David R. Henderson  

Krugman on Federal Debt

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Read the following from Paul Krugman in 2003 when the irresponsible people increasing the federal debt (he and I agree here) were Bush and the Republican Congress.

Two highlights:

That may sound alarmist: right now the deficit, while huge in absolute terms, is only 2 ? make that 3, O.K., maybe 4 ? percent of G.D.P. But that misses the point. "Think of the federal government as a gigantic insurance company (with a sideline business in national defense and homeland security), which does its accounting on a cash basis, only counting premiums and payouts as they go in and out the door. An insurance company with cash accounting . . . is an accident waiting to happen." So says the Treasury under secretary Peter Fisher; his point is that because of the future liabilities of Social Security and Medicare, the true budget picture is much worse than the conventional deficit numbers suggest.

And:

But we're looking at a fiscal crisis that will drive interest rates sky-high.

As an economist friend commented on this latter statement, "How did that prediction turn out?"

Does this sound like the Paul Krugman writing about the deficit and debt now? Here's from a piece last month:

But what about all that debt we're incurring? That's a bad thing, but it's important to have some perspective. Economists normally assess the sustainability of debt by looking at the ratio of debt to G.D.P. And while $9 trillion is a huge sum, we also have a huge economy, which means that things aren't as scary as you might think.

Here's one way to look at it: We're looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn't sound like an overwhelming burden.

Now, this assumes that the U.S. government's credit will remain good so that it's able to borrow at relatively low interest rates. So far, that's still true. Despite the prospect of big deficits, the government is able to borrow money long term at an interest rate of less than 3.5 percent, which is low by historical standards. People making bets with real money don't seem to be worried about U.S. solvency.

H/T to Bob Murphy.


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CATEGORIES: Fiscal Policy



COMMENTS (28 to date)
Doc Merlin writes:

Sigh, it seems to me that as time goes on Krugman has turned from being a serious economist into a political hack. As soon as his party came into power, he reversed his statements.

Yancey Ward writes:

And what would happen if The Treasury attempted to roll every maturing bill, note, and bond into 30 years?

Krugman is a political hack. Nothing more.

Daniel Kuehn writes:

To a certain extent I sympathize with these Krugman critiques, but I think the point is that he was alarmist back then, not that he's non-sensical now. The long-term debt is the problem and the ability of the federal government to convince it's creditors that it can reduce it's debt burden is the problem. These are REAL problems. And there was ample reason to question the wisdom of the Bush budgeters - but any mistakes of those Bush budgeters is largely incidental to the wider budget problem: the long term budget and our credibility with creditors.

THAT'S how I would choose to take Krugman to task. Instead, a lot of the criticism focuses on the counter-cyclical budgeting now, in the middle of an enormous recession. It's true (and Krugman admits this) that we do have to be wary because of the budget legacy left to Obama. He doesn't have as much wiggle room as he would have had.

But don't criticize a responsible fiscal policy that addresses the biggest hole in the deficit (the recession itself - which reduces revenue and creates more spending from automatic stabilizers). Obama is being responsible with the budget insofar as he is addressing these concerns with fiscal policy. Don't criticize him for that, criticize him for (a.) whether he's really going to be able to pay for all these other reforms he's talking about, and (b.) the background "you've gotta do something about the long-term budget" concerns that are reasonable to express to any administration.

And obviously I know why you guys always attack Krugman for the wrong things - because you fundamentally disagree on the fiscal stimulus. But from where I'm sitting, your critique is exactly backwards - you're criticizing Krugman on his position on Obama's short-term deficits (which is what Krugman has right), and not taking Krugman to task for letting Obama off too easy on his medium and long term budgets (which is the thing that Krugman has wrong!).

Badger writes:

Daniel, is this your definition of "a responsible fiscal policy"?
http://johnbtaylorsblog.blogspot.com/2009/09/alarming-debt-charts.html
Wake up man and smell the flowers man.

Daniel Kuehn writes:

Badger -
I appreciated reading that Taylor post when it first went up. The irresponsibility portrayed there is the irresponsibility of the way we've managed our long-term debt - which is EXACTLY what I say is legitimate to take Obama (and all other administrations) to task for, because they haven't adequately addressed it.

It has nothing to do with the Obama administration's responsible countercyclical fiscal policy as a response to the recession.

Take a look at the X-axis on your charts before you presume that that somehow invalidates my perspective. It SUPPORTS my perspective about the real debt problem.

