Category Archives: government debt crisis

Payroll Taxes in Europe

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In France, the rate is 42 percent; in Germany, it is 39 percent; in Italy, 40 percent; and in Spain, 37 percent.

That is from Diana Furchtgott-Roth and Jared Meyer Disinherited: How Washington Is Betraying America’s Young. I see it as saying “left-wing economics is bad for children and other living things,” but they are trying to position it differently. In any case, they are suggesting that we could be headed for much higher payroll taxes ourselves.

I had not realized that these tax rates are so high. I find it hard to reconcile Germany’s relatively low unemployment rate with this high payroll tax rate.

Government Debt, Off Balance Sheet

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John Cochrane writes,

Guaranteeing more than half of financial sector liabilities is impressive. But most of us don’t know how large financial sector liabilities are. GDP is about $17 Trillion. $43 Trillion is a lot.

This is only financial system guarantees. It doesn’t include, for example, the federal debt. It doesn’t include student loans, small business loan guarantees, direct loan guarantees to businesses, the ex-im bank and so on and so forth. It doesn’t include non-financial but likely bailouts like auto companies, states and local governments, their pensions, and so on.

He cites analysis from the Richmond Fed.

Not to worry, of course. Debt is just something we owe to ourselves.

Steven Pinker on Money as a Consensual Hallucination

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He writes,

Life in complex societies is built on social realities, the most obvious examples being money and the rule of law. But a social fact depends entirely on the willingness of people to treat it as a fact. It is specific to a community, as we see when people refuse to honor a foreign currency or fail to recognize the sovereignty of a self-proclaimed leader. And it can dissolve with changes in the collective psychology, as when a currency becomes worthless through hyperinflation or a regime collapses because people defy the policy and army en masse.

That is from p. 65 of The Blank Slate, which I am re-reading.

I would quibble that you do not get hyperinflation from a sudden loss of confidence in the currency. You get it when the government spends more than it taxes and loses the ability to borrow, so its only choice is to print money–and then people lose confidence in the currency.

The important social reality is that people are willing to lend to the government at affordable interest rates. That is what has the potential to suddenly change (see Greece) and that is why large deficits create potential instability.

The Age of Creative Ambiguity

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Tyler Cowen writes,

File under “The End of Creative Ambiguity.” That file is growing larger all the time.

What is Creative Ambiguity? I would define it as the attempt by policy makers to ignore trade-offs and to deny the need to make hard choices. Consider the Fed’s balance sheet. One hard choice might be to sell its gigantic portfolio of bonds and mortgage-backed securities. That would depress the prices of those assets and make it harder for the government to borrow and to provide mortgage loans. The other hard choice might be to provide whatever support is necessary to enable the government to borrow and to provide mortgage loans, even if it means printing enough money to risk hyperinflation. Creative ambiguity means convincing investors that neither hard choice will be necessary. Perhaps that is even true.

However, if the Fed’s hard choices are to be avoided, then at some point the government must get its fiscal house in order. That is where the real creative ambiguity comes in. See Lenders and Spenders.

Should the CBO Use Dynamic Scoring?

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John Cochrane writes,

Greg Mankiw has a nice op-ed on dynamic scoring

The issue: When the congressional budget office “scores” legislation, figuring out how much it will raise or lower tax revenue and spending, it has been using “static” scoring. For example, it assumes that a tax cut has no effect on GDP, even if the whole point of the tax cut is to raise GDP.

My thoughts.

1. I am against dynamic scoring. Dynamic scoring means using an economic model. I think that politicians and the press give too much credence to economic models as it is. Even static scoring requires some modeling, but the modeling has more to do with spreadsheet arithmetic as opposed to claiming to be able to predict economic behavior.

2. To the extent that the CBO has to predict economic behavior, I think it should present several scenarios, as opposed to a point estimate or a range. Cochrane says it well:

It’s a fact, we don’t know the elasticities, multipliers, and mechanisms that well. So stop pretending. Stop producing only a single number, accurate to three decimals. Instead, present a range of scenarios spanning the range of reasonable uncertainty about responses.

Responding to another point from Cochrane, Mankiw writes,

you need to specify how the government is going to satisfy its present-value budget constraint. You might be tempted to ask the model what happens if the government cuts taxes and never does anything else. But you won’t get very far. The model will tell you that the government has to do something else eventually, and it won’t tell you what will happen if the government tries to do something impossible.

