone with a receiver on a hook? When bureaucrats say they are eager to break out of their silos, I wonder if they if they have ever lived on a farm or anywhere close to a silo. So when politicians and financial journalists ask me earnestly, as they do, whether the Federal Reserve isn’t risking devastating “run-away” inflation by buying all those bonds, I suspect cultural lag. What Inflation? We should be so lucky! Central banks have amply proved that they know how to stop inflation—Paul Volcker showed that. They have been much less successful in getting little inflation going.

A lecture in honor of Paul Volcker is the perfect occasion for raising the fundamental question: are the major advanced economies (US, Europe, Japan) facing a new normal for which current tools of monetary, fiscal, and regulatory policy need to be restructured? ...

Over-coming cultural lag in order to prosper in a post-inflation world will take significant shifts in the mind-set of economists, economic policy-makers, politicians and the public. I see four major challenges to current thinking:

• We have to recognize that the main job of central banks is avoiding financial crisis.
• We will have to get used to central banks operating at quite low interest rates much of the time and managing big balance sheets without apologies.
• We have to rehabilitate budget policy to make it useable again and move to a sustainable debt track at the same time
• We have to find constitutional ways of reducing the power of big money in politics and economic policy—or change the Constitution.

I will get back to these four challenges, but first a very quick tour through the macro-policy landscape of the last five or six decades. ...

And, later in the essay (it is relatively long, and I don't agree with every single point that is made, e.g. when she defends ‘Simpson-Bowlesism’ and discusses the need to rein in entitlement spending, and when she argues against selling the idea "that unspecified government spending would add to aggregate demand and accelerate the recovery without adverse consequences to the long-run debt... Unspecified spending and near-term debt increase are what the public and elected officials fear, and they are skeptical of fee lunches. Instead, we have to make the case for very specific public investments that can be shown to have positive impacts on productivity growth and future prosperity" -- deficit spending in a recession has a role to play in stimulating the economy in the short-run, we shouldn't focus only on the long-run growth potential of policy -- but I do agree with the the general thrust of her comments):

... Political polarization has led to angry confrontations over the budget for the last several years complete with threats to shut down the government or default on the national debt and bizarre budget decision processes, such as the Super Committee, the fiscal cliff, and sequestration. These shenanigans are unworthy of a mature democracy and horrendously destructive of confidence in rational economic governance. The result has been worse than gridlock. It has been insanely counterproductive budget policy at a time when the federal budget could have been contributing both to faster recovery and to longer run productivity growth.

I believe the Great Recession would have been longer and deeper without the stimulus package of 2009.[8] If the stimulus had been larger and lasted longer, recovery would have been more robust and the Fed might not have found it necessary to do so much quantitative easing. Indeed, it is pretty crazy economics for a country trying to climb out of a deep recession to put the burden of accelerating a recovery on the monetary authorities—a job they have never been great at—in the face of sharply declining federal deficits that made the task of stimulating recovery with monetary tools a lot more challenging. But that is what we did.

I also believe that the United States has been dangerously under-investing in public infrastructure, scientific research, and the skills of our future labor force. Doing everything we can to nudge productivity growth back up again is essential to future prosperity. With the private investment awaiting more demand and confidence, the public sector should be moving strongly into the breach with well-structured investment in everything from roads to technical training to basic research. Instead, our bizarre budget process has been squeezed the very budget accounts that contain most opportunity for public investment. Discretionary spending is at record lows in relation to the size of the economy and headed lower while the highway trust fund is running dry. How crazy is that?

Making budget policy useful again will take major shifts in political thinking, and here I think economists can help if they use arguments the public and politicians can relate to. First, I would recommend not pushing the argument that unspecified government spending would add to aggregate demand and accelerate the recovery without adverse consequences to the long-run debt. Ball, Summers and DeLong may well be right that hysteresis is so serious a consequence of recession that spending now would juice recovery enough to bring down long run debt.[9] But they are never going to sell that argument. Unspecified spending and near-term debt increase are what the public and elected officials fear, and they are skeptical of fee lunches.

Instead, we have to make the case for very specific public investments that can be shown to have positive impacts on productivity growth and future prosperity. This should not be an argument for larger government, but for shifting from less to more effective government spending and from consumption-oriented spending (including spending in the tax code) to growth oriented spending over time. And, oh yes, that means making the tax code more progressive, more pro-growth, and raising additional revenue, as well as restructuring entitlement programs. There is plenty is such an agenda for both liberals and conservatives to like—if only they could be persuaded to talk about it. ...

'The Truth About Entitlements'

Projections of budget problems in the future are about health care costs, and there is improvement on that front:

The Truth About Entitlements, by Paul Krugman: As part of another project, I was looking at CBO historical budget data, and realized that you can summarize a lot about all those much-denounced “entitlements” with this figure:

Credit: Congressional Budget Office

Here, income security is mainly EITC, food stamps, and unemployment benefits, plus a few other means-tested aid programs. Health is all major programs — Medicare, Medicaid/CHIP, and at the very end the exchange subsidies.

