Arnold Kling  

Budget Woes

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Reminder about Comments... Policy in a Fog...

Robert E. Rubin, Peter R. Orszag, and Allen Sinai make a case that our Budget deficits are not sustainable.


If one includes the cost of the recently enacted prescription drug benefit, assumes that discretionary spending keeps pace with inflation and population growth, that the growth in the fraction of taxpayers subject to the AMT is eliminated, and that all expiring tax provisions are made permanent, the federal government would face unified deficits averaging about 3.5 percent of GDP over the next 10 years. The unified budget deficit for 2004 through 2013, on this adjusted basis, would cumulate to about $5 trillion. Those deficits, furthermore, include the temporary cash-flow surpluses in retirement trust funds. Excluding such retirement trust funds, the projected deficits would be even larger...

From a libertarian perspective, Edward H. Crane writes,

The late 1980s and the 1990s also saw the rise of supply-side economics, which further undercut the GOP’s philosophical approach to governance. Don’t worry about all the nasty arguments about the proper role of government, the supplysiders argued. Just cut marginal tax rates and the economy will be spurred on to grow faster than government, thereby shrinking government as a percentage of GDP...Republicans, with a few notable exceptions, stopped talking about less government.

Rubin, Orszag, and Sinai explicitly reject one supply-side doctrine, which is that Budget deficits will not raise interest rates or crowd out private capital.

A reasonable range for the increase in interest rates for each percent of GDP in projected deficits is 30 to 60 basis points. Using that range, the implication is that the sustained adjusted projected deficits...which average about 3.5 percent of GDP...raise long-term interest rates by about 100 to 200 basis points compared to a balanced budget.

I myself have written that tax cuts without spending cuts are a form of harmful economic populism, and I share the concerns of Rubin-Orszag-Sinai as well as those of Crane.

For Discussion. After hearing Rubin speak, a friend who teaches finance (in fact, he is a co-author of some leading finance texts), emailed me with this question: "Where does this leave you in terms of investment strategy. Bonds look disastrous; stocks look questionable at best, especially if interest rates and inflation rise; TIPS bonds [inflation-indexed Treasury bonds] will tank if real rates rise. What's left besides the money market?"


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CATEGORIES: Fiscal Policy



TRACKBACKS (3 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/43
The author at PrestoPundit.com in a related article titled http://www.hayekcenter.org/prestopunditarchive/002238.html writes:
    EconLog: "tax cuts without spending cuts are a form of harmful economic populism". Kling quotes an article by Ed Crane... [Tracked on January 9, 2004 1:42 PM]
COMMENTS (25 to date)
Ronnie Horesh writes:

"What's left besides the money market?"

Property. This links to the Income Mobility topic below. People buy property for investment, for perfectly rational reasons. But in doing so they bid up its price, and making it even harder for ordinary people to own their homes.

Witchfinder General writes:

"TIPS bonds [inflation-indexed Treasury bonds] will tank if real rates rise."

Bill Gross doesn't think real interest rates will rise much,* and hence recommends buying TIPS.

But as an anonymous poster obliquely pointed out in Brad DeLong's post on the subject,** budget deficits are not problematic as long as Asian central banks keep funding them, or more precisely that is, as long as it is in their interest to keep doing so.

Until foreign central banks have had enough and seek out euro/commonwealth assets (*short* rates in the UK by the way are a handsome 4.36%, higher than a US 10-year Treasury note yield) or until Greenspan blinks at a fast-approaching legacy of presiding over not one, but two financial market bubbles, and actually raises rates above what inflation there is, investors need not worry.

So although still speculative, it would do well to remember that reflation is wonderful as long as it's not inflationary.
---
* http://www.pimco.com/LeftNav/Late+Breaking+Commentary/IO/2004/IO_01_04.htm
** http://www.j-bradford-delong.net/movable_type/2003_archives/003012.html

Steve writes:

(moderators--Note a valid email address, sorry about ignoring that earlier)

Unfortunately, the answer to the question is "Gold".

Sad, because gold produces so few usable products while most other investments do lead to products.

Rod McFadden writes:

There was a pretty good, somewhat related, column by Samuelson yesterday (Wed, 1/7).

