Going Off on Rogoff
Tuesday, 03/2/2010 - 5:22 pm by Marshall Auerback | 20 Comments
Marshall Auerback answers a new cry from the deficit hawks.
We’ve persistently taken the view that there is no economic doctrine, no magic number, which would imply a firm external constraint as far as public spending goes, when dealing with a sovereign government issuing debt its own floating rate, non-convertible currency. At some point, we may indeed have a resource constraint, or an inflation constraint, but not a national solvency issue. Yet the hysteria surrounding fiscal policy has moved from the realm of rational debate and metamorphosed into a matter of national theology. Hardly a day goes by, it seems, where groups such as the Concord Coalition or the Peter G. Peterson Foundation do not bring us the message that we are all doomed unless we do something drastic to cut back our mounting federal debt.
A new book by former IMF economist by Kenneth Rogoff and Professor of Economics (and Research Associate at the National Bureau of Economic Research) Carmen Reinhart — This Time It’s Different; Eight Centuries of Financial Folly — has given greater academic legitimacy to the prevailing deficit hysteria. The authors purport to show that once the gross debt to GDP ratio crosses the threshold of 90%, economic growth slows dramatically. President Obama’s proposed budget will soon cross that line, so the cries of the deficit hawks have intensified.
Although the historical data which Rogoff and Reinhart amass — 8 centuries and all — sound very impressive, it is hard to see what sort of relevance a country operating under, say, an 18th century gold standard, has in regard to a country operating under a 21st century fiat currency system.
A sovereign government is never hostage to the dictates of financial capital because it no longer faces the external constraint that was always present under a gold standard regime. A nation that adopts its own floating rate currency can always afford to put unemployed domestic resources to work. Its government may issue liabilities denominated in its own currency (for interest rate maintenance reasons or to offer its savers an interest-bearing alternative to cash), and will service any debt it issues in its own currency. Whether its debt is held internally or externally, it faces neither insolvency risk, nor “structural” growth shortfalls which Rogoff/Reinhart allege when public debt levels get too high.
Nor does it make sense to lump together private and public debt, as Rogoff and Reinhart do in the book. A failure to distinguish sovereign government debt from the debt of non-sovereign governments, households, and firms calls into question the relevance of the Reinhart and Rogoff study at least as far as it applies to countries, such as the US with non-convertible currencies and flexible exchange rates. Lumping together government and private debt is meaningless and simply heightens the bogus hysteria surrounding government fiscal policy activism. Government debt is a net private asset, while private debts must net to zero. Private saving, however accomplished, increases the future consumption possibilities for the household sector at the expense of current consumption. Saving is foregone consumption which in normal times (barring huge financial crashes) will enhance future consumption.
In this context, because the household sector is revenue-constrained, it has to sacrifice consumption possibilities now to improve them later. It can increase consumption now beyond income via increasing its indebtedness or selling assets (past saving) but the budget constraint has to be obeyed at all times. But, of-course, this sort of reasoning doesn’t apply to the government. A budget surplus does not create a cache of money that can be spent later. Government spends by crediting a reserve account. That balance doesn’t “come from anywhere”, as, for example, gold coins would have had to come from somewhere. By the same token payments to government (such as via taxation) reduce reserve balances. Those payments do not “go anywhere” but are merely accounted for. A budget surplus exists only because private income or wealth is reduced, NOT because the taxes per se fund government spending directly (which would represent a true constraint).
Consequently, it makes no sense to add together the US federal government’s debt and the US private sector’s debt. It is in this regard that the Clinton budget SURPLUSES had such a deleterious impact on the US non-government sector in the late 1990s: Government surpluses squeezed the liquidity of the private sector in the late 1990s, which forced greater reliance on PRIVATE debt, creating the foundations for much of today’s economic fragility. If the US government had run sufficient budget deficits (which it could always have done because the government faced no external funding constraint) to finance the desire to save for the non-government sector overall, then the spending patterns would have been different (more public goods, less private goods) and the non-government sector would not have been forced into as much indebtedness.
