June 09, 2013
The more you borrow, the more you'll pay
A key reason to be concerned about high debt levels is very simple-- you're going to be stuck with the bill for the interest payments for the rest of your life.
According to the Congressional Budget Office, net federal debt held by the public (which leaves out the sums owed to Social Security and other trust funds) was $11.3 trillion as of the end of 2012, or 73% of GDP. Federal net interest expense for 2012 came to $220 B, for an average interest rate paid on outstanding debt of 220/11300 = 1.9%. The graph below repeats that same calculation for each of the last 40 years. Federal interest expense as a percent of debt owed is currently lower than it's been at any time during this period. For example, the average implied rate over 2000-2009 was 4.5% and the average over 1990-1999 was 6.6%.
That implied rate calculation tracks the actual interest rate on a 10-year Treasury bond fairly closely.
And that makes it pretty simple to calculate what would happen to the government's total interest expenses if interest rates were to rise. For example, if today the government had to pay the same average rate that was seen over 2000-2009, interest expense would come to (0.045)(11,300) = $508 B every year, even if the level of debt stays exactly where it was as of the end of last year ($11,300 B). With an average interest rate like we saw in the 1990s, the interest cost would be (0.066)(11,300) = $746 B. For comparison, total federal discretionary spending on all categories other than defense came to $615 B in 2012, and the entire defense budget was $670 B.
The other key parameter for assessing the interest burden is the economic growth rate. The red line in the graph below shows the average annual growth rate of U.S. nominal GDP for the 5 years prior to each indicated quarter. The nominal yield on 10-year Treasuries is shown in blue for comparison. Historically the two have been fairly close, though most of the time since 1980, the 10-year yield has been higher than the nominal GDP growth rate. For example, the average 10-year yield from 1990-2013 was 5.1% and the average annual nominal GDP growth rate was 4.5%.
The comparison between the interest rate and the growth rate matters for questions like the following. Suppose tax revenues were just sufficient to cover all items in the federal budget other than the interest expense. Then the outstanding debt would still be there at the end of the year, plus we'd owe one more year's worth of interest. On the other hand, if the economy also grew during the year, that could help make the debt look less big relative to total GDP. If the interest rate is higher than the growth rate, the first effect is going to outweigh the second. In that case, unless our taxes are enough to cover all of the government's non-interest expenditures plus at least some of the interest expense as well, then our debt will grow as a percent of GDP, and we'll be in an even deeper hole at the end of the year than when we started.
Figure 4 above plots the primary surplus for the United States-- government revenues minus spending on all items other than interest expense-- as a percent of GDP. Typically this would need to be positive in order to keep debt from growing relative to GDP. One can see this interaction by looking at the debt/GDP ratio in Figure 5 below. The large primary surpluses of the 1990s brought debt down as a percent of GDP, but most of the rest of this period saw primary deficits and a growing debt-to-GDP ratio.
Let's use the average 0.6% difference between the interest rate and the growth rate observed over 1990-2013 for some sample calculations. If net debt is 50% of GDP, it means that the primary surplus would need to exceed 0.3% of GDP every year in order to keep debt from growing relative to GDP. If net debt is 100% of GDP, a permanent primary surplus of 0.6% of GDP would be needed to keep debt from growing relative to GDP.
But there's another important detail to factor in. The experience of most countries has been that when the debt load becomes higher, the interest rate goes up. For example, Baldacci and Kumar (2010) found in a study of 31 advanced and emerging economies over 1980-2007 that a one-percentage-point increase in government debt/GDP was associated with a 4-basis-point increase in the 5-year-10-year forward interest rate. Ichiue and Shimizu (2013) found for 10 advanced countries over 1990-2010 (for which Germany was the only representative of the eurozone) that a one-percentage-point increase in government debt/GDP plus a 1% increase in external debt/GDP raised the 5-year-10-year forward rate by 3 basis points. Laubach (2009) inferred from changes in U.S. CBO projections over 1976-200 that a one-percentage-point increase in debt/GDP was associated with a 3-to-4-basis-point increase in the 5-year-10-year forward rate. Vincent Reinhart and Brian Sack (2000) analyzed the G7 countries over 1981-2000 (prior to formation of the euro) and found that a 1% decrease in projected surplus relative to GDP was associated with a 12-basis-point increase in the 10-year-3-month interest rate spread. And Greenlaw, Hamilton, Hooper and Mishkin's (2013) analysis of 20 advanced economies over the last decade found that a one-percentage-point increase in debt/GDP was on average associated with a 4.5-basis-point increase in the 10-year yield.
U.S. net debt averaged 45% of GDP over 1990-2012, the base period used in the above sample calculations. We'll be entering the next decade with a debt-to-GDP ratio 30 percentage points higher than that. The empirical studies just mentioned suggest that could easily raise the 10-year rate by more than 90 basis points relative to where it would have been if we'd held debt to 45% of GDP. In other words, given current U.S. debt loads, we might expect to see a nominal interest rate over the next decade that is 1.5% higher than the GDP growth rate instead of the 0.6% differential observed on average over 1990-2013.
There are those who argue that the interest rate is below the GDP growth rate at the moment, so why worry about it? The problem is that these debt levels are not going to go away. We're going to be stuck paying the interest on the debt we've already accumulated well into the foreseeable future, through good times and bad. That's why I think it's important to consider the longer-run historical experience of our country and others, and not just the situation holding at the moment, to get a clear understanding of exactly what we've gotten ourselves into.
