Podcast Failures: Friedman and Chile, Hume and Public Debt

I listen to a few podcasts during my commute. Two that I often appreciate are Know Your Enemy, associated with Dissent Magazine,* a series of interviews on mostly right wingers by Matthew Sitman and Sam Adler-Bell, and Past, Present and Future, a series of monologues by David Runciman, sponsored by the London Review of Books.  Both are always entertaining and informative. I'm not a specialist in most of the subjects they discuss. However, two recent episodes (or at least I listened to them recently), one from each, dealt with economic issues, and they did leave a lot to be desired, to say the least.

Very briefly, the issue with the interview with Jennifer Burns about her biography (in many ways, from this interview, and the one with Tyler Cowen, it is hard not to see it as a hagiography; more on that as soon as I read the book; it's been ordered. I hope that's just a perception and that the book provides a more balanced view of his contributions and political views) of Friedman is that the hosts accepted almost all of her very monetarist interpretation of the Allende government, and her whitewashing of Friedman's relation with the Pinochet regime (see on that this and this). In all fairness, at least one of the hosts (sorry, not sure that was Matt or Sam) questions (around 1:16) the validity of her interpretation of the relation of Friedman with the regime. But there seems to be a complacent view according to which inflation in Chile was caused by excessive monetary printing driven by the expansion of the welfare state.

The role of the US sanctions, and Nixon's infamous instruction to "make the economy scream" are never cited. And the lack of dollars was at the center of the depreciation of the currency, inflation and the collapse of the economy. Let alone that the Pinochet period wasn't that good (yes they do claim that it created the basis for future growth, a typical conservative trope, that I should write about; in another occasion). I also recommend this post by Tom Palley. On a general evaluation of the regime see this piece by Jim Cypher in Dollars & Sense.

The issues with Runciman's podcast are considerably more problematic. They don't entail a misrepresentation of the ideas of a crucial intellectual, in this case, David Hume. In fact, Runciman is relatively correct when it comes to Hume's essentially negative views of public debt (which were not all that different than those of Adam Smith, at least according to Donald Winch**; btw it was called public credit at that time, so nothing weird about it). He makes to much of Hume's drastic solution, default, for public debt, and its comparison with suicide, for the nation not the individual. And he does recognize that events essentially proved Hume wrong.

But then he commits all of Hume's (and modern mainstream economics). Presumes that the only way out of debt is to run persistent surpluses, printing money and reducing its value in real terms (endorsing a Monetarist view of inflation; it's amazing how pervasive it is), and default. He misses that debts can fall as a share of income (GDP), that is, the ability to repay, if the economy grows faster than debt (the rate of interest), and that most debt consolidations actually happened that way, while running deficits. He also gives Argentina as an example of a country that has defaulted without noticing the differences between debt in domestic and foreign currency. It's a mess. Worse, in an environment in which many conservatives want to promote default in the US he suggest that talking about it would be reasonable. He is out of his depth, should apologize and invite someone to explain the problems with his analysis.

Again, I'm only commenting on these two episodes, because they do seem off, when compared to the quality of both podcasts in general.

* I published almost 20 years ago on Dissent. Because of this I did search their online archive and my piece, and my name was misspelled. Also, it was published in the Winter of 2004, and not of 1984. In the original magazine it was spelled correctly. Oh well.

** See Donald Winch, "The political economy of public finance in the 'long' eighteenth century," in John Maloney (ed.), Debt and Deficits: An Historical Perspective, Cheltenham: Edward Elgar, 1998.

Public vs private debt

I was teaching about deficits and debt this last week. If you know me and follow this blog, you'd know that I always emphasize the importance of the distinction between debt in domestic currency and debt in foreign currency. Functional finance authors (and MMT too) are correct in noting that a country cannot default on debt in its own currency (for a model of a currency crisis and default, in foreign currency go here; as afar as I know the only formalization of a PK alternative to the Krugman model).