Note also that we need to distinguish between debt that is denominated in domestic currency versus that which is denominated in foreign currency-again a distinction that is not always clear in the Reinhart and Rogoff book. It’s like the difference between, for example, Japan and Argentina. In the case of the latter, the currency board arrangement effectively hamstrung monetary and fiscal policy. The central bank could only issue pesos if they were backed by US dollars. So dollars had to be earned through net exports which would then allow the domestic policy to expand. When exports crashed, the funding mechanism became untenable. By contrast, Japan has continued to issue debt denominated in its own currency and cannot therefore be subject to default risk; and as it represents a nongovernment sector’s net financial wealth because of the income transfer to the non-government sector, it cannot be the cause of low growth.
It may well be the case that a government that operates a pegged currency regime, or taps the markets for substantial quantities of foreign debt to finance growth, will encounter precisely the problems articulated by Rogoff and Reinhart. Reaching a limit of 90% debt to GDP might well represent a danger area and consign these countries to subpar growth for many years. But for countries like the US, Japan, Canada or Australia, which have little or on foreign currency public debt, and adopt a free-floating, non-convertible currency regime, the Rogoff/Reinhart analysis has virtually no relevance. It should not be used as a stick with which to beat back the governments that want to deploy fiscal policy to embrace full employment policies.
Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.
Marshall -
Do you think there is a relationship between deficit reduction obsession and income inequality in the U.S.?
Posted by RebelCapitalist | March 2nd, 2010 at 6:02 pm
Yes, I do. The current, self-imposed constraints under which we operate are purely VOLUNTARY. You have to ask yourself why we accede to them. I have always maintained that a policy which imparts a deflationary bias is very good for the holders of financial assets (what Keynes called “the rentier class”), as well as creating larger than necessary unemployment which weakens the power of the working classes. Businesses are able to use the existence of a high pool of unemployed to discipline wages and enhance profits. Both of these factors clearly contribute to income inequality. The problems of income inequality were far less pronounced when we embraced a relatively full employment policy, as occurred throughout much of the 1950s through to the 1970s in the US, Australia, and Canada.
Posted by Marshall Auerback | March 2nd, 2010 at 9:50 pm
“Government debt is a net private asset, while private debts must net to zero.” Can you elaborate, in english please?
What happens when interest payments on all that debt is causing inflation? Just deal with it with taxes? Can we tax china?
Speaking of china is there any economic benefit to selling them treasuries? Since our gov isnt revenue constrained and it boosts their import power unfairly.
If they wanted export biased growth they could set their prices lower/ guess it is less disruptive to set their currency lower.
Posted by Anonymous | March 2nd, 2010 at 11:50 pm
Maybe you can go off on these two next:
http://krugman.blogs.nytimes.com/2010/02/24/martin-wolf-makes-me-look-like-pollyanna/
Posted by Tschäff | March 3rd, 2010 at 12:25 am
“What happens when interest payments on all that debt is causing inflation? Just deal with it with taxes?”
This is my question as well. I’d like to say I fully subscribe to the state theory of money, but I see both yourself and Mr. Wray refer to inflation being a “problem” at times, in passing, and I fail to understand how it -could- be a problem, if taxation is available as a tool. Can’t a graduated tax be introduced as inflation starts to rise? Is the problem with potential inflation primarily political?
My apologies if these questions are stupid. I really want to understand this conceptual framework so I can explain it to my friends and family, who have been sold a bill of hysteria when it comes to the deficit.