What this chart tells you right away:

1. The “nation of takers” stuff is deeply misleading. Until the economic crisis, income security had no trend at all. ...

2. When people claimed that spending was exploding under Obama, the only thing actually happening was a surge in income-support programs at a time of genuine distress. People smirked knowingly and declared that everyone knew that the bump in spending would become permanent; it didn’t.

3. If there is a long-run spending problem, it’s overwhelmingly about health care. And we have lately been making remarkable progress on that front.

More on the same topic from the CBPP:

Low-Income Programs Not Driving Nation’s Long-Term Fiscal Problem, by Robert Greenstein, Isaac Shapiro, and Richard Kogan: Low-income programs are not driving the nation’s long-term fiscal problems, contrary to the impression that a narrow look at federal spending during the Great Recession and the years that immediately followed might leave. Lawmakers should bear this in mind as they consider proposals that may emerge in coming weeks for deep cuts in this part of the budget.

Figure 1

Low-income program spending grew significantly between 2007 and 2010 in response to the severe economic downturn, helping to mitigate its worst effects. Since peaking in 2010 and 2011, federal spending on low-income programs other than health care has fallen considerably and will continue to fall as a percent of gross domestic product (GDP) as the economy more fully recovers. By 2018, it will — based on Congressional Budget Office estimates — drop below its average over the past 40 years, (from 1975 to 2014) and continue declining as a share of GDP after that. [1]  (See Figure 1.)

As a result, these programs do not contribute to the nation’s long-term fiscal problems. ...

'The Austerity Con'

Simon Wren-Lewis in the London Review of Books:

The Austerity Con: ‘The government cannot go on living beyond its means.’ This seems common sense, so when someone puts forward the view that just now austerity is harmful, and should wait until times are better, it appears fanciful and too good to be true. Why would the government be putting us through all this if it didn’t have to?

By insisting on cuts in government spending and higher taxes that could easily have been postponed until the recovery from recession was assured, the government delayed the recovery by two years. And with the election drawing nearer, it allowed the pace of austerity to slow, while pretending that it hadn’t. Now George Osborne is promising, should the Tories win the election in May, to put the country through the same painful and unnecessary process all over again. Why? Why did the government take decisions that were bound to put the recovery at risk, when those decisions weren’t required even according to its own rules? How did a policy that makes so little sense to economists come to be seen by so many people as inevitable? ...

Erskine Bowles is Back

Erskine Bowles writes a letter to the NY Times:

The Risks of Delaying Fiscal Reforms: To the Editor:

Paul Krugman’s Feb. 2 column, “The Long-Run Cop-Out,” claims that we don’t need to deal with our long-term fiscal challenges any time soon, and that those who argue otherwise are lazy and lacking in courage. His message is a disservice to the critically important debate about our nation’s economic future. ...

Mr. Krugman’s assertion that America followed a course of austerity while the economy was still in a deep slump due to the influence of “Bowles-Simpsonism” ignores the fact that one of the key principles set out in the National Commission on Fiscal Responsibility and Reform report was that deficit reduction must not disrupt the fragile economic recovery.

Indeed, it is largely due to the failure of our elected leaders to reach agreement on long-term deficit reduction along the lines of our recommendations that we ended up with the mindless austerity of sequestration. In our report we recommended delaying significant budget cuts until the economy recovered, and implementing reforms gradually. ...

Does anyone remember Bowles or his associates objecting strenuously to the sequester, getting out in public forums and arguing it was a big mistake? Writing letters and op-eds to the NY Times, that sort of thing? I don't (and see Dean Baker below on this point - Update: from a Tweet by @BowlesSimpson, see here, but I don't see them calling for delay until the economy recovers, only for a different type of austerity, e.g. "simply waiving this sequester — or coming up with some agreement to spend partway between pre- and post-sequester levels — would represent a huge failure. It would send a message to creditors and citizens alike that Washington is not serious about the national debt and that even when lawmakers put in place mechanisms to force seriousness, they will simply vote later to evade them. Deal with the deficit President Barack Obama and Congress have a responsibility to put politics aside and work quickly to replace sequestration and put our fiscal house in order with targeted cuts and real reforms in both the entitlement programs and the tax code.").

As for the budget projections, I'm old enough to remember a time not so long ago when the main worry was what to do about the budget surplus that would begin accumulating (e.g. how could the Fed conduct monetary policy if the supply of T-Bills dried up?). We have no idea what the budget will look like 10 or 15 years from now (unless you have suddenly started to believe that economists have the ability to make accurate forecasts even a year ahead, let alone a decade or more). That's why Krugman said:

It’s true that many projections suggest that our major social insurance programs will face financial difficulties in the future (although the dramatic slowing of increases in health costs makes even that proposition uncertain). If so, at some point we may need to cut benefits. But why, exactly, is it crucial that we deal with the threat of future benefits cuts by locking in plans to cut future benefits?

