Doug Elmendorf on the Debt

He writes,

Together with Brookings Senior Fellow Louise Sheiner, I have analyzed alternative explanations for low Treasury rates and the implications of each for budget policy (Elmendorf and Sheiner, 2016). We found that most explanations imply that the country should have a higher debt-to-GDP ratio than otherwise. We find that most explanations also imply that federal investment should be higher than otherwise, and I will come back to that later. The intuition for these results is that interest rates show the direct cost to the Treasury of its borrowing and provide information about the indirect cost to the economy of Treasury borrowing—and if costs will be persistently much lower than we are accustomed to, then more borrowing, especially for investment, passes a cost-benefit test.

Pointer from Tyler Cowen.

Of course, one possible explanation for low interest rates is that growth prospects are poor. Another possible explanation is that we are in a bond bubble. If either of those turns out to be the case, then we are going to wish that we had less debt to contend with.

Jason Collins reviews Jonathan Last

Collins writes,

So, if government can’t make people have children they don’t want and can’t simply ship them in, Last asks if they could help people get the children they do want. As children go on to be taxpayers, government could cut social security taxes for those with more children and make people without children pay for what they’re not supporting. (Although you’d want to make sure there was no net burden of those children across their lives, as they’ll be old people one day too. There are limits to how far you could take that Ponzi scheme.)

Keep in mind that lower birth rates are an international phenomenon, so I am reluctant to place much weight on U.S.-specific factors. My sense is that the decline in birth rates is correlated with, if not caused by, increased education of women. If that is the main causal factor, then it probably is not something that is going to be reversed.

Also, I am not convinced that there is such a down side to slower population growth and eventual decline. Yes, it messes up entitlement programs for the elderly, but that is because those programs are ill conceived, particularly in not indexing the age of government dependency to longevity. You should fix the entitlement programs to deal with the demography rather than try to fix demography to deal with entitlement programs.

The Bond Bubble

Balazs Csullag, Jon Danielsson, and Robert Macrae write,

A rational buy-and-hold investor who trusts the central banks should not buy long-dated bonds. While a high degree of central bank credibility used to be important to bond holders, today this seems to be no longer the case, especially for those buying German bonds.

The only way to get decent long-term returns with current yields so low is to go back to the persistent deflation of the gold standard, because most post-war inflation rates imply losses. For example, there are only eight years in Germany with lower than breakeven inflation for our 30-year buy-and-hold investor today.

Pointer from Mark Thoma.

The thing is, once interest rates start rising, they could explode, because at that point people may doubt the ability of governments to pay back their debts.

What if the central banks hold all of the bonds? That means that those central banks will be sitting on losses. If their cost of funds rises (say, because the central bank has to pay a higher interest rate on reserves), then central banks become a drain on the treasury.

Consolidating the Central Bank and the Treasury

Thomas Klitgaard and Harry Wheeler write,

The discussion above offers up a perspective on what is meant by “monetizing debt.” This term refers to a central bank buying government bonds and promising to keep them on its balance sheet with the result that the increase in reserves in the banking system translates into higher prices. This outcome, though, requires that the central bank not pay the appropriate interest rates on reserves. If it does, then an asset purchase program is just an effort that shortens the maturity of public-sector debt and will likely have few or no implications for future inflation.

Pointer from Mark Thoma.

Another implication is that it makes the interest cost of the government more sensitive to movements in short-term interest rates. So a sudden loss of confidence in the government by investors which raises interest rates would become self-reinforcing. And if the only way out of such a debt crisis is to print money, then there are implications for future inflation.

An Accounting Threat

The WSJ reports,

Starting in 2017, EU rules will require European governments to calculate the total amount they must pay current and future pensioners. Making this obligation more visible could spur them to deal with it, said Hans Hoogervorst, chairman of the International Accounting Standards Board and a former Dutch finance minister. “It will make clear that the current situation is unsustainable.”

Such a rule would be helpful here, as well.

The Issue that Worries Me

Alan J. Auerbach and William G. Gale write,

Although current deficits are reasonably low, the medium and long-term fiscal outlooks have deteriorated in the past year, due largely to legislative actions (and their implications for future policy) and changes in economic projections. Even under a low interest rate scenario, the long-term budget outlook is unsustainable. Moreover, the nation already carries a debt load that is twice as large as its historical average as a share of GDP and that makes evolution of the debt-GDP ratio much more sensitive to interest rates.

