Policymakers’ Risk Fiscal Cliff

The debt ceiling, which refers to how much the U.S. federal government may go into debt, has become a bargaining chip in the final round of debate over how to avoid the fiscal cliff. Republicans have promised not to agree to raise it until President Obama offers deeper spending cuts. In a recent message to Congress, the president told Republicans that there would be no negotiating for raising it later if they allow negotiations about the fiscal cliff to fail now, and many economists feel taking the debt ceiling off the table is a smart move for the White House, if only to ensure that if a recession is to result that it comes now instead of at the end of Obama’s second term. For more on this continue reading the following article from Economist’s View. 

One more from Tim Duy:

The Debt-Ceiling Gamble, by Tim Duy: Ezra Klein reports that the White House is drawing a line in the sand on the debt-ceiling, and they really, really mean it:

The Obama administration is utterly steadfast on this point: They will not suffer a repeat of 2011, when they conducted negotiations over whether the United States should default. If Republicans go over the cliff and try to open up talks for raising the debt ceiling, the White House will not hold a meeting, they will not return a phone call, they will not look at the e-mails.

The Administration is looking to take the debt ceiling off the table forever. This is good policy; that Congress should be able to pass laws authorizing spending but not authorizing the required debt is beyond ridiculous. Also ridiculous - and irresponsible - is the willingness of the Republicans to use the debt ceiling to hold the economy hostage. Ending this travesty should be a priority for the White House.
Klein adds that the White House is ready for the fight now while their strength is up:

Boehner and the Republicans don’t want to give up the leverage of the debt ceiling forever, or for 10 years, or even, as John Engler, head of the Business Roundtable and a former Republican governor suggested, for five years. But the White House isn’t very interested in compromising on this issue, as they figure that if there needs to be a final showdown over the debt ceiling, it’s better to do it now, when they’re at peak strength, then delay it till 2014 or 2015, when their own vantage might have ebbed.

I would add another advantage. Better - from a political point of view - to have a recession at the beginning of President Obama's second term that can be blamed entirely on the Republicans. A recession in the first half of 2013 means that, most likely, the Democratic presidential nominee can run on the back of an improving economy by 2016. Alternatively, they run the risk that this recovery, anemic as it is, gets long in the tooth by 2016. Even worse would be that they agree to let the Republicans once again hold the economy hostage two years from now. Politically, if I had to pick between a recession now or closer to the next election, I would pick now.

 This blog post was republished with permission from Economist's View.

U.S. Credit Rating Downgraded: Economists Comment on S&P Error

It appears Standard & Poor’s credit agency downgraded the U.S. credit rating using an incorrect budget baseline and now analysts are questioning why they, the government or the American people should listen to an agency that is apparently incompetent. The mistake hearkens back to S&P’s failed decision to adjust its outlook or rating when the U.S. entered into the recession, and not giving a fair evaluation to investment products and policies that endangered the economy. The error, which misjudged the baseline for rating by $2 trillion, is seen by most as too big to ignore when evaluating the agency. For more on this continue reading the following article from Economist’s View.

I was asked to comment on S&P's downgrade of long-term US debt:

The Consequences of the S&P Downgrade

As I explain, I don't expect much in the way of market or interest rate reaction to the downgrade. Also, I didn't mention this, but S&P's demonstrated incompetence on matters such as choosing the right baseline is another reason to ignore their pronouncement:

I Heard It Through The Baseline, by Paul Krugman: Oh, my. Treasury has a fact sheet explaining that $2 trillion error by S&P; it may sound technical, but to anyone who follows budget issues, it’s a doozy.

When the Congressional Budget Office “scores” policies, it does so relative to a “baseline”... But S&P initially assumed that the debt deal was subtracting off a quite different baseline.

The point here is not so much the $2 trillion, which makes very little difference to real US fiscal prospects; it’s the fact that S&P stands revealed as not understanding basic analysis of budget estimates. I mean, I don’t think I would have made that mistake; real budget experts, like the people at the Center on Budget and Policy Priorities, certainly wouldn’t have.

So what we just saw was amateur hour. And these people are pronouncing on US credit-worthiness?

Donald Marron:

S&P's 2 Trillion Dollar Error: ...The error is understandable but remarkably sloppy for such an important analysis.

The source of the error is painfully familiar to anyone who deals with U.S. budget projections. S&P’s analysts didn’t use the right measuring stick — i.e., the right budget baseline — when analyzing the effects of the recently-enacted Budget Control Act.

In one sense, it’s easy to see how this error happened. Budget discussions are now hopelessly confused by a profusion of different baseline projections of what spending and revenues will look like in the future. ...