Dean Baker also responds:

Erskine Bowles Is Back and Still Pushing Austerity: Erskine Bowles, the superhero of the fiscal austerity crowd, took time off from his duties on corporate boards to once again argue the need to "put our fiscal house in order." He apparently hasn't been following the numbers lately. If he had, he would have noticed that growth rate of Medicare and other government health care programs is now on a path that is lower than the proposals that he and Alan Simpson put forward in their report. (He refers to their report as a report of the National Commission on Fiscal Responsibility and Reform. This is not true. According to its bylaws a report would have needed the support of 14 of the 18 members of the commission. The Bowles-Simpson proposal only had support of 10 members of the commission.)

Bowles also inaccurately claims they proposed delaying deficit reduction until after the economy had recovered. In fact, the report proposed deficit reduction of $330 billion (2.0 percent of GDP) beginning in the fall of 2011. This was long before the economy had recovered or would have in any scenario without a large dose of fiscal stimulus.

Bowles also fails to give any reason whatsoever why the country would benefit from dealing with large projected deficits a decade into the future. These projections may themselves be far off the mark, as has frequently been the case in the past. It is also worth noting that the rise in the deficit depends on projections of sharply higher interest rates in the years after 2020. There is no obvious basis for assuming this would be the case.

In the event that large deficits do prove to be a problem in 2025 and beyond there is no obvious reason why we would think that the Congress and president would not be able to deal with them at the time. That is what experience would suggest. In the mean time, we have real problems like millions of people unable to find jobs and tens of millions who have not shared in the benefits of growth for the last fifteen years. Or, to put it in generational terms, we have tens of millions of children growing up in families whose parents don't earn enough to provide them with a comfortable upbringing.

Paul Krugman: Nobody Understands Debt

Austerity has been a disaster:

Nobody Understands Debt, by Paul Krugman, Commentary, NY Times: ...Last week, the McKinsey Global Institute issued a report titled “Debt and (Not Much) Deleveraging,” which found, basically, that no nation has reduced its ratio of total debt to G.D.P. ...

You might think our failure to reduce debt ratios shows that we aren’t trying hard enough — that families and governments haven’t been making a serious effort to tighten their belts, and that what the world needs is, yes, more austerity. But we have, in fact, had unprecedented austerity. ...

All this austerity has, however, only made things worse — and predictably so, because demands that everyone tighten their belts were based on a misunderstanding of the role debt plays in the economy. ...

Because debt is money we owe to ourselves, it does not directly make the economy poorer (and paying it off doesn’t make us richer). True, debt can pose a threat to financial stability — but the situation is not improved if efforts to reduce debt end up pushing the economy into deflation and depression.

Which brings us to current events, for there is a direct connection between the overall failure to deleverage and the emerging political crisis in Europe.

European leaders completely bought into the notion that the economic crisis was brought on by too much spending, by nations living beyond their means. The way forward, Chancellor Angela Merkel of Germany insisted, was a return to frugality. Europe, she declared, should emulate the famously thrifty Swabian housewife.

This was a prescription for slow-motion disaster. European debtors did, in fact, need to tighten their belts — but the austerity they were actually forced to impose was incredibly savage. ...

Suffering voters put up with this policy disaster for a remarkably long time, believing in the promises of the elite that they would soon see their sacrifices rewarded. But as the pain went on and on... Anyone surprised by the left’s victory in Greece, or the surge of anti-establishment forces in Spain, hasn’t been paying attention.

Nobody knows what happens next, although bookmakers are now giving better than even odds that Greece will exit the euro. Maybe the damage would stop there, but I don’t believe it — a Greek exit is all too likely to threaten the whole currency project. And if the euro does fail, here’s what should be written on its tombstone: “Died of a bad analogy.”

Paul Krugman: Rock Bottom Economics

The era of "rock-bottom economics" is far from over:

Rock Bottom Economics, by Paul Krugman, Commentary, NY Times: Six years ago the Federal Reserve hit rock bottom. It had been cutting the federal funds rate ... more or less frantically in an unsuccessful attempt to get ahead of the recession and financial crisis. But it eventually reached the point where it could cut no more...

Everything changes when the economy is at rock bottom... But for the longest time, nobody with the power to shape policy would believe it.

What do I mean by saying that everything changes? As I wrote..., in a rock-bottom economy “the usual rules of economic policy no longer apply...” Government spending doesn’t compete with private investment — it actually promotes business spending. Central bankers, who normally cultivate an image as stern inflation-fighters, need to do the exact opposite, convincing markets ... that they will push inflation up. “Structural reform,” which usually means making it easier to cut wages, is more likely to destroy jobs than create them.

This may all sound wild and radical, but ... it’s what mainstream economic analysis says will happen once interest rates hit zero. And it’s also what history tells us. ...

But as I said, nobody would believe it. By and large, policymakers and Very Serious People ... went with gut feelings rather than careful economic analysis. ...

Thus we were told ... that budget deficits were our most pressing economic problem, that interest rates would soar ... unless we imposed harsh fiscal austerity... —... demands that we cut government spending now, now, now have cost millions of jobs and deeply damaged our infrastructure.

We were also told repeatedly that printing money ... would lead to “currency debasement and inflation.” The Fed ... stood up to this pressure, but other central banks didn’t. ...

