## March 06, 2013

### Fiscal tipping points

At the recent U.S. Monetary Policy Forum I presented the paper Crunch Time: Fiscal Crises and the Role of Monetary Policy, along with co-authors David Greenlaw (Managing Director and Chief U.S. Fixed Income Economist for Morgan Stanley), Peter Hooper (Managing Director and Chief Economist for Deutsche Bank Securities Inc.), and Frederic Mishkin (professor at Columbia University and former governor of the Federal Reserve). One of the goals of our research was to try to understand the events that can lead a country to a tipping point in which it faces rapid increases in the interest rate on its sovereign debt, as a result of which the country finds itself with an unmanageable fiscal burden.

One can characterize the essentials of debt dynamics with a simple equation. A key parameter is what we call the net interest rate (rt), which can be thought of as the difference between the average nominal interest rate on outstanding government debt (Rt) and the nominal GDP growth rate (gt):

rt = Rt - gt

Let bt denote debt as a fraction of GDP as of the beginning of year t and let st denote the government's primary surplus during that year, that is, st is government revenues minus government spending on all items other than interest costs, again expressed as a fraction of GDP. The above variables then determine what the level of government debt will be in the following year (t + 1):

If we know the country's interest rate and long-run growth rate, then we can calculate its long-run net interest cost r*. Given any debt level b*, it is then straightforward to calculate the value for the primary surplus s* that would be required in order to keep debt from growing as a proportion to GDP:

Basically equation (2) says that the primary surplus must be big enough to cover the interest costs on the debt once one takes account of the contribution of economic growth. For example, if the nominal interest rate is Rt = 3%, growth rate is gt = 2%, and debt load is bt = 100% of GDP, then revenues will need to permanently exceed non-interest spending by about 1% of GDP in order to keep debt from growing relative to GDP. If the interest rate is less than the growth rate (so that r* is negative), the government could permanently run a primary deficit (that is, maintain a negative value for s) without increasing debt relative to GDP.

What happens if the primary surplus s* that would be needed to stabilize the debt/GDP ratio is larger than the current surplus? Then debt next year will be a larger fraction of GDP than it is now. If r* is positive, the underlying dynamic equation (1) is unstable-- debt would grow to an infinite multiple of GDP if something doesn't change. One possibility is fiscal reform (tax increases or spending cuts). Another possibility is improvement in the economic growth rate. And a third possibility is that the government either partially defaults on the debt or reduces its value with an unanticipated inflation in order to bring b back down to a level that the country realistically could afford to service. Reinhart and Rogoff (2009) have reminded us that the third option has been taken by many different countries many different times.

Of course, if the would-be buyers of the government's debt assign some nonzero probability to this third possibility, they will require a higher interest rate Rt as compensation. But from equation (1), that just makes the debt grow even bigger, and the treadmill starts moving faster. The result can be a tipping point in which the government faces a fiscal crisis as a result of rapidly rising interest expenses.

To study these dynamics, we assembled a data set of 20 different advanced economies over the last decade. Our goal was to identify the factors in year t - 1 that would help statistically to predict the interest rate on 10-year sovereign debt that different countries faced in year t. We looked at both gross government debt and net government debt (the latter subtracts off sums that are owed to government trust funds) as possible predictors. Many economists might prefer to use the net debt series, reasoning that there is no burden associated with money that the government promises to pay itself. On the other hand, these trust funds may themselves entail significant off-balance sheet liabilities and commitments that matter for the government's long-term ability to service its publicly-held debt. Our approach was to treat it as an empirical question which measure, net or gross debt, was most useful for predicting sovereign interest rates. We found similar results using either measure, but a better statistical fit is obtained when we used the gross debt. Another reason this may work better than net debt is that the gross numbers are less subject to discretionary accounting decisions.

We also found that the country's current-account balance is very useful for predicting its interest rate. The more public or private debt that is owed to foreigners, the greater the burden the country may face in making its interest payments, the greater the incentive to default, and the more subject the country is to international capital flight.

Finally, we found very strong nonlinearities in the data-- high debt levels matter more than low debt levels, and they matter more when the current account is running a big deficit. The regression below captures these nonlinearities by allowing the interest rate to depend not just on the level of debt, but also the square of the level of debt and the product of the debt level with the current-account balance. As seen from the t statistics in parentheses, these nonlinear terms are highly significant.

