Arnold Kling  

Jamie Galbraith Makes an Assumption

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He writes,


But there isn't, in fact, a "long-term deficit problem." So long as interest rates stay below the growth rate, as they are, debt-to-GDP levels eventually stabilize and even decline. The notion that there is a big problem is pure propaganda based on a pseudo-debate, pitting two viewpoints that nevertheless converge on the practical issue.

Pointer from Mark Thoma.

Having an interest rate that is below the growth rate of nominal GDP is indeed a wonderful thing. The government can have an infinite debt and still be solvent.

However, it is dangerous to assume that the interest rate will always be below the growth rate of nominal GDP. In fact, the interest rate tends to fluctuate around nominal GDP growth, sometimes above and sometimes below. See the table in my article. It would be nice if Galbraith would look at this history, instead of making unrealistic assumptions.


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CATEGORIES: Fiscal Policy



COMMENTS (28 to date)
Matt R. writes:

He also forgets that the primary deficit has to be zero for his argument to work. If you keep running large primary deficits (like we have been) then you have an unsustainable fiscal policy even with very low nominal interest rates.

James Galbraith writes:

The problem is that CBO and others make the opposite, highly unrealistic assumption: that (short-term) interest rates will rise sharply, unprovoked by inflation and without causing any damage to the real economy.

My remark was necessarily short-hand for an issue explained in depth at the link, which is here: http://www.levyinstitute.org/pubs/pn_11_02.pdf

JG

[Please do not use tinyurls on EconLog, especially not for pdf files. The tinyurl has been replaced by the full url.--Econlib Ed.]

James Galbraith writes:

And, no, I did not forget the primary deficit; the paper at the link deals with it.

JG

8 writes:

Once a country crosses 100% debt/GDP, say 120% of GDP, the growth rates needs to be 120% of the interest rate, no?

How are low interest rates good? Isn't he arguing that the U.S. is Japan?

And speaking of Japan, they have to grow at 200% of their interest rate...

Growth assumptions have been too high for about four years running now...

Noah Yetter writes:
And, no, I did not forget the primary deficit; the paper at the link deals with it.
So we could, for example, borrow and spend $10 or $100 trillion a year, every year, forever? As long as we pay 0.15% on the debt and grow at 1% per year, which is about where we're at? And our debt/GDP ratio would not continue to rise faster and faster, but asymptotically approach some constant?

A curious theory.

MikeDC writes:

Goodness. I've sometimes found myself thinking, in more insecure moments, that our political class would be quite willing to give up economic growth if they could continue to spend on their constituents forever.

On a related note, telling bond holders "we can't default because we can always print more money to pay you" is effectively telling them you're going to default (in the much more practical sense of their bonds now being worth a lot less). Just wanted to get that out there since we're discussing stupid pronouncements from people who should know better.

Randy writes:

Why should we assume that we would always be able to borrow at a rate lower than the growth rate? Isn't the danger that at some point we will not? That the reason that point might be reached may be entirely political and/or irrational? That at that point rolling over a mountain of debt will be suddenly impossible?

Then again... if the plan is to simply run up the debt as much as possible until that point is reached... and then just default on everybody... well, that's actually not a bad plan.

James Galbraith writes:

My first reply on this issue has been held up, possibly because it contained a link. Here it is again without the link.

What I said was: the problem is that CBO makes an opposite assumption -- of sharply rising interest rates -- unprovoked by rising inflation and with no adverse effect on growth. This is highly unrealistic. The brief explanation in the TNR piece was a necessary short-hand, linked to a full explanation in an earlier Levy paper.

Finally, on the question of what determines the short-term interest rate: that's what we hire the FOMC to do. The rate is what they say it is. And not just here. Note that Japan has had zero interest rates for well over a decade now; there's nothing impossible about it.

JG

Daublin writes:

Sometimes common sense applies, even to the United States government. The U.S. government has run a deficit for so long that many people now consider it the norm, and they try to find reasons that in the case of the U.S., things are different.

People said much the same thing about the overall economy of the Soviet Union. It was theoretically very bad, and to many people's common sense it was bad. However, it kept going for a long time, so many commentators made up elaborate explanations for why the Soviet Union must be different. Even the econ textbooks were saying it.

Common sense prevailed in the end. Having a country full of people of people doing busy work while ignoring the big problems eventually collapsed. Likewise, having a nation that borrows recklessly and spends it on prestige projects is also not going to go well.

Daublin writes:

Sometimes common sense applies, even to the United States government. The U.S. government has run a deficit for so long that many people now consider it the norm, and they try to find reasons that in the case of the U.S., things are different.