Consider for example the historical episode over the last two generations for which the U.S. was most successful in bringing its debt load down, namely the 8 years when Clinton was president (1993-2000). Over this period, the primary surplus averaged 2.1% of GDP. Given Clinton's starting debt load of 49%, those primary surpluses were big enough to bring debt down to 35% by 2000. But if Clinton had started out with debt at 100%, and had exactly the same success with raising tax revenues and reducing non-interest spending relative to GDP, the numbers just discussed could mean that those same policies would have accomplished nothing in terms of reducing the debt burden. Moreover, if we let debt get to 100% of GDP, we'd have to repeat Clinton's success decade after decade forever just to hold debt constant at 100% of GDP.
The mathematical principle behind this is very simple. If we start with debt at 100% of GDP instead of 50%, we have to run that much faster just to stay in the same place.
And next time we're going to be running the race with a bigger fraction of the population in retirement and with much higher medical costs than under Clinton.
Here's my advice: try not to start the race owing 100%.
Posted by James Hamilton at June 9, 2013 03:41 PMdigg this | reddit
Doesn't this imply that we should sell more 30-year bonds to lock in current low rates rather than our current preference to sell shorter-term stuff and keep rolling it over? Is the demand for longer-term bonds not there?
Posted by: Brian at June 9, 2013 04:33 PM
Those all sound like good reasons why the Bush tax cuts should never have been passed. Figure 4 shows that even at the peak of the Bush recovery the primary surplus was barely into positive territory. It would be interesting to see how many of those economists who are today lamenting our high debt/GDP ratio were also some of the biggest cheerleaders for the 2001 and 2003 tax cuts. The usual excuse I hear from those economists is that the Bush tax cuts were different because we weren't close to the 90% threshold back then. But then as your post clearly implies, debt is fungible; a dollar of debt accumulated in 2006 counts the same as a dollar of debt accumulated in 2013. Except that in 2013 there are at least valid macroeconomic reasons for accumulating that dollar of debt.
There are those who argue that the interest rate is below the GDP growth rate at the moment, so why worry about it?
I don't think that's an entirely fair characterization of the argument. Krugman and others have never argued that we shouldn't worry about the debt or that we shouldn't worry about higher interest rates in the future. Their argument is really three-pronged. First, from the Treasury's perspective what counts are the interest rates at the time of the auction, not the interest rates in the secondary markets. Locking in interest rates with long term bonds would give the Treasury a lot of room to maneuver for quite a long time. And at the moment it's not like there's any scarcity of buyers for long-term Treasury bonds. The markets keep telling us MORE, MORE, MORE! The second argument is that there are many projects that will have to be paid for sooner or later. This country's infrastructure is a shambles. The smart play would be to borrow now when there is slack in the economy and interest rates are low. Contrast that with the policies of my GOP governor, who seems to think it only makes sense to fund infrastructure spending "when we can afford it"; i.e., when there's crowding out and interest rates are high. His investment strategy seems to be "buy high, sell low." The third argument is that it doesn't make a lot of sense to worry about the consequences of decisions if the decision you're making is the best one available. In other words, when the economy is in deep trouble with persistent long-term unemployment, it's just stupid to lose sleep over what you can't help. Some day the sun will engulf the earth. Only one Woody Allen's characters worries about it. You do what you have to do and move on. The voices of R&R and A&A should have been heeded in 2006 and ignored in 2010.
Posted by: 2slugbaits at June 9, 2013 06:08 PM
In June 2011 at a time when the ECB had raised their interest rate, Jean-Clause Trichet was asked about a concern for the Euro... He responded...
"...I would only mention that in the constellation of major floating currencies, it is very important what the US authorities – including, of course, Tim Geithner, the Secretary of the Treasury, and my colleague Ben Bernanke, the Chairman of the Federal Reserve System – say, and they do say it with some force, that a strong dollar is in the interests of the United States – meaning strong vis-à-vis the other major floating currencies – and also in the interests of the global economy. And I trust that."
How long can advanced countries keep interest rates low?
Posted by: Edward Lambert at June 9, 2013 06:40 PM
The Federal Reserve appears to have decided that screwing fixed-income retirees and bankrupting pension funds is preferable to the alternatives...
Posted by: Michael Cain at June 9, 2013 06:42 PM
Interest rates are on a long term downward trajectory which is why we will be needing more inflation to avoid our current predicament. Do I hear you calling for more Fed easing to lower our future debt burden? Someone should since their attention is moving in the opposite direction. We will have a lot of debt because the Fed likes having a lot of debt. Remember Greenspans concerns about not having enough to operate with in the late 90s? We will have just as much debt as the Fed wants us to have.
Posted by: Lord at June 9, 2013 07:16 PM
Posted by: Steven Kopits at June 9, 2013 07:41 PM
First, there is obviously a sharp break in the spread between growth and the 10-year at around 1980. The most obvious explanation for this is that growth and the short rate were rising before and falling later and that that trend was not anticipated by the 10-year bond yield, either before or after. I.e, the post-1980 positive spread is largely accounted for the unanticipated 30 years of great moderation.
Second, the historical mean duration of government debt is well under 10 years. If you look at five or less years, your post-1980 spread is already much smaller. If you look at the t-bill rate it completely goes away or is even reversed. And before 1980 the t-bill rate is *vastly* lower than the growth rate. So over the past 60 years or so of data, we have strong evidence of dynamic inefficiency (Abel, Mankiw '89 notwithstanding).