Troy Camplin writes:

You mean Krugman's economics and policy analysis and recommendations completely change based on who is in power? I'm shocked. Shocked to hear that. I of course an not shocked to hear that. If you know what the good is, and choose against it, then your action is evil. I don't think there are too many people engaging in evil actions, but I have thought for a while now that Krugman consistently does when it comes to his writings on economics. This definitely proves it. Why does anyone listen to this {expletives refrained from]? Why do we need any more evidence that he's a complete disgrace of a human being, and especially of an economist?

John Thacker writes:
And obviously I know why you guys always attack Krugman for the wrong things

I'm sorry, I don't see how David Henderson in this post is attacking the fiscal stimulus. True, he has done so in other posts, but here he's talking about the long term debt. That doesn't seem to be "always," Daniel Kuehn.

Daniel Kuehn writes:

John Thacker -

David is criticizing Krugman's point about the ten year deficit, much of which is the current, short term, countercyclical response. That is bigger than the ARRA, but that deficit IS the stimulus, John!!!

If he's talking about the long term debt, then why does he quote the portion of the article where Krugman talks about the short term deficits, rather than quoting the portion of the article where Krugman agrees with him on the danger of the long-term debt?

Daniil Gorbatenko writes:

2Daniel Kuehn

How can a policy (in this case the fiscal stimulus) be responsible if there is no empirical evidence that it actually works. I challenge you to find any convincing evidence that fiscal stimulus has ever worked.

I do not remember who said that "modern economics is like the 18th century medicine" but in my view he was largely right. Thus, much like the doctors, policy makers should base their actions on the first do no harm principle. In the absence of evidence that it works, fiscal stimulus is a mockery of the FDNH principle and does not qualify as a responsible policy.

Daniil Gorbatenko writes:

2Daniel Kuehn:

To clarify my point by (un)workability of the stimulus I meant that unless the stimulus has a multiplier of above 1, it necessarily has a negative effect on welfare does harm. There is no reliable evidence that the stimulus has ever had an above 1 multiplier. Thus, the application of the stimulus violates the FDNH principle.

David R. Henderson writes:

Thanks, John Thacker.

And Daniel, I don't think of 10 years as being short-term. I quoted the part of his NYT 2009 article that talks about the 40-percentage-point increase in the federal debt/ratio. In my view, most of that is long-term.

Best,

David

winterspeak writes:

High Federal debt levels actually depress interest rates, because they increase bank reserves and interest rates are set by how much bank reserves are in excess.

Also, the US Govt is able to create any quantity of US$ it wants to at any instance. What does a "credit rating" even mean given this reality?

Daniel Kuehn writes:

Daniil -
RE: "in the absence of evidence that it works"

Taylor, 2000 - JEP

Freedman, Kumhof, Laxton, and Lee, 2009 - IMF working paper

Kneller, Bleaney, and Gemmell, 1999 - Journal of Public Economics

Easterly and Rebelo, 1993 - NBER working paper

Blanchard and Perottie, 2002 - QJE

This comes up in a quick google search. I can't seriously believe you think there is an absence of evidence that it works.

Are there lingering questions? Are there disagreements about how it should be structured? Are there dissenters? Are there important identification problems that make empirical work challenging? To all of these questions the answer is "of course". I don't think any objective person can say that there isn't empirical evidence, though (and yes - there is empirical evidence against as well and people need to sort through these and argue about these differences).

So were you serious about that? Or were you just saying that YOU aren't personally convinced?

John Thacker writes:
David is criticizing Krugman's point about the ten year deficit, much of which is the current, short term, countercyclical response. That is bigger than the ARRA, but that deficit IS the stimulus, John!!!

I should certainly hope that we'll be out of the recession in ten years. Even if you favor a fiscal stimulus, surely you don't favor it once we're out of the recession? (One problem with most stimulus bills in US history is precisely that-- once the money gets disbursed, the recession's over.)

The ARRA also includes some items that cannot be viewed as short-term stimulus, because it establishes benefits changes and programmatic spending that lasts longer than the next three years even. That deficit is not just "stimulus."

Yes, "much" of the ten year deficit is the next two years, but far from all. To quote the CBO (page 26, page 42 of PDF):

Under CBO’s baseline projections, even after the economy fully recovered from the current recession, federal deficits would remain at more than 3 percent of GDP, and the federal debt would be at historically high levels and gradually increasing.

That's under the baseline proposal too. Obama's actual proposals include several things not in the baseline, like indexing (or continuing to patch) the AMT, and saving the middle-class tax cut part of the Bush tax cuts, as well as additional spending.