Regards,
James
Posted by James Call | March 3rd, 2010 at 8:05 am
Anonymous,
When I take out a loan from a bank, that loan becomes my liability and the bank’s asset. No new NET financial assets are created. Once I repay the loan to the bank, the bank’s asset and my liability disappear. In other words, they “net out”. That’s in contrast to government debt issuance. The government is in a unique position of creating new NET financial assets. There’s no corresponding liability. It adds to the overall total of financial assets. It’s an income transfer because the person/institution who buys the bond receives an income stream from it. And, as Randy Wray has pointed out in previous posts, when you die, your debts and assets need to be assumed and resolved. Firms can be long-lived, but when they go out of business or are acquired, the debts are resolved or assumed. However, there is no “day of reckoning”, no final piper-paying date for the sovereign government. True, not all governments last forever, and sometimes a new government will choose to honor debts of “deceased” governments. But it is a choice—a sovereign government is, well, sovereign. Hope this helps clarify the position.
Posted by Marshall Auerback | March 3rd, 2010 at 9:50 am
“What happens when interest payments on all of the debt is causing inflation”? Yes, deal with it via taxation, not interest rate hikes, which have a much more ambiguous impact, precisely because while the hikes punish borrowers, they benefit the income streams of those holding the debt. Fiscal policy is a much better means of restraining aggregate demand, and hence, restraining inflation. That is the purpose of taxation. To understand more fully how taxes restrain demand, read this excellent post by Bill Mitchell: http://bilbo.economicoutlook.net/blog/?p=5762
Mitchell quotes Abba Lerner (the father of “functional finance”), who expresses this view of taxation very clearly in the following passage:
“The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound and what is unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science opposed to scholasticism. The principle of judging fiscal measures by the way they work or function in the economy we may call Functional Finance …
Government should adjust its rates of expenditure and taxation such that total spending in the economy is neither more nor less than that which is sufficient to purchase the full employment level of output at current prices. If this means there is a deficit, greater borrowing, “printing money,” etc., then these things in themselves are neither good nor bad, they are simply the means to the desired ends of full employment and price stability … “
Posted by Marshall Auerback | March 3rd, 2010 at 9:56 am
Addressing a fairly narrow (but I think crucially important) issue on R&R’s paper: lag times.
The 90% threshold argument is based on the correlation between debts in a given year and GDP growth *in the same year.* (And their analysis for the U.S. centers on 5 (or 6) wildly anomalous years–’44 to ‘49.)
Is that an even vaguely useful analysis, when our important policy questions revolve around about multi-decade lags?
Too long for this comment, details here:
http://www.asymptosis.com/deficits-dont-matter-the-supposed-experts-speak.html
Posted by Steve Roth | March 3rd, 2010 at 10:38 am
Steve, thanks. Very useful post. Here’s an additional cluster bomb on Rogoff and Reinhart (whose husband, Vince, provided much of the intellectual legitimization of the horrible Greenspan Fed, and now works at the AEI, only partially in contrition, as in “the horror, the horror”):
http://blogs.ft.com/undercover/2010/03/maybe-debt-doesnt-matter-after-all/
Posted by Marshall Auerback | March 3rd, 2010 at 11:13 am
Fantastic news! There are no constraints on money. Why are we living with double digit unemployment? Printing or borrowing $10 Trillion a year or so could allow everyone in the country a pension of $100k (just guessing). Effectively we could all retire immediately and pursue our dreams. Mine is to build a life size replica of Mount Rushmore ( my image included) out of meringue. I am so glad that there are no limits on money creation.
Posted by Den | March 3rd, 2010 at 9:30 pm
So what you are saying is that as long as the US government has a compliant Fed it can print it’s way out of debt as long as people are stupid enough buy our bonds and the public does not complain about debasement and resulting inflation. Weirmar of this would you want? You are a thiefor at least an accomplice if you advocate inflation! People on fixed incomes and savers are stolen from by decreased purchasing power. Responsible people are hurt by your socialist Keynesian policies proven wrong by Mises and Hayek! Tu Ne Cede Malis
Posted by Bob D | March 3rd, 2010 at 10:10 pm
Since we are not on any type of standard and therefore no constraints why in the world are we borrowing the money, just print it. I can reduce government outlays by 400 billion dollars in the saving of interest expense annually and growing. The devaluation of money is going to occur either way. The only ones getting rich off record amounts of government debt are the primary dealers who get to borrow money near zero. They can leverage themselves and play the carry trade or sell it and make fees, and if they can’t sell it they have the Fed as the backstop. Why is Congress giving the Fed the priveledge of zero cost money and we taxpayers have to pay them interest on government securities that they purchase?