Third, Greenlaw '13 is not at all uncontroversial. Both Dube and Wang and Kimball find no, or a negative relationship when controlling for prior growth.
If you want to look at longer term debt yields, you need to consider a period without significant unanticipated changes in the short rate. But you can avoid those complications by just considering short term debt. And in that case, your conclusions are totally reversed and all indications are that we have plenty of room to maneuver.
Posted by: K at June 9, 2013 08:24 PM
One more thing... Since we have experienced secular disinflation since 1980, that means that the policy rate has been above equilibrium. So even t-bill rates are a high estimate of the nominal natural rate over that period.
Posted by: K at June 9, 2013 09:42 PM
This whole discussion reminds me of the Russian roulette scene in Deer Hunter. We are spinning the barrel and pulling the trigger and hoping nothing happens.
The earlier discussion of whether the 90% of GDP threshold is meaningful--it's ridiculous. The accepted threshold in modern times was 60%. That's what the IMF used and what the EU used. And now we're arguing about whether 90% is still a viable debt level. That's absurd.
Then take it a step further, and we're debating whether we are immune to interest rate rises. Don't worry, they say, because interest rates won't ever rise. Gravity doesn't work here because we're special. Mean regression and long-term averages are irrelevant.
In my experience, sooner or later, gravity starts to pull. Fiscal management in the US should not be conducted as though it were a game of Russian roulette.
Posted by: Steven Kopits at June 10, 2013 04:36 AM
Outstanding post, but sadly I fear our decision makers are not listening.
One element that you did not discuss is the fact that our current system is eating the seed corn. The Reagan years provided huge savings that continued through the Bush and early Clinton years. That maintained growth. But the late Clinton and Bush years ate away at the savings of our productive sector.
Obama has entered an economy with massive debt as you have clearly explained, but his administration has done nothing to restore the foundation of production. Not only are we at unprecedented debt levels but we are at seriously depleted capacity for production.
For those who are horrified by austerity as a program just hold on to your hats. You ain't seen nothing yet. If you want to protect yourself make sure you are not on the debt wagon. The government will probably confiscate your assets but if you do not have huge debts you will probably survive. If you have high debt levels not only will the government confiscate your wealth but so will the banks and financial institutions.
Posted by: Ricardo at June 10, 2013 05:19 AM
Looks as if there are only 3 actions that can be combined to influence the outcome in a positive way:
1. reduce spending - politically unpalatable.
2. raise taxes - politically unpalatable.
3. increase GDP faster than debt - now you're being silly.
Face it. We like living beyond our means.
Posted by: Bruce Hall at June 10, 2013 05:50 AM
First Great White shark siting off of Cape Cod this year. At Nausett Beach, about eight miles from where we normally vacation.
The shark was no doubt patrolling up from Monomoy Island, where a large colony of gray seals spends the summer. http://www.flickr.com/photos/mychatham/899005535/
But I think we have reached a critical turning point. We will have a fatality this year or next, I would guess, and then we're going to have to figure out how much we really like these sharks.
Posted by: Steven Kopits at June 10, 2013 05:57 AM
JDH: You have planted a flag on firm ground with this post. This is the clear essence of why debt must be taken into consideration today. I should like to see two more posts on this subject in the future. Both will be more complex. One is causation of debt to economic growth. What are the channels of this causality? And what is the grand sum of causality running from debt to growth, with empirical estimates of the magnitude? No paper of this nature exists in the economic literature.
The second post would be on optimal debt. Nor has this concept yet been assessed the way I imagine. The lower bound is zero. The upper bound is not so obvious. One candidate is the debt-to-GDP ratio beyond which no country has ever been able to revive without default. A collection of all countries with their own currency who have incurred such a debt burden where there was no other way but default is an initial step toward defining the upper bound. Default would be defined as either ordinary default, or default by extreme inflation. Vertical axis is long-term growth. Horizontal axis would be debt ratio, with range from zero to the level of debt-that-necessitates-default. Essentially you’d have a Laffer-type curve with a maximum somewhere in the middle of the range – likely skewed significantly toward the vertical axis at a relatively low but surely non-zero level of debt. This maximum of potential economic growth would then demark the optimal debt ratio.
Armed with this concept, and empirical measurement of it for a group of large open-economy countries with their own currency, you’d have one end of a tetter-totter. The other end would be current period deficit spending. The objective function would be keeping debt from crossing beyond optimal by managing today’s current deficit. The cost-benefit calculations on economic growth would keep the tetter-totter balanced in a way that fiscal stimulus (of high quality) would be applied or extracted to keep debt at its optimal point (maximum long-term growth potential). It is immediately obvious that the seemingly reasonable canard of many decades standing – balance the budget over the cycle – would give way to a slightly different and more desirable rule.
The difficult case that would arise is like that of late-2008 where the financial system was in jeopardy of breaking. Would the additional current period fiscal stimulus – which adds to the numerator of the debt ratio – be more than offset by the additional growth – which adds to the denominator of the debt ratio? This is the overwhelmingly number one question that must be asked and answered.
