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The Trouble with This Picture of the “Spending Problem”

March 21st, 2011 . by economistmom

gao-long-term-alternative-scenario-20111

The GAO just released its update of their long-term fiscal outlook report.  The figure above shows federal spending (the bars) and revenue (the line) under GAO’s “alternative” scenario, which is closely related to the Concord Coalition’s “plausible baseline” which assumes–more pessimistically but probably more realistically than current law–that most of the expiring tax cuts are extended and that discretionary spending grows at the same rate as the economy (GDP) rather than only with inflation.

Just by the way, note that the President’s proposed budget is much closer to this “alternative”–and to the higher associated deficits–than to current law.  (More on that point and elaborating on what I said on Friday about CBO’s analysis of the President’s budget soon.)

My immediate interest in putting up the chart above from the GAO report is that many people like to point to this picture (or very similar pictures) as evidence that the current deficit and longer-term fiscal gap is a “spending (only) problem” and not a revenue problem.  The revenue line doesn’t droop after all, even in this worse-if-not-worst case scenario where current deficit-financed tax cuts are permanently extended.  And the spending bar just keeps on growing.

But note by 2040 we will only be collecting enough revenue to cover the costs of net interest and not quite all of Social Security.  Note that we don’t have a choice about cutting out net interest as long as we’ve continued accumulating the debt that interest pays for.  Note that net interest is by far the fastest-growing component of spending and comes to dominate not just Social Security but both all of discretionary spending (actually, all other spending besides the programs mentioned) and Medicare and Medicaid combined.  And note that even if it is judged by many to be a “spending problem” (only or mostly), it’s nearly impossible to imagine squeezing all the spending our society will still view as essential over the next few decades under that very low (but “historically average”) revenue line–or how we will decide what doesn’t make the cut, when the wiggle room beyond net interest is so very tiny and getting smaller by the minute.

20 Responses to “The Trouble with This Picture of the “Spending Problem””

  1. comment number 1 by: Jesse

    “But note by 2040 we will only be collecting enough revenue to cover the costs of net interest and not quite all of Social Security. ”

    Totally agree that it will become difficult for the US to not default on its debt. Now what would the numbers look like with interest rates at 10% which historically is still not that high…ouch…

  2. comment number 2 by: AMTbuff

    >it’s nearly impossible to imagine squeezing all the spending our society will still view as essential over the next few decades under that very low (but “historically average”) revenue line

    True. And it will be even harder to fit beneath the even lower revenue line that we will face after a crash in the US government bond market.

    The choice we face is analogous to a person with gangrene: amputate now or die later. This is hardly a choice that appeals to the average voter, especially when politicians on both sides are claiming that no such pain is necessary.

  3. comment number 3 by: Gipper

    Economistmom,

    In 2040, if you eliminated all net interest on the debt, you’d still have federal spending at about 27% of GDP. If you think that gap (about 8% of GDP) can be solved with only increased revenue, then you’ve revealed why both sides of this deficit debate have been talking past each other.

  4. comment number 4 by: Gipper

    Economistmom also revealed why Democrats are far more fearful of deficits than Republicans. Democrats understand that net interest costs are a huge threat to all those federal programs in HHS, HUD, Education, Agriculture, Commerce, Labor, Energy. Net interest costs might do what Republicans have failed to do — eliminate all of the federal departments that duplicate what can be done more effectively at the state level with greater fiscal discipline.

  5. comment number 5 by: markg

    I could bring up the MMT point of view and explain where you are wrong. But instead I will let anyone here (including mom) explain why Japan has a debt/gdp ratio of over 200% and more than a decade of QE, yet interest rates are very low, no inflation, no default and strong yen. And then explain why the US is different. I’m waiting!

  6. comment number 6 by: AMTbuff

    It’s Japan that’s different:
    http://en.wikipedia.org/wiki/List_of_countries_by_external_debt

  7. comment number 7 by: Jim Glass

    But instead I will let anyone here (including mom) explain why Japan has a debt/gdp ratio of over 200% and more than a decade of QE, yet interest rates are very low, no inflation…

    Easy. Because the Bank of Japan controls the money supply and has targeted zero-to-negative inflation — and the central bank always gets what it wants on that score because it controls the money supply.