We also include what are known as country fixed effects in this regression (the coefficients αi), which allow each country i to have its own special characteristics, as well as year fixed effects (the coefficients γt), which allow for the possibility that something unusual was happening globally in each different year t of the sample.

The figure below gives one perspective on the above regression. On the horizontal axis are different possible values for debt as a percentage of GDP. On the vertical axis is how much higher the 10-year yield would be predicted to be if the country had that level of debt compared to if it had no debt. The different colors correspond to different assumptions about the country's average current-account balance as a percent of GDP. For example, for a country like the United States with gross debt currently about 100% of GDP and with a current-account deficit that hopefully will be no higher than 2.5% of GDP over the next 5 years, each one-percentage-point increment in debt/GDP would be expected to increase the 10-year yield by 6 basis points (that is, by 0.06 percentage points).

##### Note: CA is current account balance as % of GDP. Horizontal axis: gross debt as a percent of GDP in year t - 1. Vertical axis: amount by which a country's interest rate in year t would be predicted to be higher (measured in annual percentage points) compared to what the interest rate would be if debt in year t - 1 were equal to 0 for indicated levels of the current-account balance. Source: Greenlaw, Hamilton, Hooper, and Mishkin (2013).

The above regression summarizes the broad correlations across different countries and different years. Our paper also looked at the specific week-to-week news events that seemed to produce sudden changes in interest rates in a number of different countries. In the case of Greece, as of the fall of 2008 the country was reporting debt at 100% of GDP and anticipating a deficit around 2% of GDP, as indicated by the black line in the figure below. With a growth rate of g = 6.6% and a borrowing cost of R = 5%, the situation would have appeared to be sustainable.

##### Greek deficits and debt as reported and projected on different dates. Source: Greenlaw, Hamilton, Hooper, and Mishkin (2013).

Unfortunately, the recession produced a huge increase in the budget deficit, and the historical budget turned out to have been significantly misreported. In our paper we review the particular news developments associated with the upward lurch in Greek yields as debt eventually soared to 165% of GDP, well past the tipping point. We also review the various policy measures that were announced with great fanfare but all proved to be of only temporary value. The primary event that made a significant difference was the PSI default on March 8 of last year, which brought Greek's debt burden back down to more manageable levels.

Ireland is a very different case. The country entered the financial crisis with a low debt load but at the peak of a property-price bubble. The government responded to concerns about the banking system by guaranteeing all the liabilities of its six major banks. As property prices collapsed, the banks' losses proved to be enormous, leading to an explosion of Irish sovereign debt and moving the country to the tipping point. Stabilization of real-estate prices and fiscal reform have in our assessment likely been successful in pulling Ireland back from the brink.

Spain's situation is similar to Ireland's, although it remains unclear who will ultimately bear the losses of falling real-estate prices there. Portugal involves a mix of the problems faced by both Spain and Greece.

Another very interesting case is Italy. Twenty years ago, the country had a debt load of 120% of GDP, with which creditors seemed to have no problem. Why when debt recently returned to those same historical levels should Italy now be in danger of passing the fiscal tipping point?

##### Source: Greenlaw, Hamilton, Hooper, and Mishkin (2013).

Our answer is that Italy's growth rate is much slower today than it was then. The graph below plots an exponentially smoothed average of Italy's nominal GDP growth over the previous decade as of each date over the sample. Italy was growing at a 7.5% annual rate in 1995; today its growth rate is down to 2%.

##### Source: Greenlaw, Hamilton, Hooper, and Mishkin (2013).

One can feed these growth rates into equation (2) above to calculate the primary surplus that Italy would need to stabilize its debt/GDP at the level seen on any historical date if it faced a nominal borrowing cost of 5%. That series for the necessary surplus is plotted as the dashed red line in the graph below, to be compared with the actual surplus in black. The actual surplus was higher than necessary in 1995 (which was why debt/GDP was falling back then), but is lower than necessary in 2012 (which is why debt/GDP is rising again). Thus Italy was short of its tipping point in 1995, but dangerously close today.