The necessary adjustments will be large relative to those adopted under recent legislation. Moreover, the most optimistic long-run projections already incorporate the effects of success at “bending the curve” of health care cost growth, so further measures will clearly be needed. These changes, however, relate to the medium- and long-term deficits, not the short-term deficit.

They say that the solution is to build a wall on our southern border.

Just kidding.

Raise the Age of Government Dependency

Courtney Coile, Kevin S. Milligan, and David A. Wise write,

This is the introduction and summary to the seventh phase of an ongoing project on Social Security Programs and Retirement Around the World. The project compares the experiences of a dozen developed countries and uses differences in their retirement program provisions to explore the effect of SS on retirement and related questions. The first three phases of this project document that: 1) incentives for retirement from SS are strongly correlated with labor force participation rates across countries; 2) within countries, workers with stronger incentives to delay retirement are more likely to do so; and 3) changes to SS could have substantial effects on labor force participation and government finances. . .

This seventh phase of the project explores whether older people are healthy enough to work longer. We use two main methods to estimate the health capacity to work, asking how much older individuals today could work if they worked as much as those with the same mortality rate in the past or as younger individuals in similar health. Both methods suggest there is significant additional health capacity to work at older ages.

The simplest, most logical fix for entitlement programs is to raise the age of government dependency. Most people ought to be able to support themselves well into their seventies. Those of us who want to stop working earlier can plan for it and pay for it ourselves.

If Social Security and Medicare had been indexed for longevity from the outset, those two programs would not be in trouble today.

Social (In-) Security

Erzo F.P. Luttmer and Andrew A. Samwick write,

On average, our survey respondents expect to receive only about 60 percent of the benefits they are supposed to get under current law. We document the wide variation around the expectation for most respondents and the heterogeneity in the perceived distributions of future benefits across respondents. This uncertainty has real costs. Our central estimates show that on average individuals would be willing to forego around 6 percent of the benefits they are supposed to get under current law to remove the policy uncertainty associated with their future benefits. This translates to a risk premium from policy uncertainty equal to 10 percent of expected benefits.

My comments:

1. I believe that most economists think that even in the worst case individuals would get more than 60 percent of the benefits that they are promised.

2. Somehow, I am reminded of Foolproof, in which the attempt to reduce risk has the reverse effect. That is Social Security was supposed to increase the certainty of people’s retirement incomes, but apparently it is not doing so.

Social Security is Still Going Broke

Timothy Taylor writes,

the gap between benefits and receipts doesn’t change much after about 2035. This tells you that the Social Security problem is essentially a one-time problem, occurring as a result of the retirement of the boomer generation. If we can enact a series of reforms that moves up the receipts line and moves down the benefits line, then after about 2035 the system can be fairly stable for decades into the future.

I have a different view. Longevity has been going up pretty steadily at a rate of 2.5 years per decade. In recent decades, much of that increase has occurred at the high end (reductions in infant mortality used to be a big factor, but that has reached an asymptote). The age of government dependency (aka the Social Security retirement age) has not been increased as much. If those trends continue, then the ratio of government-dependency years to working years goes up inexorably. A system in which workers pay for retirees faces very troubling arithmetic.

Having said that, Taylor does a nice job of summarizing a CBO report on options for improving Social Security finances. I think he is more charitable than I would be toward the left’s approach, which strikes me as more of a “deny that there is a problem” strategy.

Jeffrey Miron on Fiscal Imbalance

He concludes,

The fundamental economic reality implied by fiscal imbalances is that the “rich” economies are not as rich as they would like to believe; they are planning far more expenditure than they can afford. Recognizing this fact sooner rather than later does not eliminate the problem, but it allows for more balanced, rational, and ultimately less costly adjustments. And if attention to fiscal imbalance helps cut ill-advised expenditure, economies can have their cake and eat it too.

I think that this way of putting it is vulnerable to the comeback that we can always cancel our debt, since we owe it to ourselves. I prefer to characterize the problem as one of creating political friction because of the need to disappoint people’s expectations. See my classic (in my opinion) Lenders and Spenders essay.