This was too good of an article from the FreeExchange today:
HOW much should we worry about the budget deficit? Paul Krugman is not terribly concerned, he claims economists and markets aren’t either:
Yet they aren’t facts. Many economists take a much calmer view of budget deficits than anything you’ll see on TV. Nor do investors seem unduly concerned: U.S. government bonds continue to find ready buyers, even at historically low interest rates. The long-run budget outlook is problematic, but short-term deficits aren’t — and even the long-term outlook is much less frightening than the public is being led to believe.
Like Mr Krugman, I don’t worry so much about short-term, discretionary spending. We are still in a very fragile recovery period. Cutting spending now could indeed prolong the recession and result in an even worse fiscal position. The sudden hysteria is perplexing, but serious concern is long overdue.
The long-run budget issues are very worrying. Economists tend to take a more nuanced view about debt. Many agree that running a deficit is not necessarily a huge problem; so long as the size of national debt stays low enough that interest payments do not exceed GDP growth, things are manageable. When that is the case you can keep issuing debt and making interest payments without raising taxes or cutting spending. Then, in principle, you can run deficits indefinitely. But if investors worry that the debt will become unmanageable, or outpace economic growth, they will become less inclined to buy a country’s debt. The government then must offer higher interest rates for its debt, and interest payments then do become a burden on taxpayers. That lowers growth even further. It then becomes tempting to inflate the debt away (which becomes a non-trivial concern if Fed independence is further undermined) and interest rates rise further.
Granted, suggestions that America’s economic policy is on the fast track to resembling Argentina are hysterical. But a problem still exists; the amount of debt projected to come from Medicare and Social Security in thirty years is unsustainable, for reasonable levels of GDP growth and likely interest rates. Mr Krugman points out that America must address health care spending. I’d also add entitlements to the list. Leaving it to the next decade, as Mr Krugman suggests, would be a mistake. The sooner health care and entitlement spending are fixed the less expensive the solution will be. Also, Social Security’s long term solvency issues add to uncertainty. I’ve heard people of all ages say, “Well, I can’t count on what I’ll get from Social Security.”
So long as Social Security finances remain a concern, making appropriate retirement planning and saving decisions is very difficult. I’ve heard it argued that because Medicare is a bigger threat than Social Security we can ignore the latter. But, that’s like saying don’t bother to fix a broken leg if your patient has cancer. That broken leg can still cause an infection and kill you.
Cutting current spending would be a terrible idea, but thoughtfully addressing entitlements addresses the long-term problems now. It need not even affect benefits to current retirees or impinge on the recovery. It does send a clear, credible message to markets that America can keep its debt under control. Alan Greenspan remarked on Meet the Press this weekend:
I think the thing that disturbed me most in the last week or two was when the discussion was involved in, I believe, in the Senate on the issue of forming a commission--a congressionally-authorized commission, as I read it, there was a 97-to-nothing vote to exclude Social Security from the deliberations of that commission. That said to me that we have gotten to the point in this country where spending is untouchable. I have no doubts that we have to raise taxes in order to close this huge deficit. But we cannot do it wholly on the tax side because that would significantly erode the rate of growth in the economy and the tax base, and the revenues that would be achieved would be far less than anybody'd expect. We have to recognize the fact that one of the things that we have to do, as tough as it's going to be, is that benefits are going to have to be paired in conjunction with tax increases
to resolve this very serious long-term budget problem.
What sort of message does that send to markets about America’s commitment to fiscal responsibility?
The next time America finds itself in a recession it may not be able to issue debt so easily to boost its economy. Also, America’s domestic saving rate is very low. It does not provide itself with enough capital to fund growth and expansion. America relies on foreign capital to feed growth. If that dries up, Americans will either have to seriously cut back on consumption or concede that the America economy will not grow at the pace it once did.
So why then, as Mr Krugman asks, are investors still willing to purchase American debt at such low interest rates? Does this mean markets are not worried about America’s long-run fiscal outlook? Maybe, but I doubt it. Some investors always crave “risk-free” assets. American debt still, to a large degree, is the best “risk-free” option. What else is there? Eurobonds don’t look so good at the moment. But the current lack of better alternatives can not be the justification to not get your financial house in order.