##### Source: Greenlaw, Hamilton, Hooper, and Mishkin (2013).

What about Japan? This has the highest gross debt/GDP of any country in our sample but one of the lowest borrowing costs. In terms of our regression (3), this is explained by the fact that Japan has been running a current-account surplus rather than a deficit and that Japan has unusually favorable country-specific characteristics (that is, a big negative value for αJapan). Hoshi and Ito (2012) argue that Japan's special privilege is a result of its very high domestic saving rate coupled with extreme home bias. Notwithstanding, they calculate that with Japan's aging population, their saving rate will decline and the government will soon be forced to borrow on international markets, at which point the sovereign yield will be more subject to the same forces as other countries. We share the pessimism of Hoshi and Ito (as well as many others who have studied Japan's situation) about the sustainability of current Japanese fiscal policy.

Another very interesting case is the United States. I will take this up in a subsequent post.

Posted by James Hamilton at March 6, 2013 09:57 AM

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## Comments

Regarding the US, I am eagerly waiting for the revelation that the massive tax increases have caused Federal Tax revenue to actually stay the same or fall, rather than rise.

The look on the faces of leftists will be priceless.

Posted by: Darren at March 6, 2013 12:08 PM

Interest payments as a pct. of revenue:

http://data.worldbank.org/indicator/GC.XPN.INTP.RV.ZS/countries/JP-IT-ES-GB-US-GR-PT?display=graph

The US is catching up to Japan and Greece.

US federal receipts are growing at 0% since '07, 2% since '08, and 2% since '00 against nominal GDP of 2%, 2%, and 3.6% respectively.

US federal spending has grown 4.7-5.7% since '00 and '07-'08.

Since '00, federal gov't debt owned by the public has grown at a 10% rate (doubling time of 7 years), which is a rate nearly 3 times faster than nominal GDP.

Since '08 and the effects of the Great Recession and interrupted debt-deflationary regime, US gov't debt has grown at a 16.7% rate, which is more than 8 times the rate of GDP. 8-O

At the differential rates of growth of spending, receipts, and GDP since '00, the US will reach the "tipping point" for spending and debt to GDP and interest to receipts by no later than '18-'19, and likely sooner were a recession to occur.

However, at the differential rates of growth since '07-'08, we have already reached the "tipping-point" acceleration threshold of the jubilee cycle, implying that gov't spending can no longer grow per capita without (1) a significant increase in revenue, which in turn will reduce private activity per capita and reduce the anticipated revenue; (2) the Fed fully monetizes the deficit via primary dealer banks' purchases of new gov't debt; or (3) a combination.

Fed full monetization, i.e., helicopter debt-money reserve nukes, of the US gov't debt through '20 without higher taxes would require a near quadrupling of the Fed's balance sheet to unprecedented levels of GDP and gov't spending, resembling banana republics before hyperinflationary collapses, debt defaults, social unrest, and takeover by military juntas.

Can't happen here? Think again.

I recommend that Bubble Ben Shalom Zimbabwe, "The Beard", leave his job a year early to avoid having his reputation trimmed from having to do something that earns his nickname and sad legacy.

Posted by: Bruce Carman at March 6, 2013 12:23 PM

James,

Excellent research! Please do look at the US. I see Bill Gross in January wrote a rather pessimistic article

http://www.pimco.com/EN/Insights/Pages/Money-for-Nothin-Writing-Checks-for-Free.aspx

Posted by: Jeremy at March 6, 2013 12:35 PM

"Regarding the US, I am eagerly waiting for the revelation that the massive tax increases have caused Federal Tax revenue to actually stay the same or fall, rather than rise.

The look on the faces of leftists will be priceless. "

The CBO predicts tax revenues will be at an all time high this year. Given that they are wrong about everything, looks like you'll be right.

Posted by: Anonymous at March 6, 2013 01:47 PM

JDH A couple of questions:

(1) In your paper you referred to CBO's projected tax receipts of 18.75% of GDP, which is slightly above the post-War rate of 18.5%. Why is the post-War percentage relevant? Isn't that what got us into this mess?

(2) You said:

The dramatic escalation in projected Medicare and Medicaid outlays is being driven by two factors -- demographics and rising per patient expenses.

