Thursday, May 27, 2021

r less than g seminar

 I gave an Economic policy working group talk at Hoover on Wednesday, on a little essay "r<g" with some earlier thoughts from "low interest rates and government debt" If the above embed doesn't work, it's on the Hoover webpage here.

Does an interest rate lower than the growth rate of the economy mean that debt is a free lunch, or at least a really cheap snack? I don't think so. Major points: the r<g scenarios of one-time borrowing or financing a small deficit are irrelevant for the US actual fiscal issues of perpetual huge deficits and exploding debt. I also grapple with the economics. An economy can have a well defined debt equals present value of surpluses, in which deficits must be repaid, yet show E(r)<E(g). The usual finite horizon discount factor tricks can blow up. Toward the end Markus Brunnermeier catches a subtlety important to my characterization of his work, which I will fix in the next draft, though the existing points seem to go through. (Thanks Markus for showing up and pointing it out.)  

I started with a bit of a snarky comment which I now regret, that r<g had fallen out of favor relative to "we have to pay for it, raise the corporate tax." I gather the big budget to be announced Friday moves discussion of "debt sustainability" away from debt to GDP ratios and to interest costs. So r<g, just how long it will last, and just what falls apart when it changes is like, will be back full force in the policy arena. 

Lots of r<g papers are being written with many subtle mechanisms. This is an effort to get to basics. 

29 comments:

  1. All this is rubbish since it presumes that a government must borrow to begin with.

    Please take a few moments, read the US Constitution, and find where it says that the Congress MUST (is legally obligated to) borrow under any circumstance, deficit or otherwise.

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  2. All this is rubbish since it presumes that a government must borrow to begin with.

    Please take a few moments, read the US Constitution, and find where it says that the Congress MUST (is legally obligated to) borrow under any circumstance, deficit or otherwise.

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    1. Really, Frank. "All this is rubbish?" Maybe the congress is not legally obligated to borrow -- indeed, I think the constitution would be quite happy with them raising taxes to fund their spending. That was sort of the whole point. But it is a sad reality that our government does borrow, and just how our government plans to pay it back is an issue not to be dismissed as "rubbish," just wishing away government borrowing.

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    2. "I think the Constitution would be quite happy with them raising taxes to fund their spending..."

      The Constitution would also be quite happy if the Congress approved a spending bill then refused to borrow, refused to raise taxes, and refused to coin / print money to pay for the spending.

      Under those circumstances it would be up to the Executive Branch (Treasury Department) to obtain the funding for the spending that was approved by the Legislature - See US Constitution, Article 2, Section 3, Clause 5 (aka the "Take Care" clause).

      The ONLY option left to the US Treasury would be to sell EQUITY claims against future tax revenue because the Constitution does not delegate that power to the Legislature.

      "But it is a sad reality that our government does borrow..."

      No, the sad reality is the number of economists and politicians that have become convinced that a government MUST borrow or that government debt is a consequence of deficits. I suspect that Janet Yellen is another of those sad poorly educated economists.

      "....just how our government plans to pay it back is an issue not to be dismissed as rubbish..."

      The rubbish part that I am referring to is that your equation is missing several key terms:

      1. Debt payments are made from tax revenue (not GDP). And yet, no where in your equation is your source of interest payments (tax revenue).

      2. Equity is not in your equation either.

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  3. Herbert Stein (1916-1999) was chairman of the Council of Economic Advisers under Presidents Nixon and Ford. He propounded Stein's Law: "If something cannot go on forever, it will stop,"

    My apothegm on Stein's Law is

    "Something that can’t go on forever, won’t. Debts that can’t be repaid, won’t be. Promises that can’t be kept, won’t be. Make your plans accordingly."

    My son-in-law says:

    Things that can't continue on forever won't.
    Things that are unsustainable can keep going longer than you thought possible, and fall apart faster than you imagined.
    The end result will be more bizarre than anything anyone projected.

    My financial advisor said:

    The market can stay irrational longer than you can stay solvent.

    Our Lord Keynes said: “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”

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  4. I do wonder about the seeming ability of central banks to buy back sovereign debt, without inflationary consequences.

    I mean, can we just ignore the Bank of Japan? Are Japanese taxpayers truly indebted to 250% of GDP, if the public central bank (the Bank of Japan)owes half of that debt?

    The Swiss National bank just (well, over last few years) printed Swiss francs equal to a year's GDP and bought other nation's sovereign bonds with the newly digitized loot.