The literature has hardly touched the surface of this conceptually, and hence has no good empirical evidence to answer this question. Better said, the evidence is lying all about in bits and pieces but no one has yet put it all together in this framework. Obviously it depends on the fiscal multiplier. I’ve long conceptualized the multiplier as having a short-term impulse effect and a more all-encompassing longer-term effect. If a trillion dollars of fiscal stimulus were to save the financial system from collapse, both short and long effects of the stimulus would be massive. They would easily move the debt-ratio leftward (smaller) in an expectational sense. But as the economy begins to recover from the trough of a recession, the long-term multiplier (which is a variable dependent on where the economy is in the cycle) soon (a year or two into recovery in my judgment) approaches zero and then goes negative. An injection of new fiscal stimulus at the present time in the US, now four years into recovery, would in my judgment shift the debt ratio rightward (increase it) to a level already above optimal into even more damaging territory. Longer-term growth (cumulative from present year through all out years) would be damaged by any new stimulus here in 2013. In fact today, stimulus should be removed at some optimal pace to lower the debt ratio and bring it back leftward to optimal! This of course is what the fiscal cliff and sequestration were all about.
What I propose is objective science, not ideology. Assume that we knew the optimal level of debt. Assume that the voting public were made aware of it, and that a sufficiently large portion of the public also understood it. Instinctively, households do grasp the concept of optimal debt for themselves. Though, of course, human nature will in many cases have households taking on debt beyond their point of optimality. But the larger point is the government’s example would give direction to all of society. And it would maximize the main thing – economic growth. Within this larger tent, there should be plenty of room for a well-informed society to make policy adjustments for equity.
Right now we are far from the ideal place. Generations of Keynesian trained economists are myopically cooking the goose that lays the golden eggs because they see only the one side of the tetter-totter. I can put this as a prediction: for the next decade if not far longer, real economic growth will not reach above 2% for any sustained period of time. One of the most important of a lengthy list of reasons is that debt is way larger than optimal. The core reason debt is so important is because deficit is the opposite of surplus, and the nation’s surplus is the most important economic concept of all. Price system, productivity, sound money, and surplus, these are the crème de la crème. Since the dawn of history, setting aside enough seed corn or seed grain to plant the next season has always been the most important of these four. All else springs from it.
Posted by: JBH at June 10, 2013 06:09 AM
"Is the demand for longer-term bonds not there?"
It's not. The Fed owns well over 50% of all 30 year bonds outstanding. I don't have the number handy.
Posted by: Anonymous at June 10, 2013 07:34 AM
"And at the moment it's not like there's any scarcity of buyers for long-term Treasury bonds."
I know you are a partisan hack, but to tell an out and out lie like this is just disgusting. What makes you think there is not a scarcity of long-term treasury bond buyers? Who in their right mind, OTHER THAN BEN BERNANKE, would buy a 30 year UST at 2%? Nobody.
Posted by: Anonymous at June 10, 2013 07:40 AM
"The Reagan years provided huge savings that continued through the Bush and early Clinton years."
Wut? Are you talking about private savings? And are you talking about Boomers in their prime earning years saving money? If so, the way you stated it makes it sound like Reagan "saved" money, when in fact, IMO, he started the era of modern deficit spending.
Posted by: Anonymous at June 10, 2013 07:44 AM
James, obviously you are not a Bilderberg member. Do you want to ruin the party ? Telling as that we will have to pay the bill, naughty man !
Take care of your job James, see NSA PRISM. Power doesn't investigate itself.....
Posted by: Johannes at June 10, 2013 07:47 AM
Jim: Nice post. Do you have a view on policy specifics that might help rein in the debt levels?
Ricardo: I am a little bit confused by your reference to saving under Reagan. If I Google US National Debt, it seems that debt increased under Reagan and Bush 41. That doesn't sound like saving, no?
Posted by: Robert Bell at June 10, 2013 07:48 AM
Bruce said "Face it. We like living beyond our means". Our "means" is what we can produce. You cannot consume more than you can produce so your statement has no merit. In fact, with unemployment and underemployment so high, we have been living well below our means. Unfortunately, idiots like JDH have no clue how the monetary system works. So he teaches his stupidity which keeps people stupid. I suggest you go read the MMT guys. They are the only ones who get it right.
Posted by: mark g at June 10, 2013 09:24 AM
JDH shows in a fairly straightforward and conclusive fashion the consequences of our high debt load. In response, the resident Kooky Keynesians call for even greater deficit spending.
Borrowing today may add a tiny fraction to GDP growth today, but federal debt is not paid off. The tradeoff is a bit of GDP growth today versus a perpetual debt obligation that's rolled over at a variable rate of interest that will almost certainly be higher at rollover time than it is today.
The point is that as growth returns, interest rates will rise and we will see federal interest payments crowding out federal discretionary spending. Borrowing more today because rates are low and there is slack in the economy simply locks in a higher level of debt that will be rolled over in 1,2,5,10 and 30 years down the road at higher rates.
Posted by: tj at June 10, 2013 09:41 AM
California must get the dollars it spends from taxes, borrowing, or reserves. Uncle Sam is a sovereign issuer of his own currency in which he incurs obligations. He does not have to get dollars from his citizens, businesses, or investors. Uncle Sam has an unlimited supply of dollars, which he creates at will.
Prof. Hamilton's clear and informative post results entirely from Uncle Sam's arbitrary requirement that the Treasury Department, Uncle Sam's right pocket, match expenditures in dollars with tax revenue and borrowing, while allowing the Fed, his left pocket, to issue new dollars on Ben Bernanke's say so. When the Fed buys outstanding debt, where does it get the dollars it uses to pay? It doesn't get them from taxes or borrowing.