The good news is that there is some reason to believe healthcare costs might have moderated a bit. But it's also a mistake to automatically believe that rising healthcare costs is a bad thing. Healthcare is a normal good and we would expect society to demand more healthcare as it gets richer. The problems with healthcare have a lot to do with monopoly rents and an insurance system that can't say "no." In other words, aren't the healthcare issues more about microeconomics than macroeconomics?

(3) In your paper you said:

In a country like the United States, the debt premium presumably would arise from inflation fears rather than concerns about outright default.

This presents something of a conundrum. Since all of the facts in your paper are public and well known, don't we have to ask why those inflation fears are not already included in interest rates?

(4) Finally, any theories about what happens if the primary surpluses for all advanced countries are strongly correlated and move in the same direction? Specifically, I'm thinking of correlated non-linear conditional volatility of borrowing costs across several economies.

Darren

I am eagerly waiting for the revelation that the massive tax increases

What "massive tax increases" are you talking about? Last time I checked Obama barely raised taxes on the 0.4% and permanently fixed tax rates at a level that was lower than under Bush #43. I think Obama was wrong here...he should not have promised to make the Bush/Obama tax cuts for the middle class permanent. Sooner or later we will need more revenues

Posted by: 2slugbaits at March 6, 2013 03:24 PM

2slugbaits: I think you will find answers to your questions in my next post. If not, please raise them again at that time.

Posted by: JDH at March 6, 2013 03:32 PM

Surely we are on our way to some form of consumption tax. VAT has the advantage that implementing it is nicely inflationary in practice. It is also hard to understand - another advantage.

Posted by: c thomson at March 6, 2013 03:38 PM

This is a nice piece of work.

Posted by: Steven Kopits at March 6, 2013 03:43 PM

JDH Okay, thanks. Looking forward to your next post. But you must know that the post some of us are really looking forward to is the upcoming March Madness NCAA bracket post. The Big Ten rules.

Posted by: 2slugbaits at March 6, 2013 05:29 PM

Very interesting! What if you include private debt/GDP in your regression?

Posted by: Greg Hill at March 6, 2013 06:14 PM

The question to me is why the citizens of Ireland or Spain should back the losses of their financial sector. I doubt if the gain in credit ratings will be worth the pain for them.

Posted by: don at March 6, 2013 06:43 PM

About those 20 advanced economies; is it safe to assume that a good number of them issue most of their government debt in a currency whose supply they do not control (e.g. Euros)? Is there any significant difference in the debt/interest dynamics between those nations and the rest?

Posted by: Simon van Norden at March 6, 2013 07:11 PM

Your models and data don't take into account original sin. Whether countries borrow in their own currency or not makes a huge difference to the question you try to answer. For instance, rates for countries like the US, UK, Japan (and also Germany) are very low, even though they have a significant debt burden (huge in the case of Japan.) What you talk about here is almost exclusively about countries in the periphery of the Euro, that borrow in their own currency*. So any conclusions you draw here have zero value for countries like the US (that's probably why you don't talk about it here.) By leaving out original sin (if you're competent, you know about it) you're essentially lying, because you suggests things that simply aren't true.

* (One could argue the same for Germany, but the market is very clear in indicating that it considers the Euro to be Germany's currency, and for good reasons, and Trichet has strongly confirmed that for those who can read central banks.)

Posted by: Christiaan Hofman at March 7, 2013 05:18 AM

Where this paper addresses the direct effect of debts and borrowing costs, debts servicing ability and fiscal receipts, there is as well the perverse effect of boundaries attached to debts servicing and fiscal receipts. Recoveries are taking place at the asymptote of the debts curves and not before. The corollaries are many among them, the fiscal receipts may be impaired by the limit to growth itself. To fend off contraries to the evidences, the boundaries of the asymptote have been defined by the same Reinhart &Rogoff and documented by many papers the IMF, B. Eichengreen and BIS papers dealing with the asymptote of corporate debts.
The world of micro economy is not given a place large enough in the paper, where boundaries to growth, debts servicing, tax payments exist and when merged together they may explain the asymmetry that exist between valuation, expectation and taxes contribution. The valuation of companies are way beyond a multiple of profits, cash flows and the good will is extravagant. Central Banks are the blind enablers of this situation, where capital gains expectations are the major component of the decision process.
The series in the above functions are showing the criteria of convergences that may drive to the concept of total collapse so close to Cauchy, Fourier and Bernouilli series.
Reading in the referenced paper « Europe is like Argentina and its debt load drives the worries of the German Central Bank » may require clarification and references to causes and causations so deer to the Economists principles. The great depression was caused by the excess of loans and credit to the corporate, consumers and subsequently the finding and fiancing of debts and credits inability to be serviced. The credit providers as in all financial crisis did not fulfil their functions, that is risks assessments. Since it is Argentina, needs are to be two for …………dancing the Tango.

