Debt Sustainability, Growth, Interest Rates, and Inflation: Some Charts for Discussion and Some Inconvenient Truths for MMT

In a series of posts[1] [2] [3] [4] [5] over the last couple of months, fellow Economonitor blogger L. Randall Wray and I have been exploring the conditions under which the government’s debt can be said to be sustainable. Wray writes from the point of view of Modern Monetary Theory (MMT), while I adopt a more eclectic and skeptical approach.

A pivotal issue in our discussion turns out to be whether the central bank can or should hold the nominal rate of interest on government debt, R, below the rate of growth of nominal GDP, G. (We could frame the discussion in real terms instead by subtracting the rate of inflation, ΔP, from both sides; it makes no difference.) If R is held below G, then essentially any level of the government’s budget deficit is “mathematically sustainable,” a term we have been using to mean that the debt-to-GDP ratio does not grow without limit over time. On the other hand, if R exceeds G, the budget balance must show a primary surplus, on average over the business cycle, to achieve mathematical sustainability of the debt. (See the first of the posts referenced above for a detailed discussion of the conditions for mathematical sustainability.)

It seems well established that the the central bank can hold R down to any desired level, if it wants to, by buying a sufficient quantity of government securities. Barring legal restrictions like the debt ceiling, it could, if necessary, buy up all of the outstanding government debt in exchange for currency and bank reserves. Economists call this procedure “monetizing the debt.”

The “should” part of the question concerns whether the degree of monetization necessary to hold R below G would have undesirable inflationary side effects. True, when the economy is operating far below capacity and inflation is quiescent, as it has been these last few years, low interest rates and rapid money growth, backed by strong fiscal stimulus, may be just what the doctor ordered. You don’t have to subscribe to MMT to make that argument. Just read Paul Krugman. However, what happens when the economy approaches full employment and prices begin to rise? Is it still a good idea to hold R below G? That is where I become more skeptical. >>>Read more

Tax Incentives for Retirement Saving are not Working. Can we Find a Better Way? (Part 2)

In a previous post in this series, I criticized proposals to raise the eligibility age for Social Security and Medicare. It is already getting harder to save enough for a comfortable retirement; raising the eligibility age would just make it  still more difficult. In this installment, I turn to policies to encourage retirement saving, explaining why our current system is not working well and suggesting some alternatives.

Why should we make it easier to retire? Grasshoppers vs. Ants

We can start by asking why making it easy to retire should be an objective of public policy in the first place. The fable of the grasshopper and the ant is the lens through which many people view the issue. The ant works hard and saves carefully all summer, while the grasshopper sings and dances. When winter comes, the grasshopper begs for a handout. The fable portrays the ant as justified in shutting her door to him. Why should the government, as agent of the ant-like taxpayers that pay its bills, behave any differently toward grasshoppers who don’t have the self-discipline to save during their working years?

The most common response is to justify government support for retirement as a form of social insurance. Life is full of risks. For retirement saving, the relevant risks include spells of unemployment, health problems, the risk of losses or low returns on retirement savings, the risk of inflation, and last but not least, the risk of outliving one’s savings. When we take those risks into account, we understand that some people will reach retirement age without adequate savings not because they are grasshoppers, but because they are unlucky ants. Many of the risks that can thwart the best-laid plans for retirement savings are neither under the control of individuals nor privately insurable. Only the government is in a position to pool the risks broadly enough to guarantee a minimum level of retirement income for everyone. >>>Read More

Economic Effects of Raising the Eligibility Age for Social Security: Why We Shouldn't Make it Harder to Retire (Part 1)

Last week the Business Roundtable came out with a position paper entitled “Social Security Reform and Medicare Modernization Proposals.” Its centerpiece is an increase to 70 in the eligibility for Social Security and Medicare. According to Gary W. Loveman, Ph.D., Chairman, CEO & President, Caesars Entertainment Corporation, and Chair of the Roundtable’s Health and Retirement Committee, the purpose is to modernize the programs in view of “new demographic realities.”

Raising the eligibility age is a bad idea. It is based on the false premise that, since Americans are healthier and living longer, they can and should assume greater individual responsibility for their retirement. Unfortunately, the reality is that for all but the wealthiest Americans, self-financed retirement is becoming harder, not easier. A higher eligibility age would only make it still more difficult.  >>>Read more of Part 1. Then read Part 2 here

CPI Unchanged in December; Five-Year Inflation Rate Hits 45-Year Low

Economists are sometimes accused, and justly so, of trying to read too much into the latest monthly wiggle in every data series that they watch. To counter that tendency, we can start the discussion of today’s release of inflation data with a longer-term view. Instead of looking at monthly CPI data, let’s look at five-year averages. As the following chart shows, 5-year inflation has fallen to an annual rate of just 1.9 percent, its lowest since the Vietnam War started heating things up in the 1960s.



>>>Read more
 

Can Lithuania’s New Government Meet the Economic Challenges Ahead?

Commentators often portray the Baltic countries as laboratories for testing the effects of austerity under fixed exchange rates. Although they share many common traits, Lithuania, Latvia, and Estonia have each followed distinctive paths during the global economic crisis. Estonia maintained tighter fiscal discipline going into the crisis, helping it to win entry into the Euro. Latvia suffered the deepest slump, but it has stuck with its austerity program for better or worse and has recently recorded some of the fastest quarterly growth rates in the EU. This post examines the distinctive elements that Lithuania has added to the Baltic saga. >>>Read more

What is the Liquidity Coverage Ratio for Banks and why should we Care that it has been Watered Down?