What I hear Greg saying is that to properly do dynamic scoring, you would need to include a model of future policy responses. That is a point well taken, but I am not sure that I would restrict those policy responses to be only doing things that are possible. Policy makers are doing impossible (that is, unsustainable) things now. The challenge is to predict the outcome of undertaking unsustainable policies until you cannot do so any more.

Of course, the traditional “static” scoring does not solve the problem of how to predict the outcome of unsustainable policies, either.

The Harm of Government Debt

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Tyler Cowen writes,

I worry that the general decline of discretionary government spending may make politics less stable (but also more interesting, not necessarily in a good way). When there is plenty of spending to bicker about, politics revolves around that question, which is relatively harmless. When all the spending is tied up, we move closer to the battlefield of symbolic goods, bringing us back to “less stable and more interesting.” If that is a cause, this trend is likely to spread.

For a longer essay on the way that government borrowing creates political friction, see my essay Lenders and Spenders.

529: Popular != Good Policy

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Peter Suderman writes,

this episode and the swift bipartisan opposition it generated is so revealing, not only about the short term political instincts of the Obama administration, but about the longer term political and policy dynamics of sustaining the welfare state.

He is writing about President Obama’s proposal to tax savings from “529 plans” for college saving, which the Administration has since backed away from. I read Suderman as saying that the larger point is that when it comes to unsustainable fiscal policy, we have met the enemy and he is us. My comments:

1. Re-read Lenders and Spenders. Government debt inevitably leads to political strife.

2. 529 plans are regressive. Nearly all of the benefit flows to people with high incomes.

3. 529 plans are yet another enabler for colleges to boost tuitions.

4. 529 plans subsidize affluent people for doing what they would have done anyway–send their kids to exclusive, high-priced colleges.

529 plans are terrible public policy. Instead of demagogically criticizing the Administration’s proposal to tax them, I would say let’s get rid of them altogether.

Fiscally Responsible Italy

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Lawrence Kotlikoff writes,

As for Italy, its fiscal gap of negative 2.3 percent is the lowest of any of the 24 included countries. Indeed, Italy can spend almost €180 billion more and still be able to meet all its expenditure obligations. The source of Italy’s long-term fiscal solvency is its two major pension reforms that have dramatically reduced its pension obligations. In addition, Italy has strong control of its health care spending.

Pointer from Greg Mankiw.

This is why accrual accounting would be an improvement. Under the present system, politicians have an incentive to run up their debts in the form of obligations in pensions systems. By not using this trick, Italy managed to be fiscally responsible.

How do you say ‘Have a Nice Day’ in Japanese?

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John Mauldin writes,

If interest rates were to rise by a mere 2%, it would take anywhere from 80 to 100% of all Japanese tax
revenues simply to pay the interest on the Godzillaesque Japanese debt.

If you read Mauldin, you should do so over a period of time, to get a sense of his biases, which are strong.

However, his views are consistent with my emphasis on the notion that governments and banks are subject to multiple equilibria, and that when leverage is high, the movement from one equilibrium to another can be sudden and catastrophic.

World Bank Says Have a Nice Day

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From Ian Talley of the WSJ.

A host of governments around the world don’t have enough income to buffer against growth risks and higher borrowing costs. “You might think that you have sustainable debt dynamics, but that can change dramatically,” said Ayhan Kose, a lead author of the bank’s latest Global Economic Prospects report. Part of the report was published late Wednesday.

Read the whole thing. It is hard to pick out the scariest sentence.

The way I think about institutions that rely heavily on debt is that there are two equilibria. In the good equilibrium, lenders are confident (rightly or wrongly) that the debt will be repaid, interest rates are low, and there is no crisis. In the bad equilibrium, lenders are doubtful (rightly or wrongly) that the debt will be repaid, interest rates are high, and there is a crisis. While you are in the good equilibrium, it looks like borrowing does not cause any problem. When you hit the bad equilibrium, people look back and ask how you could have been so stupid. A few years ago, I explained the challenge with predicting the trigger point for a crisis ahead of time.

The article suggests that emerging markets are more fragile because in those countries private companies often need to be propped up by government, and in a crisis credit dries up for both private and public borrowers. The implicit assumption is that developed countries are immune from such double whammies. I am not so sure.