September 22, 2009
We Should'a Run Smaller Deficits
From today's chapters 3 and 4 of the IMF World Economic Outlook, released today. From Chapter 4:
"...the results based on the small-scale regressions suggest that economies with larger current account deficits, rising inflation, and a deteriorating fiscal balance before a crisis experienced significantly larger output losses [from financial crises].
Excerpt from Figure 4.9 from IMF, World Economic Outlook, Sep. 2009
"[America] needs a combination of policies to reduce the deficit substantially so that its indebtedness to the rest of the world stops rising at some point. These policies include... A concerted effort to reduce the federal budget deficit..."
Posted by Menzie Chinn at September 22, 2009 08:12 PMdigg this | reddit
What are the comparisons though;?
Germany and Japan suffered much stronger output declines than the US and UK, and their current account situations are far stronger. The same is true for Russia...
Export oriented economies seemed to have suffered much larger declines due to the overall halt in trade with the caveat that those that were able to juice internal consumption through stimulus were able to overcome the export declines for the most part (i.e. China, Brazil).
Also, intuitively, during a global recession/financial crisis, wouldn't one expect that a collapse in exports and imports would result in a closing of trade deficits and trade surpluses to the relative benefit of nations with deficits?
Posted by: Anonymous at September 22, 2009 08:43 PM
When reading the captioned IMF summary,one may almost discern the attempt of drawing a list of deliverables for the G20 meeting.
It could be expanded when forgetting,qui t as fait comte qui t as fait roi?
How are they going to rebalance the macro accounts of their respective countries?
How do they explain the major violation of the treaty of the union when knowing that Esher Olhin, Marshall, Taylor were born well before the the date of the treaty?
Why do they feel concerned with the marginal trillion of derivatives when they missed the first 100 trillion?
How the chairmen of the most entrepreurial banks can be confidently reading their results when seating on average 50 trillion usd derivatives?
How are the long term interest curves drawn, be it in Europe and in the USA?
We were happy with the equities markets strategy meeting of the last G20 meeting, but when shall we start working?
Posted by: ppcm at September 23, 2009 02:44 AM
The first part of that seems pretty counter-intuitive. Importers (like the US) will suffer a greater output drop than exporters (like Japan)?
That's not how it looks here:
Maybe that was true during the Asian crisis in 1998 when the fiscal deficits were due to excessive investment in countries that were primarily exporters?
Posted by: Bob_in_MA at September 23, 2009 06:14 AM
Based on this information from the IMF I immediately sat down and wrote a letter to my local grocery to demand they enter into negotiations on my trade deficit with them.
Posted by: DickF at September 23, 2009 07:15 AM
If we can agree that total govt spending should not exceed 32% of GDP and that deficit reduction should be a priority as soon as we're sure it won't tank the economy, hey, sign me up.
Essentially, that would be Clinton's play book, and if Obama would stick to it, he'd be a hero.
Posted by: Steve Kopits at September 23, 2009 07:35 AM
"These policies include... A concerted effort to reduce the federal budget deficit..."
Yes, those economists who follow all of Keynes advice will advocate a Federal budget surplus at all times other than a recession, so as to prepare the nation for the inevitable downturn, when more deficit spending will be advisable. Keynes did not advocate or support the behavior of the U.S. government from 1980 - 2009. What we did was without any support from any exhaulted economistss, so far as I know. The budget surplus at the end of Clinton's term was an accident of excessive capital gains cashed out.
Clinton was salavating at the prospect of spending that "surplus" money on his priorities; Mr. Greenspan said that the surplus was dangerous in that it might discomfort the bond market.
Where were Keynes' disciples when we needed them?
Posted by: ReformerRay at September 23, 2009 07:56 AM
"Output in percent of pre-crisis trend"
I assume this means they're plotting an "output gap" by assuming that growth would have continued at the pre-crisis trend rate. But it raises an important question: Is the pre-crisis trend (and therefor the growth of "potential output") different for the two groups being compared and/or is it a consequence of the pre-crisis fiscal/current account policies being pursued? For example, it's conceivable that running current account and fiscal deficits would boost GDP growth in the short run above the "natural rate" for that economy. Thus producing an unrealistically high trend and making future output gaps for this group look larger.