At any rate, teaching about the US for mostly US kids, that is not an important distinction, since the US has only debt in its own currency. Most of them thought that the current levels of public debt are too high (with respect to what you may ask, the ability to repay or the kind of society we live in?). I would hope that by them most of them tend to think that we do not have enough public debt. I mean the amount of homeless people, or the windshield washers in the corners of the streets, suggest that we need more public spending. The graph below shows the break between public and private debt in the US.

It is clear that the amount of public debt shrank from about 50 percent of total debt in the early 1950s to something around 10 percent right before the 2008 financial crisis, and most of the growth was in the financial sector. Since then public debt has grown to about 30 percent. Household and corporate debt did increase over time, but not much. The important lesson in the case of an economy like the US (with debt in its own currency) is that public debt is safer than private debt, since the government cannot default and its spending does affect the level of activity and the ability of the private sector to thrive.

On Volcker and Peterson's debt problem

In their recent NYTimes op-ed Paul Volcker and Peter Peterson say:

Yes, this country can handle the nearly $600 billion federal deficit estimated for 2016. But the deficit has grown sharply this year, and will keep the national debt at about 75 percent of the gross domestic product, a ratio not seen since 1950, after the budget ballooned during World War II.

The practical consequence of large deficits and debts, according to them is that:

Our current debt may be manageable at a time of unprecedentedly low interest rates. But if we let our debt grow, and interest rates normalize, the interest burden alone would choke our budget and squeeze out other essential spending. There would be no room for the infrastructure programs and the defense rebuilding that today have wide support. 

It’s not just federal spending that would be squeezed. The projected rise in federal deficits would compete for funds in our capital markets and far outrun the private sector’s capacity to save, to finance industry and home purchases, and to invest abroad.

In other words, large deficits and debt will compete with funds for other activities, the savings glut which a good chunk of the profession thinks causes low interest rates will vanish, and this, in turn, will increase interest rates, which not only will increase the interest rate burden, but also will reduce the fiscal space to spend on things we agree are fine, like infrastructure.

What should we do according to them? No surprise here, cut social spending. In their words: "A realistic approach toward the major entitlement programs is required, given that they are projected to account for all of the growth of future noninterest spending." They fall short of asking for privatization of Social Security, but you can bet that this is what they are going to push for in a Clinton administration. To finish the work they started in the previous Clintocracy (the system of government in which a Clinton holds power).

I discussed fiscal issues several times here, and the problem in their argument is with basic principles really. Below Gross Federal Debt, which stands at slightly more than 100% of GDP, and once the amounts of public held by the Fed and in the Social Security Trust Fund and other government accounts are accounted for, then this leaves us with the Net debt of about the size reported by Volcker and Peterson in their piece.

Looking at the figure you might be alarmed. It has increased significantly after the last crisis. However, there are important elements that suggest that the increase in public debt is not problematic. First of all, as noted by Dean Baker, the burden of debt service (interest payments) is tiny. And will most likely remain low, since the space for normalization of interest rates is much smaller than what Volcker and Peterson suggest. The idea that government spending will grow out of line with the ability to finance it (which has little to do with the "private's sector capacity to save," btw) is difficult to believe too. Note that government spending has been subdued as the graph below shows.

Government spending in real terms remains below the pre-crisis level, and after the fiscal package, Obama has essentially followed the Clintonomics rule book of fiscal conservatism. If anything spending is kind of small, for the needs of the economy (I would say spending, and not deficits, since the result is endogenous, but I agree in general terms with the argument here). There is no problem of runaway government spending, and certainly no danger, as Volcker and Peterson suggest that "we would risk returning with a vengeance to stagflation — the ugly combination of inflation and economic stagnation that we tasted in the 1970s" if we do not cut social spending. This is the old trick of creating fear of a fake fiscal crisis to force cuts on spending for social programs.

My fear is that Volcker and Peterson, and others like them, will have an outsized influence on a Clinton administration. The danger is not the high inflation of the 1970s, but the completion of the neoliberal project of the 1990s.

