Randall Wray - Fiscal Cliff
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Transcript of Randall Wray - Fiscal Cliff
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Fiscal Cliffs, Debt Limits, and
Unsustainable Deficits: Can the US
ReallyRun Out of Dollars?
L . RANDALL WRAY, LEVY INST ITUTE & UMKC
W RAY R@ UM KC. E DU
W W W . L E V Y . O RG
WWW.ECONOMONITOR.COM/LRWRAY/
mailto:[email protected]://www.levy.org/http://www.levy.org/mailto:[email protected] -
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Fiscal Constraints
President Obama: Government is running out of money!
Economists: Unsustainable debt path!
70% of Americans say progress on Deficit needed this year
Chinese might stop lending to us!
Zimbabwe and Weimar hyperinflation!
Burden our grandkids!
Look at Euroland!
Sovereign debt crisis
Default risk
Bond vigilantes
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But Is that True?
It aint what you dont know that gets youinto trouble. Its what you know for sure
that just aint so. Mark Twain
First lets look at the data
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Debt Limits, Fiscal Cliff,Sequestration
Debt limit imposed century ago
2011 Budget Control Act created FiscalCliff to hit Jan 1, 2013
postponed until March; compromise increasedpayroll tax
Sequestration: $1.2 trillion in cuts
$600B domestic (Air Traffic, Headstart)
$600B military
Reduce GDP 1% directly, and multiplier
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Is there evidence of run-away,Weimar/Zimbabwe Deficit Spending?
Is debt at historic high?
Is govt spending out of control?
Have we hocked ourselves to China?Does debt burden our grandkids?
Will Entitlements bankrupt ourgrandkids?
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-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
2005-I
2005-II
2005-III
2005-IV
2006-I
2006-II
2006-III
2006-IV
2007-I
2007-II
2007-III
2007-IV
2008-I
2008-II
2008-III
2008-IV
2009-I
2009-II
2009-III
2009-IV
2010-I
2010-II
Federal Government Receipts and Expenditures(QoQ Change)
Source: Bureau of Economic Analysis and Authors' Calculations
Tax Receipts
TransferPayments
ConsumptionExpenditures
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Foregin Holdings of US Treasuries
(% of total he ld by Foreign Countries)
0
10
20
30
40
50
60
70
80
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Brazil
Taiw an
Hong Kong
Caribbean Banking
CentersOil Exporters
Germany
UK
China
Japan
Source: US Department of Treasury, November 2009 figures
Note: For some years the holdings of the selected countries have been insignificant, so they are included in the category
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Treasury Security Holdings (% of Total Oustanding)
0
10
20
30
40
50
60
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Q3
2010
Q1
%
-2
-1
0
1
2
3
4
5
6
7Held by Rest of
the World
Foreign Official
Holdings
Foreign Private
Holdings
Financial SectorHoldings
Current Account
Balance (Sign
Reversed)*
Source: US Flow of Funds Accounts (f or Treasury Holdings) and Bureau of Economic Analysis (for Current Account data)
*Current account data is as of the end of 2009; treasury holdings data is as of 2009 Q3
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But What About the Long Run?
Budget deficit already falling as taxrevenues recover
Some claim the problem is not with thecurrent situation, but with entitlements
We face chronic Budget Deficits and risingDebt for decades
Infinite Horizon forecasts: Tens of trillions ofdollars of unfunded commitments
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Remember Clinton andGoldilocks?
1996: US Federal Govt begins to runsurpluses; continued for 2.5 years
Clinton projects surpluses for next 15 years All Govt debt will be retired
But: Private debt explodes and then
recession restores deficits. Why: The Meaning of Zero:
0=Private Bal + Govt Bal + Foreign Bal
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PRIVATE SECTOR BALANCE + GOVERNMENT BALANCE = CURRENT ACCOUNT BALANCE
Accounting Identity of Financial Balances
INTERNAL FINANCIAL BALANCE EXTERNAL FINANCIAL BALANCE
THE CONCEPTUAL FRAMEWORK
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Purported Unsustainability ofGovernment Deficits and Debt
Sustainability issues Relation between interest rates and economic growth:
If r>g growth of debt
Growth of Debt Bond Vigilantes push up r
accelerating the rise of debt ratios
Excessive Deficit-to-GDP and Debt-to-GDP ratios:inflation and ultimately insolvency
So: We must show:
a) why govt doesnt face insolvency, and
b) why deficits dont raise interest rates
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St. Louis Fed
"As the sole manufacturer of dollars, whose debt is
denominated in dollars, the U.S. government can never
become insolvent, i.e., unable to pay its bills. In this sense,
the government is not dependent on credit markets to remain
operational. Moreover, there will always be a market for U.S.government debt at home because the U.S. government has
the only means of creating risk-free dollar-denominated
assets.
Government can NEVER run out of Dollars; It can NEVER be
forced to default; It can NEVER be forced to miss a payment; It
is NEVER subject to whims ofbond vigilantes.
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Myths, Superstition, Old-Time Religion
"I think there is an element of truth in the superst i t ion that thebudget must be balanced at al l t imes. Once it is debunked
[that] takes away one of the bulwarks that every society must
have against expenditure out of control. There must be discipline
in the allocation of resources or you will have anarchistic chaos
and inefficiency. And one of the functions ofold fashion ed
relig ion was to scare people by somet imes what might be
regarded as my ths into behaving in a way that the long -run
civi l ized l i fe requires.(Samuelson)
Necessity of balancing the budget is a myth, a superstition, theequivalent of that old-time religion.