 But... Isn’t the era of rock-bottom economics just about over? Don’t count on it..., the counterintuitive realities of economic policy at the zero lower bound are likely to remain relevant for a long time..., which makes it crucial that influential people understand those realities. Unfortunately, too many still don’t; one of the most striking aspects of economic debate in recent years has been the extent to which those whose economic doctrines have failed the reality test refuse to admit error, let alone learn from it. ...

This bodes ill for the future. What people in power don’t know, or worse what they think they know but isn’t so, can very definitely hurt us.

'The Impact of the Maturity of US Government Debt on Forward Rates and the Term Premium'

At Vox EU:

The impact of the maturity of US government debt on forward rates and the term premium: New results from old data, by Jagjit Chadha: Summary The impact of the stock and maturity of government debt on longer-term bond yields matters for monetary policy. This column assesses the magnitude and relative importance of overall bond supply and maturity effects on longer-term US Treasury interest rates using data from 1976 to 2008. Both factors have a significant impact on both forwards and term premia, but maturity of public debt appears to matter more. The results have implications for exit from unconventional policies, and also for the links between monetary and fiscal policy and debt management.

'Deficit Fetishists'

Yep:

... Interestingly enough..., now that the deficit is shrinking in large part due to a growing economy—not the other way around—the deficit fetishists seem to have grown silent. Simpson and Bowles are suddenly quiet, and John Boehner is riding other hobbyhorses.

It’s almost as if crying over the deficit weren’t about the deficit at all, but rather a cover for ideological maneuvering. ...

'Hiatt Hysterical Over Losing His Schtick'

Barkley Rosser feels "sorry for Fred." Sort of:

Hiatt Hysterical Over Losing His Schtick: Poor Fred Hiatt. For years, this Editor of the Editorial page of the Washington Post has made his named appearances on the editorial page (he daily bloviates the main ed lead anonymously) only to call for cutting Social Security, and occasionally Medicare as well. This has been his schtick for many years. Now it is over, but he fails to recognize it. ...

So, I feel sorry for Fred. Beating up on seniors who have paid in their taxes for what they are getting has been the one an only topic that has inspired him to write columns under his own name for many years. The new projections of lower deficits, good news to most of us, simply do not register with him. Actually, they probably do. But Krugman is right. As much as anybody, he is the longstanding VSP in DC who has been whining for years about cutting Social Security and Medicare, whose excuse for this argument has simply disappeared, but he and his pals simply are not willing to face the new facts.

Paul Krugman: Secret Deficit Lovers

Why isn't America celebrating the large fall in the deficit?:

Secret Deficit Lovers, by Paul Krugman, Commentary, NY Times: What if they balanced the budget and nobody knew or cared?

O.K., the federal budget hasn’t actually been balanced. But the Congressional Budget Office has tallied up the totals for fiscal 2014..., and reports that the deficit plunge of the past several years continues. ...

So where are the ticker-tape parades? For that matter, where are the front-page news reports? After all, talk about the evils of deficits and the grave fiscal danger facing America dominated Washington for years. Shouldn’t we be making a big deal of the fact that the alleged crisis is over?

Well, we aren’t, and once you understand why, you also understand what fiscal hysteria was really about.

First, ordinary Americans aren’t celebrating the deficit’s decline because they don’t know about it. That’s not mere speculation...

Why doesn’t the public know better? Probably because of the way much of the news media report this and other issues, with bad news played up and good news downplayed if it’s reported at all.

This has been glaringly obvious in the case of health reform, where every problem ... has been the subject of headlines, while in right-wing media — and to some extent in mainstream news sources — favorable developments go unremarked. As a result, many people — even, in my experience, liberals — have the impression that the rollout of Obamacare has been a disaster, and have no idea that enrollment is above expectations, costs are lower than expected, and the number of Americans without insurance has dropped sharply. Surely something similar has happened on the budget deficit. ...

Deficit scolds actually love big budget deficits, and hate it when those deficits get smaller. Why? Because fears of a fiscal crisis — fears that they feed assiduously — are their best hope of getting what they really want: big cuts in social programs. ...

But isn’t the falling deficit just a short-term blip, with the long-run outlook as dire as ever? Actually, no..., there has ... been a dramatic slowdown in the growth of health spending — and if that continues, the long-run fiscal outlook is much better than anyone thought possible not long ago. ...

So let’s say goodbye to fiscal hysteria. I know that the deficit scolds are having a hard time letting go; they’re still trying to bring back the days when Bowles and Simpson bestrode the Beltway like colossi. But those days aren’t coming back, and we should be glad.

'Do We Need a Crisis to Reduce the Deficit?'

Simon Wren-Lewis:

Do we need a crisis to reduce the deficit?: The macroeconomic case for not cutting the deficit straight after a major recession is as watertight as these things get, at least outside of the Eurozone. (It is also true for the Eurozone, but just a bit more complicated, so its easier to just focus on the US and UK in this post.) If you want to bring the government deficit and debt down, you do so when interest rates are free to counter the impact on aggregate demand. As the problems of high government debt are long term there is no urgency for debt reduction, so the problem can wait. The costs of fiscal consolidation in a liquidity trap are large and immediate, as we have experienced to our cost.

