Is there a deficit of deficit hysteria?

August 3rd, 2016 at 2:22 pm

I hope so, and it’s what I wrote about yesterday in the WaPo. Let me entertain OTEers with a few more thoughts on the topic, including feedback I got yesterday.

One response was: “You’re endorsing fiscal recklessness! There’s nothing “progressive” going on here; it’s just politicians not giving a crap about our troubled fiscal accounts.”

Surely, there’s some truth to that. There are a lot of what I call deficit-chicken-hawks out there–they pretend to care about budget deficits, but as I wrote in the piece, that’s just a ruse to cut spending and shrink government. They’re happy to pass unpaid-for tax cuts all day.

But my point is that even if they’re doing the right thing for the wrong reason, the outcome will be improved. To the extent that deficits become less of an obsession, we have the potential for better fiscal policy. And I was careful in the piece to avoid going too far in the other direction. In the long term, spending must be paid for. The point is that the time for deficit reduction is when the economy is at full strength, as opposed to “always,” which is the mindless view of too many hawks, chicken or otherwise.

This raises another good question I got: why is our political system so obsessed with “payfors,” meaning there’s no proposing anything without also proposing how you’re going to pay for it? Part of this is a function of “pay-as-you-go” rules that insist Congress offset certain spending and tax cut proposals, though these rules often get waived.

As I see it, insisting on payfors for permanent tax cuts or spending increases makes sense, at least in theory (where “permanent” means something that isn’t intended to phase out, like a discretionary countercyclical program or one-time infrastructure investment). It’s in sync with that business above about outlays roughly equaling receipts over the long run.

But in the real world, the problem is immediately apparent. Since Republicans forbid any tax increases, payfors necessarily imply spending cuts. And, sticking with the real world, that means cuts to food stamps, Head Start, or social insurance, not to the mortgage interest deduction or the carried interest loophole.

In other words, insisting on payfors in this world too often implies either doing nothing (the default position) or cutting programs that poor people depend on. So, until tax revenue increases are back on the table, in the interest of fiscal equity, which admittedly isn’t the same as fiscal rectitude, I’d suggest being a lot less constrained by payfors.

Finally, based on the discussion around the figure below, a few people thought I was suggesting that CBO had a conservative thumb on the scale. Not so. They’re rigorously non-partisan.

My point was simply that their model of interest rates is generating large and persistent forecast errors, or, less technically, poorly describing how interest rates are actually moving. This has the effect of making future deficits and debt look larger than they’re likely to be (because it predicts higher costs of debt service than a lower, more realistic interest rate path would predict), and that feeds into some of the hysteria I critique.

But that’s not CBO’s fault. Their practice is to use standard modelling assumptions until the weight of the economics profession and the peer-reviewed literature suggests alterations to the standard model.

That takes a long time (though it’s notable that financial markets move a lot quicker; “forward rates”–predictions of future interest rate based on different maturities of current rates today, have significantly adjusted downwards). While the standard model undergoes needed changes–and I’ve seen a bit of evidence of progress–it’s up to the rest of us who track this sort of thing to point out persistent errors and more importantly, make noise about their implications.

In this case, that means taking scary, long-term budget projections with an even larger grain of salt than usual, and, in reference to my suspension of payfors point above, recognizing that low rates support a current investment agenda in ways that CBO may undervalue for awhile.

Source: CBO

Source: CBO


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12 comments in reply to "Is there a deficit of deficit hysteria?"

  1. Pinkybum says:

    “But that’s not CBOs fault. Their practice is to use standard modelling assumptions until the weight of the economics profession and the peer-reviewed literature suggests alterations to the standard model.”

    This makes no sense to me. What standard model in economics predicts always increasing interest rates? This cannot be true.

    • Jared Bernstein says:

      It’s not that. It’s that the model predicts historically low rates will revert back up as the economy normalizes. And vice versa.

      • Pinkybum says:

        To be fair to the CBO the FOMC dot plot predictions have have been predicting the return to “normal” for the last 6 years! And we are still at an FFR of under 1 percent.

  2. rjs says:

    Ryan Avent pointed out that even if we enacted Trump’s massive tax cuts and spending increaes, adding $34 trillion in new debt over the next two decades, our ratio of debt to GDP two decades from now would still be 30 percentage points less than Japan’s government debt ratio is right now…and the market is still buying their negative interest rate long term debt…

    • Smith says:

      Well a more likely scenario is the one I laid out on this blog 4 days ago, where Trump doesn’t get everything he asks for, and there are some spending cuts made, so the plan costs $25 trillion not $35, but I thought it was just over the course of 10 years. Inequality would heighten, and infrastructure would suffer, but it could happen, and make the GDP rise, and the economy hum. For some.

