I’m holding off on a couple of genomics posts, and instead wearing my Mike the Mad Post-Keynesian hat, since global financial system might get…shaky. During the ongoing pandimensional clusterfuck that is the debt ceiling negotiations, one thing that is used to bolster the prophecies of budgetary DOOOM!! is the CBO (Congressional Budget Office) estimates. These estimates lead to claims that future budget deficits are ‘unsustainable.’ We must therefore
make Grandma eat catfood cut funding for the disabled and needy engage in fiscal austerity.
But, as I’ve noted many times about Social Security and Medicare, most estimates are incredibly pessimistic: for instance, the collapse of Medicare has been predicted to occur in ten to fifteen years since 1993 (do the arithmetic). Nonetheless, these estimates not only have a piss poor track record, they also have a fundamental flaw, as described by James Galbraith in a policy note, “Is the Federal Debt Unsustainable?”
So what do we mean by ‘unsustainable?’ Typically, it’s colloquially used to mean ‘really big and scary’, but that’s not something very measurable. Economist Willem Buiter, former adviser to the Bank of England, argues that sustainability in the context of deficit reduction is best thought of as a stable GDP-debt ratio: that is, relative to the size of the economy, the public debt does not increase. Seems reasonable.
I’ll leave out the equations (although the math is not very difficult), and proceed straight to the key points. First, Galbraith shows that if the inflation-adjusted interest rate (the ‘real’ interest rate) on the public debt is greater than the real growth rate of the economy, debt is unsustainable. The trajectory of that instability can vary, but it doesn’t who you are, the GDP-debt ratio is going to rise.
Second, the converse is true: when the real interest rate is lower than than the real growth rate (or, even better, negative), the GDP-debt ratio will eventually become stable. Where it stabilizes will depend on the particulars, but it will stabilize. Under that scenario, we are not DOOMED!!
So what does economic history tell us? Between 1946 and 1980, the average real return on public debt was negative (and the middle class prospered by the way). The real rate of return did increase faster than GDP growth during the 1980s and 1990s due to the after-effects of the Volcker-led Federal Reserve efforts to lower inflation (Volcker cranked up interest rates on short- and long-term bonds). But in the 2000s, real rates of return dropped, and today, public debt is actually a money-losing proposition (tangential aside: If you’re wondering why anyone would buy U.S. debt in that case, U.S debt pre-Tea Party is safer than holding onto cash. If you have $100 million, you don’t stick it in ~400 FDIC insured saving accounts).
So back to the Congressional Budget Office. What do they think? That’s kinda hard to know, since they’ve stuffed their collective head up their collective ass. Galbraith (boldface mine):
In its baseline forecasts, the CBO simply assumes that short-term interest rates will rise to around 4.5 percent nominal–or 2.5 percent real, given their low-inflation forecast–within five years. This by itself makes their projected debt/GDP path “unsustainable.” It’s a bizarre assumption. It would also be economically disastrous, since rising rates would clobber the stock, bond, and what remains of the housing markets. The CBO just assumes the disaster wouldn’t happen–but it obviously would, and it’s plain that their interest rate assumptions are inconsistent with everything else in their forecast.
Other than that, the CBO estimates are just peachy. So what are the implications of recognizing the inanity of the CBO estimates? Well, ‘sustainability’ is not a problem (emphasis original; boldface mine):
At a reasonable interest rate for risk-free liquid bonds, more-over, the present debt/GDP path of the United States is (or would be) sustainable, especially following modest economic recovery. The CBO’s assumption, which is that the United States must offer a real interest rate on the public debt higher than the real growth rate, by itself creates an unsustainability that is not otherwise there. It also goes against economic logic and is belied by history. Changing that one assumption completely alters the long-term dynamic of the public debt. By the terms of the CBO’s own model, a low interest rate erases the notion that the US debt-to-GDP ratio is on an “unsustainable path.”
The prudent policy conclusion is: keep the projected interest rate down. Otherwise, stay cool. There is no need for radical reductions in future spending plans, or for cuts in Social Security or Medicare benefits, to achieve this.
There is one assumption Galbraith makes that is jarring in light of current events (boldface mine):
Compared to other large industrial countries, the position of the United States is even better, because of the global role held by the dollar. For us, it is possible to run a low and even modestly negative real interest rate on the public debt at a low rate of inflation, and therefore to sustain quite a large primary deficit, essentially indefinitely and trouble free, so long as we provide a liquid, safe market for the world’s monetary assets. Exorbitant privilege that may be–but there are reasons why the United States is not Greece.
Way to go Tea Buggerers! Maybe we are doomed….