    As economists from big-spending Krugman to libertarian Sumner to the Japanese through the link above have made clear, the BoJ is getting what it has targeted — QE increases inflation *only* if central bank says it will allow it do so so, and not reverse it the first sign of inflation.

    If fact, the BOJ has repeatedly tightened at the first sign of any price increases, draining money from the system, and that ain’t QE! To quote Sumner on the BOJ’s record (my emphasis)…

    In the late 1990s Japanese prices were falling at an unacceptable rate. The BOJ cut rates close to zero, and did a bit of QE. By 2000 the deflation ended, and the BOJ tightened monetary policy. This succeeded in preventing any significant inflation… By 2002 the rate of deflation was unacceptable, and the BOJ again cut rates to zero, and did an even larger QE. Of course large monetary injections would be highly inflationary, unless the central bank indicates they are temporary. The BOJ did this by promising not to allow inflation.

    When inflation threatened to occur in 2006, the BOJ again tightened monetary policy, raising rates and sharply reducing the monetary base (by roughly 20%). This again tipped Japan back into mild deflation.

    Because the rate of deflation is once again unacceptably high, the BOJ just announced a series of steps including rate cuts and QE. As they said, deflation will last another “three or four years”. When deflation stops, they’ve promised to tighten monetary policy again, and thus create a new bout of deflation…

    Reducing the monetary base by 20%(!) is the polar opposite of QE! So much for the supposed QE in Japan, and why it hasn’t increased inflation there.

    As for why the Japanese debt hasn’t caused infaltion, why would it? Debt doesn’t cause inflation. Inflation is under control of the central bank, via the money supply.

    Why hasn’t the Japanese debt caused a default crisis? Well, problems carrying debt arise when the govt can’t afford to service it, but (1) with the BOJ keeping the economy deflationary, the interest rate on the debt is near zero, minimizing debt service (coincidence?), and (2) as AMTbuff noted, the bulk of the debt is owed not to the public but is intragovernmental — which carries zero servicing cost (until the future date when it will have to be cashed in to pay off retirees). Japan’s debt owed to the public is actually smaller than the OECD average.

    So there is no puzzle to explain, it is all perfectly standard economics.

    One thing the Japanese sure haven’t done fund spending by monetizing their debt to blow the doors off inflation, or worse just create money to pay the govt’s bills outright, as via Moslerism-Chartalism, and blow the doors across the street.

    The last govt in the world to openly embrace Chartalism as a rationale for the govt to just create money to pay its debts was the Weimar Republic’s circa 1922. And we know where the doors landed that time.

    That was perfectly standard economics too.

  8. comment number 8 by: AMTbuff

    >The last govt in the world to openly embrace Chartalism as a rationale for the govt to just create money to pay its debts was the Weimar Republic’s circa 1922. And we know where the doors landed that time.

    If printing money really did allow unlimited government spending without adverse consequences, Krugman would have been advocating it since the day he changed careers from innovative economist to predictable political hack writer. I rest my case.

  9. comment number 9 by: SteveinCH

    I kind of hope that MMT is correct. If I were convinced, I’d just lobby the government to give every citizen a billion dollars. That would certainly help my retirement fund wouldn’t it? No wait, if the government gives everyone a billion dollars and the stock of goods and services available for purchase stays the same, I’m sure that something must happen…