Sometimes austerity proponents will admit this basic macroeconomic truth, but say that it ignores the politics. Politics means that it is very difficult for governments to reduce debt during booms, they say. Although it would be nice to wait for interest rates to rise before cutting the deficit, it will not happen if we do, so we have to cut now. Like all good myths, this is based on a half truth: in the 30 years before the recession, debt tended to rise as a share of GDP in most OECD countries. And it always sounds wise to say you cannot trust politicians.

However both the UK and US show that this is not some kind of iron law of politics. ...

Paul Krugman: Depression Denial Syndrome

What is the price for getting it wrong?:

Depression Denial Syndrome, by Paul Krugman, Commentary, NY Times: Last week, Bill Gross, the so-called bond king, abruptly left Pimco, the investment firm he had managed for decades. People who follow the financial industry were shocked but not exactly surprised; tales of internal troubles at Pimco had been all over the papers. But why should you care?

The answer is that Mr. Gross’s fall is a symptom of a malady that continues to afflict major decision-makers, public and private. Call it depression denial syndrome: the refusal to acknowledge that the rules are different in a persistently depressed economy. ...

Now, we normally think of deficits as a bad thing — government borrowing competes with private borrowing, driving up interest rates, hurting investment... But, since 2008, we have ... been stuck in a liquidity trap... In this situation,... deficits needn’t cause interest rates to rise. ...

All this may sound strange and counterintuitive, but it’s what basic macroeconomic analysis tells you. ... But many, perhaps most, influential people in the alleged real world refused to believe...

Which brings me back to Mr. Gross.

For a time, Pimco — where Paul McCulley, a managing director at the time, was one of the leading voices explaining the logic of the liquidity trap — seemed admirably calm about deficits, and did very well as a result. ...

Then something changed. Mr. McCulley left Pimco at the end of 2010..., and Mr. Gross joined the deficit hysterics, declaring that low interest rates were “robbing” investors and selling off all his holdings of U.S. debt. In particular, he predicted a spike in interest rates when the Fed ended a program of debt purchases in June 2011. He was completely wrong, and neither he nor Pimco ever recovered.

So is this an edifying tale in which bad ideas were proved wrong by experience, people’s eyes were opened, and truth prevailed? Sorry, no. In fact, it’s very hard to find any examples of people who have changed their minds. People who were predicting soaring inflation and interest rates five years ago are still predicting soaring inflation and interest rates today, vigorously rejecting any suggestion that they should reconsider their views in light of experience.

And that’s what makes the Bill Gross story interesting. He’s pretty much the only major deficit hysteric to pay a price for getting it wrong (even though he remains, of course, immensely rich). Pimco has taken a hit, but everywhere else the reign of error continues undisturbed.

'Stupidest Article Ever Published?'

Via email, I was asked if this is the "stupidest article ever published?":

The Inflation-Debt Scam

If not, it's certainly in the running.

Inflation, Fear of Inflation, and Public Debt

Posting the video mysteriously causes formatting problems for the blog, so took it down and replaced it with link to the video:

Chris Sims: Inflation, Fear of Inflation, and Public Debt

Paul Krugman: The Forever Slump

The risks from tightening policy too soon are much greater than the risks from leaving policy in place too long:

The Forever Slump, by Paul Krugman, Commentary, NY Times: It’s hard to believe, but almost six years have passed since the fall of Lehman Brothers ushered in the worst economic crisis since the 1930s. ... Recovery is far from complete, and the wrong policies could still turn economic weakness into a more or less permanent depression.

In fact, that’s what seems to be happening in Europe as we speak. And the rest of us should learn from Europe’s experience. ...

European officials eagerly embraced now-discredited doctrines that allegedly justified fiscal austerity even in depressed economies (although America has de facto done a lot of austerity, too, thanks to the sequester and cuts at the state and local level). And the European Central Bank, or E.C.B., not only failed to match the Fed’s asset purchases, it actually raised interest rates back in 2011 to head off the imaginary risk of inflation.

The E.C.B. reversed course when Europe slid back into recession, and, as I’ve already mentioned, under Mario Draghi’s leadership, it did a lot to alleviate the European debt crisis. But this wasn’t enough. ...

And now growth has stalled, while inflation has fallen far below the E.C.B.’s target of 2 percent, and prices are actually falling in debtor nations. It’s really a dismal picture. ... Europe will arguably be lucky if all it experiences is one lost decade.

The good news is that things don’t look that dire in America, where job creation seems finally to have picked up and the threat of deflation has receded, at least for now. But all it would take is a few bad shocks and/or policy missteps to send us down the same path.

The good news is that Janet Yellen, the Fed chairwoman, understands the danger; she has made it clear that she would rather take the chance of a temporary rise in the inflation rate than risk hitting the brakes too soon, the way the E.C.B. did in 2011. The bad news is that she and her colleagues are under a lot of pressure to do the wrong thing from [those] who seem to have learned nothing from being wrong year after year, and are still agitating for higher rates.