Obama is on pace to have higher deficits during a recovery and the up part of the business cycle than Bush had during the recovery and up part of the business cycle following the 2000-2001 recession. It's not all his fault, but he is making it worse. (The same could be said for Bush and Co.) Surely you view that as a problem?

MikeM writes:

winterspeak, I think you miss the point:

"High Federal debt levels actually depress interest rates, because they increase bank reserves and interest rates are set by how much bank reserves are in excess.

Also, the US Govt is able to create any quantity of US$ it wants to at any instance. What does a "credit rating" even mean given this reality?"

David's talking about interest rates on government bonds, which the government has to take out to pay for deficit spending. So higher deficit spending and more debt make buyers of government bonds skittish about the U.S. government's ability to pay it back, so the U.S. has to sell them at higher interest rates to "clear" the amount of deficit into debt.

As to your second paragraph, well, yes, but if investors in the U.S. bonds market get the whiff that the fed is going to turn the dollar into monopoly money, they'll factor that into their decision and start demanding that inflation risk in the form of (exponentially) higher interest rates.

winterspeak writes:

MikeM: The Government does not need to take out bonds to pay for deficit spending. They issue debt to drain reserves, which operationally, just means that a treasury debt account is credited, and a treasury reserve account is debited. This is how they keep the FFR above zero.

Look at it this way, anyone who wants to buy Treasury bills needs to pay for them in dollars. Dollars sit in the reserve account at the Treasury. Treasury bills set in the Treasury account at the Treasury. Buying t-bills means you debit reserves, and credit treasuries. When the Govt pays the t-bills back, it reverses the transaction, crediting reserves, and debiting treasuries. This is all simple accounting.

Claims (by David and others) that "higher deficit spending and more debt make buyers of government bonds skittish about the U.S. government's ability to pay it back etc." were true in gold standard times, but are no longer true.

The UK has considered halting all bond auctions. I hope the US does the same to clear up all this confusion that surrounds how the US Monetary system actually works.

It would also be great that the US just set prices (interest rates) all along the yield curve and let quantity adjust. Then we wouldn't hear anything more about "skittish investors driving up interest rates".

Don the libertarian Democrat writes:

I agree with the essay written by Milton Friedman entitled " A Monetary and Fiscal Framework for Economic Stability". I see a great difference between borrowing during an economic downturn, and borrowing during an economic upswing. The first makes sense, while the second doesn't. This was also Keynes position. Hence, I find the borrowing during most of the Bush years ill-advised, and much more acceptable now. Indeed, the fiscal situation that we found ourselves in as we entered this downturn has made the downturn much worse.

It seems, and I could be wrong, that the main point being made is that Krugman didn't like borrowing during the Bush years, but does now. As long as he agrees with my view above, I'm fine with his position. It is true that sometimes I think that he does agree with me, and sometimes that he doesn't. His columns veer back and forth between economics and political economy, and sometimes do drift into pure politics. All I can say is that it seems to draw an awful lot of publicity and responses, which I take it that he is being paid for.

Daniil Gorbatenko writes:

2DK,

I only managed to access two papers out of those you mentioned. Of these, the IMF paper tries to project a multiplier by simulation which for me is not evidence.

The paper by Blanchard and Perottie looks only at the US post-WW2 experience and claims that multipliers of government spending increases were slightly more than 1 (under what they call deterministic trend (DT)) and lower than 1 (under stochastic trend(ST)). I am not an economist by training therefore I may not make a conclusion on the relative importance of DT and ST. I also do not know whether their method od analysis (structural VAR approach is sufficient to determine the effects of fiscal policy)

Anyway, that is hadly the evidence which allows to apply a potentially very harmful spending stimulus. Especially taking into account what Barro wrote in http://online.wsj.com/article/SB123258618204604599.html

Would you apply a potentially dangerous drug if you had such evidence as currently exists with regard to stimulus?

Daniel Kuehn writes:

Daniil -
Of course it wasn't an exhaustive list. Like I said, it was what came up on google (which was sort of the point - if that was what I could come up with doing a quick search, you can bet there's a lot more). If you're really interested in engaging the empirical evidence, the IMF put out another working paper this spring that did an economist's version of a meta-analysis of the literature on fiscal stimulus. They concluded it was an important policy tool as well - with some qualifiers of when it was found to be more important than others.

In the list I did have, I even made a point of including sources like the Taylor paper that have major differences of opinion (in his case, that automatic stabilizers are an appropriate form of countercyclical fiscal policy but discretionary spending is not).