    So now taxpayers globally are shoveling money towards Switzerland. But Swiss inflation is dead.

    Should the Fed ever give up its balance sheet? Why? Does not a large Fed balance sheet ease investor concerns that the US government cannot pay its debt?

    So what about inflation? In Japan, there is deflation.

    Does that mean Western macroeconomic axioms do not apply in Japan? Then are they axioms, or culture or nation-specific maxims?

    In the US there is some inflation now, but tied to macroeconomic demand, or a strange C19 year?

    Why does the Reserve Bank of Australia dismiss inflation as a threat? Bank Indonesia has been directly buying debt from the national government. No inflation.

    .....

    And as I always say, if you want to beat inflation in the US, then get rid of property zoning and the criminalization of street-vending.



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    1. California decriminalized street-vending in 2018 - see:

      https://en.wikipedia.org/wiki/Street_vending_in_Los_Angeles

      "In September 2018, California Governor Jerry Brown signed the Safe Sidewalk Vending Act, or SB 946, which decriminalized street vending in throughout the state. SB 946 limits violations and fines imposed on said vendors."

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    2. How dare you ask these insulting questions!

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    3. DoDeals / Benjamin Cole,

      The answers that you seek can be found here:

      https://economictimes.indiatimes.com/news/international/business/japans-debt-mountain-how-is-it-sustainable/articleshow/76298563.cms?from=mdr

      "In fact, 90 percent of the debt is held by Japanese investors."

      "Another thing that keeps market confidence high: Japan is the world's biggest creditor, holding more than $3 trillion in net assets in foreign currency reserves and direct investment abroad."

      "The only way to avoid adding to the pile is to reduce budget deficits by boosting taxes or cutting public spending -- but this threatens to throttle growth in Japan's already recession-hit economy."

      The article gets this wrong. The Japanese government could sell equity claims against future tax revenue and use the proceeds to retire debt.

      "One drastic step could be to write off the debt held by the BoJ -- a step that would be an accounting trick with no consequence on the real economy, said Frederic Burguiere, an economist specialising in Asia."

      "But this does not take into account the moral dimension of economic mechanisms... if we allow states not to repay their debts, what becomes the rules for private investors and the state itself? asked Burguiere."

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  5. Bank of Japan "owns" not "owes" half of Japan national debt....

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  6. This probably does not change your conclusion, but why is government debt, a stock concept, compared to GDP, a flow concept? Why not compare debt to a stock variable such as the economy’s capital stock?

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    Replies
    1. For the same reason the bank compares the price of the house you want to buy, a stock, with your income, a flow. For the same reason you compare the stock price, a stock, to the dividends it pays, a flow. Not easy, but not silly.

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    2. John,

      1. The payments on your house are made from your income.
      The payments on government debt are NOT made from GDP.

      That would be like a bank looking at the purchase price of the house I want to buy and comparing it to my 2nd cousin's income.
      Yes it is that silly.

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    3. Long run tax revenue is better. Long run surpluses are better. Debt relative to the present value of surpluses is the right concept. The thinking is that tax revenue and surpluses roughly scale with GDP. We use backs of envelopes everywhere. I agree that it's worth thought. I used consumption as a measure of permanent GDP and got a lot of complaint about it. A better back of the envelope would be great, or at least remembering just how rough and ready GDP is.

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    4. John,

      "The thinking is that tax revenue and surpluses roughly scale with GDP."

      Tax revenue MIGHT scale roughly with GDP and then again might not for a variety of reasons:

      1. Tariffs - Tax revenue on net imports will not be captured by GDP since net imports subtract from GDP.

      2. Existing Goods - Taxes are assessed on the proceeds of both new and existing goods where as GDP is a measure of the production and sale of new goods only.

      3. Government Services - Government provided services (court system, police, military, etc.) are not treated as part of GDP and yet members providing those services pay taxes the same as you or I.

      "Debt relative to the present value of surpluses is the right concept."

      The present value of future surpluses is un-observable. I mean, Economists are still scientists aren't they?

      How is comparing the size of a distant black hole (that can't be directly observed) to the size of our sun the "right concept"?

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    5. Like a lot of Grumps, you continue to measure the wrong things. The Federal Debt doesn't need to be even measured, much less reported. It's TOTALLY irrelevant. it's fricken tea leaves. It's a total plug. The important thing is UNEMPLOYMENT, which should be kept at ZERO at all times, and INFLATION, which should be kept at a low and comfortable number, through fiscal policy (Job Gty and automatic taxes.)