Eric Krieg writes:

All this talk of budget deficits sounds suspiciously like all the talk a few months ago about the falling dollar.

The fall in the dollar has turned out to be orderly and with no negative consequences. I suspect the same will happen with the deficit.

I'd like to see the Asians TRY to stop buying our T-Bills. They wouldn't be able to manipulate their currencies and maintain their trade surpluses if they tried to kick their T-Bill/ crack habit.

The bottom line is that, even with a weak dollar, even with a huge trade deficit, even with a 600 billion dollar budget deficit, America is still the best place to put your money.

And no, this is not Larry Kudlow secretly posting!

Monte writes:

Ronnie & Steve touched on it...tangible assets (real estate, precious metals, etc.). When rising interest rates and inflation threaten, hard assets are an ideal investment.

Having said that, I intend to stay fully invested in the market. I base my decision to do so on the time honored tradition and record of expert economists mis-predicting the future inevitability of apocalyptic events.

Tim Shell writes:

A good investment strategy is to admit you cannot reliably predict the future, and that no one else can either, and then to diversify across all major asset classes instead of trying to guess which class will outperform the others.

dsquared writes:

I take it that one of those finance texts wasn't "Investing Overseas for Dummies" :-)

Boonton writes:

Whatever the budget deficit is today is almost irrelevant. The Treasury Market is attempting to estimate the future. Stock markets do the same thing. It means nothing that a company made $1B in 2003. I need to estimate what it will make in 2004, 5 and so on.

Unfortunately Bush's policies are for the current deficits to be the tip of the iceberg...not a temporary feature of the slump. Even with positive economic growth, even strong growth, he has set the deficit towards an ever increasing portion of the GNP.

This will crowd out productive investment and lock in higher taxes for future generations who already will have to deal with the retirement of the baby boomers.

Lawrance George Lux writes:

Is it only I who sees the loss of Property value entailed with increased Debt? DeLong was correct in his statements, and Asian banks will become less interested in Treasuries as Interest rates are not allowed to rise. The Supply-Side argument is entirely wrong on this Issue, as there will be abandonment of U.S. Treasuries at some point, unless these Instruments begin to reflect the loss of American value through Interest rate hikes. lgl

Eric Krieg writes:

>>Unfortunately Bush's policies are for the current deficits to be the tip of the iceberg...not a temporary feature of the slump. Even with positive economic growth, even strong growth, he has set the deficit towards an ever increasing portion of the GNP.

Once again, this opinion is based on... what? Wishful thinking?

The fact is that tax reciepts are GROWING. See the link.

http://www.nationalreview.com/nrof_buzzcharts/buzzcharts200401090936.asp

We're going to grow ourselves out of this deficit.

Bob Dobalina writes:

I wouldn't look at real estate in a rising rate environment. (Especially residential real estate). Real Estate is subject to supply and demand, just like everything else. For real estate (as in investment) to perform well, demand must hold up. And when you consider how heavily leveraged most real estate investment is, and how widespread ownership has become, demand could be wiped out quickly.

Eric Krieg writes:

>>And when you consider how heavily leveraged most real estate investment is, and how widespread ownership has become, demand could be wiped out quickly.

Yeah, you know, after everyone has a no money down interest only loan, where are you gong to go from there? Where does the ability for the average person to afford these outrageous home prices come from?

Assuming, of course, that you believe in the forcasting abilites of Robert Rubin. Yeah, he's a guy with no political agenda.

Eric Krieg writes:

I bristle at the notion that "tax cuts without spending cuts is economic populism".

What economist recommends cutting spending in a recession?

Boonton writes:

Eric,

Considering that Bush's tax cuts are back loaded (their real cost/benefit hits years from now) there is no way you can legitimately make the 'tax hikes in a recession' or 'spending cuts in a recession' argument. Economists are not fretting that the budget went in the red for 2-3 years during an economic slump.

David Thomson writes:

Why are we spending so much time discussing an issue of secondary importance? This is nowhere near as important as the continuing threat of protectionist legislation. Let me me blunt: it is dumb to worry about balanced budgets if we don’t allow the creation---and destruction---of jobs when deemed necessary by the gods of creative destruction. Protecting jobs=a weak and faltering economy. It's as simple as that.

