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The land of the free – sliding further into oppression

Overnight, the US Bureau of Labor Statistics released their latest Mass Layoffs data (May 2011) which showed that the number of mass layoff events in May increased by 2 percent. Further, another month went by and the US national unemployment rate remained unchanged at (a very high) 9.1 percent. There is very little happening to reduce it and the omens are bad. Also yesterday the US Federal Reserve decided to keep interest rates on hold in the 0 to 1/4 per cent range indefinitely and the Congressional Budget Office (CBO) released its 2011 Long-Term Budget Outlook. The statements accompany the central banks decision by its Chairperson Ben Bernanke about long-run fiscal problems and the very aggressive message in the CBO Outlook suggest that the politicians will continue to retard the US economic recovery and lock millions into entrenched unemployment and poverty. The US leaders are sure making a mess of things and the advice they are getting is appalling. The omens are clear – aggregate demand growth is desperately required to attack unemployment. But the land of the free is sliding further into oppression – self-induced by its political class.

There was a Bloomberg story this morning (June 23, 2011) – Gold softens as Fed abandons stimulus – defined this abandonment in terms of the decision not to introduce QE3.

The Statement from the US Federal Open Market Committee (FOMC) which was released after their two-day meeting to determine their on-going monetary policy strategy said:

To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee will complete its purchases of $600 billion of longer-term Treasury securities by the end of this month and will maintain its existing policy of reinvesting principal payments from its securities holdings.

More realistically, QE1 and QE2 were hardly what we might consider to be “stimulus” measures and while they do not seem to have done any harm (and why would they) it is clear they have not promoted meaningful growth capable of reducing unemployment in any significant way.

At his press conference following the FOMC decision, the US Federal Reserve Chairman reiterated the fact that the central bank is not independent in the US. He could have been presenting the Congressional Budget Office’s latest Long-term Fiscal Outlook (which I consider below) given his obsession with the “long-term deficit problem”.

On several occasions, including his regular briefing to the US Congress, Bernanke has been contributing the deficit hysteria and influencing impressionable but ignorant politicians to charge into fiscal austerity.

Meanwhile the accountants in the US are getting ahead of themselves. I refer to the US Congressional Budget Office latest release (June 22, 2011) – CBO’s 2011 Long-Term Budget Outlook which contains some truly mind-boggling analysis. I think they should stick to adding up and subtracting numbers and leave the analysis to those who know what they are talking about.

Which raises another question – who might that be?

But leaving that aside what is wrong with the latest CBO outlook? A more efficient strategy might be to ask what is correct. Answer: very little that can be discerned.

The CBO outline two scenarios which “embody different assumptions about future policies governing federal revenues and spending”. They are: (a) The Extended-Baseline Scenario – which “adheres closely to current law” (meaning “the expiration of the Bush tax cuts”, “the growing reach of the alternative minimum tax” and changes to the recent health care system); and (b) The Alternative Fiscal Scenario – “which incorporates several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period”. Basically, this is includes the reversal of the things in the Baseline Scenario.

They claim that “(m)any budget analysts believe that the alternative fiscal scenario presents a more realistic picture of the nation’s underlying fiscal policies than the extended-baseline scenario does” to which I say all the deficit terrorists who are beating their drum assume the most extreme assumptions so that their graphs hit the ceiling of the chart border more quickly. That is, after also conveniently manipulating the scale of the graph for maximum effect.

While neither scenario scares me the fact is that the alternative scenario is a ruse. It holds tax revenue constant at 18.4 per cent of GDP from 2021 until 2085 and assumes federal spending to rise from 24.1 per cent of GDP in 2011 to 75.9 per cent of GDP in 2085. The underlying macroeconometric model that delivers the simulation is very strange indeed.

From the perspective of the economy the CBO assumes that:

1. Unemployment falls to 5 per cent by 2030 and remains at that level (their “NAIRU” or full employment level) until 2085.

2. Inflation is assumed to be stable from 2024 to 2085 at 2.5 per cent despite this massive escalation in public spending.

3. Real GDP growth is basically stable at at average rate of 2.3 per cent from 2011 to 2085 (basically trend).

4. The real interest rate is constant at 3 per cent from 2015 to 2085 which when you combine the assumption about inflation being constant means that nominal interest rates are assumed to be stable at 5.3 per cent over this period (on average).

5. Real wages growth is assumed to be stable at around 1.4 per cent per annum over the period to 2085.

So are you getting the picture? A pretty stable economy. Stable inflation, stable real wages growth, stable real GDP growth, and stable and low interest rates.

