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Both federal and state politicians are biased toward deficit‐​spending, but state experience shows that this impulse can be restrained and stabilized.

Romina Boccia


Fitch Ratings, one of three major credit rating agencies, downgraded the U.S. debt from AAA (the highest possible rating) to AA+ yesterday, explaining:
"The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance…"

A ratings downgrade is intended to serve as a signal to markets that an issuer of bonds is less likely to repay interest or principal. In this case, the ratings downgrade is minor, from an "extremely strong capacity to meet financial commitments" to "very strong" capacity.
This is the second time in U.S. history that a major credit agency has downgraded the country's debt. Standard & Poor's downgraded the U.S. debt rating in 2011. Rates on 10‐​year Treasury bonds fell after the announcement. While past performance is not necessarily indicative of the future, it's not clear that interest costs will necessarily rise as a result of the downgrade. The U.S. economy is relatively strong, despite the drag from high and rising government debt, and the U.S. dollar remains the pre‐​eminent global reserve currency. And yet, the long‐​term fiscal trajectory is abysmal, with more than $100 trillion in deficits projected over the next 30 years as debt surges to an unprecedented 180 percent of gross domestic product (GDP).
While many commentators are focused on whether the Fitch credit rating downgrade reflects discontent with the nature of U.S. debt limit negotiations, we shouldn't mistake a symptom for the cause. The United States faces a potentially catastrophic fiscal crisis in the long run, if spending and debt continue growing unabated. The responsible choice at the debt limit is to adopt reforms that address the driving forces behind the growth in the debt. The outcome of the May debt limit deal is indicative of legislative myopia and the tendency to kick the can down the road.
Congress should address the largest spending growth drivers, especially major health insurance programs like Medicare and Social Security. Following the inadequate debt limit deal that left the biggest cost drivers unaddressed, some members of Congress are eyeing the possibility of establishing a fiscal commission. A well‐​designed commission, modeled after the successful Base Realignment and Closure Commission (BRAC) can help Congress overcome political gridlock and signal to markets and credit rating agencies that U.S. legislators are committed to stabilizing the growth in the U.S. debt.
Whether this credit rating downgrade turns out to be a blip or a more significant market event, we know that the U.S. budget is on a highly unsustainable path that threatens to undermine American prosperity and security if it goes unaddressed for much longer. Congress should seize this moment to establish a mechanism for stabilizing the growth in the debt. A BRAC‐​like commission can help Congress see this through.
Recommended Reading:
From Debt Ceiling Crisis to Debt Crisis

National Security Implications of Unsustainable Spending and Debt


Medicare and Social Security Are Responsible for 95 Percent of U.S. Unfunded Obligations


Designing a BRAC‐​Like Fiscal Commission To Stabilize the Debt


Cato Explainer Video: The Price of a U.S. Credit Rating Downgrade

In recent days, the markets have refocused attention on Italy's shaky public finances and sent the Italian-German government bond spread to its highest level since the start of the year. The Italian government should change economic course soon if it wants to avoid a full-blown debt crisis next year.
The post Unpleasant Italian Debt Arithmetic appeared first on American Enterprise Institute - AEI.