Posted by: ppcm at March 7, 2013 06:16 AM

Simon van Norden and Christiaan Hofman: Yes, our results are primarily driven by the experiences of five of the countries discussed in particular above, namely Greece, Ireland, Spain, Portugal and Italy, all tied to the euro. Of course you are not saying that simply being tied to the euro was the cause of their problems, for a theory is needed as to why some countries were vulnerable and not others, and why in some years and not others. Perhaps you are accepting our thesis that the answer to those questions are to be found in the debt levels and current-account deficits, and perhaps you are accepting our thesis as to exactly why that should be the case.

It is true that when the debt is denominated in the country's own currency, the erosion of the real value of government debt will presumably take the form of inflation rather than technical default. Certainly the outcome for the 5 countries just mentioned could also have taken that form, e.g., repayment of creditors at the nominal terms promised but using "Greek euros".

Our original analysis also included Iceland, for which the relation holds as well. We ended up dropping Iceland from the final analysis because we found that different data bases are reporting very different values for Iceland's historical interest rate series, and thought it was simplest just to stay away from that issue.

Both of you are basically raising the question of whether these results have any implications for a country like the United States. There are a number of very important issues associated with that question, for which I want to make sure we have a full discussion. That is why I plan to devote an entirely separate blog post and thread to your question, which I promise will come within a few days.

Posted by: JDH at March 7, 2013 06:26 AM

The Iceland case history is interesting for at least two reasons: (1) They have their own currency and (2) They chose (via popular referendum if memory serves) not to bail out the banks).

Of course, the common comparison is Ireland, which does not have its own currency and which chose to bail out the banks.

Following is a link to an article from a year ago:

Lesson From Iceland And Ireland: Don't Bail Out Banks

Read More At Investor's Business Daily: http://news.investors.com/economy/030212-602944-iceland-fixes-bank-crisis-ireland-a-mess.htm#ixzz2Mrd2Y3hm

Posted by: Jeffrey J. Brown at March 7, 2013 06:33 AM

Bruce C.

"...which in turn will reduce private activity per capita and reduce the anticipated revenue..."

This statement is only presumed true at full employment. Since you seem familiar with economics, I can't believe you have not been exposed to thinking about the difference in impact of fiscal policy at less than full employment at at full employment - when the central bank raises rates in response to faster growth and when it encourages faster growth with zero rates.

If you are not familiar with this thinking, then I don't think the rest of us can afford to credit any of your other assertions about how things will work out. If you are familiar with the notion that fiscal expansion works when there is an output gap, but have pretended that it does not, then surely the rest of us cannot afford to credit anything you say, ever.

Please clarify - are you less familiar with economics than you pretend to be, or are you being disingenuous?

Posted by: kharris at March 7, 2013 06:50 AM

Professor,

Excellent use of econometrics - for analysis not to establish policy.

It appears that the greatest problem you face is bad government statistics as demonstrated by your comments on Greece.

My only concern is that this doesn't tell us how to actually change critical variables, such as growth rates, to gain a positive result, but it does warn us of what is to come.

I too an interested in your analysis of the US.

Posted by: Ricardo at March 7, 2013 08:54 AM

Professor Hamilton,
How does one factor-in what caused the debt to increase? For example has debt increased to fund transfer payments or to fund “true” investments that will help to grow the future GDP.

Posted by: AS at March 7, 2013 09:45 AM

AS: Over time that should show up in the growth rate g.

Posted by: JDH at March 7, 2013 09:47 AM

@kharris, what is your assumption for "potential GDP"? The CBO's estimate is 2.1-2.4% (nominal 3.8-4.6%) over the next 5-10 years.