But it’s still remarkably sloppy. Budget experts are well-aware of the problem of multiple baselines. Indeed, we all pepper our conversations and analysis with the question “what baseline are you using?” It’s stunning that S&P didn’t have multiple analysts asking the same question to make sure their original numbers were right.

He adds that:

It’s own revised calculations show net general government debt hitting 85% of gross domestic product in 2021 instead of 93%. That’s a big difference. ... S&P was too dismissive in its clarification.

Experts wouldn't have made this mistake. So why is anyone listening to S&P?

This article was republished with permission from The Economist's View.

Looming Default Reminder of Past Debt Problems

Currency expert Kathy Lien revisits a time in 1979 when the U.S. missed a Treasury bill payment, pointing out that the value of the dollar only dropped 0.6% immediately following the lapse; however, the value plummeted less than one month after the one-time default. Lien notes that it would be a mistake to attribute the drop in value on the actual missed payment, but the real reasons were increased inflation and global concerns over the security of the U.S. dollar. For more on this continue reading the following article from Kathy Lien.

Although the U.S. government has never officially defaulted on its debt, it missed payments on some Treasury Bills in 1979. Then as now, Congress was playing a game of chicken with Republicans and Democrats bumping heads on raising the debt ceiling. The debt limit was a fraction of its current levels and at the time, the dollar only fell briefly. The 0.6 percent drop in the Dollar Index was so small that it was barely left an imprint. However less than a month later, double digit inflation and concerns about the outlook for the U.S. economy along with the security of the U.S. dollar drove the greenback sharply lower. It may be tempting to attribute this decline to the short term default on U.S. debt but the Treasury started making its T-bill payments again after a very short delay.

Here’s a chart of how the dollar behaved when the U.S. government missed its debt payment in 1979:

This blog post was republished with permission from Kathy Lien.

Economist Advocates Expansionary Debt Relief Plan

Rober Shiller is convinced that a plan requiring raising taxes and government spending on a one-for-one basis – a “balanced-budget multiplier” – will help stimulate the economy and reduce the deficit without endangering the possibility of economic recovery. Shiller argues this will help solve real problems like high unemployment without necessarily expanding the size of the government, if spending is focused on infrastructure projects and funding private-sector projects. He also skewers ratings agencies for making the problem worse by promising to downgrade the country’s credit rating if it doesn’t figure out how to trim trillions from the deficit while also avoiding another recession – what many analysts now see as impossible. For more on this continue reading the following article from Economist’s View.

Robert Shiller:

Taxing and Spending, in Balance, by Robert Shiller, Commentary, NY Times: The fight over the debt ceiling has deflected attention from the serious problems of fixing the economy and finding jobs for the 14 million unemployed. Worse, it has created strong negative feelings about fiscal policy, just when other policy measures seem incapable of restoring economic health.

The very term “fiscal stimulus” has become tainted. ... Fiscal stimulus is actually very useful and appropriate in the current circumstances. But rather than despair, we should ... never give up proposing sensible economic policies. ...

In December, I wrote about the concept of the balanced-budget multiplier and of raising taxes and government expenditure by the same amount, dollar for dollar..., such a policy would be one-for-one expansionary...

This is an expansionary change in fiscal policy that won’t require additional increases in the national debt. We should start a dialogue right now about taking such action, before the damage of protracted unemployment worsens. ...

Such a policy needn’t make government substantially bigger. Instead, the government would act as a kind of investment banker specializing in public goods. It wouldn’t need a lot of employees itself. It would seek private-sector proposals for building infrastructure and other useful projects, and bring in private-sector panels to review them. This would be akin to the role government already plays for science with the National Science Foundation. ...

Current trends suggest that we may be dealing with high unemployment for years. We should be prepared to provide balanced support to the economy.

I appreciate the sentiment that "we should ... never give up proposing sensible economic policies." We should certainly do our best to educate people and to fight for better policy. But there's no way a policy that involves a substantial increase in taxes will pass right now.

But do I have something better to offer that might pass? Nope -- "might pass" and "better" are non-intersecting sets, and that won't change before the debt ceiling deadline. My effort right now is directed toward avoiding the stupidity that might lead to a failure to raise the debt ceiling, or almost as bad, a deal that raises it stupidly (I avoid using the word stupid here for the most part so that when I do use it, it will have more force).

In that respect, I am annoyed at the (demonstrably incompetent) ratings agencies, S&P in particular. They are now saying that simply raising the debt ceiling is no longer enough, there must be trillions in deficit reduction -- enough to derail the recovery and potentially send the economy back into recession -- to avoid a ratings downgrade. So S&P is making it more likely that a recovery killing deal will be made, and less likely that there is a last minute deal that "cleanly" raises the debt limit, avoids the recession risk associated with immediate debt reduction, and also avoids the risk of the severe economic problems associated with default. [Update: see here too, and here.]