Posted by Craig Walters | March 4th, 2010 at 1:23 am
I have to echo Craig’s comments above. I suspect the answer is political - it’s easier to sell bonds because the bond-holding class is also the same class that benefits from high unemployment. If we had a “benevolent dictator” I would imagine that simply forgiving every Americans’ private debts and then issuing large grants to large and small business and enforcing a significant capital gains tax would be the way to go. Right?
Posted by James Call | March 4th, 2010 at 11:28 am
Marshall
Don’t know if this is the place to ask this question nor do I know if I read this from you, Warren Mosler, Randall Wray or James Galbraith but the question involves the gold standard.
If we switch to a Gold Standard do China and other debt holders have an immediate claim on that gold for whatever amount we owe them?
Posted by Charles Yaker | March 4th, 2010 at 11:44 am
Charles, I can answer that for you. The reason we went off the gold standard in the first place was foreigners saw that our Government was starting not to live within it’s means in the late 60’s (Vietnam was a big cause). They had taken half of our gold before Nixon stopped it. There is no point of going back on a gold standard unless we plan on living within our means both from a government standpoint but also trade standpoint. Large trade imbalances are still occurring that were not happening in 1970. All that will happen is we will lose the rest of our gold. By the way has anybody seen our gold? Since it hasn’t been audited since Eisenhower now that it is worth 300 Billion dollars.
Posted by Craig Walters | March 4th, 2010 at 2:18 pm
James,
We sell bonds because the Treasury, by law is not allowed to run an overdraft at the Fed. It is mandated to issue debt dollar for dollar with government spending, even though there is no causality between the two in the conventional wisdom sense that the bonds “fund” the spending. This is a legacy from the gold standard era. But in reality, there is no operational reason why we need to issue bonds, short of offering savers an interest bearing alternative to cash or to help the Fed maintain a reserve rate target. It’s dumb, however. And even here, the self-imposed constraints are easily circumvented. Randy Wray has discussed this before. He notes, for example, in the US, when the Treasury does not have sufficient funds in its deposit at the Fed, it sells bonds to special depositories that are allowed to buy the bonds by crediting the Treasury’s deposit. The Treasury then transfers its deposit to the Fed before spending. This would normally result in a reserve debit from the accounts of those banks but the Fed allows “float” (postpones the debit) because the spending by the Treasury will restore the reserves. The final result after the Treasury has spent is that banks hold bonds and their customers have received demand deposits. If the banks would prefer to hold reserves, the Fed will engage in an open market purchase—buying bonds and crediting bank reserves. The net effect is exactly the same as if the Fed had bought the bonds directly from the Treasury.
Posted by Marshall Auerback | March 4th, 2010 at 7:36 pm
What restrains dose imply if a nation set up rules that the state cash in on bonds at the central bank but when it need money it have to get it from the market?
That’s roughly how It’s expressed in the central bank law in Sweden.
Posted by Lars G | March 5th, 2010 at 1:46 am
Thanks for the explanation Mr. Auerback!
Posted by James Call | March 8th, 2010 at 1:42 pm
Mr. Auerback, isn’t the USD a convertible currency? If so, how does this feature change your analysis?
Thanks.
Posted by CTC | March 23rd, 2010 at 7:04 am
OK, I see you likely mean convertibility into gold (as opposed to other currencies). Never mind…
Posted by CTC | March 23rd, 2010 at 7:07 am