An interesting question is does the "net federal debt held by the public" include federal debt held in Uncle Sam's left pocket. Does Prof. Hamilton's concerns about future interest payments apply to debt held by the Fed?
Posted by: Left Coast Bernard at June 10, 2013 09:43 AM
Very good article – it must be primary budget balance week because I posted a similar piece today. I saw your article on my blog review this morning, though, and made a note at the end of mine. My article is part two of a critique of Paul Krugman’s book, End This Depression Now! If you (or anyone) are interested in the primary budget balance math implied by Krugman’s book, here’s the link:
Posted by: F.F. Wiley at June 10, 2013 10:08 AM
Agreed, with some caveats ...
You need to take into account the debt held by the Fed, for which we pay only the IOR. Since the Fed is buying most net issuance, it's increasingly important. The sustainability of monetary financing of deficits is a very different calculus from the sustainability of true debt financed deficits. My sense is there's no exit without recession, and even a bit of taper will prove to be more tightening than intended.
Demographics is a huge factor. It's the reason why Japan's debt is skyrocketing despite real growth per working age person not much different than the US. The slower population growth, the more public debt costs in real terms, per person. The drop in birth and immigration rates since '08 changes the story. This is one of many reasons why we're in a very different situation than post-WW2.
Posted by: Tom at June 10, 2013 10:31 AM
It's funny that conservatives said nothing about debt when Reagan reversed decades of declining debt and pushed debt over the 60% cliff (according to Kopits above, 60 is the new 90) and at the same time pushed the burden of interest to three times its level today.
Clinton spent a lot of political capital cleaning up the debt mess left by Reagan and the Republicans. Yet in 2001 when Republicans took over and again we had a budget surplus, conservatives argued that budget surpluses were a danger to the economy and immediately squandered it on tax cuts for the rich.
Now, once again, with a Democrat in the White House, it seems that there are suddenly demands that we clean up the debt mess left by conservatives, even though the interest burden of the debt is one-third what it was during the Reagan era.
As we have seen over and over again, there is no "grand bargain" that Obama can make to fix long term debt that Republicans cannot completely reverse within a couple of years. Therefore Obama should forget the long term, because there is nothing he can do about it, and fix what needs to be fixed now and that is unemployment.
Posted by: Joseph at June 10, 2013 10:54 AM
Great article. Sadly Many silly political hack comments from usual culprits.
When the house is on fire it makes sense to try to put the fire out. Blaming someone else for the cause of the fire or doing nothing about it "because it wasn't me who started it" is so puerile.
In the real world (not academia), we get paid to FIX problems - NOT to squabble about who is at fault!
Posted by: Jeremy at June 10, 2013 11:31 AM
3. increase GDP faster than debt - now you're being silly.
Sadly, this is what the Fed thinks.
Posted by: Lord at June 10, 2013 11:31 AM
That is the tragedy, because cutting spending or raising taxes will not reduce the debt, only slow it and increase the deficit. So it is not the third possibility but the only one.
Posted by: Lord at June 10, 2013 11:38 AM
"When the Fed buys outstanding debt, where does it get the dollars it uses to pay? It doesn't get them from taxes or borrowing."
Yes it does. Sure it merely creates the new money, but it is a stealth tax on anyone who owns dollars and dollar denominated assets. I can't believe you and your types don't seem to get this.
Posted by: Anonymous at June 10, 2013 11:50 AM
"Demographics is a huge factor."
Agreed, and criminally underdiscussed by economists. Old people don't produce, plain and simple. You can't squeeze growth out of an old population. The "pro growth types" are just silly, as we should be expecting in both Europe, Japan, and the USA, LESS growth than the last 40-50 year trends.
Posted by: Anonymous at June 10, 2013 11:53 AM
to some extent I agree that Conservatards gave Reagan and the Bushes a pass on deficits. That is unfortunate but that doesn't mean their concerns now aren't valid. Plus under those presidents the debt levels were not this high nor spiraling this fast out of control.
Posted by: Anonymous at June 10, 2013 11:55 AM
90 is the new 60, Joseph.
As for debt and Presidents:
- debt was stable around 20% of GDP under Carter
- increased to 40% of GDP under Reagan (not a horror by any means at that level, although a big increase in percentage terms)
- increased to 50% under Bush I (Bushes were never my favorite presidents)
- decreased to 35% of GDP under Clinton (best Republican president since Coolidge)
- increased to 38% under Bush 2, pre-recession
- increased to around 50% for Bush 2 recessionary period
- increased to 73% under Obama
Now, I'm a balanced budget guy. On the other hand, the economy did well under Reagan and that deficit spending helped bring down the Soviet Union, so I'll bank that as a win.
As for Bush I, Big Government spender.
Clinton, really a great job on the fiscal side (although a number of market distortions seem to emanate from that period). But I'll mark that as the best fiscal policy since the 1960s.
Bush II, Big Spender, but deficit wasn't out of control until the end of his administration.
Obama, no discipline, no coherent vision.
Posted by: Steven Kopits at June 10, 2013 12:49 PM
Kopits: "Obama, no discipline, no coherent vision."
That's funny because Obama has decreased the deficit handed to him by conservatives at the fastest rate in history. Again.
Alas, we know it is a fool's errand because as soon as conservatives cut back entitlements, which is truthfully their only real agenda, they will blown up the budget again with tax cuts for the rich. We have seen this pattern over and over.