  10. comment number 10 by: markg

    Japan’s central bank has maintained a zero rate policy. It was .5% for the last half of the 1990s and .1% for the last decade. The monetary base or level of excess reserves does not matter. Larry Summers should know better. Banks make loans (create deposits) based on credit conditions; not reserve positions. Monetizing debt is a gold standard term. It has no application in a fiat currency system. Welcome to post 1971.
    Apparantly none of you decided to look up the deficition of external debt in the CIA factbook. It is not related to govt debt held by the public - the subject of this debate.
    And Steve, MMT does not say there are no financial constraints (such has giving everyone a billion dollars). If you take the time to read the MMT literature (i would suggest Mosler’s 7 deadly innocent frauds) you would understand this. In a nutshell, as long as there are unused real resources (such as labor), the fed govt can give tax cuts or buy the resources without causing inflation. Any attempts to exceed those real constraints could lead to inflation. The budget outcome is what it is under those real constraints.
    One final thing. MMT is more about how the monetary system works than it is about policy. Some MMT’ers would like to see more govt spending, others (like myself) would like to see a demand side tax cut (such as a payroll tax cut). William Vickrey had some very progressive policy positions; way beyond what I would consider. But we all understand how the monetary system works and how people like the concord coalition are damaging the economy with their defict fears.

  11. comment number 11 by: Gipper

    Mosler and MMT fail because they don’t understand the equation Net Worth = Assets - Liabilities.

    Mosler makes the ridiculous claim in Innocent Fraud #3 that “Government Budget Deficits add to Savings.” Why? Well a private party buys a T-Bill and it is an asset on their balance sheet. Whoopee! Except Mosler forgets that the rest of society, including that T-Bill purchaser, got a liability entry in their collective balance sheet of the exact same amount. So there is no net creation of wealth.

    Duh!

    The idiocy continues: “There can’t be a budget surplus with private savings increasing (including nonresident savings of USD financial assets). There is no such thing, yet not a single mainstream economist or government official had it right.”

    Mosler is saying that running a budget surplus means that US Treasury bonds are being retired so holdings of those assets decrease in private balance sheets. However, the liability side of the government’s balance sheet decreases so USG Net Worth increases. No net change in aggregate net worth.

    When you don’t grasp the net worth equation, then all sorts of stupid ideas are possible. And that’s only with Innocent Fraud #3. There’s more stupidity from Mosler to wade through if you have the stomach for the intellectual stench.

  12. comment number 12 by: markg

    Gipper,
    Now that the US is no longer on the gold standard, money has value for only one reason. The governmant imposes a tax payable only in the currency it issues. So if the government spends more money than it receives in taxes, the private sector is accumulating tax credits. These are an asset to the holder because they can be used to pay future taxes. Of course they are valued by others because they can also use them to pay taxes. But how is this a liability to others? How is someone holding tax credits a liability to anyone? It is not. So when the govt deficit spends it is creating an asset that is a liability to no one. Again it is worth repeating. This does not mean the govt can create unlimited assets. There are constraints that all MMTers recognize. Also, the assets created by deficit spending can be held by the public as money or bonds. The only difference is bonds pay interest. Some say QE is inflationary because the Fed is swapping money for bonds, and more money in the hands of the public would lead to more spending. But if all banks stopped paying interest on savings accounts, would people go out and spend their life’s savings because they are not getting interest? I doubt it.
    Sorry, I got off subject a bit, but do you understand why govt deficits in a non convertable fiat money system can be an asset to the holder but a liability to no one?

  13. comment number 13 by: AMTbuff

    >So when the govt deficit spends it is creating an asset that is a liability to no one. Again it is worth repeating. This does not mean the govt can create unlimited assets. There are constraints that all MMTers recognize.

    This is incoherent. Diluting the money supply shifts supply and demand curves rightward. Economists call this phenomenon inflation. Inflation sets many socially destructive forces in motion.

    MMTers remind me of Marxists in their religious fervor for ideas which sound good but have been proven disastrous in practice. For both MMT and Marxism, experts had no problem seeing that disaster was inevitable. To which the true believers answer: Oops! We’ll get it right if you just give us one more chance.

  14. comment number 14 by: Gipper

    Markg is simply making the standard Keynesian claim that with idle resources and unemployment, government stimulus (deficit spending) won’t inflate price levels. There’s nothing novel about this assertion requiring an elaborate MMT superstructure. But Keynesians and MMTers have a big problem explaining stagflation from 1973-1975 when the Phillips Curve tradeoff of inflation and unemployment collapsed.

  15. comment number 15 by: Jim Glass

    Japan’s central bank has maintained a zero rate policy. It was .5% for the last half of the 1990s and .1% for the last decade. The monetary base or level of excess reserves does not matter.