I'm not arguing in favor of fiscal deficits in general (though at present it's necessary) or current account deficits (ultimately we'll need a weaker dollar to rebalance). Just questioning whether projections from the pre-crisis trend are in fact fair.
Posted by: lilnev at September 23, 2009 09:00 AM
I guess I have to withdraw my previous kudo to the IMF for noticing the financial crisis. Here I have to give them "two heads up" their arses for extrapolating pre-crisis trends and the associated bubble fueled twin deficits as being sustainable growth.
Our fiscal deficit is not really sustainable, and it is also structural at this point, which of course is something that Keynes never advocated.
I did find some good quantitative data on where the trade deficit really came from, besides the fact that we weren't paying taxes high enough to cover our level fiscal spending.
Here's an older CR blog with a nice graph of MEW this decade. Note this is quarterly data, and a few years we had MEW running at $600B-$700B.
This data was generated using the Kennedy-Greenspan method. Note that they use Flow of Funds data, but Flow of Funds lumps together MEW with mortgage debt. It does not treat it as "consumer credit", so it does not show up in that line item of Flow of Funds. Nor does it have a separate line item, it takes a study to separate out MEW from mortgage debt.
So here is the eye-popping graph of MEW....
Posted by: Cedric Regula at September 23, 2009 10:08 AM
You want smaller deficits? QUIT spending more than you take in from the taxpayers. It's OUR money they are wasting!
Posted by: Michael Knowles at September 23, 2009 01:16 PM
Interesting observations & reasonable conclusion.
In reducing the Federal deficit, we should ever bare in mind that the true burden of the government on its citizenry is what it spends [rather than what it taxes]. And that reducing the unnecessary burden of government is as important as reducing the amount of borrowing.
Posted by: bryce at September 23, 2009 06:58 PM
Chinn's quotation about the need to reduce deficits is from 2005 and at that time he was right. We shouldn't be running deficits in boom times, which is all the IMF report is saying.
That really doesn't say anything about our present times, which are decidedly not boom times.
In down times, deficit spending is appropriate and necessary. The really big question that's not being addressed is one of timing. How do you know for sure that boom times are here and that it's time to start attacking deficits.
Posted by: DS at September 23, 2009 07:29 PM
I am a huge fan of the Tea Parties but understand this thread is not about the budget deficit. It is about the trade deficit. They are different things. Make sure you know what you are talking about when you interject.
Posted by: DickF at September 24, 2009 08:30 AM
U.S. borrowers behaved badly, no question. The government ran deficits and leveraged banks carelessly allowed mortgage borrowers to over-lever themselves. However, foreign currency policies also must share the blame. China amassed $2 trillion in foreign reserves over just a few years by intervening in currency markets. Other Asian countries amassed another $2 trillion and the yen carry trade added even more to ROW borrowing. (Though not official intervention, the common perception that Japan would not allow the yen to appreciate sharply surely encouraged this carry trade.) To lay a big part of the blame on such policies seems to accord with reason - the U.S. was only one of a number of countries that are now suffering from the effects of over borrowing.
It seems to me an analogy is making liver pate by stuffing a goose. Hundreds of billions per year in official capital outflows from China, coupled with capital controls to limit private inflows certainly 'stuffed' borrowing on the rest of the world. The only question is, how big a role did these policies play in setting up the imbalances we are ow paying for? To lay all the blame on U.S. fiscal profligacy and careless bankers seems inappropriate.
Posted by: don at September 24, 2009 11:54 AM
Comrade Chinn wants smaller deficits? *dials pastor* "Is hell freezing over?"
Posted by: Anonymous at September 24, 2009 05:40 PM
Of course, the federal budget deficit did get substantially smaller after Menzie wrote that in September 2005.
So the US wasn't facing a "deteriorating fiscal balance" immediately before the crisis at all. The 2007 budget deficit was 2.5% of GDP, and falling. Second, the rising inflation was entirely due to the cost of oil, as James Hamilton had mentioned. Either you consider that true inflation or not, but there was little that the government could have done about it.