“Massive softening of Basel bank rules” read the headline in the print edition of Monday’s Financial Times. “Betrayed by Basel,” wrote Simon Johnson in a blistering post on his New York Times blog. At issue was a rule called the liquidity coverage ratio promulgated by the Basel Committee on Banking Supervision. If you are a banking wonk, the headlines would have been enough, but in case you are among those who are hazy on just what the liquidity coverage ratio is, what the Basel Committee does, and why we should care, read on. >>>More

Note to econ instructors: Check out these two slideshows on Basel III capital regulations and liquidity regulations for additional classroom-ready material.

Inflation Expectations are at a Record Low—or are they Soaring?

Both private investors and policymakers pay close attention to estimates of expected inflation. If investors expect inflation to be high, long-term, fixed-rate securities become less attractive, and market prices of those securities fall. If central bankers see that investors’ inflation expectations are high, they may decide to tighten policy. The trouble is, neither investors nor central bankers can observe inflation expectations directly, and not all methods for inferring expectations from market data give the same result. Sometimes, as at present, different estimation methods even point in opposite directions.>>>Read more

What is Holding Back Natural Gas as the Transportation Fuel of the Future?

The natural gas revolution has brought big changes to the U.S. energy scene. Natural gas prices, which used to move closely together with oil prices, have plunged in the last five years, as the following chart shows. One result has been the rapid displacement of coal by natural gas in electric power generation. According to a recent report from the Union of Concerned Scientists, some 100 gigawatts of coal-fired electric plants, representing more than a quarter of coal capacity and nearly a tenth of total U.S. electric capacity, have either been closed or are likely soon to be closed because they have become uncompetitive with natural gas. Natural gas has also been displacing oil at a rapid rate as a home heating fuel. In transportation, however, the use of natural gas is spreading more slowly.

Transportation ranks second only to electric power generation in total energy use. There are at least three ways to use natural gas to power transportation. One is to generate electricity with natural gas, which can then power electric cars or electrified rail lines. Another is to convert natural gas to liquids like methanol or synthetic gasoline. However, as I discussed in this post two years ago, the biggest potential lies in the direct use of compressed natural gas (CNG) or liquid natural gas (LNG) as a fuel for natural gas vehicles (NGVs). >>>Read more

Long-term Unemployment Falls as Labor Market Ends 2012 on a Quiet Note

The Bureau of Labor Statistics reported on Friday that the U.S. job market ended 2012 on a quiet note. Both the narrow and the broad unemployment rates were the same in December as in November. The economy added 155,000 payroll jobs, almost exactly equal to the month before. A jump of 30,000 in construction jobs suggested that Superstorm Sandy may have had an impact on the numbers, but there was no indication that the labor market was affected either for better or worse by uncertainty surrounding negotiations over the fiscal cliff.

The most significant change was a drop in the percentage of unemployed who had been out of work for 27 weeks or more, from 40 percent to 39.1 percent (see attached slideshow). That is the lowest level since October 2009. Long-term unemployment has been far higher throughout the recent recession and recovery than during earlier post-World War II contractions. >>>Read More

Follow this link to view or download a classroom-ready slideshow with charts of the lastest job market data.

The Not-so-Simple Economics of Right to Work Laws

There was much hand wringing and an equal amount of triumphant cheering last month, when Michigan became the twenty-fourth state to adopt a right to work (RTW) law. It joined Indiana, which went RTW last February, as only the second major industrial state with such a policy. Much of the commentary portrayed the spread of RTW as a victory for corporate power over working America, but do we really know what the effects will be? The rhetoric surrounding the passage of Michigan’s law has shed more heat than light on the matter. A less impassioned review of the issues suggests that the effects of RTW on labor markets are not as simple as supporters and opponents make them out to be. >>>Read more

The Budget Deal: What We Have Left Undone

Making fiscal policy is never going to be easy, but it would be easier if we broke the process down into a logical sequence of steps. Here are those steps, as I see them:

1. Decide how large a government we want in terms of government purchases and transfer payments. Any such number will necessarily have to be a political compromise, because not everyone will agree, but the result should be consistent with inescapable realities such as demographic trends.
2. Agree on a set of budget procedures for prioritizing line items within the constraint imposed by (1), and then follow the agreed procedures.
3. Determine the tax revenue needed to support the desired level of spending. This amount should be consistent with long-term considerations of sustainability.
4. Agree on a set of rules for adjusting spending and revenue over the business cycle. The rules should allow for a prudent amount of cyclical stimulus and restraint as appropriate, while maintaining consistency with decisions (1) and (3).
5. Agree on a tax structure that collects the amount of revenue required by (1), (3), and (4) in a way that is consistent with efficiency (broadest feasible base, lowest feasible marginal rates) and fairness (another political compromise).

Which of these five steps did Congress accomplish in 2012? Not one of them.  That conclusion will hold whether or not the House approves the last-minute stopgap measure passed by the Senate on New Year’s Eve.

In the consensus view, two things are holding back the recovery. One is the fear of an “austerity bomb”—a dose of British-style front-loaded austerity early in 2013, when what the economy really needs is a fix for its long-run inability to manage its budget. The other is sheer uncertainty—how many kilotons of fiscal TNT? Will it be all cuts? If so, which programs will be hit? If revenue is to rise, how much will come from structural tax reform and how much from increases to marginal rates? The New Year’s deal does nothing to answer these questions. All it does is to ensure that we go through the whole exercise again at another midnight a couple of months from now.

So here’s a resolution for the Honorable Members of the incoming Congress: Let’s do in the New Year those things which we left undone in the old. All five of them.

Originally posted on Economonitor.com. Reposted with permission.