Lawrance George Lux writes:

Eric
I am an Economist calling for Spending Cuts in a Recession. The performance of the Economy depends on Capital Flow, and current Government spending puts too many funds in the hands of Corporate Contractors, who cannot redistribute those funds effectively; the funds are being pumped into Companies of high technological cost, low employment cost, and restricted Shareholder populations. Such practice does not generate Jobs, Consumer Spending, or even support many SubContractors.

David,
What Protectionist legislation are you talking of? Is it my proposal for a two percent, across-the-board, tariff? Most estimates I make say it will raise the price of foreign imports by 17-20%, raise Retail prices by 7-8%, and create 1.5 million additional Jobs at the cost of $200 a year per Household. lgl

John Thacker writes:

"I am an Economist... and create 1.5 million additional Jobs"-- Lawrance George Lux

Now I'm even more certain that Mr. Lux a crank than I was when he was just using extraneous capital letters. The idea of a tariff creating jobs is fairly ridiculous. So too, of course, is the idea of cutting tariffs, at least in any long run sense. Unemployment is a fiscal and monetary issue; tariffs and trade affect productivity and efficiency, and hence standard of living and wages. But in the long run, not jobs.

Replacing the entire current tariff and quota scheme with an across the board 2% import tax could actually be useful, because it would end some massive distortionary effects on particular goods, such as sugar and textiles. It seems from your post that you're talking about raising tariffs. I'm still not sure how a 2% tariff leads to 20% increases in prices; that seems extraordinary unlikely.

Lawrance George Lux writes:

Mr. Thacker
"The idea of a tariff creating jobs is fairly ridiculous. So too, of course, is the idea of cutting tariffs, at least in any long run sense. Unemployment is a fiscal and monetary issue; tariffs and trade affect productivity and efficiency, and hence standard of living and wages. But in the long run, not jobs."

A tariff will create Jobs when it significantly curtails outsouring of production. The 17-20% increase in the retail of foreign products comes from additional American markup of Distribution and Retail of these Products--both as Parts and Final Products. Jobs are not even primarily a fiscal or monetary issue. Many Supply-Siders like to claim so, but are rudely awakened by the Job outlook. There is not way to cheapen Interest rates for Government deficit, business enterprise, or Consumer debt. Bush Tax Cuts were ineffective as economic incentive, and the deficits would probably have did more, if the wealth had been distributed among the Unemployed; and told to spend it on Consumer Goods.

Economists must understand Jobs are almost totally disassociated from Monetary or fiscal policy. Jobs are a direct result of the expansion of Consumer Demand, which means increase of Household incomes. Government deficit spending which only enhances the incomes of Corporations is of not value. lgl

Mcwop writes:

LGL,
Did the steel tariff's create any jobs?

Lawrance George Lux writes:

Mcwop,
Specialized tariffs impede the flow of trade, and create Sector distortions. A uniform tariff, on the other hand, artifically raise the cost of foreign labor. Another way of looking at the situation, foreign production has to pay the same level of domestic taxation, as does domestic industry. Strict Economic theorists claim this is heresy, but the Ricardian comparative advantage does not protect the domestic standard of living. lgl

Mcwop writes:

LGL, still can't simply buy into this theory. Smoot-Hawley comes to mind. If we raise tariffs, and other countries retaliate - then our exports could decline costing jobs, which may offset what I believe to be unlikely gains from imposing the tariffs in the first place.

Lawrance George Lux writes:

Mcwop,
There is always debate in Economics, it is how things are finally settled in the long run. No One sensible will attempt a tariff war with the United States. These all sell more to Us than anyone else, and a tariff war would be worse for them than Us; as We possess multiplex Suppliers. We won't have, though, if We don't shore up the Dollar. lgl

Bernard Yomtov writes:

LGL,

A uniform tariff also impedes the flow of trade and leads to misallocated resources. This is basic.

And the Ricardian theory of comparative advantage does in fact protect the domestic standard of living. The distributional effects may be cause for concern, but not the effect on national income.

Bernard Yomtov writes:

Eric,

Don't take that NRO article seriously. It shows exactly two months' worth of data, and in one of the two months receipts decreased. It's just silly to make any sort of claims on that basis.

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