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  7. Let's start with this fact. Then we can go from their: The US government debt is not a problem in any way shape or form. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. Not recommending this course of action, just pointing out that it is possible.

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    1. Ok, fact - The Legislature is not obligated to borrow in the first place.

      And it's "there" not "their".

      "The US government debt is not a problem in any way shape or form."

      The US government debt IS a problem in the same way that every other government entitlement program IS a problem.

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    2. RE: "... The Legislature is not obligated to borrow in the first place. ... ..."
      • Right. So?

      RE: "... And it's "there" not "their". ... ..."
      • Get a life Dude!

      RE: "... The US government debt IS a problem in the same way that every other government entitlement program IS a problem. ... ..."
      • Like I said: The US government debt is not a problem in any way shape or form

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    3. This comment has been removed by the author.

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    4. This comment has been removed by the author.

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    5. RE: "... The Legislature is not obligated to borrow in the first place. ... ..."
      • Right. So?

      SO, if the Legislature is not required to borrow, then why should they?
      If you can't answer that simple question, then you should refrain from commenting further.

      RE: "... And it's "there" not "their". ... ..."
      • Get a life Dude!

      Take a spelling class and come back again.

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  8. Frisky: Borrowing is currently an artifact of the prior (to 1971) restraints of a pseudo gold standard. The Federal Reserve Act spells out what the Fed can and (indirectly) can't do. Currently it can't buy securities directly from Treasury, or gift money to the Treasury. It's just not in the Federal Reserve Act. So the workaround is that Treasury sells Treasuries (borrows) to Primary Dealers (private sector), and then Fed buys from private sector - only if needed to hit interest rate target. It's truly not necessary to borrow if not for this constraint and interest rate, and to a lesser extent, inflation targets.

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    1. I asked why the Legislature should borrow (not what the Fed can and cannot do).

      They are given the ability, but not the legal imperative to borrow.

      Please read carefully before answering.

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    2. Learn words Dude. The Legislature does NOT borrow. Treasury borrows. The "Legislature"(Congress) can borrow if they want to. They don't need a legal imperative. They make the laws. Please write carefully. (sheesh!)

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    3. https://www.law.cornell.edu/constitution/articlei

      "The Congress shall have power to lay and collect taxes, duties, imposts and excises, to pay the debts and provide for the common defense and general welfare of the United States; but all duties, imposts and excises shall be uniform throughout the United States;

      TO BORROW MONEY ON THE CREDIT OF THE UNITED STATES"

      The Congress / Legislature authorizes all borrowing that is then executed by the Treasury department. Neither the Treasury nor any portion of the Executive branch of the US government can borrow of it's own volition without express consent from the Congress.

      "They don't need a legal imperative.
      They make the laws."

      The Legislature makes some of the laws. Others are embedded directly in the Constitution. The Congress / Legislature is Constitutionally limited in the laws that they can impose and they are legally bound to perform certain actions.

      "Please write carefully."

      It was a simple question that you refuse to answer.

      Why should the Legislature borrow?

      If you don't have a concise answer explaining the benefits / drawbacks of government borrowing versus other methods of government finance then please don't answer at all.

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    4. Yes of course the Legislature authorizes spending, taxing, and borrowing, but Treasury actually borrows. (sheesh).

      Borrowing is a relic of the Gold Standard and Gold Standard Lite years when the govt DID have to tax or borrow in order to spend, particularly before the Legislature established the Fed. Using this relic, it's is also a way to have the Fed fund the Treasury indirectly (through Primary Dealers) as the Fed can't buy securities directly from Treasury or gift money to the Treasury as this is not spelled out in the Federal Reserve Act which spells out what the Fed CAN do.

      Now that the borrowing has already occurred, "govt borrowing" (Fed selling securities) is a way of slowing economic activity - cooling inflation; although its highly inefficient as issuing securities also injects net financial assets (interest) into the private sector, partially offsetting the contractionary effect of higher interest rates.

      It's all so unnecessary. A tweak in the Federal Reserve Act can allow the Fed to "gift" money to Treasury, its "co-subsidiary" and eliminate the need for the unnecessary Federal Debt. (Aaaaahhh!!! Zimbabwe!!!!!!!!! Weimer Republicccccc!)

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