John Taylor on U.S. Debt

Prof. John Taylor argues that the recent downgrading of British sovereign debt by Standard & Poor’s should be a warning that spending maybe out of control.

Standard and Poor’s decision to downgrade its outlook for British sovereign debt from “stable” to “negative” should be a wake-up call for the US Congress and administration. Let us hope they wake up.

Under President Barack Obama’s budget plan, the federal debt is exploding. To be precise, it is rising — and will continue to rise — much faster than gross domestic product, a measure of America’s ability to service it. The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years.

“A government debt burden of that [100 per cent] level, if sustained, would in Standard & Poor’s view be incompatible with a triple A rating,” as the risk rating agency stated last week.

Professor Taylor notes that if things go as CBO projects, and there are many assumptions that could change that projection, that taxes would need to rise by 60%, across the board, or print enough money to double all prices (i.e. inflation—a tax on money really).

The latter has its one problems—i.e. think of late 1960’s and the 1970’s where we had some periods of rapid inflation followed by recessions coupled with one of the worst recessions of the post-WWII era to bring the whole situation back in hand. And there are other negative consequences as well.

The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.

And I’m sure many commenters here will bring up the usual load of excuses, but Prof. Taylor has a reply to them.

“We have an unprecedented financial crisis and we must run unprecedented deficits.” While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession. Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times. The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.

“But we will cut the deficit in half.” CBO analysts project that the deficit will be the same in 2019 as the administration estimates for 2010, a zero per cent cut.

“We inherited this mess.” The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan’s last year in office, the same as at the end of 2008, President George W. Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?

Now the CBO projections are just that and things could change that would mitigate the current bleak projections…or it could get even worse. Running up the national debt to 80% plus of GDP, having deficits that are huge no matter how you measure them (nominal, percentage of GDP, real, etc.) are not signs of fiscal responsibility or restraint. Hoping that things will turn out better while the President is hoping to spend to the point of GDP reaching levels we haven’t seen since WWII is rather disquieting to say the least.

Via Greg Mankiw.

FILED UNDER: Economics and Business, Government, , , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. odograph says:

    I’m good with this:

    “We have an unprecedented financial crisis and we must run unprecedented deficits.” While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession. Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times. The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.

    The proper argument is how to shape spending cuts and tax increases (it will take both) on the tail end of the recession.

    (California is in a kind of dead-lock I’d hate the see the nation fall into. Here half the state refuses spending cuts and the other half refuses tax increases. It’s a recipe for disaster, but it is a natural outcome of “bar-bell politics”, with voters at both ends and few at the center.)

  2. steve says:

    Agree that reducing debt should be a priority once the economy turns around. If you read the Romers’ big paper on this topic, that is what we did up until 1980. The question is really how we should accomplish that goal.

    When polled on what to cut on the spending side, neither Republicans nor Democrats consistently come up with areas that they are willing, meaning more than 50%, to cut (Ok, NASA gets a lot of votes for cutting with its $18 billion budget). Yes, we get the inevitable pork and earmarks, but nothing specific. I will believe no politician who says he wants to cut spending unless they tell me exactly what they want to cut.

    On the tax side, polls tend to show no one wants to increase them either. I just dont see how we will cut the debt without some combination of spending cuts, and the entitlement programs will have to be included, and tax increases.

    Steve

  3. just me says:

    I think it is time the people stop looking to the government as a candy store for all the goodies they want.

    At some point the government is going to have to cut spending and so far I haven’t seen obama at all inclined to really do it-and he wants to spend more, because I sure as heck don’t buy his “the best way to spend less money is to provide insurance for everyone” argument.

    Also at some point the “i inherited this mess from Bush” excuse is going to wear thin-especially since the democrats have actually been in charge of appropriations since 2007.

    The excuse wore thin with me a long time ago.

  4. Tlaloc says:

    “We inherited this mess.” The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan’s last year in office, the same as at the end of 2008, President George W. Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?

    This is misguided. The issue of inheritance is not just the debt but a debt plus a crumbling economy. And the bush mistake was not in running a 40 percent debt but in doing so during relatively good economic times when he should have been continuing and maybe expanding the Clinton surpluses. Consequently Obama is not doubling down on Bush’s failed policy, he’s taking the inappropriately used Bush policy and applying it when it should be applied, but he has to go twice as far into the hole because of the idiocy of the Bush whitehouse.

  5. just me says:

    Sorry Tlaloc but I don’t entirely buy that either. At some point Obama gets to own his own debt and outrageous spending and the democrats already get to own much of that spending-they have been in charge of congress for 2 years.

    I am already pretty sick of Obama’s “Well I have to spend a trillion dollars because Bush made me” excuse.

    Obama was part of congress while they were spending all that cash-congress is in charge of appropriations, where was obama? He was part of the problem-he was one of 50, but he was still part of the problem.

