On the Debt Deal and the unBBA

TIME has five economists react to the debt deal, Mohamed El-Erian, Douglas Holtz-Eakin, Simon Johnson, Stephen S. Roach and yours truly.

Holtz-Eakin really works his apocalyptic imagery:

The river of entitlement red ink courses through a broken budgetary landscape. America is borrowing $58,000 every second—more than the median income of its households—and the gross debt already exceeds the level (90% of gross domestic product) that has historically been seen as toying with danger. Even worse, the federal debt promises to explode in the next decade, which will surely result in a Greece-style debt crisis. Erskine Bowles, co-chair of the President’s fiscal reform commission has called it the “most predictable crisis in history.”

When the crisis inevitably arises, the painful memories of 2008—panic; no credit; monthly job losses in the hundreds of thousands; Main Street businesses shuttering their windows and closing their doors; highly-qualified college graduates despairing of ever finding real work—will seem quaint and mild by comparison.

Stephen S. Roach wonders what will happen as China rebalances.

For China, the fiscal crisis and Great Recession was a wake-up call — a signal to rebalance away from unsustainable external demand toward untapped internal consumption. Such efforts now appear to be underway. And that’s where it comes full circle. China, the world’s biggest surplus saver, gets it. It will now save less and consume more. Conversely, the United States, with world’s biggest savings deficit, doesn’t get it. At least, that’s the message to take from the disappointing outcome of the debt ceiling debate.

…Absent the Chinese buyer of Treasuries, who will step up and fill the void? And on what terms? That latter point is key. With increasingly skittish foreign lenders now likely to require concessions in the form of a weaker dollar and higher U.S. interest rates, there will be new pressures on U.S. inflation and growth.

The timing of Roach’s comments are odd since interest rates are falling madly. On the other hand, the Chinese credit rating agency did just downgrade US debt.

I discuss the virtues of an unbalanced budget amendment. I won’t repeat what I wrote earlier but here are a few added remarks:

The idea of an unbalanced budget amendment is not new. Sweden’s government has been required since 2000 to budget for a 1% surplus over the business cycle. Since implementing their unBBA, Sweden has successfully brought their budget into balance and created a surplus.

Even more ancient sources are supportive of an unBBA. In the Bible, Joseph doesn’t advise the Pharaoh to balance the budget instead he tells the Pharaoh, save during the seven fat years so you are prepared for the seven lean. An unbalanced budget amendment reflects this simple and ancient wisdom.

For more, Ed Dolan has a good post on Sweden’s fiscal rules. See also this IMF paper for an extensive look at fiscal rules around the world. A hat tip to Ennuigogo.


'The timing of Roach’s comments are odd since interest rates are falling madly'
Not according to Trichet - I think that a stock market or two in the world may have noticed his little remark about needing to raise interest rates to contain inflation - that the ECB had done just that recently adding a bit of plausibility to that remark - along with how growth rates don't look that rosy currently.

Whether such remarks and actions are actually a smart thing to do is another question entirely - but interest rates have not only stopped falling madly, at least in the world's largest economic bloc, they are actually rising.

They are rising to banking institutions that have too much risk or where the risk to the lender is unkown..

Interest has a risk component as to a specific lender. And, sometimes the risk gets so high, you don't even lend.

Which interest rates are falling madly? You mean Treasury rates? So I'm basically assured of a nominally riskless dollar yield from Uncle Sam for another couple of years. If I don't like the risk of paying your kids to produce goods that might find a profitable market now, I can pay Uncle Sam to deliver the yield of threatening to shoot your kids in the future instead? Those rates?

Alex, you are confusing constitutional rules that constrain the budgetary process and the power to tax and to borrow with fiscal rules. The IMF paper refers only to fiscal rules that are defined (p. 4) as

4. A fiscal rule is defined as a permanent constraint on fiscal policy through simple numerical limits on budgetary aggregates (Kopits and Symansky, 1998). Each of the elements in the definition is important: a rule delineates a numerical target over a long- lasting time period with a view to guiding fiscal policy; it specifies a summary operational fiscal indicator to which it is applicable; and it is simple so that it can be readily operationalized, communicated to the public, and monitored.1

I understand that no constitution includes that type of fiscal rules. In his post on Sweden Dolan refers to fiscal rules and in a previous post on Chile, he writes also about fiscal rules. The latter refers to a recent paper by J. Frankel on the Chilean rules. Neither Frankel nor Dolan refer to Chile's constitutional constraints on the power to tax and to borrow and on the budgetary process, however. It would take too long to explain you how these constraints originated in Chile's fiscal crises before 1980 and their important consequences --one of which was the adoption, 20 years later, of the fiscal rules that Frankel and Dolan refer to. Let me just say that since 1975, Chile has enjoyed fiscal discipline to a degree none had expected that year --and it has succeeded despite the large economic crisis of 1982-83, the slowdown of GDP growth since 1997, and the large increase in government revenue thanks to the high price of copper in the past seven years.

