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When Will It Be OK to Worry Out Loud About the Costs?

November 30th, 2008 . by economistmom

With the excitement of the incoming Obama Administration and their bold plans to both change how Washington does its business and “rescue” the economy, it’s been really uncool to raise the question “how are you going to pay for it?” or “where is this money coming from?”  But we seem reluctant to ask this question even of the out-going (and not-so-cool) Bush Administration, even as they’ve already committed hundreds of billions of dollars to help the economy, in far less-than-transparent ways.

A few days ago a Washington Post editorial was willing to rain a bit on the Obama economic team “parade” and ask the question, how exactly will President Obama (once he’s president) eventually pay for all the bold things he’ll want to do to address the economic crisis?:

…Mr. Obama is talking about adding hundreds of billions of dollars in federal debt. That is reasonable under the dire economic circumstances, but it is scarcely adequate to couple that with platitudes about eliminating wasteful spending. As Mr. Obama well knows, and as his first-rate new budget director, Peter R. Orszag, understands as keenly as anyone, it will take far more than that to get the nation’s fiscal house in order…

Mr. Obama was on firmer ground when he talked about focusing on “one of the biggest long-run challenges that our budget faces, namely the rising cost of health care in both the public and private sectors.”… Yet here, too, Mr. Obama engaged in a bit of happy talk, skating lightly over the difficult choices that controlling health-care costs will entail… slowing the growth of health-care costs alone won’t be enough to deal with the fiscal ramifications of the baby boomers’ retirement. Yesterday may not have been the moment for Mr. Obama to lay all this out, but at some point he is going to have to stop talking vaguely about the need for “sacrifice” and be more candid about what that will entail.

And I did an interview with Kathleen Pender of the San Francisco Chronicle last week where I did worry out loud quite a bit about the economic rescue tab that seems to be running up rapidly:

The federal government committed an additional $800 billion to two new loan programs on Tuesday, bringing its cumulative commitment to financial rescue initiatives to a staggering $8.5 trillion, according to Bloomberg News.

That sum represents almost 60 percent of the nation’s estimated gross domestic product.

Given the unprecedented size and complexity of these programs and the fact that many have never been tried before, it’s impossible to predict how much they will cost taxpayers. The final cost won’t be known for many years…

It’s hard to say how much the overall rescue attempt will add to the annual deficit or the national debt because the government accounts for each program differently.

If the Treasury borrows money to finance a program, that money adds to the federal debt and must eventually be paid off, with interest, says Diane Lim Rogers, chief economist with the Concord Coalition, a nonpartisan group that aims to eliminate federal deficits.

The federal debt held by the public has risen to $6.4 trillion from $5.5 trillion at the end of August. (Total debt, including that owed to Social Security and other government agencies, stands at more than $10 trillion.)

However, a $1 billion increase in the federal debt does not necessarily increase the annual budget deficit by $1 billion because it is expected to be repaid over time, Rogers said.

Annual deficit

A deficit arises when the government’s expenditures exceed its revenues in a particular year. Some estimate that the federal deficit will exceed $1 trillion this fiscal year as a result of the economic slowdown and efforts to revive it.

The Fed’s activities to shore up the financial system do not show up directly on the federal budget, although they can have an impact. The Fed lends money from its own balance sheet or by essentially creating new money. It has been doing both this year.

The problem is, “if you print money all the time, the money becomes worth less,” Rogers says. This usually leads to higher inflation and higher interest rates. The value of the dollar also falls because foreign investors become less willing to invest in the United States.

Today, interest rates are relatively low and the dollar has been mostly strengthening this year because U.S. Treasury securities “are still for the moment a very safe thing to be investing in because the financial market is so unstable,” Rogers said. “Once we stabilize the stock market, people will not be so enamored of clutching onto Treasurys.”

At that point, interest rates and inflation will rise. Increased borrowing by the Treasury will also put upward pressure on interest rates.

Deflation a big concern

Today, however, the Fed is more worried about deflation than inflation and is willing to flood the market with money if necessary to prevent an economic collapse.

Federal Reserve Chairman Ben Bernanke “has ordered the helicopters to get ready,” said Axel Merk, president of Merk Investments. “The helicopters are hovering and the first cash is making it through the seams. Soon, a door may be opened.”

Rogers says her biggest fear is not hyperinflation and the social unrest it could unleash. “I’m more worried about a lot of federal dollars being committed and not having much to show for it. My worst fear is we are leaving our children with a huge debt burden and not much left to pay it back.”…

 And today’s New York Times editorial seems to worry a little:

This page has consistently held that the government must intervene in markets when failure to do so would cause even greater economic harm. The impending collapse of Citi or an unrelenting credit freeze demand intervention. But good crisis management also requires that the calamity of the moment not be allowed to overwhelm good governing. Unfortunately, that is not the case now.