    Ha! Well, I take this as at least dropping the “Japan has pushed QE for twenty years” claim. :-)

    One of the many things about MMTers that saps their credibility and keeps them from being taken seriously by near the entire world is that — much like post-modernists in English departments — they just keep endlessly repeating themselves in minor variations rather than answering others’ observations. For instance, check the MMT logic on this point up to here…

    MMT: “Money policy doesn’t matter. As proof, look how Japan has pushed QE ever since 1990 yet has no inflation! If money policy matters, how do you explain that?”

    Factual observation: “Well, Japan in fact has followed contractionary monetary policy, successfully targeting 0% to -1% inflation, by repeatedly reducing the money base (by up to 20%!) as needed — the polar opposte of QE.”

    MMT: “That’s irrevelant because money policy doesn’t matter. Larry Summers should know better …” :-)

    As having MMTers run us around in such circles is a total waste of time, the options are (1) ignore them, as most of the world chooses to do, or (2) see if one can prod them to relate to empirical reality and see the result. (Trick them if necessary — recall how Alan Socal got Social Text to publish the article describing gravity as a social construct. That took care of more post-modernists that 20 years of debate.)

    Before returning to option #1, I’ll make a brief attempt at #2.

    Being that the Japanese situation was his example, perhaps markg can explain to us, if the BoJ’s monetary policy (changes in money base, etc) really doesn’t matter as he says:

    A) Why has the BoJ over the last 20 years consistently enaged in money policy to keep moving the rate of inflation up/down back to its target level, by sequentially increasing and decreasing the money base, etc?

    Is the BoJ, oh … stupid?

    B) Why has inflation in fact responded just as the BoJ desired after every such monetary policy move — up after increasing the money base, down after decreasing it 20%, etc.? So inflation has exactly hit the BoJ’s announced target for 20 years? So its money policy has been entirely, well, successful.

    How does MMT explain this … happy coincidence?

    Please be specific regarding both answers. And responsive, of course, with explanations. Don’t just repeat the same claims yet again.

    Apparantly none of you decided to look up the deficition of external debt in the CIA factbook

    Apparently you didn’t decide to look up the facts that net of intragovernmental debt and fiscal assets held by Japan earned via its historical surpluses, Japan’s net debt held by the public is 80% of GDP, not 200% — and that thanks to this plus its deflation-caused low interest rates, Japan’s annual interest payment on its debt as a percentage of GDP is 30% less than the US’s.

    Hey, how could they avoid a debt crisis while paying debt interest at that level? :-)

    MMT and empirical facts, they don’t play so well together.

  16. comment number 16 by: Jim Glass

    Mosler makes the ridiculous claim in Innocent Fraud #3 that “Government Budget Deficits add to Savings.” Why? Well a private party buys a T-Bill and it is an asset on their balance sheet.

    Gipper, the Moslerites live by the sophomoric mistake of arguing by accounting identity, and in particular have entranced themselves with: “+ government deficit = + private net financial savings”. Which is true enough. From which they deduce the government provides the private sector with the savings it needs to function, and that surpulses deprive the private sector of savings. It must be true! How can it not be? It’s an accounting identity!

    But even more, they deduce with iron logic that there can be *no* net financial saving at all in the private sector by itself. Because every asset is a liability to someone else, netting to $0. Ergo, all private saving comes from govt debt. And savings are very, very important — who can deny that? We need more savings, and thus we *must* need more govt debt! QED. And since this all follows from an identity who can argue against it? This is a good part of the sea of quicksand upon which they’ve built their church.

    But note their use of the weasel words “net” and “financial”. From this one can pose two teeny little quibbles with their theology that have been too small for them to notice.

    [] The minor one is that of course there are great gobs of real savings that aren’t financial. If you use your income to buy land, improve it, and turn it to profitable business use, you’ve saved a bundle. But these savings don’t exist to Moslerites because they are not “financial”.

    Here we also first see their so called argument-by-identity butchering accounting identies. When you save as above, you illustrate the identity “saving = investment spending”. You spent your bundle of savings on a real productive capital investment. The accounting identity at the national level is “saving = investment spending”, spending on real capital investment. More on this below.