Austerity Sucks: Mark Blyth on the follies of US budget policy

The following is from a presentation before the US Senate by Mark Blyth, author of “Austerity: The History of a Dangerous Idea” It is a scholarly rebuke of mainstream notions about public debt and investment in social welfare that are driving domestic economic policy.

My name is Mark Blyth and I am the Eastman Professor of Political Economy at the Watson Institute for International Studies and Brown University in Providence RI. I am also the author of a book entitled Austerity: The History of a Dangerous Idea (Oxford University Press 2013) a book, which oddly just received a national award in Germany, the country most associated with budgetary austerity. Given that irony is not a German national trait, it might be the case that even the Germans are re-thinking their stance on balanced budgets. As I shall show you today, it’s really not working out so well in Europe and it would be a disaster if it were tried here too.

And yet balancing the budget as a matter of principle is intuitive. After all, you can’t spend more than you earn. It is also appealing. After all, people want more money in their pockets rather than less, so spending ‘other people’s money’ now so that they would have less in the future because of debt interest repayments seems to be the height of folly. But balancing the budget because of these arguments is also folly. While they are intuitive, these arguments are systematically wrong, because they are based upon two faulty analogies: one drawn between households firms and states and another between savings always being good and spending always being bad. I begin by taking each in turn before giving more specific examples.

Read rest here. Blyth’s presentation is viewable here, starting at the 46:20 mark.

Hamilton's Reports and the American Economic System

Alexander Hamilton's reports to Congress go against the grain of much of the core principles of mainstream economics. Hamilton had read the main economic authors of his time, including David Hume and Adam Smith, both of which had a much more critical view of public debt than Hamilton did. He was also influenced by policy makers like Jacques Necker (see here; subscription required), a Genevan banker and finance minister of France just before the Revolution, and Robert Morris, who is often referred as the Financier of the Revolution (see Ron Chernow's biography of Hamilton).

The Hamiltonian plan, which was to a great extent based on the British economic model, was based on the need to consolidate all debts incurred by the states under the Federal government, and to provide the latter with revenues from foreign trade, implying tariffs, and excise taxes (e.g on whisky) to allow to pay the interest on the new national debt. Hamilton argued famously in his Report on Public Credit that a well-funded national debt would be under certain circumstances a blessing, and writing about Jeffersonians* -- which would surprisingly look not very different than some members of the current GOP -- said that: "a certain description of men are for getting out of debt, yet are against all taxes for raising money to pay it off."

Further, he was for a national bank, being instrumental in the founding of the First Bank of the United States, modeled on the Bank of England. Not only the bank would promote the expansion of credit, but also it would provide funding for the government. Further, he was very clear that tariffs on foreign trade were needed not just to raise revenue, but also for the protection of domestic industry. In his famous Report on Manufactures, which advanced ideas on infant industry later developed by Frederich List (for other more recent critics of free trade go here and here), he said:

"The superiority antecedently enjoyed by nations, who have preoccupied and perfected a branch of industry, constitutes a more formidable obstacle, than either of those, which have been mentioned, to the introduction of the same branch into a country, in which it did not before exist. To maintain between the recent establishments of one country and the long matured establishments of another country, a competition upon equal terms, both as to quality and price, is in most cases impracticable. The disparity in the one, or in the other, or in both, must necessarily be so considerable as to forbid a successful rivalship, without the extraordinary aid and protection of government."

All the elements of his economic plan, discussed in his five reports to Congress (available here), were central in what eventually became known as the American System, usually associated to Henry Clay.

* Jefferson abhorred public debt, but was very fond of private debt, being constantly indebted. In 1815 he sold his library, in part to pay his debts, which formed the basis of the Library of Congress.

Who's afraid of foreign public debt?