  6. odograph says:

    I think Tlaloc framed it as could-have-been counter-cyclical spending. The key was that Bush ran a deficit during a growing economy. Obama faces a falling economy, where everyone (even the “only unemployment and welfare” folks) see their spending increase.

    You have to be kind of simple to interpret that as “Well I have to spend a trillion dollars because Bush made me.”

    It was Lehman and AIG and Wall Street that made him go beyond common Democratic responses like increased unemployment benefits and retraining. If anything the common thread is that Obama and Bush/Paulson accepted the Wall Street argument.

    The money in fact did not go to the typical Democratic targets.

  7. odograph says:

    Here’s a good one:

    Brazen Tunneling and Inflation

    Is there a political dysfunction here? Do conservatives face a mental block about criticizing “business” and so make it “Obama’s” debt and so miss the story?

  8. […] Steve Verdon Now the CBO projections are just that and things could change that would mitigate the current bleak projections…or it could get even worse. Running up the national debt to 80% plus of GDP, having deficits that are huge no matter how you measure them (nominal, percentage of GDP, real, etc.) are not signs of fiscal responsibility or restraint. Hoping that things will turn out better while the President is hoping to spend to the point of GDP reaching levels we haven’t seen since WWII is rather disquieting to say the least. […]

  9. Boyd says:

    …but he has to go twice as far into the hole because of the idiocy of the Bush whitehouse.

    So, Bush’s policies were idiocy (not inherently so, but due to timing), but the economy has changed so much since he left office in January that Obama has to push those same policies twice as hard. And that’s merely expressing economic wisdom on Obama’s part.

    It’s a good thing you’re a touch-typist, since you undoubtedly can’t see the keyboard or monitor with your nose buried so far up Obama’s ass. I suppose it’s a also good thing for you that his shit don’t stink, either.

  10. odograph says:

    So, Bush’s policies were idiocy (not inherently so, but due to timing), but the economy has changed so much since he left office in January that Obama has to push those same policies twice as hard. And that’s merely expressing economic wisdom on Obama’s part.

    I think you need to go look at a time-line. The debt crisis really hit the rocks when the overnight credit markets seized. That was in September, 2008

  11. Tlaloc says:

    Sorry Tlaloc but I don’t entirely buy that either. At some point Obama gets to own his own debt

    Sure he does, but he’s been in office for all of FOUR months. You don’t seriously believe the enormous inertia of the US economy turns on a dime, right?

    The average recession lasts 13 months. The great depression lasted something like 14 years. Some economic indicators are closer to the depression than a recession (and some aren’t). Expecting him to have the thing not only wrapped up in 120 days but also for him to be on to debt/deficit reduction seems a wee bit unrealistic.

    Obama was part of congress while they were spending all that cash-congress is in charge of appropriations, where was obama? He was part of the problem-he was one of 50, but he was still part of the problem.

    To be fair Obama wasn’t in congress very long at all. He was a senator for about a year before the campaigning for president started up (and yes I am very sympathetic to arguments that he’d have been better served with more time at the federal level before running for president, but that ship’s not only sailed it’s docked and disembarked passengers on the other side).

  12. Tlaloc says:

    It’s a good thing you’re a touch-typist, since you undoubtedly can’t see the keyboard or monitor with your nose buried so far up Obama’s ass. I suppose it’s a also good thing for you that his shit don’t stink, either.

    That’s pretty hilarious given that I was almost banned from Balloon juice for pointing out how they were in the Obama Kool-aide. I’m not a great fan of Obama. I didn’t vote for him (nor McCain, although I would have considered it if he hadn’t run so hard to the right).

    That said I’m not going to blame Obama for the things that aren’t his fault. I’ll have plenty of things to blame him for (I already have his FISA vote, his tepid walkback of torture, and so on).

  13. spencer says:

    If the consensus forecast is right that the recession end in 2009 the economic environment at the end of this recession in terms of capacity utilization, unemployment, etc will be roughly comparable with the situation at the bottom of the 1981-82 recession under Reagan. That is about what the administration is projecting. But excluding the TARP program, the Obama budget deficits will be a smaller share of GDP than the Reagan deficit were.

    If the Reagan deficit were appropriate for a large recession, why are the Obama deficits inappropriate for a similar recession?

  14. spencer says:

    At the time of the 1981-82 recession the cry was that the deficits would “crowd out” private investment. The critics failed to look at the US as closed economy and failed to anticipate that Japanese investment would prevent “crowding out”.

    Now we have wide spread anticipation that the domestic personal savings rate will rebound from the near zero bottom of a few years ago back to levels reached in the late 1970s, early 1980s. If this happens the supply of savings will expand much more than the federal deficits, so the supply to finance the deficit will be readily available and this actually implies that US dependence on foreign capital will fall sharply.