What about only borrowing for things that provide cash flows tomorrow instead of further cash outlays tomorrow?

The short answer is --be careful, money is fungible. The long answer involves designing schemes that tie or dedicate borrowed funds to particular investment projects. My main concern, however, is not how government is financed but the huge waste in government expenditure. Even in Chile, regardless of how many good things can be said about fiscal discipline (it has not been as "perfect" as J. Frankel and other people want to believe), waste has been and will be a serious problem for a long time.

I like your idea, but it needs a better name before it can get political traction. Can anyone imagine a politician saying out loud that she/he wants an unbalanced budget? It just sounds bad from the get go.

Yes, I can imagine that, because Rep. Justin Amash (R-MI, fairly libertarian) has just proposed a "balanced over the business cycle" amendment based on these ideas.

I like the "Balanced over the business cycle" packet
That makes sense.
But, since I don't think we can govern in a straightjacket
I would rename it the
"Keynesian Balance Budget Amendment"
Just to attract conservative voters.

"Business Cycle Balanced" is a much better name to sell it by than "Unbalanced," I think we have to agree.

Unless you're selling it to deliberate contrarians, I guess.

I like Paygo rules during a period of surplus or at least when the economy is operating at 5-6% unemployment. I would tie and limit stimulus spending--either tax cuts or jobs programs--to the level of unemployment. If you have a stimulus tax cut you know will create a deficit, or a stimulus expenditure program, that is set to last ten years, you know you have a problem because you will never change it. Cuts and stimulus should be tied to the level of unemployment.

"I like Paygo rules "

Ah, the source of our entitlement fiasco!

O dear god. As if Congress didn't have enough incentives to muck with employment. I can see them handing out jobs 'for free' if it allows them to spend more.

Please support your claim that Paygo is the source of the entitlement fiasco.

Matt, If they gave out jobs for free, they would get to spend less. Got it backwards.

Since you haven't responded to my request for evidence, let me give you evidence of my assertion that Paygo would prevent an entitlement or result in the entitiment: Medicare Part D.

Rep. Amash calls it the "Business Cycle Balanced Budget Amendment." It was introduced on July 21 as H.J.Res.73 and has 27 bipartisan cosponsors, and neither Democratic cosponsor is a "Blue Dog Democrat," which are typically thought of as the more conservative Democrats.

Biblical Budget Amendment.

Slam dunk.

Oh great, now the ACLU will declare the budget unconstitutional.

No, they won't buy into it.

Government is the Great Satan,

And, all you would be doing is preserving it.

Crazy stuff. Not that the US has its house in order but the panic right now is mainly a European issue, yet Stephen Roach et al can't wait to take potshots at the US.

Perhaps if more of Europe had taken such potshots when they didn't have their house in order but didn't have a panic, they wouldn't have a panic right now.

Question: is that 1% of GDP or of the total budget?

Sweden always knew how to manage the country budget. As income per person Sweden has more above the average income in many other Europe countries. asigurari locuinte

Surely when all those capital gains from the DOW 35,000( Douglas Holtz-Eakin)are realized, the taxes will wipe the deficit away.

Unlike Sweden's fiscal rules--which enjoy consent of both parties and operate under a majorician model--our constitutional proposals work in the opposite direction: they are aimed at giving a minority (1/3 or 40%) of elected representative control. We would be better and trying to work at consensus, rather than giving minority control. As we've witnessed, holdup opportunities abound.

There are some other differences pointed out in the article on Sweden:

"Another reason the United States needs to tilt toward discipline is a lower level of political consensus. In Sweden, the major political parties agree on the importance of following the rules. Look again at the chart of Sweden’s debt and deficit since the fiscal reforms of the mid-1990s: The chart shows no sign of any disturbance when the government changed from Social Democratic to center-right in 2006. Compare that to the radical change change from the budget discipline of the Clinton years to the fiscal irresponsibility of the Bush years. A very strong set of chains indeed would have been needed to prevent euphoric Republicans from squandering the once-in-a-lifetime budget surpluses they inherited after the election of 2000.

