Category Archives: government debt crisis

Consolidating the Central Bank and the Treasury

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Thomas Klitgaard and Harry Wheeler write,

The discussion above offers up a perspective on what is meant by “monetizing debt.” This term refers to a central bank buying government bonds and promising to keep them on its balance sheet with the result that the increase in reserves in the banking system translates into higher prices. This outcome, though, requires that the central bank not pay the appropriate interest rates on reserves. If it does, then an asset purchase program is just an effort that shortens the maturity of public-sector debt and will likely have few or no implications for future inflation.

Pointer from Mark Thoma.

Another implication is that it makes the interest cost of the government more sensitive to movements in short-term interest rates. So a sudden loss of confidence in the government by investors which raises interest rates would become self-reinforcing. And if the only way out of such a debt crisis is to print money, then there are implications for future inflation.

An Accounting Threat

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The WSJ reports,

Starting in 2017, EU rules will require European governments to calculate the total amount they must pay current and future pensioners. Making this obligation more visible could spur them to deal with it, said Hans Hoogervorst, chairman of the International Accounting Standards Board and a former Dutch finance minister. “It will make clear that the current situation is unsustainable.”

Such a rule would be helpful here, as well.

The Issue that Worries Me

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Alan J. Auerbach and William G. Gale write,

Although current deficits are reasonably low, the medium and long-term fiscal outlooks have deteriorated in the past year, due largely to legislative actions (and their implications for future policy) and changes in economic projections. Even under a low interest rate scenario, the long-term budget outlook is unsustainable. Moreover, the nation already carries a debt load that is twice as large as its historical average as a share of GDP and that makes evolution of the debt-GDP ratio much more sensitive to interest rates.

The necessary adjustments will be large relative to those adopted under recent legislation. Moreover, the most optimistic long-run projections already incorporate the effects of success at “bending the curve” of health care cost growth, so further measures will clearly be needed. These changes, however, relate to the medium- and long-term deficits, not the short-term deficit.

They say that the solution is to build a wall on our southern border.

Just kidding.

Raise the Age of Government Dependency

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Courtney Coile, Kevin S. Milligan, and David A. Wise write,

This is the introduction and summary to the seventh phase of an ongoing project on Social Security Programs and Retirement Around the World. The project compares the experiences of a dozen developed countries and uses differences in their retirement program provisions to explore the effect of SS on retirement and related questions. The first three phases of this project document that: 1) incentives for retirement from SS are strongly correlated with labor force participation rates across countries; 2) within countries, workers with stronger incentives to delay retirement are more likely to do so; and 3) changes to SS could have substantial effects on labor force participation and government finances. . .

This seventh phase of the project explores whether older people are healthy enough to work longer. We use two main methods to estimate the health capacity to work, asking how much older individuals today could work if they worked as much as those with the same mortality rate in the past or as younger individuals in similar health. Both methods suggest there is significant additional health capacity to work at older ages.

The simplest, most logical fix for entitlement programs is to raise the age of government dependency. Most people ought to be able to support themselves well into their seventies. Those of us who want to stop working earlier can plan for it and pay for it ourselves.

If Social Security and Medicare had been indexed for longevity from the outset, those two programs would not be in trouble today.

Social (In-) Security

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Erzo F.P. Luttmer and Andrew A. Samwick write,

On average, our survey respondents expect to receive only about 60 percent of the benefits they are supposed to get under current law. We document the wide variation around the expectation for most respondents and the heterogeneity in the perceived distributions of future benefits across respondents. This uncertainty has real costs. Our central estimates show that on average individuals would be willing to forego around 6 percent of the benefits they are supposed to get under current law to remove the policy uncertainty associated with their future benefits. This translates to a risk premium from policy uncertainty equal to 10 percent of expected benefits.

My comments:

1. I believe that most economists think that even in the worst case individuals would get more than 60 percent of the benefits that they are promised.

2. Somehow, I am reminded of Foolproof, in which the attempt to reduce risk has the reverse effect. That is Social Security was supposed to increase the certainty of people’s retirement incomes, but apparently it is not doing so.

Social Security is Still Going Broke

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Timothy Taylor writes,

the gap between benefits and receipts doesn’t change much after about 2035. This tells you that the Social Security problem is essentially a one-time problem, occurring as a result of the retirement of the boomer generation. If we can enact a series of reforms that moves up the receipts line and moves down the benefits line, then after about 2035 the system can be fairly stable for decades into the future.

I have a different view. Longevity has been going up pretty steadily at a rate of 2.5 years per decade. In recent decades, much of that increase has occurred at the high end (reductions in infant mortality used to be a big factor, but that has reached an asymptote). The age of government dependency (aka the Social Security retirement age) has not been increased as much. If those trends continue, then the ratio of government-dependency years to working years goes up inexorably. A system in which workers pay for retirees faces very troubling arithmetic.