There’s an old joke about the man who decides to cheer up, because things could be worse — and sure enough, things get worse. That’s more or less what happened to Europe, and we shouldn’t let it happen here.

'Will the US Inflate Away Its Public Debt?'

Ricardo Reis:

Will the US inflate away its public debt?, by Ricardo Reis, Vox EU: Should the US Federal Reserve raise the inflation target from its current level of 2%? And will it? One benefit would be to make hitting the zero lower bound less likely, which would lead to less severe recessions, as Olivier Blanchard, Giovanni Dell’Ariccia, and Paolo Mauro (2010), Daniel Leigh (2010), and Laurence Ball (2013) have argued on this website. Other benefits of higher inflation that Kenneth Rogoff has been emphasising for a while might include accelerating the fall in real wages during the recession, and deflating away debt overhang (Rogoff 2014).¹

One of the most indebted economic agents is the government. The federal debt limit has had to be raised repeatedly in the past few years, and at the end of the 2013 fiscal year the gross federal debt outstanding was 101% of GDP – the highest ratio since 1948. It is therefore natural to imagine – like Aizenman and Marion (2009) –that inflating away the public debt is possible, perhaps effective, and maybe even desirable. Using a simple rule of thumb to estimate the effect of higher inflation on the real value of debt, they venture that US inflation of 6% for four years could reduce the debt-GDP ratio by roughly 20%.

However, in our recent work we show that the probability that US inflation lowers the real value of the debt by even as little as 4.2% of GDP is less than 1% (Hilscher, Raviv and Reis, 2014). Why is this estimate so small? We show that there are two reasons: first, the private sector holds shorter maturity debt; second, high levels of inflation in the next few years are extremely unlikely. ...

He concludes:

One way or another, budget constraints will always hold. This is true as much for a household or a firm as it is for the central bank or the government as a whole. If the US government is to pay its debt, then it must either raise fiscal surpluses or hope for higher economic growth; the former is painful and the latter is hard to depend on. It is therefore tempting to yield to the mystique of central banking and believe in a seemingly feasible and reliable alternative: expansionary monetary policy and higher inflation.³ Crunching through the numbers we find that this alternative is not really there.

Paul Krugman: The Fiscal Fizzle

"We don’t have a debt crisis, and never did":

The Fiscal Fizzle, by Paul Krugman, Commentary, NY Times: For much of the past five years readers of the political and economic news were left in little doubt that budget deficits and rising debt were the most important issue facing America. Serious people constantly issued dire warnings that the United States risked turning into another Greece ...

I’m not sure whether most readers realize just how thoroughly the great fiscal panic has fizzled...

In short, the debt apocalypse has been called off.

Wait — what about the risk of a crisis of confidence? There have been many warnings that such a crisis was imminent, some of them coupled with surprisingly frank admissions of disappointment that it hadn’t happened yet. For example, Alan Greenspan warned of the “Greece analogy,” and declared that it was “regrettable” that U.S. interest rates and inflation hadn’t yet soared.

But that was more than four years ago, and both inflation and interest rates remain low. Maybe the United States, which among other things borrows in its own currency and therefore can’t run out of cash, isn’t much like Greece after all.

In fact, even within Europe the severity of the debt crisis diminished rapidly once the European Central Bank began doing its job, making it clear that it would do “whatever it takes” to avoid cash crises in nations that have given up their own currencies and adopted the euro. Did you know that Italy, which remains deep in debt and suffers much more from the burden of an aging population than we do, can now borrow long term at an interest rate of only 2.78 percent? Did you know that France, which is the subject of constant negative reporting, pays only 1.57 percent?

So we don’t have a debt crisis, and never did. Why did everyone important seem to think otherwise?

To be fair, there has been some real good news about the long-run fiscal prospect, mainly from health care. But it’s hard to escape the sense that debt panic was promoted because it served a political purpose — that many people were pushing the notion of a debt crisis as a way to attack Social Security and Medicare. And they did immense damage along the way, diverting the nation’s attention from its real problems — crippling unemployment, deteriorating infrastructure and more — for years on end.

Medicare Growth is Really Low

Aaron Carroll:

Medicare growth is really low: ... It turns out that actual Medicare growth for the first eight months of the fiscal year has been 0.3%. That’s amazing. But, of course, there are some temporary policies in place that have been restraining spending. These include things like the seqester, some ACA stuff, and frozen means-tested Medicare premium income thresholds.* Without these policies in place, growth would have been 2.5%. ...

Economic growth is 3.9%. That means that Medicare growth is nowhere near the GDP + 1% or so that would be needed to see the IPAB kick in. This has important, and positive, effects on the long-term federal budget outlook.

*Of course, there are temporary ACA-related things like the filling-in donut hole, which are increasing spending as well, so actual growth is likely less. Amazing!