Even, as the rescue tab rises, taxpayers are not being adequately informed or protected. There is as yet no effort to deal effectively with the underlying causes of the problem, especially mass mortgage defaults that feed bank losses. And officials seem to think urgency to act absolves them from considering the longer-term implications of the actions they take…

Another danger is that in fighting today’s crises, the government is teeing up the next one. To finance the bailouts, the Treasury is borrowing money and the Fed is printing it. That bodes ill for a heavily indebted nation, presaging higher interest rates and higher prices — perhaps sharply higher. That is not an argument for inaction. But frank acknowledgment of the dangers would put a premium on getting the rescues right today. As it is, the reckoning is postponed…

4 Responses to “When Will It Be OK to Worry Out Loud About the Costs?”

  1. comment number 1 by: B Davis

    The Fed’s activities to shore up the financial system do not show up directly on the federal budget, although they can have an impact. The Fed lends money from its own balance sheet or by essentially creating new money. It has been doing both this year.

    The problem is, “if you print money all the time, the money becomes worth less,” Rogers says. This usually leads to higher inflation and higher interest rates. The value of the dollar also falls because foreign investors become less willing to invest in the United States.

    I was not very familiar with the Federal Reserve’s balance sheet until this financial crisis. I have heard some discussion that it has greatly expanded recently. I did run across a explanation of it at this link. It shows “reserve balances” expanding to $171 billion and “factors supplying reserve funds” expanding to $1,533 billion. However, these numbers are for October 1st. The Fed document at this link shows that these numbers have since increased to $606 billion and $2,144 billion, respectively.

    In any event, I am not completely clear on the significance of this increase. Does the Fed have to sop these increased funds back up at some point? If it does not, does it somehow get added to the debt or does it simply increase the money supply? From your mention that this usually leads to higher inflation and higher interest rates, I assume it is the latter.

    Rogers says her biggest fear is not hyperinflation and the social unrest it could unleash. “I’m more worried about a lot of federal dollars being committed and not having much to show for it. My worst fear is we are leaving our children with a huge debt burden and not much left to pay it back.”…

    That is likewise my concern. There still seem to be many people, including politicians, who believe that “deficits don’t matter”. Even though it should be clear that our children will have to pay interest on any increased debt, there are some who believe that it will not be a burden due to a projected increase in their standard of living. They also seem to think that we can depend on interest rates on that debt remaining low. I fear that many people believe that the Fed’s creation of new money likewise comes at a negligible cost.

    Hopefully, those who are committing the federal dollars do not believe that it will come without a serious cost. Then they will likely be much more careful to commit those dollars in a way that is likely to provide a return. I am heartened somewhat by the quality of the people on Obama’s economic team. However, they do face a very difficult task, likely made all the more difficult by pressures to spend the dollars in a less-than-wise manner.

  2. comment number 2 by: pgl

    Dean Baker and Paul Krugman are must reads on this one and on the macroeconomic assumptions that Paul makes clear, it seems Bernanke is in basic agreement:

    econospeak.blogspot.com/2008/12/cost-and-benefits-from-fiscal-stimulus.html

    Rest assured, however, the new Administration is thinking in terms of long-run fiscal restraint:

    econospeak.blogspot.com/2008/11/return-of-rubinomics.html

  3. comment number 3 by: Jason Seligman

    To sort out how this might play out remember that the loans will be repaid, unless the businesses fail in spite of them, there is no magic there (though terms can change as they have on some of the early AIG borrowing). Thus over time the expansion of credit will more-or-less disappear, either through repayment or business failure (which would curtial private credit expansions). Since we appear to be in a credit crunch, this lender of last resort function is a wonderful tool.

    More “miraculous” but equally tractable is the ability to monetize Treasury debt. The Fed can purchase this debt and effectively retire it–either wholesale or on the margin by contributing coupon and principal payments back to Treasury incrementally. Doing the later allows the Fed to more dynamically manage money supply expansions at a later date by reselling the Treasuries in its portfolio, thereby shrinking the money supply. The Fed has always chosen the latter route to the best of my knowledge, at least since the mid fifties… (less ongoing opperating expenses.) So again, a wonderful tool.

  4. comment number 4 by: B Davis

    pgl wrote:

    Dean Baker and Paul Krugman are must reads on this one and on the macroeconomic assumptions that Paul makes clear, it seems Bernanke is in basic agreement:

    I did read Krugman’s New York Times editorial today. I think that everyone agrees with implementing however large a fiscal expansion is required “to keep the economy from going into free fall”, as Krugman puts it. However, I was surprised by the following paragraph in the editorial:

    Should the government have a permanent policy of running large budget deficits? Of course not. Although public debt isn’t as bad a thing as many people believe — it’s basically money we owe to ourselves — in the long run the government, like private individuals, has to match its spending to its income.

    Surely Krugman knows that nearly half of the total public debt (and a great majority of the recent public debt) is held by foreigners. Hence, it is not strictly “money we owe to ourselves” unless you take “ourselves” to be the entire world.

    Still, I am glad to see that Krugman does mention that any stimulus program resulting in large deficits cannot be permanent and that some sort of living within our means must occur in the long run. Likewise, I agree with his editorial referenced by your second link that states that a permanent tax cut is not the way to address a temporary economic downturn.