Debt and Deficits

Some of you who know me and endured my classes may remember (if you stayed awake) that I liked to show you the National Debt Clock . (This is a different one, but I think it's pretty cool.) And in class I would generally answer concerns about the size of the debt and deficits to our real GDP, in loose terms the income of the country. My favorite analogy was to compare the country's debt load to that of a homeowner, where higher income people had significantly higher debt loads, particularly on home mortgages, and it was okay because their higher incomes allowed them to adequately service the debt -in other words, they could afford the payments on the debt.

I'm becoming concerned that the National Debt is approaching an unaffordable point. We are now borrowing so much money and running such massive deficits that we may be putting the United States in the same position as the credit card abuser who runs up huge debts and has nno way to erver pay the debts off. And while this trend became somewhat troubling during the Bush Presidency, the acceleration of the spending and piling up of debt which has occurred so far in the Obama Presidency is frightening. Take a close look at this chart:

In today's news, a prominent economist is predicting that the United States will have to default on Treasury Bonds - not pay the debts when they are due. After that, who would lend to us ever again? What about the effect on interest rates? The rate you pay is based in significant part on risk premium, whether the lender believes you'll pay them back. Default, and rates go up. Or do we say this is the US government, let's just print the money? I don't want to become the next Zimbabwe.

I don't have a good feeling about this. The answer seems to me that government spending needs to be controlled, and ways of increasing revenue need to be found. And as I've said before, I don't think the revenue increase is going to come from simply raising taxes on the rich.

Disturbed?

Cash for Clunkers?

In class, I follow the traditional appraoch to teaching macroeconomics. We teach a little of the Keynesian aggregate expenditures theory, followed by quite a bit of "fiscal policy". The we do quite a bit of monetary policy. Then, almost as an afterthought, we spend about a single class session on supply side approaches. This is in part a reflection of how the material is ultimately tested by the College Board and partly a reflection of our textbooks.

Personally, I have serious questions about Keynesian fiscal policy, and I have seen and studied much evidence supporting the effectiveness of supply side approaches. But let's see if we can spot one of my major misgivings about Keynesian fiscal policy in the current "Cash for Clunkers" program.

A digression: if I see one of you at Sonic, and I ask you to come dig a hole in my backyard and pay you $100, then tomorrow I ask you to come fill it in and pay you another $100, how is our economy enhanced? Where is the economic growth? All we have done is transfer $200 from me to you, without there being any economic substance or growth.

If the government pays you $4,500 for your car so that you can buy a new car and insists that your old car be destroyed, how is that any different in substance from my hole-digging analogy? What have we done other than transfer money from the government to the car manufacturers indirectly through this program? Yes, the auto manufacturers employ workers and pay them, but by destroying the traded in cars, we eliminate the potential of real economic growth. Maybe GDP will grow in the immediate time-frame, but how much of this represents purchases that would have occurred in the future? We are time-shifting economic activity, not creating growth.

That's my fundamental problem with most fiscal policy solutions. By having the government increase its spending, it is spending money that taxpayers would otherwise spend on their own. The money the government spends is taken away from taxpayers (or printed - see the post below on inflation) and therefore the taxpayers don't get a chance to spend it on what they want or need. An editorial I read recently in the Wall Street Journal suggested that the logical extension of this is the government should give us incentive payments for other things we buy so that we'll buy them now rather than deferring our purchases - makes as much sense as paying you to dig and then fill in holes in my yard.

Taxes?

Remember during the Presidential campaign? Remember how then-candidate Obama said 95% of Americans would see a tax decrease?

One of the major disputes between Keynesian and Supply-Side economists is the relative roles of government spending and taxes. Both sides see tax decreases as expansionary, with the arguments over the size and mechanics of how tax decreases work to stimulate an economy. Supply-siders focus on incentives and rely on what is sometimes characterized as "trickle-down" while Keynesians argue that tax decreases increase disposable income, thereby increasing consumer spending (as influenced by the marginal propensity to consume).

I think both economic perspectives would see a tax increase as contractionary, not expansionary. Traditional Keynesians see a government spending increase accompanied by a tax increase as being only slightly expansionary.

In any event, despite claims during the campaign that his planned spending increases would necessitate tax increases which were adamantly objected to and refuted by the candidate, the President has now sent his top economic advisors on a round of Sunday talk shows to float the idea that middle class tax increases may be necessary. Let's see: unemployment is still rising and the recovery, if we have reached bottom, is weak, so let's raise taxes. Campaign on no tax increases, then increase taxes. Does anyone remember George H.W. Bush (Bush 41) and his statement "Read my lips, no new taxes"? After going back on that pledge, he became a one-term President as Bill Clinton pointed out over and over "It's the economy, stupid."

Those who don't remember history are doomed to repeat it. Or is it merely hubris?