'America's Debt and the Economy: A Hard Look at Public Spending and Finance'

This session, as I thought it would be before it started, was annoying:

America's Debt and the Economy: A Hard Look at Public Spending and Finance: With mandatory programs consuming 13.6 percent of GDP and rising, security spending at 5 percent, debt service at 1.5 percent (under benign interest-rate conditions), and revenue at 19 percent, there is little or no room in the nation's budget to fund the discretionary programs that support competitiveness and growth over the long term. That will require investment in infrastructure, technology, environmental protection, education and job training, among other areas. Despite the shutdowns and threats of default, both Republicans and Democrats understand that our future prosperity demands a responsible focus on these imperatives. But how can the government's budgeting process move beyond short-term fixes? This discussion will identify areas for strategic bipartisan collaboration to put the U.S. on track for meaningful reform, leading to the creation of a budget that better addresses our challenges and reflects our priorities.

Speakers:

• Douglas Holtz-Eakin, President, American Action Forum; Former Director, Congressional Budget Office; Former Chief Economist, Council of Economic Advisers
• Maya MacGuineas, President, Committee for Responsible Federal Budget
• Steven Rattner, Chairman, Willett Advisors; Former Counselor and Lead Auto Advisor to the U.S. Secretary of the Treasury
• Gene Sperling, Former Director, National Economic Council, The White House
• Moderator: Maria Bartiromo, Anchor and Global Markets Editor, Fox Business Network

I heard things such as:

Need to get spending under control to create a good investment climate.

Large spending programs are crowding out discretionary programs such as defense and infrastructure.

One of the most serious issues we face.

Wait until rates go up.

Nobody in Washington is interested in talking about it.

We have to cut entitlements (Medicare, Medicaid, Social Security).

Our economic growth is lower because of the debt. Our economy is worse off because of it.

Huge benefit right now from cutting deficit.

Anyone who is sensible would agree with us.

Neither Bush nor Obama has been willing to explain to the public what a huge problem the debt is.

We need to do this, it is an important thing for our children.

President needs to make this a national priority, like it did with income inequality.

With all the problems in the world, is now the time to be cutting defense spending?

Simpson Bowles was a very, very, very good plan.

You get the idea. There was very little about tradeoffs, e.g. higher unemployment when we reduce the debt during a not so robust recovery, though Sperling did address this a bit, not enough on revenue enhancement, and -- though it did come up at times -- the relationship between health care costs and our long-term debt problems was not made as clear as it should have been.

When it comes to recovering from the recession, these people are the problem, not the solution.

But maybe I'm just being cranky (and biased from the start) -- watch the video and tell me what you think...

'Ryan Budget Shows G.O.P. Stuck in Rah-Rah Land'

Another quick one. John Cassidy on Paul Ryan's budget:

Ryan Budget Shows G.O.P. Stuck in Rah-Rah Land, by John Cassidy: Here’s all you need to know about the G.O.P.’s effort to face reality, moderate its policies, and present a more coherent policy platform to voters in 2016. David Camp, the Michigan Republican who chairs the powerful House Ways and Means Committee, and who in February introduced a sweeping tax-reform plan that, at least, recognized the basic laws of arithmetic, is leaving Congress. Paul Ryan, the conservative Moses of Capitol Hill, is sticking around. On Wednesday, he unveiled the latest of his right-wing manifestos, thinly disguised as a serious budget, proposing to repeal Obamacare, privatize Medicare, and slash spending on Medicaid and food stamps.

No, it wasn’t an April Fool’s joke. The Republican Party’s reform effort, which was heralded by a March, 2013, internal report that said that the G.O.P. was trapped in “an ideological cul de sac,” is over almost before it had begun. On issue after issue (gun control, immigration, gay marriage, Obamacare, climate change, unemployment benefits, the minimum wage), suggestions that the Party might revise its extreme positions have been stomped on. The ultras have won out. And nowhere is this more true than in the biggest policy area of all: taxes and spending. ...

Paul Krugman: Fiscal Fever Breaks

The deficit scolds have been discredited:

Fiscal Fever Breaks, by Paul Krugman, Commentary, NY Times: In 2012 President Obama, ever hopeful that reason will prevail, predicted that his re-election would finally break the G.O.P.’s “fever.” It didn’t.

But the intransigence of the right wasn’t the only disease troubling America’s body politic in 2012. We were also suffering from fiscal fever... Instead of talking about mass unemployment and soaring inequality, Washington was almost exclusively focused on the alleged need to slash spending (which would worsen the jobs crisis) and hack away at the social safety net (which would worsen inequality).

So the good news is that this fever, unlike the fever of the Tea Party, has finally broken. ... What changed?...

First, the political premise behind “centrism” — that moderate Republicans would be willing to meet Democrats halfway in a Grand Bargain combining tax hikes and spending cuts — became untenable. There are no moderate Republicans. ...

Second, a combination of rising tax receipts and falling spending has caused federal borrowing to plunge. This is actually a bad thing, because premature deficit-cutting damages our still-weak economy... But a falling deficit has undermined the scare tactics so central to the “centrist” cause. Even longer-term projections of federal debt no longer look at all alarming.

Speaking of scare tactics, 2013 was the year journalists and the public finally grew weary of the boys who cried wolf... — for example, when Erskine Bowles and Alan Simpson ... warned that a severe fiscal crisis was likely within two years. But that was almost three years ago.