Ricardo Hausmann decided to get his two cents on the public debt debate started by the Reinhart and Rogoff debacle. Hausmann was a famous defender of dollarization (see here his instructions for implementation, because, you know, it's a no brainer; you can go here to see his predictions that emerging markets will no longer have national currencies, since they cannot borrow long term in their own currencies) in the past, when he was the chief economist at the Inter-American Development Bank, and was for it in Argentina, Ecuador and other places.

Coming from Venezuela, Hausmann knows that foreign debt and domestic debt should not be mixed. He fudges the issue and does not explicitly says that public debt in national currency is not a problem (and that you cannot default on a currency you print), but he does say that: "The level of debt does matter, and its currency composition matters even more." In other words, foreign denominated debt does matter, since a government cannot monetize a foreign denominated debt. The level that matters is the foreign one, that is, the composition. That's all, and actually this points out a significant problem in Reinhart and Rogoff's work, which does not distinguish carefully enough between foreign and domestic denominated debt.

Note that the examples given by Hausmann of countries were high public debt became problematic ("Mexico in 1994, Russia in 1998, Ecuador in 1999, Argentina in 2001, Uruguay in 2002, the Dominican Republic in 2003, and even the UK in 1976") are all in countries which debt was denominated in foreign currency (dollars for the most part). His explanation that Spain could not pursue expansionary fiscal policy, because as deficits increased interest rates also increased, misses the point that Spain debt is in Euros, and the European Central Bank (ECB) has been, for the most part, unwilling to buy enough Spanish bonds to keep their interest rates low.*

So his conclusion that you must be an Austerian in a boom in order to be able to be a Keynesian in the crisis is plain wrong. Like his defense of dollarization (which he later retracted, and suggested a plan B for Argentina). The principle that debt in domestic currency is not problematic is fine, but his defense of austerity in the face of a recession for certain situations is just plain wrong. Hopefully he will change his principles on this subject too.

* Interestingly enough Spain is like a dollarized country, something he defended in the past.

Should the AER retract Reinhart and Rogoff's paper?

The case of Dutch social psychologist Diederik Stapel fraud, now in the news, which led to the retraction of several of his papers by academic journals suggests that this might be the right course of action for the American Economic Review (AER). Even if Reinhart and Rogoff's (RR) results do not necessarily amount to fraud, something that I'm sure could become a matter of dispute, it's still a fact that they are incorrect, as admitted by the authors. So the AER should clear the record and retract the paper that suggests that growth collapses when a country has a debt-to-GDP ratio of more than 90%.

PS: As the NYTimes notes there is a blog about scientific papers that are retracted here. The blog dealt with RR case here.

Does High Public Debt Consistently Stifle Economic Growth?

Thomas Herndon, Michael Ash and Robert Pollin show in this new paper that the studies by Carmen Reinhart and Kenneth Rogoff which correlate national debt-to-GDP ratios over 90% with sharp declines in growth are not correct. They find that when properly calculated, meaning using the full data set not just part of it, the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90% is actually 2.2 percent, not -0.1 percent as published in Reinhart and Rogoff (RR). That is, contrary to RR, average GDP growth at public debt/GDP ratios over 90% is not dramatically different than when debt/GDP ratios are lower. Reinhart and Rogoff claim the mistake resulted from a technical error involving a spreadsheet, and say that they “do not, however, believe this regrettable slip affects in any significant way the central message of the paper.” You would think that growing at 2.2% rather than a recession of 0.1% would make them think that their results are incorrect.

A Shackled Revolution? The Bubble Act and Financial Regulation in 18th Century England

New Working Paper by Bill McColloch, which refutes anti-Keynesian (crowding out) views on the Industrial Revolution (IR). From the abstract:

"Revisionist estimates of growth rates during the British industrial revolution, though largely successful in presenting a more modest picture of Britain’s ‘take-off’ prior to the 1830s, have also posed fresh analytical difficulties for champions of the new economic history. If 18th-century Britain was witness to a diffuse explosion of ‘useful knowledge,’ why did aggregate growth rates or industrial output growth rates not more closely shadow the pace of technological change? In effort to explain this paradox, Peter Temin and Hans-Joachim Voth have claimed that a few key institutional restrictions on financial markets – namely the Bubble Act, and tightening of usury laws in 1714 – served to amplify the "crowding out" impact of government borrowing. Against this vision, the present paper contends that the adverse impact of financial regulation and state borrowing in 18th century Britain has been greatly overstated. To this end, the paper first briefly outlines the historical context in which the Bubble Act emerged, before turning to survey the existing diversity of perspectives on the Act’s lasting impact. It is then argued that there is little evidence to support the view that the Bubble Act significantly restricted firms’ access to capital. Following this, it is suggested that the “crowding out” model, theoretical shortcomings aside, is largely inapplicable to 18th century Britain. The savings-constrained vision of British capital markets significantly downplays the extent to which the Bank of England, though founded as an institution to manage the public debt, provided the entire financial system with liquidity in the 18th century."

The paper by Temin and Voth is here. Their recently published book is here.

Crafts and Harley's re-interpretation of the IR in Britain, alluded to in the text, is available here (subscription required). The classic book on the British IR that Crafts and Harley try to supersede is by Deane and Cole (here). A discussion of the two views by Temin is available here.

On whether the British government had a role in financing the IR, it is worth remembering Pressnell's (subscription required) words, for whom:

"Amongst the half-truths of economic history is the generalization that British Governments did not finance the Industrial Revolution. That public financial aid was not a regular and conscious process cannot be doubted; equally, it is indisputable that Government was not distinguished during the eighteenth and early nineteenth centuries by the provision of financial facilities commensurate with a period of economic expansion. In practice, however, a considerable volume of public money swelled the funds of private bankers, and in this indirect fashion helped to fructify private enterprise."

Pressnell suggests that country bankers were often tax collectors, and closely related to industrial activities. The incredible growth of public debt, to 260% of GDP by the end of the Napoleonic Wars, and the increase in government revenue to pay for debt service, implied a signiifcant increase in liquidity which is associated to the financing of the IR.

PS: Newton (pictured above) lost his pants in the South Sea Bubble, and also was famous for getting the exchange rate between gold and silver wrong (he was the Master of the Mint), leading to hoarding of silver, and the beggining of an effective Gold Standard in Britain.

More austerity, more debt

How is that austerity working for you? According to a recent policy brief by UN-DESA, not so well. The authors (Oliver Paddison and Rob Vos) say that:

"Available evidence suggests that fi scal austerity is not helping restore economic growth or debt sustainability; countries that made the biggest spending cuts to reduce fiscal deficits have seen their debt-to-GDP ratios rise even further (see figure)."

The graph shows that higher primary surpluses (difference between revenue and spending, excluding financial payments) are correlated with higher level of public debt. The reason is that austerity reduces the level of activity and depresses revenues as you would expect according to Keynesian principles.

I think increasingly we have an analogy with evolution and creationism in the debate about the effects of austerity. Logic and evidence are clearly on one side, but belief, well that goes in any direction. The problem is that beliefs, ideology, and vested interests have an impact on policy.

Too many things wrong (Sargent and Field edition)



And not enough time to blog about all of them. Two that seem to be really important and worth noticing in recent debates around the blogosphere among the chattering classes are the idea  (subscription required) that State Defaults after the Jacksonian economic crisis were good to establish US credibility, and the notion that Total Factor Productivity (TFP) was essential for the US recovering from the Great Depression.

Very briefly I’ll discuss why these two propositions are just wrong. Sargent argues that by guaranteeing State debts the Hamiltonian system created moral hazard, and that the States defaults of the 1840s, which resulted from this arrangement, were instrumental in creating a credible fiscal commitment to sound finance. In his words: “in refusing to bail out the states in the early 1840s … the federal government reset its reputation vis-à-vis the states, telling them in effect not to expect it to underwrite their profligacy.” The lesson for Europe is let the periphery default, and, by the way, that would lead them to fiscal consolidation by even more austerity (yep he never heard of multipliers). At any rate, this account of the United States experience is pure fiction.