      My comment
      The most relevant portion (with grammatical correction):
      “If Trump should win (god forbid) and pass his tax plan, cut from $400 to $300/billion a year, partly offset by spending cuts of $50 billion**, so a net -$250 billion, this adds over 2% of GDP a year to the deficit, public debt shoots from 87% to 107% of GDP, counting some increased growth, albeit no where near the dynamic scoring farce, it can happen here. It’s about framing the issues.”

      “You’re not saying the economy is great are you? I think the rhetorical trap that Trump has accidentally or masterfully laid is in the slogan that implicitly asks that question.”

      ** Is this a magic asterisk? Cut all non military discretionary spending 10%, done.

  3. Leonard C. Tekaat says:

    There is a time and place for everything. It is impossible to accuracy predict the future, or where something will occur. The economy is continually changing from one economic cycle to another. This why tax policy must automatically change annually, so it is in sync with what cycle the economy is in. It is better for an capitalist economy to correct imbalances in the value of financial assets (debt/money) and the value of hard assets (homes/land/other colattoral) before either one is excessively desired more than the other. This will help control “irrational exuberance” and “bubble formation”, which are destructive to an capitalist economy. To maintain a more stable economy and full employment we need to enact the 2% Appreciation/Infllation Taxation Policy. To read more about this policy please go to or http://wp.p42WQA-7c. Please feel free to read the other articles also. Thank you!

  4. Kaleberg says:

    Surely you have noticed by now that all this fuss about deficits is just partisan rhetoric. Democratic presidents are expected to balance the budget, even if it means giving up on our future, while Republican presidents are given a free pass to borrow hundreds of billions, even if the money mainly goes to destabilizing the Mideast or giving tax cuts to people who don’t need them.

    A balanced budget is ridiculous. No one expects people or businesses to avoid borrowing. The only reason for individuals to avoid debt beyond a certain limit is that they are going to die someday. Arguing that the US, or Japan for that matter, needs to worry about its deficit, is arguing that the US or Japan is going out of business. I suppose some people call that patriotism.

    • Pinkybum says:

      This is great!

      Additionally, I suppose you can say that there should be “reasonable” limits on the debt and that there is a long run constraint but these are really concerns about stability in the economy not the nominal level of the deficit/debt level.

  5. Avraam Jack Dectis says:

    Spending does not have to be paid for.

    Debt can be monetized.

    Inflation can be controlled by many levers other than income taxes.

    Anachronistic gold standard style thought processes are not helpful.

  6. john says:

    On payfors, if government has a positive NPV project where public IRR exceeds private IRR, it should be done. Period. Full stop. Regardless of economic conditions. Regardless of financing, to be determined later.

    Such projects add to aggregate wealth faster than all other projects. To not do them is to choose a poorer USA. And at this time, with financing costs of all sorts nearly free or better, we are insane not to load the boat and spend.

  7. Nick Estes says:

    PAYGO is a very destructive and unnecessary public policy constraint. If Larry Summers is correct and we are in a period of secular stagnation, we will need to have the government regularly spend more than it taxes, so as to add demand to the economy. Since we already have a pretty high national debt ratio, it would be sensible to have this difference financed by the Fed creating the necessary money and transferring it to the government to spend. We should steer the economy by the inflation rate–shooting for 2-3% and adjusting the difference between taxes and spending to roughly achieve that. This will correct for over-saving in the private sector and keep our economy operating at the highest reasonably-possible level. Exactitude is not required. When inflation is running at 2-3%, we have employed all the workers we can (while focusing on making more and more workers employable at higher and higher levels of skill and education). Thanks.

  8. Fred Donaldson says:

    Payfor is a religion that has been around for decades in the private sector. To me, it is idiotic, lazy management.

    An example: I’m at a budget (1,000 plus pages) meeting with the CEO of a $750 million annual sales newspaper group, reviewing my group’s share of revenues and expenses, when we come to a classified sales position I plan to add because we only have one class rep on staff at that publication, and there is a good potential for growth.

    “How are you going to pay for it?” I’m asked, which is code for what am I going to cut to pay the salary.

    My answer is that I don’t want to cut anything. The position will pay for itself, based on my experience that a classified rep on average generates $73m a year in profit – in this case for a $23m personnel expense, meaning a net of $25m.

    “But won’t it take time to get these sales? What if the person doesn’t reach the sales goal?”

    Answers: if they reach half the goal in the first year we still net $13.5m. If the person can’t even sell their salary we replace them.

    This went on for a half hour until they were tired of arguing with me and reluctantly and sadly agreed.

    Nothing is an expense if it generates profit in business. Nothing is an expense in Government if it is a priority for the nation.

    By the way, that giant publishing company (headed by two charter accountants) subsequently went bankrupt a few years later.