Having said that, Taylor does a nice job of summarizing a CBO report on options for improving Social Security finances. I think he is more charitable than I would be toward the left’s approach, which strikes me as more of a “deny that there is a problem” strategy.

Jeffrey Miron on Fiscal Imbalance

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He concludes,

The fundamental economic reality implied by fiscal imbalances is that the “rich” economies are not as rich as they would like to believe; they are planning far more expenditure than they can afford. Recognizing this fact sooner rather than later does not eliminate the problem, but it allows for more balanced, rational, and ultimately less costly adjustments. And if attention to fiscal imbalance helps cut ill-advised expenditure, economies can have their cake and eat it too.

I think that this way of putting it is vulnerable to the comeback that we can always cancel our debt, since we owe it to ourselves. I prefer to characterize the problem as one of creating political friction because of the need to disappoint people’s expectations. See my classic (in my opinion) Lenders and Spenders essay.

Anil Kashyap on Greece

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Probably the best analysis so far. Mostly, it is a recap of the past. But in talking about the pending referendum, he writes,

if the public sides with Tsipras government, then there will be a very sharp recession over the next few months. Tax collection is likely to collapse. The Tsipras government is unlikely to survive the economic collapse.

He also writes,

Greece should have defaulted in 2010. Its debt burden then was unsustainable and nothing since then has changed this. It is true that financial markets were much more jittery at that time, but the money that was raised to pay off the creditors in that bailout could have been diverted to support Greece and other weak countries. Once the bad rescue of 2010 was undertaken, it was inevitable that some form of debt relief was going to be necessary.

Imagine how different the political dynamics in Europe would have been if the German and French banks had been explicitly bailed out.

Pointer from John Cochrane (and from Greg Mankiw and James Hamilton). Of course, I think that explicit bailouts are exactly what the political system will not allow. Even going forward, I still think that “opaque bailout” is the most likely outcome. But I also think that there are some lessons for us.

1. At some point, you do run out of other people’s money (that is actually more true for us than for Greece, because we are bigger and therefore harder to bail out).

2. When you run out of other people’s money, political tensions rise considerably. See my essay Lenders and Spenders.

When Economists Were Right, Allegedly

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Richard Baldwin writes,

Barry Eichengreen added specificity to this in January 2009 with his insightful column “Was the euro a mistake?”, noting: “What started as the Subprime Crisis in 2007 and morphed in the Global Credit Crisis in 2008 has become the Euro Crisis in 2009. Sober people are now contemplating whether a Eurozone member such as Greece might default on its debt.” He wrote that the alternative to default was “fiscal retrenchment, wage reductions, and assistance from the EU and the IMF for the cash-strapped government.”

He predicted – again dead on – that “[t]here will be demonstrations against the fiscal cuts and wage reductions. Politicians will lose support and governments will fall. The EU will resist providing financial assistance for its more troublesome members. But, ultimately, everyone will swallow hard and proceed … In the end, the EU will overcome its bailout aversion.” The farsightedness is astounding. In January 2009, few knew the Greeks had a problem serious enough to require debt restructuring.

Pointer from Brad DeLong, via Mark Thoma.

That sounds impressive. He also cites other economists. But a couple of cautionary notes.

1. The best way to develop a reputation as far-sighted is to make many vague, conditional predictions. Later, you call attention to those that sound correct, and if necessary you wiggle out of those that sound incorrect by pointing out the conditions or taking advantage of their vagueness. I am not accusing Eichengreen of doing this. I have others in mind. But what might Baldwin have found had he had searched through past articles and looked for bad predictions?

2. How best to generalize this point? My guess is that “Economists’ predictions should always be taken as gospel”

3. Is the correct lesson that we should pay attention when economists warn about sovereign debt issues? Consider that many of us have issued warnings about the United States.

Opaque Defaults

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James Hamilton writes,

The bottom line for me is that Greece’s current debts and any new loans that get extended from here are not going to be repaid in the present-value sense defined above. The current debt load and its associated interest bill are simply too big. The only solution is default on a significant portion of outstanding Greek debt. Indeed, significant debt restructuring is a necessary step for Greece to move forward, whether within the euro or based on a new currency. My view is that any realistic negotiations at this point simply have to take those facts as given.

My bottom line is to suggest that in forecasting the outcome of sovereign debt crises, assume that everyone’s goal is to make defaults as opaque as possible. For a small country like Greece, there ought to be many ways to do this. When the crisis hits Japan, it will be more difficult. When it hits the U.S., it will be more difficult still. But by then the international technocrats will have had a lot of practice.