The US fiscal gap now stands at an estimated $205 trillion, or 10.3 percent of all future US GDP. Closing this gap is imperative, and requires a fiscal adjustment of an immediate and permanent 37 percent reduction in spending (apart from servicing official debt), an immediate and permanent 57 percent increase in all federal taxes, or some combination of the two. The necessary size of this adjustment increases the longer it is put off.
1. John Cochrane presents a chart showing that over the last 25 years, the employment-population ratio tracks the ratio of people aged 25-54 to the total population.
Pointer from Mark Thoma. The chart is from Torsten Slok of Deutsche Bank.
2. John Taylor has a chart showing that the labor force participation rate is several percentage points that which was projected several years ago based on demographics. The chart comes from a paper by Chris Erceg and Andy Levin.
The first chart suggests that most of the decline in the employment/population ratio in recent years is due to demographic changes. The second chart suggests the opposite. How to reconcile the two?
3. And then there is Binyamin Appelbaum:
In February 2008, 87.4 percent of men in that demographic had jobs.
Six years later, only 83.2 percent of men in that bracket are working.
Pointer from Tyler Cowen.
My verdict is that Slok’s chart, referred to by Cochrane, is misleading. Here is the chart:
The way that the two lines are superimposed makes it appear that 2007 was a glorious year of over-employment, and the plunge in the employment-population ratio looks like a reversion to trend. Suppose you were to slide the blue line up vertically so that it just touches the red line at the peak in 2007. That would make the chart look much more like Appelbaum’s, shown below:
Some other issues:
–I suspect that some of the drop-off in employment has occurred among youth, who are outside of the 25-54 bracket that Slok uses.
–Another issue is what you think should have happened outside Slok’s bracket at the other end, namely 55-64 year olds. These are baby boomers, so that their share of the labor market has been soaring. The most likely reconciliation of the two charts is that the baby boomers have been retiring early at rates higher than historical norms.
As far as labor force participation goes, is 55 the new 65? If so, then somebody should trace out what that means for Social Security. Fewer people paying in and more people collecting disability cannot be a good thing for solvency.
Update: Cochrane offers another take, more nuanced.
Timothy Taylor writes,
Huntley describes the central estimate about the long-run effects of more government borrowing based on the review of the evidence like this: For each additional dollar of government budget deficit, private saving rises by 43 cents, and the inflow of foreign capital rises by 24 cents. Thus, [e]ach additional dollar of deficit leads to a 33 cent decline in domestic investment.
Jonathan Huntley works for the Congressional Budget Office. Taylor links to the full report. I like the way that Taylor explains the issue.
A few remarks:
1. A Keynesian would be quick to note that crowding out varies over the business cycle. When the economy is weak, there is excess saving, and there is no crowding out.
2. Larry Summers’ hypothesis of secular stagnation says that there has not been crowding out for two decades.
3. I have never heard a conservative economist complain about crowding out during a Republican Administration.
4. I have never heard a liberal economist complain about crowding out, ever. Complaining about (3) does not count.
This report comes out at a time in which the CBO has gotten an unusual amount of negative press. See this WaPo story, for example. Some remarks about this:
1. I think it is difficult for journalists or the general public to understand that some economic estimates are more unreliable than others. For example, estimating the cost of a government program is subject to some error, but most of the time you can get in the ballpark. There is more uncertainty about revenue from tax changes, because of behavioral responses, but one can still arrive at a reasonable range of estimates. On the other hand, estimating the macroeconomic impact of fiscal policy (the so-called multiplier) poses a much higher level of difficulty. You need a macroeconomic model. You need to take a position on the theory of monetary offset. When I was invited to give a lunch talk at CBO, I tried to emphasize that the difference between the uncertainty involved in macroeconomic forecasting and analysis on the one hand and the uncertainty in forecast and estimating the cost of a government program is a matter of kind, not just of degree. And I recommended that CBO should do something to emphasize this to the public. The crowding-out analysis is one that I would put in the high-uncertainty category.
2. It disturbs me that the press takes shots at the CBO only when the analysis raises doubts about progressive policies. If you are not going to raise doubts about CBO analysis of the stimulus, which is based on models that by now are far out of the mainstream, then you should not raise doubts about legitimately mainstream analysis of minimum wages, the employment effects of Obamacare, and, yes, crowding out.
3. Progressives who attack the CBO may be seeking a short-term gain in material at a long-term positional cost. Looking ahead a few moves, I do not think it helps progressives if they convince the public to distrust nonpartisan government experts.
Chris Edwards dissects it.
Transfers are the largest and fastest-growing activity. Since 2000, transfers have grown at an annual average rate of 6.7 percent, which compares to purchases at 6.0 percent, compensation at 5.5 percent, and aid to the states at 5.0 percent. Total federal spending grew at 5.5 percent during this period, while the consumer price index grew at just 2.4 percent.