But what if the US real "potential GDP" is much slower than you assume, or negative, owing to Peak Oil, Boomer demographic drag effects, extreme wealth and income concentration to the top 1-10%, US gov't debt/GDP, total gov't spending/GDP, large fiscal deficits/GDP, offshoring and labor arbitrage, deindustrialization, accelerating automation of labor and loss of wage income and purchasing power, and the resulting ongoing decline in wages/GDP?

Can unprecedented US gov't deficit spending and central bank printing to liquidate banks' balance sheets have any sustainable positive effect against the aforementioned structural constraints?

What if the trend 2% nominal, 0.5% real, and negative per capita rates since 2007 are the "new normal" resulting from the aforementioned structural conditions?

Thus, what if there is no "output gap" in the context of the emerging post-Oil Age, post-growth epoch?

Are you aware of what the 5- and 10-year average trend rates of real GDP per capita were during previous Long Wave debt-deflationary eras of the 1830s-40s, 1880s-90s, and 1930s-40s, and for Japan since the 1990s, and the US and EU since 2000?

Are you aware of the secular causes of those slower or negative growth rates?

Are you aware of the proximate causes of the end of those secular regimes?

If so, what are the implications for today?

If not, do some research; it's worthy of a Ph.D. thesis, if you can find five committee advisers who have any idea what you're talking about. Perhaps you can teach them.

Posted by: Bruce Carman at March 7, 2013 09:50 AM

Professor Hamilton,
Thanks for the above response.

If one were to use a VAR analysis with the variables consisting of the percent change in transfer payments, the percent change in investment and the percent change in public debt would this analysis be of any measurable value regarding the identification of beneficial public debt?

Posted by: AS at March 7, 2013 10:38 AM

Bruce C,

You originally stated flat out that fiscal stimulus does result in a reduction in private investment, and so a reduction in growth. Now, you've fallen back on a list of "what ifs". The "what ifs" don't excuse your first misbehavior.

If you believe that there are factors reducing potential growth from what it has been in the past, you were free to list them in your first assertion. That would have left a bunch of "ifs" in that assertion, rather than a flat out claim that government borrowing reduces private investment and so reduces growth. You ask about my views on trend growth, peak oil or any other factor, but my views don't have anything to do with your initial claim and so cannot be part of an excuse for your initial claim. You either meant to mislead or you are pretending to understand economics better than you do. Those are the only plausible explanations for your initial statement.

Posted by: kharris at March 7, 2013 12:52 PM

JDH said
It is true that when the debt is denominated in the country's own currency, the erosion of the real value of government debt will presumably take the form of inflation rather than technical default.
So why is all the talk in DC about running out of money? The Dems say we need more revenue, the GOP says we don't have the money to spend. But you are saying it is all about inflation. Sounds like your profession is doing a poor job educating politicians. And if inflation is just around the corner, why are banks making 30 year loans for under 4%. I know some (most) bankers are stupid, but all of them?

Posted by: Markg at March 7, 2013 02:07 PM

"you are pretending to understand economics better than you do"

@kharris, okay, let's try this: How much of the "fiscal stimulus" resulted in growth of domestic private investment, employment, wage growth, and real GDP per capita growth since '08?

Moreover, how much of gov't fiscal deficits resulted in domestic private sector investment, employment, and wage growth since '00-'01? Then, subtract the amount of gov't deficit spending, and spending in general, that went to spending for imperial wars. How much private investment, employment, and wage growth is left? I bet you don't know.

How much of US "exports" are US firms shipping capital goods and component and intermediate goods to US supranational firms' subsidiaries and contract producers in China-Asia to produce goods to "export" intra-Asia and then back to the US? I bet you don't know.

How much of the US "fiscal stimulus" resulted in US firms' FDI and energy and materials consumption, goods production, employment, and wage growth in China-Asia and elsewhere rather than in the US? How much did that "fiscal stimulus" cost domestic private investment, production, employment, and wages because of the leakages to China-Asia and elsewhere? I bet you don't know.

How much of US "oil exports" go to US subsidiaries' demand abroad, military facilities and war theater supplies, and China-Asia contract producers to produce "exports" to send back to the US? I bet you don't know.

The point is, if you don't know the net effects of these activities, you have no idea why "fiscal stimulus" won't result in growth of US private domestic investment.

If you don't understand the deterministic nature of long cycles of capitalist evolution, you won't know that you won't be able to anticipate secular trends and, once you're in the midst of the secular effects, that what you think you "know about economics" misinforms your perceptions and policy prescriptions.