    Someone tell me what is wrong with this scenario?

  15. odograph says:

    Spencer, consensus forecasts are never right. That doesn’t mean that recovery will necessarily be later, but to trust them is madness.

  16. Steve Verdon says:

    This is misguided. The issue of inheritance is not just the debt but a debt plus a crumbling economy. And the bush mistake was not in running a 40 percent debt but in doing so during relatively good economic times when he should have been continuing and maybe expanding the Clinton surpluses. Consequently Obama is not doubling down on Bush’s failed policy, he’s taking the inappropriately used Bush policy and applying it when it should be applied, but he has to go twice as far into the hole because of the idiocy of the Bush whitehouse.

    Problem is that in the out years when we are running deficits just as large as will be run in the next few years you aren’t dealing with a crumbling economy anymore. So this just doesn’t fly. At all.

    And Obama owns a significant chunk of this debt. He voted for it as a Senator and he pushed the stimulus, and he pushed the massive budget. He can’t just run away from it and say, “Its Bush’s fault!”

    I think Tlaloc framed it as could-have-been counter-cyclical spending.

    The recession wont last 10 years unless Obama and crew f*ck it up enough to make it last 10 years.

    I think you need to go look at a time-line. The debt crisis really hit the rocks when the overnight credit markets seized. That was in September, 2008

    You’re off by about a year actually. Things caught on in the popular media at that time, but back in 2007 things were looking really rocky already in the finance sector. We can turn, once again, to John Taylor (pdf). That paper was frist written in Feb ’08, and figure 1 shows a sudden detioration in the LIBOR, effective Fed Funds, and Target Fed Funds rate in August 2007. Looking at figure 2 you see the LIBOR OIS spread showing the same problems starting in about August of 2007. These were the first warning signs of problems.

    Sure he does, but he’s been in office for all of FOUR months. You don’t seriously believe the enormous inertia of the US economy turns on a dime, right?

    Wasn’t that part of the argument for the stimulus and huge budget this year? That it will turn things around sooner rather than later? Yet, we are below the Administrations unemployment targets, other economic indicators aren’t much better.

    The average recession lasts 13 months. The great depression lasted something like 14 years.

    No. Since WWII the average recession is 10 months. For all recessions the NBER has dated have an average length of 17 months. However, post-WWII and pre-WWII have radically different economic policies in place so you have some issues comparing the two.

    During the 1930’s there were two recessions, one from August 1929 to March 1933 and then another from May 1937 to June 1938. So no 14 year recession and no 14 year Depression if you consider a depression worse than a recession. However, during much of the 1930’s economic growth was significantly below potential. Some like Ohanian et. al. and Luca and Rapping have argued that the economy should have returned to full potential or near to it by 1936, IIRC. Their explanation were the wrong-headed policies of FDR (and you can also look at James Hamilton on this as well).

    At the time of the 1981-82 recession the cry was that the deficits would “crowd out” private investment. The critics failed to look at the US as closed economy and failed to anticipate that Japanese investment would prevent “crowding out”.

    What? Didn’t you mean that they failed to consider the economy as an open one where Japanese investment could prevent the crowding out?

    If the Reagan deficit were appropriate for a large recession, why are the Obama deficits inappropriate for a similar recession?

    Did Reagan’s deficits drive the national debt up by 2x, or was it projected too?

    Spencer, consensus forecasts are never right.

    You got anything to back that up other than your pathological dislike of economists? Combinging forecasts tend to actually do better than individual forecasts. Now that being said, I’m curious on what you base that statement other than nothing.

  17. odograph says:

    Spencer, consensus forecasts are never right.

    You got anything to back that up other than your pathological dislike of economists? Combinging forecasts tend to actually do better than individual forecasts. Now that being said, I’m curious on what you base that statement other than nothing.

    LOL. There was a link there, dude.

  18. odograph says:

    You’re off by about a year actually. Things caught on in the popular media at that time, but back in 2007 things were looking really rocky already in the finance sector. We can turn, once again, to John Taylor (pdf). That paper was frist written in Feb ’08, and figure 1 shows a sudden detioration in the LIBOR, effective Fed Funds, and Target Fed Funds rate in August 2007. Looking at figure 2 you see the LIBOR OIS spread showing the same problems starting in about August of 2007. These were the first warning signs of problems.

    I was moving a little fast, just trying to give Boyd a link.

    Actually my reference says the same thing, August. I just spit in the date of the article.

    The important thing, big picture wise, is that the timeline is not sync’d to Obama’s Presidency. You agree that is easy to find in the historical record.

    So, why do people persist in believing that it is? Or that it is sync’d to the change to a Democratic congress? The data is there. It’s easy to see.

    There is a name for the condition when you don’t trust your eyes or your ears, and when you prefer the visions in your head. It’s called madness.