- “Higher levels of debt imply higher interest payments on that debt, which would eventually require either higher taxes or a reduction in government benefits and services.
- Rising debt would increasingly restrict policymakers' ability to use tax and spending policies to respond to unexpected challenges, such as economic downturns or financial crises. As a result, the effects of such developments on the economy and people's well-being could be worse.
- Growing debt also would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government's ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates. Such a crisis would confront policymakers with extremely difficult choices. To restore investors' confidence, policymakers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.”
Friday, June 24, 2011
The CBO Doesn’t Get It
On June 22, the Congressional Budget Office issued its 2011 Long-Term Budget Outlook.
The supposedly non-partisan CBO makes arguments that favor the politically correct deficit terrorists even though they are wrong. The role of the CBO is to make straight forward projections based on current or proposed law. Consequently the projections are prone to be as wrongheaded as the law. The CBO should stick to accounting and stay out of politics.
One can quibble with the CBO assumptions and calculations, but its reasoning and conclusions appear to come from a fiscally constrained paradigm like a gold standard. In the report Summary we have the following.
“In particular, large budget deficits and growing debt would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States.”
Students of modern money operations could not disagree more with this statement. We know that “national saving” has no meaning for a country that creates its own sovereign currency as it needs it. Growing debt in itself cannot lead to higher interest rates, because the Fed sets those rates not the global market. More borrowing from abroad is optional, and domestic investment would be increased as federal spending puts dollars into the private sector.
We could stop here, but there is more to chew on. In the full report we find the following.
“Increased government borrowing generally draws money away from (crowds out) private investment in productive capital, leading to a smaller stock of capital and lower output in the long run than would otherwise be the case. Deficits generally have that effect on private investment because the portion of people’s savings used to buy government securities is not available to finance private investment.”
This statement might be true in an economy with a fixed amount of currency, that is, a financially constrained system where the private and government sectors compete for the existing dollars and bid up interest rates.
In the modern view, government does not “crowd out” private investment because the money supply expands through the banking system according to demand. Consequently, there is ample capital available. Further, deficits put money into the private sector, so there are more funds for private investment. It is government surpluses that take funds out of the private sector not deficits.
The negative consequences of rising levels of debt according to the CBO are:
These consequences are wild speculation and contrary to observed fact.
Japan, which also has a sovereign, fiscally unconstrained money system, has experienced high deficit and debt ratios, vastly higher than foreseen by the CBO, for many years while maintaining low interest rates.
With a sovereign currency, we have unlimited ability to use tax and spending policies to respond to unexpected challenges.
Lastly, there can be no sudden crisis that screws our ability to borrow at affordable rates, because we do not need bond sales to fund our deficit. The government just borrows back its own spending to meet it target interest rate. It is merely conversion of funds in reserve checking accounts at the Fed to interest bearing accounts.
“Bonds? We don’t need no stinkin’ bonds!” In fact, they are a voluntary holdover from the gold standard, when we did need them.
The CBO is only politically correct when it concludes that the US government “will need to increase revenues substantially as a percentage of GDP, decrease spending significantly from projected levels, or adopt some combination of those two approaches.” We would prefer that “in the long-term” be substituted for substantially and significantly.
We would conclude just the opposite. The government should reduce taxes and/or increase spending at the present time to accelerate demand during a demand-deficient recession.