People said much the same thing about the overall economy of the Soviet Union. It was theoretically very bad, and to many people's common sense it was bad. However, it kept going for a long time, so many commentators made up elaborate explanations for why the Soviet Union must be different. Even the econ textbooks were saying it.

Common sense prevailed in the end. Having a country full of people of people doing busy work while ignoring the big problems eventually collapsed. Likewise, having a nation that borrows recklessly and spends it on prestige projects is also not going to go well.

James Galbraith writes:
Common sense prevailed in the end. Having a country full of people of people doing busy work while ignoring the big problems eventually collapsed. Likewise, having a nation that borrows recklessly and spends it on prestige projects is also not going to go well.

I agree with this! Wars and aircraft carriers are a huge waste, and they use up real resources.

But Social Security and Medicare are not: they are efficiently run universal insurance programs, maintaining large parts of the population in modest comfort.

The deficit is not the issue. The interest rate is not the issue. The issue is precisely that we are hyperventilating about the deficit while ignoring the big problems.

JG

Dave writes:

JG:

"Finally, on the question of what determines the short-term interest rate: that's what we hire the FOMC to do. The rate is what they say it is."

And do you believe that no harm ever comes from the Fed artificially holding short term interest rates low for an extended period of time?

James writes:

James Galbraith:

Most Social Security and Medicare expenditures go to segments of the population that would be quite comfortable without them.

quadrupole writes:

JG:

"But Social Security and Medicare are not: they are efficiently run universal insurance programs, maintaining large parts of the population in modest comfort."

Large parts of the population who are no longer, nor will in the future be contributing to society, and who have already spent their past contributions to society. As such, SS and Medicare are at least as much a black hole as Wars and Aircraft carriers.

Dave writes:

JG: "But Social Security and Medicare are not: they are efficiently run universal insurance programs, maintaining large parts of the population in modest comfort."

Galbraith is what I like to refer to as a believer in the Efficient Government Hypothesis.

Richard writes:

Dave: "Galbraith is what I like to refer to as a believer in the Efficient Government Hypothesis."

This is obviously contradicted by the fact that Galbraith thinks wars and aircraft carriers, which are government projects, are black holes.

With that said, "Efficient Government Hypothesis" is quite clever. I'll have to remember that one.

mark writes:

Sorry, the assertion is wrong. More precisely, it is only true so long as (1) the principal of the debt is less than GDP at Tzero, (2) you never add debt in any subsequent year greater than the increase in GDP and 3) maturity is infinite so the run is never broken by having to repay principal. And while there is no doubt a case in which those conditions theoretically exist, they don't in the US.

If debt is 150% of GDP at Tzero and you're running a 5% of GDP primary deficit every year, and have 25% of your debt maturing every three years, the fact that you have a 5% GDP growth rate and a 4% interest rate does you little good. Your hole gets bigger every year. Until one day the bottom falls out.

Eric Mroey writes:

James Galbraith:
The Statement to the Commission on Deficit Reduction [1] you linked to has some excellent points specifically 2 through 5. The Levy Institute paper [2] is also interesting. The I wish you would have used your time to explain and expand on them rather that write what will appear to most as either uninformed or non sequitur ramblings. The information in your papers is key to having any rational discussion of the tnr.com article. I fear that you lost your audience with the "necessary short-hand" you used.

[1] http://www.fiscalcommission.gov/meetings/public-forum/additional/James_Galbraith.pdf

[2] http://www.levyinstitute.org/pubs/pn_11_02.pdf

Dave P writes:

Reason had a blog post about the supposed efficiency of medicare yesterday. They stated:

What about the claim that Medicare’s administrative costs are only 2 percent, compared to 10 percent to 15 percent for private insurers? The problem with this comparison is that it includes the cost of marketing and selling insurance as well as the costs of collecting premiums on the private side, but ignores the cost of collecting taxes on the public side. It also ignores the substantial administrative cost that Medicare shifts to the providers of care.

Studies by Milliman and others show that when all costs are included, Medicare costs more, not less, to administer.

http://reason.com/blog/2011/08/10/medicare-is-more-efficient-if

Dave writes:

Hold on, Richard. I never properly defined the Efficient Government Hypothesis for you. It's the belief that the government always designs programs which are perfectly efficient, EXCEPT when the programs are favored by those warmongering Republicans. Under this definition, JG clearly qualifies.