    [] The MAJOR one is that the very concept “net financial savings” is a made-up bogosity that doesn’t have anything at all to do with the actual savings needed for the economy to function. The real savings needed for the economy welfare are CAPITAL ACCUMULATION, investment spending. You know, savings invested in factories, R+D, education, etc, which produces a real economic return to the economy. The things that will support life in the future.

    For instance, people have $200 billion or so saved and invested in Microsoft, which produces real things of value. (The $200 billion is discounted net value of what it is expected to produce into the future).

    Yet the Moslerites say this $200 billion represents “net financial savings” of zero — because Microsoft has a financial liability of $200 billion on its balance sheet to its shareholders. Right, markg?

    So their is no net financial value to the public in Mircrosoft stock.

    But if the govt goes another $200 billion into debt, because the financial liability for them isn’t on the private sector’s side, now the Moslerites say this +$200 billion in savings assets to the private sector. See! It follows irrefutably from the rules of accounting (cough, choke — see the sleight of hand involved?). Even though ZERO investment in capital accumulation results to produce anything for the future. Yet this is the only savings the private sector can even have! :-)

    Is this sane? No, it is ludicrous. And it is not even real accounting, it is bogus accounting. Go to the national accounts at the Bureau of Economic analysis and see, check the *real* accounting identities!

    I’m running too long to go through them here, but the Congressional Research Service recently covered just this subject in The Economics of the Federal Budget Deficit[.pdf]. See page 6, “Fiscal Policy in the Long Run”.

    I’ll give the gist here, quoting the last paragrph, (my bold, italics in original). National saving = total investment spending, and…

    total investment spending is equal to the sum of private saving (S), the government budget surplus (T - G, which, if it is negative, is a deficit), and the difference between imports and exports of goods and services (M - X). The last equation is an identity.

    In other words, investment is by definition equal to the sum of private saving, the budget surplus, and net capital inflows from abroad. Other things being equal, a reduction in public sector saving means less investment and slower growth in the capital stock.

    I.e.: Larger deficits … slower growth in capital stock … a poorer tomorrow.

    “In the long run, a shift from a budget surplus to a deficit represents a reduction to national saving. Less saving means a shift from future to present consumption. Consuming more now means less investment now, a lower level of output of goods and services in the future”

    So much for the “net financial savings” scam.

  17. comment number 17 by: Nathaniel

    If tax revenue is going to be 18% of GDP, I’d like to see the assumptions that are used to calculate GDP. According to the graph submitted by the GAO, the GDP stops growing at year 2020. Hmm, that seems suspicious to me.

    Anyway, we obviously have problems with not enough revenue and too much spending. But making bad assumptions isn’t helpful to finding a solution.

  18. comment number 18 by: Jim Glass

    According to the graph submitted by the GAO, the GDP stops growing at year 2020. Hmm, that seems suspicious to me.

    GAO ends its projections when the annual deficit hits 20% of GDP and rising, since the economy as we know it cannot that exist with that condition.

    It projects the end of growth of GDP some time before that, as the end of growth preceeds collapse and the end times. Specific dates vary by the assumptions of each projection.

  19. comment number 19 by: Anna Lee

    I don’t think EconomistMom is implying the revenue side is an answer. I think the point is that the spending side doesn’t hold all of the answer. The GAO report cited carries the same theme.

    The chart above reminded me of Senator Conrad’s charts warning of the dangers of the Bush tax cuts and extreme danger of extending these past five years. I found these charts on his website but don’t know how to create a link in this box. The subject was Social Security but one of the charts predicts (perhaps accidentally) a cost of extension past the five years. The web page is:

    http://economistmom.com/2011/03/the-trouble-with-this-picture-of-the-spending-problem/

    I see his emphasis has changed since he lost that battle. I think he is calling for both spending and revenue “bipartisanship” now.

  20. comment number 20 by: Anna Lee

    That link should have read:
    http://conrad.senate.gov/issues/statements/socialsecurity/040227_FloorSpeechCharts.pdf