First of all the collapse had nothing to do with profligacy, and all to do with prices of cotton falling, and States defaulting on foreign debt, not domestic debt. In Europe the countries do print the money in which their debt is denominated, the problem is that the ECB is not willing to do it. The crisis is self-made, and if the ECB monetized a bit of debt there would be no danger of inflation, since the economies are really (really) far from full employment.

Further, the US national government at that point had no public debt (Jackson paid it down and caused a financial crash; he also required payments of public lands in specie, that is the crisis was worsened by austerity and sound money), and no national bank or monetary authority. Hence, it could not bail the States out. Only after the Civil War, with greenbacks, a more centralized management of debt and money were created in the US. So there is no possibility that the reputation of something that did not exist until the 1860s was built in the 1840s.

Sargent's anal fixation with austerity in order to pay debts, even those in domestic currency, and his lack of understanding of basic events in the history of the United States are appalling. And this guy got a Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (yep, it’s not a real Nobel!).

Field is an interesting case. The mistake in his book is not of his making, in all fairness, but the result of the profession's lack of understanding of basic economic principles. His point, well explained by Mark Thoma, is that part of the recovery in the 1930s was caused by rapid growth in productivity (TFP). Nothing against the argument, which might be (and probably is) true, to some extent. Note also that productivity is not only pro-cyclical but also structural and demand-led, which means that some of the increase in productivity was actually caused by the recovery. But the problem is that TFP is not a measure of productivity.

Note that TFP is based on the notion that there is a production function in which output (Y) is a function of labor (N) and capital (K), and forget for a second the problems of using the notion of a quantity of capital. In addition, we know that income (Y) is equal to the payments to labor (N) and capital (K). So we have a theoretical construct and an identity:

Y=f(N, K) and Y=wN+rK

Obviously if you derive Y with respect to time, you must obtain from either equation that the growth of Y over time is a function of growth in labor and capital, and either some additional part, which depends on the technology f(…) in the theoretical construct, and the weighted average of the growth of wages (w) and profits (r) in the identity. And yes the second is an identity and by definition (constructed in the national accounts) true. So TFP is a residual that says something about income distribution. Let’s please use labor productivity, when discussing productivity. For more on that see, for example, Felipe and McCombie (2001; subscription required).

Long-term versus short-term debt

In a previous post I have referred to the Fiscal-Military State, and Brewer's classic book on it. It is worth remembering, for those afraid about debt these days, that public debt in the UK during the Napoleonic Wars peaked at more than 250% of GDP.

One of the important ways in which the British were able to out-finance the other major European powers, fundamentally France, during the 18th century was the ability to borrow long at at low rates. The graph below shows the proportion of unfunded to funded debt (from Brewer's book). The UK rapidly moved from almost 100% of unfunded debt to less than 10%.

Funded debt, was debt for which specific taxes were set aside to service it, and it tended to be long-term, while unfunded debt was usually short-term debt. Debt service consumed a great amount of the budget, but that was simply the result of the incredibly large amount of debt, since interest rates remained relatively low. I guess the lesson is that long term debt in your own currency is okay.

Greek Debt is not that large

The NYTimes tells us that Greek debt is out of control, and financial markets fear that a default is around the corner.  It might be true, but the size is not a big problem. According to the Times:

"Total Greek public debt is about 370 billion euros, or $500 billion. By comparison, Argentina’s debt was $82 billion when it defaulted in 2001; when Russia defaulted, in 1998, its debt was $79 billion."

The point of this is that it is supposed to be large even when compared to Argentina and Russia that defaulted. Note, however, that the GDP of the euro-17 (the 17 countries of the euro currency area) is around 12.3 trillion euros, and as a result Greek debt corresponds to slightly more than 3% of the euro-17 income.  It is true that the euro countries, or the ECB, may not want for political reasons to buy Greek bonds, but given its size and the potential risks it is puzzling, to say the least.