Therefore, the only logical policy for Obama is to ignore the long-term debt because he can do nothing about it. It is entirely in the hands of future Republican presidents. They are the ones who keep blowing up the budget.
Posted by: Joseph at June 10, 2013 01:27 PM
Shorter JH: Less debt is better than more debt
Corrected shorter JH: All else being equal, less debt is better than more debt.
The uncorrected message implies the foolish assumption that all else is equal and we merely need to choose less debt. Gee, thanks for the insight.
The corrected message makes the assumption explicit, clarifying that the "less debt is better than more debt" statement is not a helpful guide to real world policy choices.
In the real world, more debt is sometimes better (consider running WWII on the cheap, for a non-controversial example). The post above ignores that possibility.
In the real world, there are a lot of different ways to increase or decrease debt. The post above doesn't provide insight as to what choices are more desirable in given sets of conditions.
In the real world, government spending and revenue collection serve purposes other than to generate deficit and debt numbers for economists to analyze.
Considering the services we currently ask the government to provide now and in the future, any concern about the long-term effects of deficits and debt should quickly proceed to questions of how we can reduce the cost of healthcare and national defense/security.
Posted by: ottnott at June 10, 2013 01:43 PM
Anonymous Who in their right mind, OTHER THAN BEN BERNANKE, would buy a 30 year UST at 2%? Nobody.
Well, last month's Treasury auction saw the lion's share of 30 year (non-TIPS) bonds having been bought by dealers, brokers and investment houses. The Fed's share was trivial. Same with the previous month. In fact, on the primary auction market over the last several years the Fed has only bought about 12 percent of the 30 year stuff. True, the Fed does buy some of it back on the secondary markets, but even allowing for that there's still a huge appetite for 10yr and 30yr Treasuries. And France is selling 75yr bonds with great success.
Steven Kopits Bush II, Big Spender, but deficit wasn't out of control until the end of his administration.
Bush was also a big tax cutter, and that's what got us in trouble. And please note that under Bush II the deficit that matters was out of control. When the economy is at its cyclic peak the primary surplus should be well above zero. It wasn't. Again, you don't seem to understand that a large deficit in a weak economy is okay; but a smaller deficit at the top of the business cycle is not. You need to look at the cyclically adjusted primary surplus when comparing economic policies. And you also need to focus on the on-budget side. A lot of Bush's deficits were masked by the large FICA surpluses. The on-budget deficits are the part of the budget that the President and Congress control. The on-budget deficit was out of control because Bush recklessly cut taxes and then fought a war with a credit card. Here's a simple test. If you voted for Bush in 2000, Bush in 2004 and Romney in 2012, then you really aren't in a position to complain about the structural deficit, which is the one that we should worry about over the long run. Cyclical deficits smooth out; structural deficits hang around forever.
Anonymous Plus under those presidents the debt levels were not this high nor spiraling this fast out of control.
Again, look at what Bush did to the primary surplus. Look at the distance Bush took us from a large primary surplus to a large deficit. That shows the magnitude of the change in the fiscal picture under Bush. Obama gave us cyclical deficits; Bush gave us structural deficits. And you're wrong about the current deficit spiraling out of control...unless you mean to say that it's coming down too fast, which I would agree with.
Jeremy In the real world (not academia), we get paid to FIX problems - NOT to squabble about who is at fault!
In the real world we also look at resumes and track records. Many of the same people who are most exercised about the current and recent deficits today are also the same folks who gave us huge tax cuts and reminded us that Reagan taught us deficits don't matter. There is a time and a place to worry about deficits; but that time isn't when 4 million people are long term unemployed and employment to population data has been flat for several years. Why weren't Greg Mankiw and Glenn Hubbard concerned about the debt back when they had an opportunity to do something about it? Why are so many of the Bush retreads obsessed with cyclical deficits while having been indifferent about structural deficits? Why would you trust those people? That's why it's important to assign blame.
Give me full employment and a closing of the output gap and I'll turn into Mr Deficit Hawk in a heartbeat.
Posted by: 2slugbaits at June 10, 2013 03:08 PM
Deficit hawks had perhaps the clearest choice in a generation during the 2000 campaign. Gore clearly stated that we should use the budget surpluses during good times to pay down the debt. He also had a good grasp of the implications of interest burden, just as JDH talks about, because he pledged to use the interest savings from debt reduction to shore up Social Security.
On the other hand you had Bush who pledged to take the budget surplus and give it to the rich as a tax cut, "because it was their due" as Cheney famously said.
So there you had it -- one candidate that wanted to use surpluses to reduce the debt and the other that wanted to cut taxes for the rich and increase the debt -- as stark a choice as possible.
I really wonder how JDH chose back then. Anyone who chose wrongly has no right to come back a decade later and say all those Bush tax cuts didn't work out like we figured so I guess we will just have to take it out of the hides of the retired. We could have had real debt reduction over the last decade, just like we had during the Clinton years.
I see no reason for Obama to get suckered again, giving in to Republican demands for entitlement cuts just so they can turn around and cut taxes for the rich.
Posted by: Joseph at June 10, 2013 04:09 PM
The mindset behind most of these comments is fascinating.
The largest economy in the history of the world is perceived to be something like a train going down a well-mapped track.
If the forces of good can get control of the switches, the economy can readily be switched onto the correct track to take the train smoothly to the promised land.