The difference between the scenarios is that under the Extended-Baseline, the public sector is smaller whereas under the Alternative fiscal scenario the private sector goes on holidays and saves like hell – given their share of total spending is squeezed dramatically.

It would take me beyond the time I have today to fully explain to you the underlying modelling that the CBO uses to model their growth trajectories but the point remains that it is hard to see anything really wrong with the assumed economic trajectories.

But taking their assumptions at face value how then do they conclude that “the impact of growing deficits and debt” will be very detrimental.

… large budget deficits and growing debt would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States.

The GDP growth rate by their own admission “would be less affected by rising debt than GNP would be because the change in GDP does not reflect the increased future outflow of profits and interest generated by the additional capital inflows”. GNP is Gross National Product and differs from Gross Domestic Product “primarily by including the income that U.S. residents earn from their investments abroad and excluding the income that nonresidents earn from their investments in this country”.

So workers in the US who typically do not have investments abroad are not particularly disadvantaged by the trajectories assumed – they enjoy a constant unemployment rate, low inflation and borrowing rates and constant growth in real wages.

The CBO Report has an extended section on “crowding out”. They claim that:

Increased government borrowing generally draws money away from (crowds out) private investment in productive capital, leading to a smaller stock of capital and lower output in the long run than would otherwise be the case. Deficits generally have that effect on private investment because the portion of people’s savings used to buy government securities is not available to finance private investment.

There is no robust evidence to support this claim. Further, an understanding of the way the monetary system works and the impact of deficits would conclude the opposite.

The financial crowding out assertion is a central plank in the mainstream economics attack on government fiscal intervention. At the heart of this conception is the theory of loanable funds, which is a aggregate construction of the way financial markets are meant to work in mainstream macroeconomic thinking.

The so-called loanable funds market is alleged to mediate saving and investment via interest rate variations. It was the Pre-Keynes paradigm. Accordingly, if consumption fell, then saving would rise and this would be instantaneously (painlessly) accommodated by the economy without a decline in output because private investment (capital goods production) would rise in proportion with saving. Why? Because the rising saving would depress interest rates (more funds available to lend) and that would stimulate investment.

Changes in the interest rate thus create continuous equilibrium such that aggregate demand always equals aggregate supply and the composition of final demand (between consumption and investment) changes as interest rates adjust.

According to this theory, if there is a rising budget deficit then there is increased demand is placed on the scarce savings (via the alleged need to borrow by the government) and this pushes interest rates to “clear” the loanable funds market. This chokes off investment spending.

The mainstream economists conceive of this as the government reducing national saving (by running a budget deficit) and pushing up interest rates which damage private investment.

Further, from a macroeconomic flow of funds perspective, the funds (net financial assets in the form of reserves) that are the source of the capacity to purchase the public debt in the first place come from net government spending. Its what astute financial market players call “a wash”. The funds used to buy the government bonds come from the government!

There is also no finite pool of saving that is competed for. Loans create deposits so any credit-worthy customer can typically get funds. Reserves to support these loans are added later – that is, loans are never constrained in an aggregate sense by a “lack of reserves”. The funds to buy government bonds come from government spending! There is just an exchange of bank reserves for bonds – no net change in financial assets involved. Saving grows with income.

Additionally, credit-worthy private borrowers can usually access credit from the banking system. Banks lend independent of their reserve position so government debt issuance does not impede this liquidity creation.

So there is no valid conceptual basis to the CBO’s insistence that crowding out will be endemic in the US over the next 74 years.

Conceptually, the CBO thinks that budget deficits destroy “national saving”. In fact, they do the opposite. Following the previous discussion, the important point is that deficit spending generates income growth which generates higher saving. It is this way that Modern Monetary Theory (MMT) shows that deficit spending supports or “finances” private saving not the other way around.

Further, the concept of a fiat currency issuing government “saving” in its own currency is nonsensical. Saving is the act of postponing consumption in return for higher consumption possibilities in the future. It is an act of an intrinsically revenue-constrained entity like a household (or non-government entity in general).

But the national government that issues its own currency can spend whenever there is something for sale in that currency and never has to “save up” to exploit better spending opportunities in the future.

The CBO clearly doesn’t understand the different roles that the government and non-government sectors play in the macroeconomic system. It assumes the government is like a (big) household. The reality is that the national US government is not remotely like a US household. It is a fully sovereign government and is never ultimately revenue constrained because it is the monopoly issuer of the currency. American households use the currency and have to find ways of getting it from the government.