Finally, over the course of 2013 the intellectual case for debt panic collapsed. ... For ... several years fiscal scolds ... leaned heavily on a paper by ... Carmen Reinhart and Kenneth Rogoff, suggesting that government debt has severe negative effects on growth when it exceeds 90 percent of G.D.P. ...

Then Thomas Herndon, a graduate student at the University of Massachusetts, reworked the data, and found that the apparent cliff at 90 percent disappeared once you corrected a minor error and added a few more data points. ...

Still, does any of this matter? You could argue that it doesn’t — that fiscal scolds may have lost control of the conversation, but that we’re still doing terrible things like cutting off benefits to the long-term unemployed. But while policy remains terrible, we’re finally starting to talk about real issues like inequality, not a fake fiscal crisis. And that has to be a move in the right direction.

Paul Krugman: Addicted to the Apocalypse

Why is Chicken Little so popular?:

Addicted to the Apocalypse, by Paul Krugman, Commentary, NY Times: Once upon a time, walking around shouting “The end is nigh” got you labeled a kook... These days, however,... you more or less have to subscribe to fantasies of fiscal apocalypse to be considered respectable.

And I do mean fantasies. Washington has spent the past three-plus years in terror of a debt crisis that keeps not happening, and, in fact, can’t happen to a country like the United States, which has its own currency and borrows in that currency. Yet the scaremongers can’t bring themselves to let go.

Consider, for example, Stanley Druckenmiller... Or consider the deficit-scold organization Fix the Debt, led by the omnipresent Alan Simpson and Erskine Bowles. ... [gives examples of doomsaying] ...

As I’ve already suggested, there are two remarkable things about this kind of doomsaying. ... On the Chicken Little aspect: It’s actually awesome, in a way, to realize how long cries of looming disaster have filled our airwaves and op-ed pages. For example, I just reread an op-ed article by Alan Greenspan ... warning that our budget deficit will lead to soaring inflation and interest rates ... published in June 2010... — and both inflation and interest rates remain low. So has the ex-Maestro reconsidered his views after having been so wrong for so long? Not a bit. ...

Meanwhile, about that oft-prophesied, never-arriving debt crisis:... two and half years ago, Mr. Bowles warned that we were likely to face a fiscal crisis within around two years... They just assume that it would cause soaring interest rates and economic collapse, when both theory and evidence suggest otherwise. ...

Look at Japan, a country that, like America, has its own currency and borrows in that currency, and has much higher debt relative to G.D.P. than we do. Since taking office, Prime Minister Shinzo Abe has, in effect,... persuaded investors that deflation is over and inflation lies ahead, which reduces the attractiveness of Japanese bonds. And the effects on the Japanese economy have been entirely positive! ...

Why, then, should we fear a debt apocalypse here? Surely, you may think, someone in the debt-apocalypse community has offered a clear explanation. But nobody has.

So the next time you see some serious-looking man in a suit declaring that we’re teetering on the precipice of fiscal doom, don’t be afraid. He and his friends have been wrong about everything so far, and they literally have no idea what they’re talking about.

Paul Krugman: Dealing With Default

Don't listen to the default deniers:

Dealing With Default, by Paul Krugman, Commentary, NY Times: So Republicans may have decided to raise the debt ceiling without conditions attached — the details still aren’t clear. Maybe that’s the end of that particular extortion tactic, but maybe not, because, at best, we’re only looking at a very short-term extension. The threat of hitting the ceiling remains...

So what are the choices if we do hit the ceiling? ... What would a general default look like? ...

First, the U.S. government would ... be ... failing to meet its legal obligations to pay. You may say that things like Social Security checks aren’t the same as interest due on bonds... But ... Social Security benefits have the same inviolable legal status as payments to investors.

Second, prioritizing interest payments would reinforce the terrible precedent we set after the 2008 crisis, when Wall Street was bailed out but distressed workers and homeowners got little or nothing. We would, once again, be signaling that the financial industry gets special treatment because it can threaten to shut down the economy if it doesn’t.

Third, the spending cuts would create great hardship if they go on for any length of time. Think Medicare recipients turned away from hospitals...

Finally, while prioritizing might avoid an immediate financial crisis, it would still have devastating economic effects. We’d be looking at an immediate spending cut roughly comparable to the plunge in housing investment after the bubble burst... That by itself would surely be enough to push us into recession.

And it wouldn’t end there. As the U.S. economy went into recession, tax receipts would fall sharply, and the government, unable to borrow, would be forced into a second round of spending cuts, worsening the economic downturn, reducing receipts even more, and so on. So ... we could ... be looking at a slump worse than the Great Recession.

So are there any other choices? Many legal experts think there is another option: One way or another, the president could simply choose to defy Congress and ignore the debt ceiling.

Wouldn’t this be breaking the law? Maybe, maybe not — opinions differ. But not making good on federal obligations is also breaking the law. And if House Republicans are pushing the president into a situation where he must break the law no matter what he does, why not choose the version that hurts America least? ...

So what will happen if and when we hit the debt ceiling? Let’s hope we don’t find out.