Yesterday, I posted a reply to John Cochrane's Sept 4 post on the national debt. John alerted me to his Sept 6 update, which I somehow missed. Given this update (together with some personal correspondence), let me offer my own update. John begins with an equation describing the flow of government revenue and expenditure. With a debt/GDP ratio of one, the sustainable (primary) deficit/GDP ratio is given by g - r, where g = growth rate of NGDP and r = nominal interest rate on government debt (I include Federal Reserve liabilities and currency in this measure). John assumed g - r = 1% (so about $200B). In a post I published last year, I assumed g - r = 3% (so about $600B); see here: Is the U.S. Budget Deficit Sustainable? Two things to take away from these calculations. First, this arithmetic suggests that the U.S. federal government can easily run persistent primary budget deficits in the range of 1-3% of GDP. Not only does the debt not need to be paid off, but it can grow forever. Second, primary budget deficits are presently far in excess of this range. What does this imply?Let's step back and think about John's equation. The arithmetic of the government "budget constraint" basically says this:Deficit/GDP = [1 - (1+r)/(1+g)] x Debt/GDPNote that a sustainable primary deficit is only possible if r < g. If r > g, then a primary surplus is needed to service the interest expense of the debt. Students of monetary theory may recognize the expression above as a Laffer curve for inflation finance. That is, in the case of currency we have r = 0. Let g represent the growth rate of the supply of currency and assume a constant RGDP (so that g also measures the growth rate of NGDP). Finally, replace debt with currency, so that Seigniorage revenue = [1 - 1/(1+g)] x Money/GDP Again, this is just arithmetic. Economic theory comes in through the assumption that the demand for money is decreasing in the rate of inflation, g. If this is true, then an increase in g has two opposing effects: it increases seigniorage revenue by increasing the inflation tax rate, but it lowers seigniorage revenue because it decreases the inflation tax base. There is a maximum amount of seigniorage revenue the government can collect by printing money. That is, there are limits to inflation finance. (See also my post here.)Now, I know John is fond of saying that Federal Reserve liabilities and U.S. Treasury securities are essentially the same thing (especially if the former exist mainly as interest-bearing reserve accounts). I happen to agree with this view. But then we can use exactly the same logic to characterize the limits to bond finance, recognizing that U.S. Treasury securities are essentially money. To this end, assume that the Debt/GDP ratio is an increasing function of (r - g). To make things a little simpler, let me continue to assume zero RGDP growth, so that g represents both inflation and NGDP growth. Finally, let me assume that r is a monetary policy choice (just as setting r = 0 for currency is a policy choice). Next, we need a theory of inflation. In the models I work with, the rate of inflation in a steady state is determined by the growth rate of the nominal debt, g, which I also treat as a policy parameter. So, the magnitude r - g is policy-determined, at least, within some limits. By lowering r and increasing g, the government is making its securities less attractive for people to hold. But this just tells us that the demand for debt is lower than it otherwise might be--it does not tell us how large this demand is in the first place, or how it is likely to evolve over time owing to factors unrelated to r or g (e.g., regulatory demand, foreign demand, etc.).So, with this apparatus in place, my interpretation of what worries John is the question of what happens if [1] the federal government finds itself near the top of the bond-seigniorage Laffer curve; and [2] a shock occurs that requires a large fiscal stimulus. Barring alternative forms of securing resources (e.g., through direct command/conscription), the government will not have the fiscal capacity to lay claim against the resources it needs. Printing more money/bonds here is not going to help even with zero interest rates. The ensuing inflation would simply put us on the right-hand-side of the Laffer curve -- the government's ability to secure resources would only diminish. Assuming I have captured at least a part of John's concern accurately, let me go on to critique it. To begin, there's nothing wrong with the logic I spelled out (I don't think). But I want to make a couple of points nevertheless.First, the demand for U.S. government securities (D/Y) seems to be growing very rapidly and for a very long time now. We know, anecdotally, that the UST is used widely as collateral in credit derivatives markets and repo, that foreign countries view it as a safe asset, that investors value its safety, and that recent changes to Dodd-Frank and Basel III have contributed to the regulatory demand for USTs. The global demand for the U.S. dollar is, if anything, growing more rapidly than ever (re: the recent "dollar shortages" that resulted in the Fed opening its central bank swap lines). We don't know where this limit is, but judging by how low U.S. inflation is (together with low UST yields), it seems fair to day that there's still plenty of fiscal capacity. (And I want to stress that this has nothing to do with the ability of a country to pay back its debt -- I'm not sure why John keeps mentioning this while at the same time understanding that this debt is money). I suspect that John is likely to agree with what I just said. Sure, there may be more room now, but how much more? With bipartisan concern for debt absent in Congress, with no sign of inflation in sight, with interest rates so low, how can we not hit this limit at some point?My own view is that we are bound to hit this limit (though, economists like Simon Wren-Lewis have warned me not to discount the forces of austerity). The question is what happens once we hit that limit? I say we get USD depreciation and some inflation (not hyperinflation). John seems to be worried about hyperinflation after all, which he likens to a debt rollover crisis. I just don't see it. (Of course, if John is simply suggesting that the fiscal authority will continue to run persistently large deficits in the face of high inflation, then I agree with him. While I don't see this happening, who can say for sure?)Finally, what happens if we're near the debt limit and there's a shock. Well, what type of shock exactly? The type of shock that hit us in 2008 is likely to increase the demand for debt, expanding fiscal capacity. So, here too, I'm not sure what form the debt crisis is supposed to take. It would be great to appeal to a model (but please, not one of Greece). 

As Chris suggests, one of the most memorable disasters at Crooked Timber was the seminar on David Graeber's book, Debt. Timothy Burke described it at the time as conveying: that feeling of grad school as Hobbesean nightmare, of small arguments quickly and casually intensified into thermonuclear exchanges, losing all potentially meaningful disagreements along the way. […]

By KIM BELLARD Among the many things that infuriate me about the U.S. healthcare system, health systems sending their patients to collections – or even suing them – is pretty high onContinue reading...

By borrowing, legislators push the costs down the road for future legislators and taxpayers to deal with.