But undaunted the CBO then went hysterical claiming that higher public debt levels:

  • … imply higher interest payments on that debt, which would eventually require either higher taxes or a reduction in government benefits and services.
  • … would increasingly restrict policymakers’ ability to use tax and spending policies to respond to unexpected challenges, such as economic downturns or financial crises. As a result, the effects of such developments on the economy and people’s well-being could be worse.
  • … would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates. Such a crisis would confront policymakers with extremely difficult choices. To restore investors’ confidence, policymakers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.

From bad to outright hysterical.

On the first prediction – please see Japan – 20 years of high deficits (relative) and the public debt ratios way over the scenarios simulated by the CBO for the US and interest rates (and government bond yields) hover around zero (or just above). Totally stable and totally within the control of the Bank of Japan rather than private markets.

There is no implication that tax rates or reductions in services would be necessary. The politicians might connive to increase taxes or cut public services but there would be no underlying operational reason stemming from the characteristics of the monetary system.

What I would see were the rising income levels of the private sector (receiving the interest payments) and the declining public deficits as private spending grows. I would see rising private wealth and the improved options that that state offers as a result of the rising public debt.

All of which would be a positive future – especially given the underlying economic assumptions that CBO makes (all good – except for the 5 per cent unemployment rate which I would reduce to 2 per cent via a Job Guarantee).

Second, following the logic about national saving above, the rising public debt levels categorically do not “restrict policymakers’ ability to use tax and spending policies to respond to unexpected challenges, such as economic downturns or financial crises”. That is an outright lie. The national government can spend whenever it likes on things that are for sale in USD. This is independent of it previous fiscal state – surplus or deficit.

There is never a financial constraint on the US government’s ability to respond to fluctuations in private spending which endanger stable growth.

Finally, the hysterical claim that the US government will enter a “sudden fiscal crisis” – which the Republican nut Paul Ryan called an “ominous credit cliff” – and no-one will lend to them at “affordable rates” – is without any empirical or conceptual foundation.

When has that ever happened? Answer: never.

The fact is that the bond markets need government debt not the other way around. The requirement that the US federal government issue debt to match its net spending is voluntary only.

In financial terms, there is no such requirement. The US government knows that and the bond markets know that. If at any point, the bond markets considered they had more “power” than they actually have and started to make life difficult for the US government (under the current arrangements) those voluntarily-imposed requirements would change very quickly.

Japan has had larger deficits to match against public debt issuance for two decades now and they have never had any trouble finding purchasers despite near zero yields over that time.

Please read my blog – Who is in charge? – for more discussion on this point.

Further, should bond markets lose interest in staying on the US government’s corporate welfare teat then the following memo would suffice:

From: The President
To: Ben Bernanke
Re: Crediting a few Treasury bank accounts.

Dear Ben

Get on that computer and flick a few numbers our way please. Or else.

Best wishes
The boss

Remember the US 60 minutes interview with Ben Bernanke on June 8, 2009?

The CBS interviewer (Scott Pelley) and Bernanke talked about US government spending:

Asked if it’s tax money the Fed is spending, Bernanke said, “It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It’s much more akin to printing money than it is to borrowing.”

“You’ve been printing money?” Pelley asked.

“Well, effectively,” Bernanke said. “And we need to do that, because our economy is very weak and inflation is very low. When the economy begins to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation.”

Current institutional arrangements notwithstanding, the US government (the consolidated treasury and central bank – for monetary purposes) can never go broke, never has to rely on private bond markets, and can at any time change the arrangements which are in place to present an illusion of the government being privately funded.

As noted above, the government just borrows back its own spending. There are no funds to borrow without prior public spending.


The conclusion by the CBO that the US government “will need to increase revenues substantially as a percentage of GDP, decrease spending significantly from projected levels, or adopt some combination of those two approaches” has not basis in reality.

Unemployment levels are very high (and layoffs have starting increasing again). Inflation is benign. Interest rates are low. Real GDP growth is positive but being threatened by the dysfunctional polity.

The urgency is that the US federal government should reduce revenues substantially, increase spending, or adopt a combination of the two depending on your value system and political leanings.

Either way more net public spending is currently needed not less.

Taking “earlier action” along the lines recommended by the CBO would jeopardise the recovery.

That is enough for today!

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    This Post Has 9 Comments
    1. Bill, I agree – except for one minor quibble.

      In the passage starting “But undaunted…”, you answer the CBO’s concerns about higher debt levels leading to more interest payments by referring to Japan, with its very high debt to GDP ratio and very low rate of interest. Plus you say, as I understand you, that these interest rates are “within the control of the Bank of Japan rather than private markets”.