No one seems to acknowledge that the US is a vast sloppy seething mass of over 300 million diverse, individualistic people with a venal, incompetent government. Our recent presidents have been duds, regardless of party. Our Congress merits contempt.
Fortune may shine upon us once again but it won't be due to good economic decision making - or control of the switches.
Hope for luck.
Posted by: c thomson at June 10, 2013 04:14 PM
Well... it looks to me that we will finally end up actually trying to reduce the totally out of whack trade deficit after what, about 15 YEARS NOW? If the private sector isn't willing or unable to take on any more debt (the savings rate is abysmally low AGAIN), and the size of federal budget deficits are under constant scrutiny, then that leaves net exports. Get ready for an intense resurgence of nationalism (for good or ill). The ramifications of those tensions will be the real worry, not just the level of debt.
Posted by: Doc at the Radar Station at June 10, 2013 04:21 PM
Great post. Again.
I think the 10 year nominal T yield against nominal GDP growth will be one of the more meaningful charts for many indebted countries going forward.
I couldn't help but notice that the first half of the chart 1960-1980 showed nominal GDP growth mostly higher than 10 year Ts. Perhaps the Fed will again be able to financially repress the economy to achieve the same results.
With your race analogy at the end of the post, what's the finish line? No debt? "Reasonable" debt levels? I think an interesting question to ask is how important ia lower debt/GDP ratio is in The context of other economic goals (unemployment, GDP growth, poverty reduction, etc.)? If lowering the debt/GDP ratio comes at the expense of these other objectives, what's the point? Reducing debt cannot be done without ramifications, short term and long term, resulting in both winners and losers. I guess this is what makes public policy so difficult.
I do agree that with higher levels of Debt/GDP (and we may be close to the limit) a country will have far less flexibility to use deficits to achieve other economic goals. I, for one, would prefer not to live in an economy unable to use deficits to smooth the harsh effects of a macro economy. I've read too much about pre-1930s business cycles.
Posted by: Steve at June 10, 2013 09:50 PM
One of the key foundations of our financial system is "borrow now, spend now, let our children pay the bill". And James, you are putting that into question (not only from an ethical point of view) ?
I wonder how long it will take that via NSA Prism you are classified and going to loose your job.
Posted by: Johannes at June 11, 2013 02:57 AM
One problem I have with Professor Hamilton's obsession with the Federal debt is that it leaves out the other parts of the National Accounting equation, most significantly the "Current Account Deficit/Capital Account Surplus." I must assume Professor Hamilton and others also don't want to see a repeat of the explosion in private debt and collapse of personal savings that occurred in the U.S. during the "Oughts."
If personal savings and deleveraging continues in the U.S., that means personal consumption will be constrained. If in turn Fiscal austerity is applied to the programs I assume Professor Hamilton believes should be targeted, Social Security and Medicare, that will further reduce personal consumption by the beneficiaries of those programs and as well as inducing higher savings for retirement and medical emergencies. Unless there is a corresponding fall in imports, import substitution with domestic production, increased net exports, and thereby an steep reduction in the current account deficit, then the fall of consumption will mean a slower growth, lower inflation, falling tax revenues, pro-cyclical State & local Government cuts, a possible recession - that will lead to higher Federal deficit!
It makes one wonder if the Political Economic objective deficit hawkery is not the elimination of the 20th century Social Insurance programs and a further redistribution of wealth and benefits to the .1%
Posted by: sherparick at June 11, 2013 04:30 AM
So what's the point? YES, debt servicing becomes more difficult when debt/interest rises. We all know that.
So what's your solution? More welfare for rich farmers and even richer bankers? Or cuts to the solvent social security system and the not so solvent medicare system? Or perhaps finding ways to more jobs and growth?
Please let us know.
Posted by: anon2 at June 11, 2013 10:34 AM
So basically you are saying that government should focus on employment and helping poor?
Why then are we not approving infrastructure projects on a grandiose scale such as pipelines?
Why then is the deficit being used to help Banksters, solar energy companies and Ethanol producers who are all droving up the cost of energy and food? Why had America stoped building coal-fired power stations while China adds two each week?
Posted by: Jeremy at June 11, 2013 11:52 AM
Fixed income retirees have not suffered the past 5 years. They should not be living off savings accounts, but bonds. How have bonds fared the past 5 years? Lower interest rates mean higher prices for bonds. Retirees should have already purchased their bonds, so BOOM capital gains! How is that bad?
Posted by: winstongator at June 11, 2013 01:06 PM
"Well, last month's Treasury auction saw the lion's share of 30 year (non-TIPS) bonds having been bought by dealers, brokers and investment houses. The Fed's share was trivial. Same with the previous month. In fact, on the primary auction market over the last several years the Fed has only bought about 12 percent of the 30 year stuff. True, the Fed does buy some of it back on the secondary markets,"
The Fed can not buy T's on the primary market. They are the ones buying from the primary dealers. Hence the term front running the fed. GS buys T's, and sells them to the Fed for profit. Cool story tho bro.
Posted by: Anonymous at June 11, 2013 01:55 PM
Posted by: Anonymous at June 11, 2013 01:56 PM
The System Open Market Account operations within the Fed does buy through Treasury auctions. Not large amounts, but they do buy some.