The stock of national debt is now larger than our annual national income in the United States. Is this something to worry about? Does it matter how big the debt-to-GDP ratio gets? Is there any limit to how large it can grow and, if so, what is it this limit and what factors determine it? A lot of people have been asking these questions lately. John Cochrane is the latest to opine on these questions here: Debt Matters. I'm not even sure where to begin. I suppose we can start with the famous debt clock pictured on the right. Whenever I look at the debt clock, I'm reminded of James Tobin who, in 1949 remarked:   The peace of mind of a conscientious American must be disturbed every time he is reminded that his government is 250 billion dollars in debt. He must be shocked by the frequent announcement that every newborn baby is burdened, not with a silver spoon, but with a debt of $1700. The national debt is now 100 times larger than it was in 1949. Society has somehow managed to hold itself together since then. At the very least, this suggests we need not pay attention to the debt clock. It does not, however, not mean we shouldn't pay attention to managing the debt. Ironically, worrying about the debt is, in a way, what permits us not to worry about it. The time to start worrying is when we and our elected representatives stop worrying about it. According to John, "The notion that debt matters, that spending must be financed sooner or later by taxes on someone, and that those taxes will be economically destructive, has vanished from Washington discourse on both sides of the aisle." That is, it may be time to start worrying. I think there's an element of truth to this. For example, while it's true that the Reagan deficits were large, it's also true that there was strong bipartisan support for "doing something about the growing debt." And it wasn't just words. As Justin Fox reminds us, Congress increased taxes seven times between 1982-93. Well, what about Japan? As I explain here, Japan is a poster child for "worrying about the debt." To make a long story short, the debt-to-GDP ratio in Japan has stabilized (pre-Covid, at least), inflation is below target, and the fiscal authority keeps raising the sales tax. Rightly or wrongly, the Japanese "care" about the national debt--the effect of which is to keep fiscal policy "anchored." But what exactly is there to fear if fiscal policy becomes "unanchored?" For a country like the United States, it seems clear that outright default will never happen. U.S. Treasury securities (USTs) are too important for global financial markets. A default may very well trigger a global financial meltdown. The only practical option is to continue rolling over the debt, principal and interest (the latter of which is very low these days). Is there a danger of "bond vigilantes" sending the yields on USTs skyward? Not if the Fed stands ready to keep yields low (related post here on yield curve control). And, in any case, even if the Fed raises (or is expected to raise) its policy rate, the U.S. Treasury can just continue to issue the bills necessary to make the scheduled payments. Treasury securities and Federal Reserve reserves are just different forms of interest-bearing money. To put things another way, the national debt need never be paid back--like money, it can be held in private wealth portfolios forever. The only question is on what terms it will be willingly held.This last point gets to the question of what can be expected to happen if the debt gets too large (say, because the fiscal authority plans to run large primary budget deficits off into the indefinite future). Much will depend on the evolution of the global demand for USTs. If that demand stops growing while fiscal deficits run unabated, surely we can expect the U.S. dollar to weakened and the domestic price-level to rise. The former is likely to contribute to an export boom, which should serve to close the trade deficit (mitigating the adverse consequences of global imbalances). The latter is likely to promote the growth of nominal GDP.  Needless to say, an export boom and higher NGDP growth don't sound like disaster scenarios, especially in the current economic environment. John seems to worry that whatever happens, it's likely to happen suddenly and without warning. We know Naples is going down (in the manner of Pompeii c. 79AD), we just don't know when. But how does the lava flow correspond to the economic consequences of a debt crisis? (Keep in mind, we're not talking about a country that issues foreign-denominated debt.)Should we be worried about hyperinflation? Evidently not, as John does not mention it (see also this nice piece by Francis Coppola). But he does mention something about fiscal capacity (the ability of the fiscal authority to exert command over resources). As I explain here, there are limits to how much seigniorage can be extracted in this manner. To put things another way, there are economic limits to how large the debt-to-GDP ratio can get. But reaching this limit simply means that the required tax (whether direct or indirect via inflation) is high--it does not mean disaster. John concludes with the following warning: "The closer we are to that limit, the closer we are to a real crisis when we need that fiscal capacity and its no longer there." This is one of those sentences that starts your head off nodding in agreement. But then you think about it for a minute and wonder what type of "real crisis" he has in mind? If it's a financial crisis, the implied positive money-demand shock (flight-to-safety) is likely to increase fiscal capacity, not diminish it. A war perhaps? In these types of emergencies, the nation bands together and governments use other means to gather the resources necessary (e.g., conscription). So, to conclude, I'm not saying that John is wrong. It's just not very clear in my mind how he imagines a U.S. debt crisis to unfold exactly. What is missing here is a model. This is odd because one of John's great strengths is model building. And so my conclusion is that it would be very interesting to follow the logic of his argument through the lens of one of his models. Let's see the model, John! 

Senatorial candidate Hovde presents this picture. Source: Hovde. I'll trust that the candidate's staff did the adding correctly, although I think the calculation is pretty meaningless. For instance, how does individual colony debt in 1776 get counted? More substantively, does it make sense to report nominal debt over such a long period?* I think maybe […]

Unlike Democrats, Senate and House Republicans have released proposals that would actually tackle the root causes of increasing student loan debt.