      I think there are a couple of flaws in this argument. First I suspect low interest rates in Japan stem largely from the very high savings desires by Japanese households. Second, ASSUMING a monetarily sovereign country takes the lunatic decision to borrow instead of using its printing press, then the relevant interest rate will be determined by the market, as much as by the central bank. To illustrate, if the Fed has total control over the interest rate on Treasuries, why doesn’t it offer Treasury holders Japanese style interest rates? Reason is there’d be no takers.

      I.e. the best answer to the above CBO point is this. “If you don’t like paying interest, then don’t borrow: use your printing press instead. Plus, only a lunatic PAYS for something they can produce themselves for free, so just stop borrowing, stupid.”

    2. Sometime in the past fortnight The International Herald Tribune, published in Paris, editorial said that American business was no longer concerned with selling into their domestic market, they saw sales growth occurring in the developing markets of India and China. The International Herald Tribune said it suited corporations for US labor costs to be reduced and they expected strong growth in expensive consumer labels.

    3. Ralph, the interest rate on treasuries is actually lower than the Fed target rate of 0.25%. So if the government printed money instead of borrowing (short term), its interest expense would increase.

    4. Thanks for that Ralph. There always comes a point in an MMT argument when someone says. “Japan is different to the US /UK because they have high private savings and a current account surplus”.

      I’d also like to know if Bill or anyone has a smart response to this FAQ.

    5. Dear Andrew (at 2011/06/23 at 22:18)

      Both Japan and the US have a central bank that can be instructed by the government to do its bidding. Ultimately whatever other institutional arrangements exist (deep domestic savings etc) the governments in these nations can render the private bond market irrelevant irrespective of whether it be dominated by local buyers or China.

      best wishes

    6. A quibble:
      The CBO list of assumptions seems reasonable enough, at least to the extent one can make predictions over 75 years (!), except for the real interest rate of 3% being greater than the growth rate of 2.3%. Empircally I believe this is not actually the case in the US, as per Scott Fullwiler. Further, if one assumes that ”printing money” ( the central bank being a major primary purchaser of treasury securities) is bad and therefore ruled out, this assumption becomes problematic because it in large part drives the escalating debt-to-GDP ratio deficit alarmists are so concerned about and use very effectively in their public statements.

      Since the interest rate is a policy decision (as you point out repeatedly) it would be possible to ensure the interest rate is a couple of points below the growth rate whereupon the debt\deficit ”problem” melts away or at least becomes much less scary in the hands of the alarmists. Since this was actually done for 30 years during and post WW II it makes for a credible policy option even within the confines of the mainstream. Some conservative economists (e.g Reinhart) and bond traders (e.g. PIMCO) have recently woken up to this possibility.

    7. Ralph,

      “To illustrate, if the Fed has total control over the interest rate on Treasuries, why doesn’t it offer Treasury holders Japanese style interest rates? Reason is there’d be no takers.”

      Not sure that is the case. What else are they going to do with their currency. Leave it on ice at the even lower overnight rate?

      I rather think the higher interest rate is there to ensure that the bond issue clears – and for corporate welfare. For example the latest gilt auction (which is more of a tender than an auction) of 2% UK Treasuries was oversubscribed by 1.56 times. If that was a proper competitive auction and the government was quite happy to leave the gilts on the shelf then that rate would be a lot lower.

    8. Help please in understanding an apparent contradiction.
      Instructions from the President to Ben “– markup a few Treasury accounts–”
      Bernanke to 60 minute interviewer—-‘we lend money to the banks by making a few computer entries — which is effectively printing money’
      (My slight editing does not, I think,change the gist)

      How can I reconcile these two ‘statements.’

    9. Neil, You ask “What else are they going to do with their currency?” My answer is that this is a classic supply / demand scenario. I.e. some would, as you suggest, “Leave their money on ice at the even lower overnight rates”. Others would take their money out of the country in search of better returns elsewhere. And a third group would buy Treasuries, and just grin and bear the new lower interest rates.

      So the Fed is left with a problem: it would not be able to borrow as much as it wanted. Of course the Fed has the power to reduce interest rates, but it can only do that by printing money and buying Treasuries, and my comment above was based on the assumption that the central bank does NOT print money, but borrows instead.

      I say “classic supply / demand scenario” because it’s a bit like the price of apples going up: some apple consumers pay the new higher price and grin and bear it, some purchase other stuff instead, etc etc.


      In reference to countries that are monetarily sovereign, I like Bill’s point that “governments in these nations can render the private bond market irrelevant”. Quite so. I’d just like to see these governments get on and do it!


      JB, I don’t see where the inconsistency is between the two statements.

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