CBO estimates that federal debt held by the public will equal 74 percent of GDP at the end of this year and 79 percent in 2024 s. 4 (the end of the current 10-year projection period). Such large and growing federal debt could have serious negative consequences, including restraining economic growth in the long term, giving policymakers less flexibility to respond to unexpected challenges, and eventually increasing the risk of a fiscal crisis (in which investors would demand high interest rates to buy the government’s debt).
1. The CBO are Koch-funded austerians.
2. Just like the reduction in hours worked that the CBO forecasts for Obamacare, eventually increasing the risk of a fiscal crisis is actually a good thing.
3. More government debt gives the Fed more debt to buy, which in turn makes the stock market happy.
The Congressional Budget Office, a Koch-funded organization known to be affiliated with the Tea Party, writes,
CBO estimates that the ACA will reduce the total number of hours worked, on net, by about 1.5 percent to 2.0 percent during the period from 2017 to 2024, almost entirely because workers will choose to supply less labor—given the new taxes and other incentives they will face and the financial benefits some will receive.
Federal revenues are expected to grow by about 9 percent this year, to $3.0 trillion, or 17.5 percent of GDP—just above their average percentage of the past 40 years…
Federal outlays are expected to increase by 2.6 percent this year, to $3.5 trillion, or 20.5 percent of GDP—their average percentage over the past 40 years. CBO projects that under current law, outlays will grow faster than the economy during the next decade and will equal 22.4 percent of GDP in 2024.
These right-wing nut cases do not acknowledge that the real problem that we face is austerity.
When the U.S. real estate bubble burst in the late 1980s, there was a downturn in output and employment but no financial crisis. No capital markets froze up for instance and risk premia never deviated much from normal in the first place. And if that late 1980s-like path is what someone is predicting for the Nordics, Canada, or Singapore, well maybe so. I’m not predicting it myself but I certainly can see that within the realm of the plausible.
Much is within the realm of the plausible. Too much.
If you are a creditor of a government or of a large bank, your thoughts are probably along the lines of, “All of the governments and regulators of the world are doing everything that they can to prevent me from suffering from a default. So I’ll just hang in there.”
That is one equilibrium. But it is easy to transition to another equilibrium. Suppose that, in spite of all the best efforts of the same folks who were not able to stop the financial crisis of 2008, there is a large painful default by any one of the countries on Tyler’s list. If that happens, then a likely scenario is that all of the rest will go down very quickly.
The current policy approach perhaps reduces the probability of any one nation or one bank going under. However, it increases the probability of a huge, horrible, systemic collapse. A benefit of reducing government budget deficits is that it helps to reduce the probability of this Armageddon scenario. Even if you believe that reducing government deficits is painful austerity, from my perspective the benefit exceed the costs.
In a podcast with Russ Roberts, he says,
I think we are probably in worse fiscal shape and any developed country. The reason, Russ, is we’ve been piling up debts for over 6 decades; and when I say ‘we’ I’m referring to Republican and Democratic administrations and Congresses. And we’ve been hiding them. We’ve been keeping them off the books and using economic labels, words, to pretend that they are not real liabilities of the government…we have all these obligations to something like 30-40 million current retirees and close to 80 million baby boomers who are about to start collecting Social Security benefits if they haven’t already. All those obligations are not reported as part of the government’s debt, so we are missing those off-the-book obligations.
But the real economic emergency is inequality. Or austerity. Or something.
From a new working paper by Bryan Lutz and Louise Sheiner.
A major factor weighing down the long-term finances of state and local governments is the obligation to fund retiree benefits. While state and local government pension obligations have been analyzed in great detail, much less attention has been paid to the costs of the other major retiree benefit provided by these governments: retiree health insurance. The first portion of the paper uses the information contained in the annual actuarial reports for public retiree health plans to reverse engineer the cash flows underlying the liabilities given in the report. Obtaining the cash flows allows us to construct liability estimates which are consistent across governments in terms of the discount rate, actuarial method and assumptions concerning medical cost inflation and mortality…Relative to pension obligations discounted at the same rate, we find that unfunded retiree health care liabilities are 1/2 the size of unfunded pension obligations.
Perhaps the most interesting aspect of the paper is the amount of effort it took on their part to find the data to do the calculations. Similarly, one of the biggest challenges for Reinhart and Rogoff is to find data on government debt outstanding. There are strong incentives for politicians to avoid transparent accounting, and not much in the way of countervailing power.
[we need] policies that restore a situation where reasonable growth and reasonable interest rates can coincide. To start, this means ending the disastrous trends toward ever less government spending and employment each year
By 2038, CBO projects, federal spending would increase to 26 percent of GDP under the assumptions of the extended baseline*, compared with 22 percent in 2012 and an average of 20½ percent over the past 40 years.
Did you two visit the same country?
*The “extended baseline” is an unrealistic scenario, which includes spending cuts that are embedded in current law but unlikely to be retained by Congress. The more realistic “alternative fiscal scenario” projects even higher spending relative to GDP.