Peder Beck-Friis and Richard Clarida at Pimco have a nice blog post on the recent inflation, including the above graph.  I have wondered, and been asked, if the differences across countries in inflation lines up with the size of the covid fiscal expansion. Apparently yes. It's a simple fact, and it's dangerous to crow too loudly when things go your way. Fiscal theory says that inflation comes when debt or deficits exceed expectations of a country's ability or will to repay. The latter can differ a lot. So, it does not predict a simple relationship between debt or deficits and inflation. Still, it's nice when things come out that way, and more fun to write qualifications than to come up with excuses for a contrary result! I have seen other evidence that doesn't look so nice (will post when it's public). One example is across eurozone countries. But that's a good reminder where to expect success and where not to expect success. Inflation as described by most macro models, including fiscal theory, monetarism, etc., is the component common to all prices and wages. It is in essence the fall in the value of currency. In any historical experience we see lots of relative price changes on top of that, in particular prices over wages. Indeed inflation is only measured with prices, and a central idea is to measure the "cost of living," not the value of the currency. Across the eurozone there is only one currency and thus only one underlying inflation. The large variation in measured inflations are relative prices, real exchange rates between countries, and can't go on forever. That we cannot hope to explain inflation variation across countries in the eurozone with a simple theory that describes the value of currency gives you some sense of the error bars in this exercise as well. Beck-Friis and  Clarida also look at money growth, above. There was a big expansion in M2 before the US inflation. Monetarists took a victory lap. M2 has since fallen a lot. There is not much correlation between monetary expansion and inflation across countries however. The slope of the regression also clearly depends on one or two points. Money or debt, which is it? When governments print money to finance deficits (or interest-bearing reserves), fiscal theory and monetary theory agree, there is inflation. Printing money (helicopters) is perhaps particularly powerful, as debt carries a reputation and tradition of repayment, which money may not carry. A core issue separating monetary and fiscal theory is whether a big monetary expansion without deficits or other fiscal news would have any effects. Would a $5 trillion QE (buy bonds, issue money) with no deficit have had the same inflationary impact? Monetarists, yes; fiscalists, no. Beck-Friis and  Clarida opine that fiscal stimulus is over and central banks now have all the levers they need to control inflation. I'm not so sure. The US is still running a trillion or so deficit despite a 3.6% unemployment rate, and here come entitlements. And, as blog readers will know, I am less confident of the Fed's lever. We shall see. Update:Mark Dijkstra makes the following graph (see comments for link), based on IMF data for all countries. Hmm, doesn't look so good. However, when you look at lots of small countries, weird things happen. The far right data point is Estonia, with 100% increase in debt and 14% cumulative inflation. Estonia started with 8.2% debt/GDP, however, so its rise to 18.4% is a 100% rise in debt to GDP ratio. So, Estonia spent 10% of GDP on covid and now military, compared to 30% of GDP for the US. Again, fiscal theory is not debt or deficit = inflation, but debt vs. ability and will to repay. One can argue that this increase in debt is more repayable. Argentina has -8% growth in debt/GDP and 100% inflation. Inflation is inflating away debt/GDP faster than the government can print the debt. The high inflation countries in this graph are Uzbekistan, Ghana, Guinea, Sierra Leone, Turkmenistan, Nigeria, Zambia, and Haiti. They are all plausibly fiscal inflation, from preexisting fiscal problems, not stable countries that suddenly borrowed/printed 30% of GDP with no plans to pay it back, the rather special case of the US, EU, UK. OK, I'm making excuses and I'm glad I started with the cautionary paragraph. Fiscal theory is not so easy as debt = inflation! But we do have to confront the numbers, and I hope this spurs some more serious analysis.  

In yesterday's post, I noted a recession forecast based on a probit specification incorporating a debt-service-ratio yielded a substantially lower probability for 2024M05 than a plain vanilla specification. Part of why this is true is that the debt-service ratio is fairly low, despite high Treasury yields. Figure 1: Debt-service ratio for private nonfinancial sectorcorporations, % […]

Federal debt held by the public of $28.5 trillion is eight times larger than the combined debt of all state and local governments of $3.3 trillion.

Consolidating public resources is an obvious step to help alleviate Egypt's growing debt burden, but one that Sisi's regime avoids at all costs.

It took 15 ballots, but eventually, new Congressional leadership was elected. Urged by President Trump to "play tough" on the debt ceiling, the House immediately set out to provoke a crisis. Another one. For a few months, the Treasury has gotten by on extraordinary measures like delaying contributions to pension funds. But that margin will soon be exhausted, maybe as soon as June 1. The edge of the precipice now in sight, negotiations are starting. But what, exactly, is the debt ceiling? Is it really that important?