It's like being in a raging storm on a sailboat at sea thinking that the reason your listing severely is because you aren't trimming the sails properly or you brought onboard too much beer below. The waves are bearing down on you, and you can't do a bloody thing about it but hold on and hope you don't capsize or have your head taken off by the boom.

We are in a predictable once-in-a-lifetime capitalist secular debt-deflationary regime that has not yet resolved, implying the weakest Kitchin and Juglar cycles in a lifetime are ahead.

The banksters and Bubble Ben Shalom Zimbabwe's Fed know this and are desperate to liquidate banks' balance sheets before the global debt-deflationary tsunami hits, and to keep the stock market propped up because it's the only game left in town. Let the equity market correct to the implied historical levels in a secular bear market for valuation against corporate debt, replacement costs, dividends, and long-term trend earnings, and you're looking at another 50% or larger decline and another wipeout of capital in the hopelessly overleveraged financial sector (now at ~100:1 for equity index futures and options on futures via offshore bank PTFs in Caribbean banking centers levering up US Treasuries, MBS, and foreign exchange holdings, even larger than the leverage before Bear Stearns, Lehman, and AIG implosions before the meltdown in '08-'09).

Fiscal deficits will not "stimulate" the private economy with the massive private and public debt overhang, overvalued and highly leveraged financial assets, wages/GDP at a record low, Boomer demographic drag effects set to intensify, high payroll taxes on the bottom 90%, Obummercare taxes, and \$110 Brent oil. Higher deficits/GDP will only bring the nation to an interest moratorium, "austerity", and sovereign default sooner rather than later.

Posted by: Bruce Carman at March 7, 2013 06:57 PM

Bruce, c.

"...if you don't know the net effects of these activities, you have no idea why "fiscal stimulus" won't result in growth of US private domestic investment."

See, there's that bias again. If we don't know the net effects, then we don't know WHETHER fiscal stimulus resulted in growth. There is no evidence that it didn't, so we are not in a position to honestly question why stimulus did or did not result in anything. You have utterly begged the question here. You have written you bias into you statement of the problem. It should probably be noted here that the weight of expert opinion firmly supports the notion that fiscal stimulus did help.

Economics ain't engineering. We can't pull out a tape measure, figure out the length of the lever and the location of the fulcrum and know what the multiplier is. We don't have absolute evidence that stimulus led to John Q. Doe being hired on December 9th, 2012 in Lincoln Nebraska. Never will. It is similarly true that we will never know whether tax cuts, regulatory changes, flood, fire or famine led to the hiring of a particular individual. If that is the standard you are hinting at, you aren't actually thinking in economic terms, no matter what vocabulary you employ.

The trick of the anti-stimulus crowd, kinda like the anti-evolution crowd, has long been to insist that in the absence of incontrovertible evidence for the other side, their denialist view is the correct one. That's nonsense, and the fact that, in three out of three efforts, you have relied on nonsense does not speak well of your intentions.

If we are going to look at evidence, though, I think it is notable that GDP began to grow again at about the same time as large amounts of fiscal stimulus were employed. That employment stopped falling by hundreds of thousand each month soon after. It is notable that the UK, which engaged in an intentional, overt policy of fiscal contraction, is back in recession when the US is not. The UK government likes to blame Europe for UK troubles, but Europe is also engaged in fiscal contraction, and also in recession.

Posted by: kharris at March 8, 2013 05:08 AM

Markg:

"And if inflation is just around the corner, why are banks making 30 year loans for under 4%. I know some (most) bankers are stupid, but all of them?"

Aren't virtually all 30 year mortgages funded or supported in some way by federal agencies?

I know that ING Direct (now Capital One 360) did not do 30 year fixed rate mortgages, because of the interest rate risk. They did fixed rates for 5-7 years, and then the interest rate floats.

Posted by: Jeffrey J. Brown at March 8, 2013 05:33 AM

"At the differential rates of growth of spending, receipts, and GDP since '00, the US will reach the "tipping point" for spending and debt to GDP and interest to receipts by no later than '18-'19, and likely sooner were a recession to occur."

You write this with such assurance and yet have no proof and no idea what you're taking about.