The third lesson is that although the United States may need a stronger dose of fiscal discipline than Sweden does, discipline can also be too tight. An example is the procyclical annual balance requirement embodied in the balanced budget amendment that is so enthusiastically championed by House Republicans. By requiring severe budget cuts each time the country entered a recession, such a rule would make the troughs of the business cycle deeper and recoveries slower. Far from bolstering confidence and promoting long-run growth, the proposed amendment would be a recipe for chronic instability and stagnation."

Regarding the Unbalanced Amendment, I think you might also want to look at the history of state budgets and not just Sweden or Chile.

In the United States, many states created "rainy day" funds or even ran surpluses via set aside funds, anticipating there would come a time when there would be a need to draw down on them.

Guess what happens.

Some guy runs on the platform: it's your money and you should get it back, or gov'mnt is too big because it has all this money, after getting elected, sends checks to the citzenry, only to have the state have a deficit two years later when the economy tanks.

The other thing you might want to look at with state budgets is that most have a balance requirement. The lucky thing about states, though, is that when they have a crisis, they often balance their budget by passing off the work payment obligations to local governments.

I don't think we could shift Federal government operations, such as defense and corresponding payment obligations for it to Texas, Miss, Ala, Ga, SC and FL, but I would sure like to.

What interested me about Sweden was that they had a majority consensus on what to do (balance over the cycle); we don't even have that, when persons say: we should cut spending during a recession because it will take a burden off of business. Dah.

I've heard this criticism of rainy day funds before but have never seen it actually happen. Could you cite an example? Or is this just conjecture that voters won't recognize when they are pillaging the rainy day run.


Matt, Sure, Minnesota under Gov. Jesse Ventura.

Matt, Here's an interesting issue. Some states with rainy day funds, don't use them because it requires a supermajority to release them because the minority wants to shrink the size of government.
Interesting article on Gov Perry here: http://www.texastribune.org/texas-legislature/82nd-legislative-session/perrys-rainy-day-fund-used-up-say-some-republicans/

Matt, the other issue that pops up when a state runs a surplus is that there is a battle whether the surplus goes into the rainy day fund or not. So, if the fund is low or depleted when the state runs a surplus there is no obligation to rebalance it or avoid the debate about what to do with the surplus.

What balanced budget in 2000?

When someone extols the Clinton balanced budget, a conservative must attack Clinton with this two prong attack:
1) the budget wasn't balanced - the debt increased by 0.25% of GDP for the best of the four years of supposed budget surplus
2) the balanced budget was the result of the Republicans forcing austerity on Clinton and the tax cuts in 1997 budget on capital gains that unleashed the wealth creation of investing in stocks and real estate which increased capital values by at least $5 trillion dollars in just 4 years generating huge tax revenues proving tax cuts increase tax revenue.

Simon nails it here: "Fiscal policy was too expansionary in the 2000s."

The problem is that politically speaking the economy is never doing well enough for contractionary policy. I think this is partly a legacy of TGS, because expectations are too high.

I keep hearing the argument "we can't cut spending during a recession!" even when we're not actually in a recession. If we keep piling up debt the choices will be much uglier later than those we face now.

That's great. We seem to have the things that are always smart and the things that are sometimes smart mostly backwards.

OTOH Mohamed's comments that "they fabricated a crisis and inflicted unnecessary pain on the innocent," by contrast, are disappointingly nonsensical. The only people fabricating a crisis are those (like him) who claimed and continue to claim that reaching the debt limit was equivalent to default. If there was any actual damage attributable to the debt-limit debate itself that would have shown up in the short-term rates, which in reality rightly ignored the entire brouhaha as virtually irrelevant to interest payments.

More fundamentally, the only way to have real damage from bumping the debt limit is because we are Lehman Brothers and can't roll over the debt and can't make the payments. This is the exact problem 'we' are trying to fix.

Given the overall contraction since 2001 and the really really weak expansion, how can the fiscal policy since 2001 be called expansionary?

Has anyone argued "if Bush hadn't cut taxes 8 times, and started two wars, and run massive deficits, the economy would have been much worse, in the Second Great Depression from 2001 to 2006. The problem is Nancy Pelosi imposed austerity measures on Bush, just like FDR was forced into austerity in 1937 by deficit hawks."