HOW much should we worry about the budget deficit? Paul Krugman is not terribly concerned, he claims economists and markets aren’t either:
Yet they aren’t facts. Many economists take a much calmer view of budget deficits than anything you’ll see on TV. Nor do investors seem unduly concerned: U.S. government bonds continue to find ready buyers, even at historically low interest rates. The long-run budget outlook is problematic, but short-term deficits aren’t — and even the long-term outlook is much less frightening than the public is being led to believe.
Like Mr Krugman, I don’t worry so much about short-term, discretionary spending. We are still in a very fragile recovery period. Cutting spending now could indeed prolong the recession and result in an even worse fiscal position. The sudden hysteria is perplexing, but serious concern is long overdue.
The long-run budget issues are very worrying. Economists tend to take a more nuanced view about debt. Many agree that running a deficit is not necessarily a huge problem; so long as the size of national debt stays low enough that interest payments do not exceed GDP growth, things are manageable. When that is the case you can keep issuing debt and making interest payments without raising taxes or cutting spending. Then, in principle, you can run deficits indefinitely. But if investors worry that the debt will become unmanageable, or outpace economic growth, they will become less inclined to buy a country’s debt. The government then must offer higher interest rates for its debt, and interest payments then do become a burden on taxpayers. That lowers growth even further. It then becomes tempting to inflate the debt away (which becomes a non-trivial concern if Fed independence is further undermined) and interest rates rise further.
Granted, suggestions that America’s economic policy is on the fast track to resembling Argentina are hysterical. But a problem still exists; the amount of debt projected to come from Medicare and Social Security in thirty years is unsustainable, for reasonable levels of GDP growth and likely interest rates. Mr Krugman points out that America must address health care spending. I’d also add entitlements to the list. Leaving it to the next decade, as Mr Krugman suggests, would be a mistake. The sooner health care and entitlement spending are fixed the less expensive the solution will be. Also, Social Security’s long term solvency issues add to uncertainty. I’ve heard people of all ages say, “Well, I can’t count on what I’ll get from Social Security.”
So long as Social Security finances remain a concern, making appropriate retirement planning and saving decisions is very difficult. I’ve heard it argued that because Medicare is a bigger threat than Social Security we can ignore the latter. But, that’s like saying don’t bother to fix a broken leg if your patient has cancer. That broken leg can still cause an infection and kill you.
Cutting current spending would be a terrible idea, but thoughtfully addressing entitlements addresses the long-term problems now. It need not even affect benefits to current retirees or impinge on the recovery. It does send a clear, credible message to markets that America can keep its debt under control. Alan Greenspan remarked on Meet the Press this weekend:
I think the thing that disturbed me most in the last week or two was when the discussion was involved in, I believe, in the Senate on the issue of forming a commission--a congressionally-authorized commission, as I read it, there was a 97-to-nothing vote to exclude Social Security from the deliberations of that commission. That said to me that we have gotten to the point in this country where spending is untouchable. I have no doubts that we have to raise taxes in order to close this huge deficit. But we cannot do it wholly on the tax side because that would significantly erode the rate of growth in the economy and the tax base, and the revenues that would be achieved would be far less than anybody'd expect. We have to recognize the fact that one of the things that we have to do, as tough as it's going to be, is that benefits are going to have to be paired in conjunction with tax increases
to resolve this very serious long-term budget problem. What sort of message does that send to markets about America’s commitment to fiscal responsibility?
The next time America finds itself in a recession it may not be able to issue debt so easily to boost its economy. Also, America’s domestic saving rate is very low. It does not provide itself with enough capital to fund growth and expansion. America relies on foreign capital to feed growth. If that dries up, Americans will either have to seriously cut back on consumption or concede that the America economy will not grow at the pace it once did.
So why then, as Mr Krugman asks, are investors still willing to purchase American debt at such low interest rates? Does this mean markets are not worried about America’s long-run fiscal outlook? Maybe, but I doubt it. Some investors always crave “risk-free” assets. American debt still, to a large degree, is the best “risk-free” option. What else is there? Eurobonds don’t look so good at the moment. But the current lack of better alternatives can not be the justification to not get your financial house in order.
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