Ross Perot was crying wolf over the debt in the early Nineties and spoke of Mexico taking out jobs. And yet by the late 90s thanks to the stock bubble we had 4 percent unemployment and federal surpluses. In your view Perot was right he just needed to wait until 2020.

http://krugman.blogs.nytimes.com/2013/03/08/fatal-fiscal-attractions/

Fatal Fiscal Attractions by Krugman

Posted by: Peter K. at March 8, 2013 11:00 AM

2slugbaits,

How convenient that you forget the 3.8% tax increase on capital gains under Obamacare.

LT Capital Gains have risen from 15% to 23.8%.

ST Capital Gains have risen from 35% to 43.4% (for the top bracket).

You lied :

Last time I checked Obama barely raised taxes on the 0.4% and permanently fixed tax rates at a level that was lower than under Bush #43.

Whatever you 'checked' was not an official source.

And don't you socialists claim that all capital gains are made by the top 1%? Thus, Obama has inflicted an 8.8% tax increase on capital gains.

Like I said, I want to see the look on their faces when tax revenue comes in so much lower than their Laffer-Curve-ignorant projections.

Posted by: Darren at March 8, 2013 11:24 AM

Well, several comments mention the importance of a country having its own currency. Obviously this is critical point.

And, it seems the analysis falls apart if Euro countries are removed.

http://krugman.blogs.nytimes.com/2013/03/08/fatal-fiscal-attractions/

Posted by: mike at March 8, 2013 11:38 AM

Darren You referred to "massive tax increases." Your words, not mine. The tax hikes you cited are a long way from any plausible understanding of "massive." And if you think any of those higher rates are anything close to being on the other side of the Laffer curve, then I'm afraid you're addicted to clownshow economics.

Posted by: 2slugbaits at March 8, 2013 01:42 PM

@kharris: "If we are going to look at evidence, though, I think it is notable that GDP began to grow again at about the same time as large amounts of fiscal stimulus were employed. That employment stopped falling by hundreds of thousand each month soon after."

I take your point, but I would add that the US economy experienced the worst constraction in decades, if not a lifetime; therefore, you no doubt will concede that such a contraction results has the tendency for a reflexive recovery owing to reduced capacity, labor underutlization, and a collapse in energy and commodities prices.

Yet, I will in turn concede that without the \$5 trillion or more so far in deficit spending, the US economy would have experienced an 1890s- and 1930s-like nominal contraction of 20-25%.

But note the trend rate of recovery since '07-'08 against the 5- to 10-year real GDP and per capita rate. The assumption is that the long-term 3.3% real GDP rate and 2.1% real rate per capita is what we should expect; but the historical secular precedent during a Long Wave debt-deflationary regime argues otherwise.

Moreover, we have added constraints that did not exist in the 1830s-40s, 1880s-90s, 1930s-40s, and Japan since the '90s, notably, peak global oil production and oil exports per capita, peak food production, 7 billion people, loss of arable land and forests, and growing water shortages.

Therefore, the trend rates from '00 and '07 suggest that the US will lose an equivalent 1890s- and 1930s-like amount of real GDP growth per capita over the course of two decades or so through late decade to early '20s, just as Japan has lost 40% of real GDP per capita from the secular peak in '90 and the onset of their debt-deflationary regime in '98.

Posted by: Bruce Carman at March 8, 2013 03:02 PM

wow for us bricklayers out there who can reed Iif its possible I would like a really simple in fact 3 year old breakdown if you have time of " if inflation is just around the corner, why are banks making 30 year loans for under 4%. because interest rates are going to go up in the next year or two at most ?

Posted by: marcus at March 9, 2013 12:12 AM

Great post, Prof. Hamilton.

Two questions:

1) Italian voters just voted against austerity. However, the ECB is telling them to hold fast on austerity. From a political-economics perspective, what does this imply? Do voters have a say in the evolution of their country (i.e., is Italy a democracy)? Or,

2) Is the ECB -- dominated as it is by Germany -- effectively ruling the countries on the periphery? That is to say, what the voters say does not matter, since they've ceded monetary policy to Brussels?

Of greater moment, as a bracketologist, I'm anxious to get to the NCAAs this year. When are you posting your brackets?

Posted by: markets.aurelius at March 9, 2013 12:13 PM