So what is the truth? If economics is to rise above superstition, weneed to know.
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How Government Spends its OwnCurrency: Keystrokes
Spending credits
Government credits banks reserves; bank creditsaccount of recipient
Taxes debits
Government debits banks reserves; bank debitsaccount of taxpayer
Deficits net credits
Government net credits banks reserves; bank netcredits account of recipient
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Money as Scorekeeping
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Bond Sales by Government: Why the Bond VigilantesCannot Dictate Terms
Deficit spending net credits reserves Creates Net Financial Wealth in nongovt sector
Excess Reserves bid overnight rate down
To Feds support rate (fed funds rate)
Bonds: Interest earning alternative (IRMA)
Part of Monetary Policy, whether new issues or openmarket sales
Changes form of Net Financial Wealth (longer maturity)
(NB: Surpluses net debitsOMP or Redemptions)
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Self-imposed constraints
Budgeting, debt limits
Operational constraints:
Treasury writes checks on accounts at CB
CB prohibited from buying Treasury Debt new issues
Use of Special Depositories
Use of Tax and Loan accts
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Central Bank Policy
Consensus: central banks always operate on overnight
interest rate
Accommodates Demand for Reserves
Convertible vs. non-convertible currencies
Convertible: can lose control of interest rate (Greece)
Nonconvertible: controls overnight rate (Japan)
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Sovereign Currency: Summary
Deficit spending creates private financial wealth Note that CB operations do not; it buys government bonds or
lends against collateral (helicopter drop is fiscal policy)
CB Lends; Treasury Spends
Doesnt matter whether bonds must be sold firstso long asCB accommodates reserve demand
Doesnt matter whether CB prohibited from buying new
issuesroundabout through banks
Doesnt matter whether Treasury must have money in itsacct at CB to spendCB and banks cooperate
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Principles of Functional Finance(Abba Lerner)
i. Government shouldspend more if there isunemployment
ii. Government shouldsupply more money (reserves) ifinterest rates are too high
NB: Budgetary outcome, Debt outcome should never be
primary consideration
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Friedman or Keynes?
Let us suppose that one day a helicopter flies over this
community and drops an additional $1000 in bills fromthe sky, which is, of course, hastily collected bymembers of the community Milton Friedman, Optimal
Quantity of Money If the Treasury were to fill old bottles with bank notes,
bury them at suitable depths in disused coal mines
and leave it to private enterprise on tried principles of
laissez faire to dig the notes up again there need beno more unemployment and the real income of the
country would then become a good deal greater than it
actually is. JM Keynes, The General Theory
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Friedman or Keynes?
Martin Wolfe, FT: In the present exceptional
circumstances, when expanding private credit andspending is so hard, if not downright dangerous, thecase for using the states power to create credit and
money in support of public spending is strong.
Adair Turner: Japan should have done some outrightmonetary financing over the last 20 years, and if it haddone so would now have a higher nominal grossdomestic product, some combination of a higher pricelevel and a higher real output level, and a lower debt togross domestic product ratio.
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Japan: a scary precedent?
Japan: rapid growth in 1980s, with highestbudget deficits in developed world
Massive real estate boom in late 1980s
Govt Budget moved to surplus Economy collapsed; 20 years of
recession, deflation, falling real estate
prices Relies on zero interest rates and massive
XR (QE)
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EURO: Non-Sovereign Currency
Member states gave up own sovereign currencies
Adopted a foreign currency, the Euro
Much like a USA state: a user of the currency, not issuer
Constrained in its spending: tax revenue, bond sales,
willingness of ECB to lend
Problem: no fiscal equivalent to Uncle Sam in Washington
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Euro is the Problem
By adopting the euro sovereign nations have turnedinto something like U.S. states.
Unlike U.S. states euro governments have to fundpensions and healthcare
Euro governments had to deal with banking problems
in the U.S. the Fed did the bailing out.
U.S. States Debt/GDP Ratios
(Average 1997-2008)
Alaska 15.7 Montana 12.2
Connecticut 12.1 New Hampshire 13.0
Hawaii 12.2 New York 10.5
Maine 11.0 Rhode Island 16.9
Massachusetts 16.5 Vermont 12.6
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Conclusions
Currency-issuing Government spends bycrediting bank accts, taxes by debiting
Can always afford to spend more
Issues: inflation, exchange rate effects, interest rateeffects
Sovereign currency gives more policy space
No default risk
Can control interest rates
Can use policy to achieve full employment
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What I did and did NOT say
I did say: Sovereign Government faces no financial constraints;
cannot become insolvent in its own nonconvertible currency
But it can only buy what is for sale
I did NOT say that Government ought to buy everything for sale
Size of Government is a political decision with economic
effects
I did NOT say that deficits cannot be inflationary:
Deficits that are too big can cause inflation I did NOT say that deficits cannot affect exchange rates:
Sovereign Governments let currency float; float means
currency can go up and down
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Thank you
L. Randall Wray
Professor of Economics, UMKCSenior Scholar, Levy Economics [email protected]/LRWRAY/
http://www.levy.org/http://www.levy.org/