In Argentina and Russia that option was out of the table altogether, since debts were in dollars, and no world central bank could stand to actually buy their bonds. So default was the only alternative. At this point, it is as if the ECB and the European elites do not want to save the euro. And the Greek people's patience is running thin.

UNCTAD against fiscal austerity

The Trade and Development Report (TDR, 2011) has been published.  It says many important things, but I think that what stands out in the the current environment is its defense against fiscal austerity.  It says:

"The current obsession with fiscal tightening in many countries is misguided, as it risks tackling the symptoms of the problem while leaving the basic causes unchanged. In virtually all countries, the fiscal deficit has been a consequence of the global financial crisis, and not a cause. (...) Policymakers should not focus only on debt stock. They need to consider the relationship between the stock of debt and the flow variables, including interest rates and fiscal revenues that affect a country’s ability to support its debt. A major factor that influences changes in the burden of public debt is GDP growth: it is virtually impossible to lower high debt-to-GDP ratios when an economy is stagnant, unless the debtor obtains a significant debt reduction. Hence, the level of a country’s fiscal deficit (or surplus) needs to be viewed from a more holistic and dynamic perspective, in the context of its impact on the sustainability of a country’s financial position and on its economic stability and growth prospects."

Economic growth is the way out of debt, and that should be done with more deficits now.

PS: The NYTimes has a story citing Heiner Flassbeck the head of the Division that writes the TDR report.

Public debt is too small

That's what Alex Izurieta says in his last paper (available here). He provides several important points to justify this view. First, once one excludes the debt owned by intra-government institutions the net debt-to-GDP ratio is around 60%. Not particularly large. Second, since 2009 government spending has faded away in its contribution to growth is turning negative, which means that in the absence of other sources of demand, the government is the only thing between us and a protracted recession. More importantly, since agents are in a "liquidation phase", that is still dealing with the consequences of falling assets prices on their balance sheets, then:

"to recover from a financial crisis, the ideal instrument is government support in the form of public debt, i e, government liabilities that are transferred to the balance sheets of private sector agents as their assets."

Not very likely to happen, but the reasons are not economic, and the solution is within the reach of reasonable, well-informed policy makers.

Lorie Tarshis on National Debt

Tarshis was a student of Keynes, and the author of an early textbook (published in 1947, a year before Samuelson's more well known manual), which included the main elements of Keynesian economics (Colander and Landreth discuss the reception of the book here).  One of the last chapters of the manual deals with national (meaning public) debt.  Note that this was written when the debt-to-GDP ratio in the United States was around 120 percent. First, contrary to many economists today, he clearly distinguishes public and private debt, and notices that:

"Since it [the Federal Government] may either impose taxes, or borrow through its control of the banking system, there can be no question of the federal government going bankrupt."

Interestingly, at that time, even at the beginning of the McCarthyte Red Scare, he would not imagine the possibility of the debt-ceiling not being raised.  So default in domestic currency is impossible. Further, he argues that:

"Even though a high federal debt threatens neither bankruptcy nor an exhaustion of government credit, it does have certain other consequences. ... If the government collects taxes to pay interest on its debt, it transfers money from the tax payer to the bondholder ... the transfer is in the direction of those in the higher income brackets ... [that] generally reduces the propensity to consume."

For him, there are a few solutions for the contractionary bias of public debt financed by taxes.  Reduce the rate of interest, by having the Fed buy bonds, and borrow from the Fed.  Shift taxation from the poor to the rich, reducing Social Security taxes and increasing the marginal tax for higher income brackets.  Republicans are adamantly opposed to the second alternative, and are going to eliminate the first by not allowing the debt-ceiling to be raised.  The consequences are clearly contractionary, as a good manual, back in 1947, already showed.

PS: To have an idea of how strong anti-Keynesian ideas were among businessmen see the following letter in response to Leonard Reed's campaign against Tarshis's book.  Would also recommend Invisble Hands, by Kim Phillips-Fein.