This blog post was republished with permission from Mark Thoma.

Ross Perot Prophecy Comes True

Economist Tim Iacono reflects on the wisdom of Ross Perot during the 1992 Presidential election. He highlights a video made of a debate between Bush, Clinton and Perot wherein Perot warns of a wage convergence between Mexico and the U.S., and notes how now the country at issue is China as their wages climb while America’s falls. Meanwhile, he notes, everyone is too busy talking about taxing and spending to take note of the problem. For more on this continue reading the following article from Tim Iacono.

Spotted over at Patrick.net this morning, 1992 Presidential candidate Ross Perot’s warning about a steady decline in U.S. wages from almost 20 years ago sounds quite prophetic. All you have to do is substitute “China” for “Mexico” when you hear about wages converging at six dollars an hour – ours going down, theirs going up.

Sadly, no one talks about his much – instead, you get a political debate about taxes and spending. And, of course, monetary policy at the Federal Reserve that is largely based on a consumer price index that doesn’t distinguish between imported goods and goods that are produced domestically only exacerbates the problem.

This blog post was republished with permission from Tim Iacono.

Debt Ceiling Disagreement Persists

Economist Mark Thoma argues that the disagreement between Republicans and Democrats over whether to increase the debt ceiling is less about reducing the debt and more about controlling the size and role of government by either maintaining or changing the current tax structure. Thoma points out that even conservative supporters are mystified by Republican stubbornness when it comes to arguably helpful ideas about how to steer federal revenue, citing the GOP’s refusal to close the tax loophole on the ownership of corporate jets by way of example. For more on this continue reading the following article from Economist’s View.

If you had any doubt that the fight over the debt ceiling isn't really about the debt:

Paul Ryan Responds To David Brooks: We Won’t Cut Loopholes To Reduce Deficit, Only To Finance More Tax Cuts, ThinkProgress: As the August debt ceiling deadline looms and Republicans continue refusing to consider revenue increases, conservative New York Times columnist David Brooks excoriated the GOP for its intransigence. Writing yesterday that it “may no longer be a normal party” but rather a movement of “fanatic[s]” with a “sacred fixation” on tax cuts, Brooks slammed the GOP for rejecting a “no-brainer” compromise with Democrats, which would include closing tax loopholes for things like corporate jet ownership...

But Brook’s plea for sanity was lost on House Budget Committee Chairman Paul Ryan (R-WI), who responded to the column on conservative radio host Laura Ingraham’s show this morning. Ryan said that if Republicans gave up the loopholes now without securing a deal to lower marginal tax rates overall, they would lose an opportunity to demand new tax cuts in the future:

RYAN: What happens if you do what he’s saying, is then you can’t lower tax rates. So it does affect marginal tax rates. In order to lower marginal tax rates, you have to take away those loopholes so you can lower those tax rates. If you want to do what we call being revenue neutral … If you take a deal like that, you’re necessarily requiring tax rates to be higher for everybody. You need lower tax rates by going after tax loopholes. If you take away the tax loopholes without lowering tax rates, then you deny Congress the ability to lower everybody’s tax rates and you keep people’s tax rates high.

...Ryan is arguing that raising taxes on corporate jet owners and others is only acceptable if the money raised is plowed back into new tax cuts, not to paying down the deficit. He is clearly more interested in cutting taxes than dealing with the deficit, and is willing to let these egregious loopholes stay in the tax code until he can best exploit their removal to lower taxes...

With Republicans nitpicking at spending programs and eliminating their favorite targets, even small ones that don't generate much revenue, I appreciated this:

Ironically, just moments earlier in the interview, Ryan attacked President Obama for wanting to close the loopholes, saying doing so would generate an insignificant about of revenue to pay down the deficit. But when it comes to tax cuts, closing those same loopholes would apparently generate plenty of revenue.

The GOP argues that we must eliminate all wasteful spending no matter how small the expenditure (where wasteful means it does not agree with Republican ideology), deficit reduction demands it! Or so they argue. But closing tax loopholes would generate too little revenue to be bothered with?

But it's the "we're open to tax increases so long as they don't increase taxes," i.e. the insistence that all tax changes be "revenue neutral" that gives away the real game. This is about the size and role of government, it has very little, if anything, to do with the debt.

This article was republished with permission from The Economist's View.