Posted by: John Thacker at September 26, 2009 12:39 AM
John Thacker: A more up to date set of statistics is in this post. I would say running a 1% cyclically adjusted budget deficit in the peak of a boom (only about 0.8 ppts smaller than when I wrote the CFR report -- I was looking for a bigger adjustment) is still a big budget deficit. And I suspect with actual GDP revised upward in the latest benchmark, we might very well see that the cyclically adjusted budget deficit to be larger than currently estimated.
Posted by: Menzie Chinn at September 26, 2009 09:43 AM
Wait is this being made into something about trade deficits or budget deficits because I'm seeing both here. I must ask in both cases....
How can every country run a trade surplus? durrr that is a really intelligent conversation that takes no economic information
If we're on the Budget deficit, then it should be noted that every time throughout history the US tries to run a surplus or "get rid of the debt" it falls into a depression in the near future.
As long as GDP grows more than the national debt in the long run (which is the recent historical trend besides the recovery process)then it doesn't matter what the deficit is.
People need to stop worrying about what economic school they follow and what that says and start using the brains they have to figure out how money actually exchanges and how banking actually works.
Posted by: Anonymous at September 26, 2009 11:42 AM
LOL What data are you seeing that suggests GDP is growing faster than our debt?
Posted by: Anonymous at September 27, 2009 05:26 PM
The main factors differentiating the GDP declines of various countries in this crisis is the extent to which their economies are service-oriented (the more so the less decline) and, as others have said, the extent to which their economies are export-oriented (the more so the greater the decline). The US is on the better-protected side on both counts.
Moreover, the US is a special case due to the outsized role that the dollar and Treasuries play in the global economy, which made them safe havens during the peak of the crisis, which allowed the US government to fund large bailouts and stimulus, which cushioned the US GDP decline.
But that doesn't mean the US economy is healthier. It shows how we had less to lose, as our manufacturing and exports were pitiful already.
As US manufacturing and exports have declined, one hears more and more double-talk that seeks to explain how manufacturing and exports are not really the basis of a country's wealth. Meanwhile the countries that manufacture and export are catching up, and the US is spending down its accumulated capital, with accelerating speed. Total foreign holdings of US treasuries - basically, the principal of US foreign debt - grew by ~$350bn in Jan-July of this year, and by ~$720bn last year. In the past 19 months, the principal of US foreign debt has grown by as much as it did in the previous five years. And 2003-2007 was itself a period of vastly accelerated debt growth compared to previous eras.
The second anonymous poster is right, the first anonymous poster must be living in a Clinton era time warp. But actually, there's a lot more to sound (or unsound) fiscal policy than just making sure debt growth doesn't exceed GDP growth. All the eastern European countries had GDPs growing faster than their debts in 2003-2007, and just look how much that helped them.
In a world with marketable government debt, the market decides whether or not your government has a debt crisis, and markets can change their mind overnight. Markets tend to look at governments as if they were businesses. What's the debt relative to income (exports net of imports that are re-exported)? By that measure, it was clear the east Europeans were in way over their heads. Just because all US debt is in dollars does not mean the US is exempt from that kind of analysis. One of the most common triggers of a currency crisis is when the market suspects the government will have to devalue its currency to repay domestic-currency-debts held by foreigners.
The US is of course a very special case. I don't at this point see a dollar crisis on the horizon. Because of its importance globally, a dollar crisis would be something truly comparable to the Great Depression.
What I do see is a nation walking into a debt trap, with no one in charge giving any serious thought to the long-term consequences. A nation taking its privileged status for granted while steadily spending down its capital.
The quandary that Obama will have to face up to sooner than he wishes is that there is never a "good" time to withdraw stimulus - especially stimulus on this unprecedented scale. It's like a very expensive drug addiction. Obama's message to the financial markets boils down to: Don't worry guys, I won't make you go cold turkey. But then how will it end? No one knows. All we hear is wishful thinking about an economy that's going to "naturally catch fire", as if prolific government spending were ideal kindling.
Posted by: Tom at September 30, 2009 06:08 PM