There is a reason why (as Greg Mankiw reports) 90% of economists agree fiscal stimulus has a significant impact on a less than fully employed economy. Barro deserves respect, but Barro is very partisan on this. You can't cite Barro in the Wall Street Journal and imagine that his reservations negate the decades of research on this. I'm not asking you to be convinced - I'm asking you to be realistic about how your understanding of fiscal policy may differ drastically from the understanding held by most of the field, rather than simply assuming there is no convincing evidence.

Evelyn Guzman writes:

I prefer his previous opinion as it is not so alarmist as the present one. It is true though that when we factor in all those other expenses, the total debt is really more than what appears. But I have faith in the goodwill and talent of people to see us through this.

Evelyn Guzman
http://www.debtchallenges.com (If you want to visit, just click but if it doesn’t work, copy and paste it onto your browser.)

jean writes:

You should read P.Krugman better:
His argument is that we are in a liquidity trap now whereas 2003 was a year where crowd-out effect was present.

http://krugman.blogs.nytimes.com/2009/09/28/crowding-in/
http://krugman.blogs.nytimes.com/2009/09/29/the-true-fiscal-cost-of-stimulus/

If you really want to bother Krugman, show him this:
http://www.pkarchive.org/japan/japtrap2.html
http://www.pkarchive.org/japan/scurve.html

Daniil Gorbatenko writes:

2DK

The Barro WSJ article is useful just because it summarizes his reasearch.

Putting that aside, the IMF paper you cited summarizes other research on fiscal policy multipliers. The papers cited as prominent by the IMF experts are Blanchard, Perottie (2003), which you also cited and I summarized, and Romer, Romer (2008). The latter studies the impact of tax changes.

This is hardly convincing evidence in favor of Keynesian spending stimuli. Where are your "decades of research" supposedly supporting the multipliers idea?

Theoretically, the multiplliers are even more dubious. John Cochrane does a pretty good job showing this. http://faculty.chicagobooth.edu/john.cochrane/research/Papers/fiscal2.htm

The spending stimulus logic rests on the weird idea that the government can somehow determine the idle resources and utilize them without crowding out private investment. And you also have to fully reject expectations of a future tax increase. And finally you have to have Platonic Guardians in charge so that they actually allocated taxpayer funds to promising projects rather than paying off of the politicians' favorite constituences.

For me, these theoretical conditions for the viability of stimuli are unrealistic enough to negate the currently available weak and unconclusive evidence (if any) that spending stimuli work.

Daniel Kuehn writes:

OK - again, you're matching your John Cochrane to my Olivier Blanchard. I'm not sure exactly what that adds. After all, I'm not suggesting there isn't disagreement. Have you read DeLong's reaction to Cochrane and Fama? Some people wonder how Cochrane still has a job. It doesn't prove DeLong's case, but these aren't objective arbiters you're citing.

You're wrapping straw man assumptions around the argument for stimulus. Of course the government can make mistakes. The case for stimulus doesn't rest on the idea that they can't. Platonic guardians are irrelevant to my understanding of stimulus (which they should be because of course Platonic Guardians are nonsense). In a liquidity trap there isn't a risk of crowding out private investment. You're more likely to crowd it in. Your concerns do apply to a normal economy, but they don't apply to a depressed economy - which is exactly why stimulus isn't advocated in a normal economy.

RE: "And you also have to fully reject expectations of a future tax increase."

No, you don't. It's perfectly fine to admit that expectations could dull the impact of stimulus. That's fine - I've never denied that. Besides, talking about future tax increases is meaningless unless you talk about changes to the future tax base - which will increase as a result of stimulus.

Koromo writes:

Daniel,

Cochrane is a very respected economist. It's not because DeLong disagrees with him that he is not.

Daniel Kuehn writes:

Koromo -
I hope you didn't get the impression I was saying he wasn't respected.

My point was that simply introducing some of Cochrane's reservations is hardly proof of anything since he is heavily criticized (in addition to being very respected, which he rightfully is). Since I've granted that it's not unanimous and that there are contrary opinions, citing two contenders for the "most embattled and critiqued economist" award as proof that there's no evidence for fiscal stimulus is... well... it's a really bad argument that there's no good evidence for fiscal stimulus.

As I've said - I'm not making the case that Daniil and Cochrane and Barro should be convinced. I'm not qualified to make that case. I'm simply asking that he doesn't close his eyes and pretend that there isn't substantial empirical work supporting stimulus. Barro and Cochrane raise doubts. Others raise doubts about those doubts. The failure to agree isn't the same thing as an absence of evidence. We'll always argue about the evidence - that's our job.

Jim Glass writes:

You should read P.Krugman better: His argument is that we are in a liquidity trap now whereas 2003 was a year where crowd-out effect was present.