Focus on Reducing Deficit Risky, Analysts Say

President Barack Obama made recent comments that have some economists questioning the administration’s plan to maintain fiscal responsibility without endangering an already fragile economy. President Obama reiterated the need for deficit reduction, which could mean an increase in taxes, cuts in federal spending or both, and many believe either of these moves could jeopardize economic growth. Political pundits argue Republicans may support a U.S. default if it means a boost in polls during election time, which is a cause for concern if it increases the chances the administration may be forced into a position that makes avoiding default impossible. For more on this continue reading the following article from Economist’s View.

This is in the mid-range of the Brad DeLong Shrill-O-Meter, but I think it's safe to conclude that he's not happy with the president's remarks in yesterday's press conference:

This Is Very Bad: Barack Obama Fail Department, by Brad DeLong: Can't anybody in the White House play this game?

Barack Obama:

Transcripts: There are a lot of folks out there who are still struggling with the effects of the recession. Many people are still looking for work or looking for a job that pays more. ...

But there are ... steps that we can take right now that would help...

Of course, one of the most important and urgent things we can do for the economy is something that both parties are working on right now, and that's reducing our nation's deficit...

No. No. No. No. No. No. NO. NO!!!!!!!!!

Absolutely the last thing, the last thing, the country needs is to cut federal spending or raise taxes in fiscal 2011, 2012, and it is now looking like fiscal 2013 as well.

Absolutely the last thing the country needs.

It gets worse. Obama:

[B]ecause of the work that's been done, I think we can actually bridge our differences. ... Nobody wants to put the creditworthiness of the United States in jeopardy. Nobody wants to see the United States default. ...

Does Obama read? There are some people who are looking forward to a default. And some of them are in the Republican legislative caucus--or so John Bresnehan and Jake Sherman claim:

"Who has egg on their face if there is a sovereign debt crisis, House Republicans or the president?" said another senior GOP lawmaker.

We have Republicans threatening to default on the debt and blow up the economy if they aren't allowed to put the economy at risk in another way -- through immediate deficit reduction -- and a president selling the demands from the other side as a jobs package. To make it worse, some Republicans seem eager for default to happen based upon the false belief that they'll somehow gain political advantage for wrecking the economy. No wonder the economic outlook is so grim.

With the economy struggling to get back on its feet, "Absolutely the last thing, the last thing" we should be doing right now is making threats or enacting policies that increase the risks of an economic setback. I think it's important to realize that the threat to default on the debt puts the economy at risk even if it is never acted upon, especially as the critical date to lift the debt ceiling draws closer. Republicans aren't just threatening to put the economy at risk in the future if they don't get their way, they are already doing so. If this continues there will likely come a point when markets get the jitters, and if that happens, watch out.

This blog post was republished with permission from The Economist's View.

Parties Differ On U.S. Economic Policy

Opinions about how to repair the economy in the United States vary from one party to the next, but broadly trend either toward reducing debt or spending more to in an effort to stimulate the financial infrastructure. The vast majority of conservative Republicans and a majority of Independents advocate reducing debt, while Conservative and Liberal Democrats favor more spending. For more on this continue reading the following article from Tim Iacono.

There’s nothing really surprising about the results of a new Pew Research poll in which one party favors deficit reduction to boost the economic recovery while the other party favors more spending, but, it is kind of interesting to see the data all in one graphic.

Following the departure of another Republican from the debt ceiling/deficit reduction negotiations, President Obama has injected himself directly into the talks in the hope that some kind of a deal can be struck prior to the debt ceiling deadline on August 2nd. Somehow, the fat tail of a U.S. debt default seems to have grown just a bit fatter.

This post was republished with permission from Tim Iacono.

A Glance at the U.S. Credit Rating Outlook Downgrade

Yesterday's S&P downgrade of the rating outlook for U.S. debt was outlined this morning in The Wall Street Journal. Read about what the analysts had to say in this full post from The Mess That Greenspan Made.

The Wall Street Journal provides a thorough examination of yesterday’s S&P downgrade of the rating outlook for U.S. debt in this story in today’s paper that includes the graphic below showing where we stand on our credit rating, outlook, and debt. As many analysts have noted over the last 24 hours, the warning would carry a lot more weight if the ratings firm hadn’t done such a poor job in assessing mortgage securities just a few years ago.


Officials in Japan voiced confidence in U.S. Treasuries, though the Chinese government has yet to offer an official reaction to the news, however, the head of their largest credit rating agency said the move was well deserved (according to this WSJ item, he said, “the U.S.’s actual debt repayment ability has already collapsed”). Yikes!

Meanwhile, American economists poo-pooed the whole idea of the U.S. losing its AAA credit rating, offering markets the assurance that it’s virtually impossible for America to default on its debt because said debt is denominated in dollars and we can print as many of those as we desire, a view that, sometime in the not-too-distant future may prove to be another example of how conventional wisdom is often wrong.

This post was republished with permission from The Mess That Greenspan Made.