Who holds the American public debt?

Just a clarification following up my comments on Nick Rowe's post.  Several people are under the impression that the Fed can still monetize debt if the debt-ceiling is not raised beyond the US$ 14.3 trillion limit.  Not the case. Otherwise there would be no default by definition.  There might have been some problems associated with monetization, but not default (see more about monetization here).

Of the US$ 14 trillion of debt outstanding by December 2010, around US$ 5.6 were held by the Fed and other intra-government agencies (Fed holds around US$ 1.6; see Dean Baker's proposal and discussion here).  So if the Fed buys debt, to monetize it, it just reduces the privately held part of the debt and increases the publicly held, but it cannot increase the total amount.  The graph below shows the public, private, and the foreign (within the private) held shares of US public debt.

As you can see, since the Great Recession, the private share increased from around 50% to close to 60%, and of that the increase has been mostly associated to foreign ownership.  So apparently nobody has been worried (correctly so) about the possibility of an American default.  In fact, since the crisis Treasuries have been increasingly a demanded asset by the private sector, particularly foreign investors, as a safe heaven against the risk of default (data here).  The problem is that the debt-ceiling limit creates a situation which would otherwise be impossible, namely: the US can default on bonds issued in its own currency.

Well understood what the debt-ceiling limit implies is a fiscal restriction, and it would force drastic cuts in spending.  Consider it a very large government shutdown.  So in reply to Nick, if you are Keynesian, and believe your model, this is really bad news.

The debt-ceiling limit: a guide for the bewildered

It is very difficult to explain American politics to those that are not Americans and/or have not lived here long enough. Add to that the confusion over basic economic principles, and it becomes almost impossible to explain the debt-ceiling debate to rational people.

As noted by James Galbraith, this is not a fiscal crisis, which should be obvious, since it was a Wall Street driven bubble.  Also, contrary to what you think the Republicans are the big government party. The graph below shows total federal government spending as a share of GDP (in black), and some spending categories as a share of government spending (in colors). As it can be seen total spending goes up in 1981, 1989, 2001, when Republicans assumed the administration, and down in 1993, when Clinton did.  Also, note that even if spending went up in 2009, as a result of the crisis, it did come down in 2010 (which is not a good thing, by the way) with Obama.

Read the rest here.

Fiscal expansion is expansionary!

Talk on fiscal policy at the ILO.  The preliminary paper is here.  The graphs I refer to in the talk are at the end of the paper. The link for the other papers presented is here.  The session was on macroeconomic policies for employment creation.

Many Economies, Just One Medicine

The IMF in its last Fiscal Monitor suggests that developed countries must adjust because public debt is growing out of hand, and Latin American (and other developing regions) should do fiscal adjustment because their economies are overheated.  First, the graph below shows public debt in four developed countries.  It is clear that in all debt-to-GDP ratios went up after the crisis.  In other words, public debt is the result of the crisis not is cause.



It is important, also, to remember that the crisis has destroyed private wealth (even though governments went out of their ways to compensate some for their losses, in particular the big banks that got us into the crisis).  If private debt falls, and with it private demand, then public demand (spending) has to increase to compensate, unless one wants lower levels of activity.  So it is far from clear that the increase in public debt is problematic at all, and surprising that the “reformed” IMF already is pushing for contraction (note that the IMF has a central role in promoting brutal fiscal adjustments in Eastern Europe and the periphery of the euro too).

But what is really interesting is that if increasing public debt is a sign of dangerous fiscal profligacy, one would expect that Fund to at least be more lenient with countries that have constant or decreasing public debts.  The figure above shows the case of four Latin American countries.

In other words, if debt increases do fiscal adjustment. If debt falls do fiscal adjustment.  I’m starting to think the IMF is always for fiscal adjustment.  Instead of Dani Rodrik’s One Economics, Many Recipes, their motto is Many Economies, Just One Medicine.