Noah Yetter writes:
Finally, on the question of what determines the short-term interest rate: that's what we hire the FOMC to do. The rate is what they say it is.
This is a highly naive view of how monetary policy is set in the US. In the short run, the FOMC does not take orders from the President or indeed anyone. We have all seen rising interest rates in our lifetimes (remember 1999?) and we will see them again. The CBO's assumptions are arbitrary (unavoidably so), but reasonable.
Bob Murphy writes:

Arnold Kling wrote:

Having an interest rate that is below the growth rate of nominal GDP is indeed a wonderful thing. The government can have an infinite debt and still be solvent.

I realize Prof. Kling was trying to stipulate something for the sake of argument, but he went too far here (as "mark" above pointed out). Forget governments and just think in terms of households. Suppose my income goes up 10% a year. If interest rates are less than 10%, does that mean my household can stay solvent even with an infinite debt? Of course not, and the thing that "gives" isn't that my puny household causes the market interest rate to rise above 10%. Even with an interest of 5%, if I have a debt of $900 trillion, and my salary of $100,000 rises by 10% faithfully every year, I'm still insolvent right?

(It's 2am my time, and I was never very good at infinite sums. My apologies if Kling is right.)

roger erickson writes:

Even arguing over the fiat interest rate arbitrarily assigned to fiat currency creation is leaving endless options unexplored. We didn't always have Treasury Securities, there are simple, arbitrary reasons why we use them, and we could easily stop issuing Treasury Securities altogether.

End of story. No imaginary fiat "interest rate", no fiat "deficit", & no fiat "national debt". All by fiat.

ps: Listening to economists argue about the limits of staying within arbitrarily imposed rules is rather like listening to people arguing about preserving Ptolomy's astronomy. What on earth happened to American ingenuity? No concept of courage & audacity in economics textbooks? Sounds like very poor management of risk & uncertainty.

What if someone in oh, say, China, decided they had no qualms about exploring all possible uses of a fully fiat currency? What then? Horrors upon horrors! You might actually have to think? In this case about streamlining some absolutely useless, archaic rules?

If you can give up wood stoves for microwave ovens, surely you can give up gold-std thinking for adaptive fiat currency operations?

Matt Bramanti writes:
So long as interest rates stay below the growth rate, as they are, debt-to-GDP levels eventually stabilize and even decline.

I had the same immediate reaction that Matt R. did -- that this is only true when there's a balanced budget. I thought I must have missed something. I don't think I did.

I also have a problem with his statement that "any path that eventually stabilizes is sustainable," combined with the 100-year time axes on his charts. To be of practical use, the projected date of stabilization has to be near enough to matter to people.

His Figure 5 shows debt falling to 80% of GDP by 2060. Well we ran it up from 60% to 100% in just 10 years! Any spikes in the primary deficit will push that 100-year curve even farther out into the future.

Lance writes:

Bob,

You could theoretically roll over the debt so it never matures. Your income growing more than the interest rate insures that you are able to make interest payments while reducing the principal by the difference. Certainly, an individual person does not exist forever, so the comparison is not as apt for a household as a country.

But, most likely, the interest rate would change, right, if you continually try to roll it over. I think JG's argument is the Fed has the power to make the effective interest rate lower than the expected growth rate of the economy through monetary policy.

Philip Pilkington writes:
The government can have an infinite debt and still be solvent.

The government can always have infinite debt and remain solvent. Greenspan said this the other day -- Jamie and MMTers have been saying it for over a decade:

http://www.youtube.com/watch?v=dqs4vyVWcm8

The potential threat is inflation. Mainstream macroeconomists needs to catch up -- fast. They're losing credibility fast. Why? Because they still live in the Gold Standard 60s and the world is becoming less like they describe it every day.

Scott Fullwiler writes:

Actually, Treasury rates related to the average maturity of issue have on average been below nominal growth of GDP since 1953 (when the Fed/Tsy Accord went into effect). The only period during which rates were above GDP growth was 1979-2000, when the Fed ran a significantly tighter policy (and most of that was from the 1979-1990 period), further confirming that rates follow monetary policy stance, as Jamie argued. See table 4 and figures 6, 7, 8 here

Hugh writes:

Rather late to the party but.....:

1) the annual deficit (including interest payments) has to be less than or equal to the growth in nominal GDP to avoid debt growing as a percentage of GDP;

2) Italy is just going through the experience of having a quite healthy annual deficit (running a primary surplus) but getting into trouble due to interest rates spiking on its 120% GDP of accumulated debt. I understand that if interest rates reach 7% the annual deficit would also jump, and Italy would enter a death spiral of ever increasing debt.

I cannot for the life of me understand why we are still discussing completely theoretical outcomes to the debt crisis when reality is all around us.

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