In any event, I don't think you're helping your argument. As the Bloomberg article shows, there is plenty of demand for safe Treasury assets. Hey...one of the points of the article was that the Fed's buying spree was soaking up the very assets that private sector actors need and want. Like I said, there's plenty of appetite for long term Treasury assets. That won't always be the case, but it is now so why not accommodate the market?
Posted by: 2slugbaits at June 11, 2013 04:15 PM
In all of these retrospectives on Reinhart and Rogoff (which is basically what Professor Hamilton's post looks like), I keep not seeing one thing: what is it that debt is being accumulated for?
If we had not taken on debt in World War II, we would have lost it. The savings would not have been worth it.
That's an example to supply the reductio ad absurdum. But the same principle applies to money not spent on research, education, public health, infrastructure... the list is long. Nations that refuse to take on debt for things that improve productivity end up being unproductive.
Why is this point so universally not mentioned? Everyone knows that more debt means more debt service payments. But amazingly, people still buy houses!
Posted by: Charles II at June 11, 2013 10:57 PM
"So what's your solution? More welfare for rich farmers and even richer bankers? Or cuts to the solvent social security system and the not so solvent medicare system? Or perhaps finding ways to more jobs and growth?"
Or - glory be - raise taxes? Has America really come to this, that even a hypothetical conception to raise taxes is off the table?
Posted by: a at June 12, 2013 06:14 AM
That's an example to supply the reductio ad absurdum. But the same principle applies to money not spent on research, education, public health, infrastructure... the list is long. Nations that refuse to take on debt for things that improve productivity end up being unproductive.
The issue is not whether we fund these activities. The issue is the marginal return from another dollar of debt. If we borrow another $100 billion for education, will it actually generate more than $100 billion + interest in return? Maybe so, maybe not. We already spend a tremendous amount of money on various public goods. Diminishing returns do not automatically mean we shouldn't spend more on public goods, but it does mean we should be much more judicious in how we allocate our public funds.
Your point is well-taken, however. In the near future, we will have borrowed to the extent that we will have to ration public goods when the next recession rolls around and tax revenue falls. At that point, the folly of relying on federal debt to borrow our way to prosperity will be obvious.
The debt mongers would have you believe that fiscal policy can bridge any recessionary trough, but unfortunately that's a short-sighted view. It fails to consider the consequences of a second recession while debt/gdp is at unsustainable levels.
Posted by: tj at June 12, 2013 06:25 AM
The cause of the sharp increase in debt levels was the collapse of a bubble.
That would suggest a primary focus has to be on what has been effective in spurring growth post bubble collapse.
It also suggests THAT THE MOST SINGLE MOST IMPORTANT FISCAL POLICY IS ONE THAT AVOIDS BUBBLE CREATION.
Until I see an analysis that focuses on debt loads before and after bubbles I will remain highly skeptical of work like the one presented in this article.
As I will restate that any discussion of the US Fiscal future that does not discuss moving to Single Payer is at best ignorant.
Posted by: fladem at June 12, 2013 09:09 AM
tj says, "The issue is not whether we fund these activities. The issue is the marginal return from another dollar of debt. If we borrow another $100 billion for education, will it actually generate more than $100 billion + interest in return? Maybe so, maybe not."
Actually, cost-benefit analysis is routinely done by CBO (one can see one of the earliest attempts here). Things like research, education, health, and infrastructure have strongly positive returns. If private industry could obtain the rates of return that are seen for some of them, they'd be in heaven.
Bottom line: the US is far, far below the optimal levels for public expenditure. In large part, this is because much of those expenditures on military adventures, paying off health insurance, pharmaceutical, and oil companies, and other fundamentally non-productive things, while productive investments like improving transportation and public health are all but ignored.
Posted by: Charles II at June 12, 2013 01:56 PM
Don't worry, interest rates will stay low as long as GDP growth is low. And the threat of interest rates growth will keep GDP growth low.
Posted by: aaron at June 13, 2013 06:28 AM
Ricardo seems to live with an imaginary Reagan era, as do most Republicans (to paraphrase from August 2011 blog entry from Tiny Revolutions, they were so firehosed with money by Reagan that thought everyone got rich. The reality is that most working and middling people saw their standard of living fall during the 1980s.) But he mentions "Reagan's savings." Well, since Reagan was the first one to create a deficit crisis, he could not mean Government savings. Did he mean "personal savings?" Again, looking at this chart from FRED, the personal savings rate trended down during the 1980s. http://research.stlouisfed.org/fred2/series/PSAVERT/
I note that this savings rate is really much to low, even if there is no cut in social security and Medicare benefits which basically only provides enough for subsistence existence at the poverty level if one is past 65 and not working with no pension. The rate fell off the table at the beginning of the year with expiration of the FICA tax cuts. If it rises, and their is no compensatory investment spending or net export increase to compensate for the fall in consumption, already slack demand will further, and in a reverse of Say's law, supply will decrease to meet demand.
Posted by: sherparick1 at June 13, 2013 10:18 AM
Cut the welfare dispensed to the 1% and debt servicing won't be a problem. Also, halve health care expenditure to reach developed country average by going to single payer. Finally, worry about the denominator, not the numerator.
We just had a massive private debt crisis which caused a relatively minor public debt increase due to automatic stabilisers and crisis abatement measures. A modicum of perspective would be useful, but the US being the US, I doubt we'll see it anywhere within a bulls roar of the GOP or Wall Street connected Democrats.
Posted by: AlanDownunder at June 17, 2013 07:34 AM