Um, no, wrong. You should read Krugman in plain English.

The difference between his two scenarios is that in 2003 he said he was "terrified" that the gov't going to be crushed by the cost of Medicare and Social Security...

because of the future liabilities of Social Security and Medicare, the true budget picture is much worse than the conventional deficit numbers suggest ... the conclusion is inescapable. Without the Bush tax cuts, it would have been difficult to cope with the fiscal implications of an aging population. With those tax cuts, the task is simply impossible. The accident, the fiscal train wreck, is already under way....
In the second, written last month, the "impossible" task of dealing with "the fiscal implications of an aging population" has simply ... disappeared!

So things will be no worse in 2019 than they were for Ozzie & Harriet!

See Krugman versus Krugman (which contrasted these two Krugmans in some detail a month ago, the day after the second one appeared.)

Another oddity about the "new" Krugman compared to the old: While the old Krugman savaged and villified the Bush tax cuts (as above) relentlessly, now that Obama has proposed to renew the bulk of the Bush tax cuts, extending them forever, new Krugman doesn't say "peep" about it.

Hey, the deficit situation is fine even with the bulk of the Bush tax cuts renewed! What's to complain? It turns out that there was nothing wrong with the Bush tax cuts that them becoming the Obama tax cuts won't fix!

(And the money from the minor portion of the Bush tax cuts that Obama proposes to repeal isn't going to be saved to avert the "train wreck" -- Obama's already promised to spend it two or three times over. That doesn't bother former budget alarmist Krugman either.)

Obama's budget director Peter Orszag warned that giving away near $100 billion a year in potential revenue to big energy companies by handing them the cap-and-trade permits for free would be "the biggest act of corporate welfare in American history". (CBO said the energy companies would be fully compensated with just 15% of them) Then Congress did it!

Krugman -- the former scourge of Republican corporate cronyism -- says "fine!" to that. He's still endorsing that deal, making up rationalizations for it.

Bottom line for Krugman: As long as the Democratic political agenda is being pushed, no budget problem that could be a possible obstacle to them can ever possibly exist.

They just ... disappear! Like Medicare and Social Security.

Daniil Gorbatenko writes:

@DK

=OK - again, you're matching your John Cochrane to my Olivier Blanchard. I'm not sure exactly what that adds. After all, I'm not suggesting there isn't disagreement. Have you read DeLong's reaction to Cochrane and Fama? Some people wonder how Cochrane still has a job. It doesn't prove DeLong's case, but these aren't objective arbiters you're citing.=

After De Long had erased Steve Horwitz's comment on his blog debunking with crystal clear evidence the myth De Long propageted that Hoover was a laissez faire advocate, De Long is no more an authority for me. He is a political hack. And his treatment of opponents showed it.

And I do not see any flaw whatsoever in Cochrane's argument let alone anything immoral in it. In contrast to De Long and Krugman, neither Cochrane, nor Barro have tried to offend their opponents.

=You're wrapping straw man assumptions around the argument for stimulus. Of course the government can make mistakes. The case for stimulus doesn't rest on the idea that they can't. Platonic guardians are irrelevant to my understanding of stimulus (which they should be because of course Platonic Guardians are nonsense). In a liquidity trap there isn't a risk of crowding out private investment. You're more likely to crowd it in. Your concerns do apply to a normal economy, but they don't apply to a depressed economy - which is exactly why stimulus isn't advocated in a normal economy.=

No, these are not straw man assumptions. Your argument is based on the idea that somehow economic principles do not apply in a recession. I do not see any reason why it should be so. At least, I hope that you do not believe that the demand curve is vertical in a recession.

I do not understand how it is possible for the government to not crowd out private investment if the government is systematically unable to correctly identify the proper resources to employ. That is a necessary condition for government spending to work. Two things prevent the government from doing that - the absence of the necessary knowledge and the capture by the special interests. If you call this a straw man there is nothing more to argue over.

jean writes:

@Jim Glass:
Please read my whole comment. I said that Krugman contradicts himself but NOT where you think.

There are two similar situations where Krugman emitted different advices on fiscal policy:
_Japan in the 1990's (pro-deficit then mildly anti-deficit)
_USA in 2008-2009 (pro-deficit)

The rest of the time, Krugman always argued against fiscal policy, since the Fed nullifies the effect of fiscal policy if the Fed can raise or lower the Fed rate (Now, the Fed can no longer lower its rates, so what he said in 2003 is no longer relevant).

Now, you are probably right on one point: Krugman may want to help the current administration to raise the budget.

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