Seriously? We doubled federal spending in nominal dollars.

And in other news, is to economics as Obama is to leadership. Thank you again, Rick Santelli.

Ezra Klein - http://www.youtube.com/watch?v=uKwWa1h7Sd4&feature=player_embedded

Stephen S. Roach:
…Absent the Chinese buyer of Treasuries, who will step up and fill the void? And on what terms? That latter point is key. With increasingly skittish foreign lenders now likely to require concessions in the form of a weaker dollar and higher U.S. interest rates, there will be new pressures on U.S. inflation and growth.

So China will pursue a policy that results in a weaker dollar, that is, a stronger yuan.

What color is the sky on his world?

I'm always surprised that people don't seem to understand China isn't funding our deficits because they like us, or the implications for both the Chinese and U.S. economies of a weak dollar/strong yuan policy.

China isn't funding the deficit; Chinese holdings are falling. The US investors who have lots of money from the Bush tax cuts and corporate austerity measures are the ones buying all the Treasuries, not to mention Europeans, because they can't find anything to invest in that offers better safety and returns.

Face it,the things that really need real investment, like bridges and roads and levies and toxic waste cleanup and fighting the climate change that is devastating the US farms, are much worse investments than US Treasuries, even if Treasuries default.

Chinese holdings have only fallen very slightly very recently. They're up considerably from 2010.


They've also been hiding just how large their purchases were.


Holtz-Eakin :
Even worse, the federal debt promises to explode in the next decade, which will surely result in a Greece-style debt crisis.

Because, of course, the US debt is in a currency the US doesn't control, just like Greece.

Hyperinflations isn't an alternative to default, it is caused by default---or a clear risk thereof.

1. Lenders, judging the existence of a clear risk of loss of any funds lent to a government accumulating debt that it has no realistic chance of being able to repay or service, begin selling their assets denominated in the currency issued by the government's central bank. Yields on government bonds spike and the local currency plunges in value.

2. The government, unable to raise any more money in capital markets at anything like affordable rates, and unable or unwilling to put its budget in order, in desperation turns to the central bank, ordering it to print money and "lend" it to the government. The result of course, is to drive the value of the currency down still further as demand plunges.

3. Eventually, of course, the currency issued by the central bank is completely rejected even in local markets; people simply stop accepting it in payment of debts if they have any choice. At this stage the government defaults on its obligations anyway, and is forced to face the consequences thereof.

No, the US won't turn into Greece. Bolivia, maybe.

You missed a step.

The government prints money AND

China and others who manipulate their currencies purchases it and they collapse.

Greece is in such a bind precisely because they don't have a currency to print or a central bank to order around. They cannot devaule, they can only default.

Larry's right, I think, the analogy by Holtz-Eakin is at best imprecise.

Hmm...this seems to the counter-cyclical strategy at the heart of the (Keneysian) Economics 101 course I took...(number deleted)... years ago. And all that stuff about deposits and withdrawals still seems relevant. Somehow after all these years, the basics still come out the basics, and neo-classical economics still smells like a dead pig.

But I propose a variation on this scheme which involves an explicitly balanced budget: when a Republican president is in charge, taxes must be raised to balance the budget, but when the President is a Democrat, spending must be cut. To avoid immediate disaster, the balanced budget target should approach balance over a 10 year interval. Each side would be forced to look at its priorities very carefully.

Now let's be honest, the only two presidents to run a surplus in the last forty years were Jimmy Carter (a small one) and Bill Clinton (a relative large one). The presidents who established monster deficits following these surpluses were Ronald Reagan, the grand master of huge deficits, his direct successor G Bush 1st, and his son G Bush 2nd, who converted the large surplus he was handed back into a monster deficit. So Republicans have a definite love of deficits while governing and love of complaining about their handy-work while in opposition.

To stop this foolish behavior, Republicans need to face up to what they are doing to the public finances and raise taxes if they want whatever they want on behalf of the 5% of the population they so lovingly represent economically. Democrats who can not generate surpluses need to be reminded that they will have to find a balance - they obvious one they have ignored is the triple increase war department budget achieved in less than 15 years with no credible co-equal threat on the planet. (Quick what did it cost to kill Ben Landen? My guess is northwards to $30 billion dollars on one man - undoubtedly the most expensive hit in human history).

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