Archive

Archive for the ‘Fiscal Cliff’ Category

Financing Government Deficits with Money

May 10, 2018 6 comments

In an earlier post, I described the budget constraint faced by the federal government. Here I want to point out how a deficit can lead to inflation. I will also indicate how the European Union (EU) and Greece are related to this discussion since there is an interesting difference between the U.S. and Greece regarding deficits and inflation.

Financing Deficits by the Central Bank

Suppose that the government has a deficit meaning that its spending for all purposes exceeds its tax revenue and that the government is unwilling to raise tax rates and/or cut spending. Now imagine that lenders will not lend to the government by buying the bonds that the government has tried to sell. In this situation, one financing option (bond sales to the public) for deficits is unavailable.  If nothing else is done to deal with the deficit, the government simply runs out of money and must shut down its operations until new tax money arises. But there is another option in the U.S. and many other countries; the central bank (the Federal Reserve in the U.S.) can buy the bonds sold by the government.

To see how this works, consider what the Fed can do. The government sells the bonds sold by the government and creates bank reserves as a result. Bank reserves would just be deposits at the Fed owned by banks. Those bank reserves will expand the money stock and so we have the Fed “printing” money to finance the government’s deficit. But to paraphrase the late Milton Friedman, inflation is a monetary phenomenon. Thus the government’s deficit can be accompanied by inflation. This appears to be happening now in the socialist paradise of Venezuela. But for Greece the situation is different because of its membership in the European Union (EU). Read more…

Advertisements

The Government Budget Constraint

May 3, 2018 1 comment

My last post reported on the latest Congressional Budget Office (CBO) analysis of the federal government budget showing unprecedented increases in the ratio of government debt to GDP. That ratio emerges from the government’s budget constraint which is the topic addressed here.

The Government Budget Constraint

The government’s sources and uses of funds are collected together into one expression, known as the Government Budget Constraint, which states that the sources of funds must equal the uses of funds by the government. The table below lists these items.

Uses of Funds Sources of Funds
Spending on Goods and Services Tax Revenue
Interest Payments Government Bond Issue
Net Transfer Payments

The uses of funds include spending on goods and services, interest payments, and net transfer payments to the public. This latter category includes, among other things, the Social Security and Medicare programs. So Net Transfer Payments rise as the entitlements crisis unfolds. If interest rates on government debt rise, interest payments by the government must rise as well.

On the sources side of the ledger, the government gets tax revenue which it uses to pay for its spending and/or it may issue government bonds to pay for spending if its spending exceeds its tax revenue. So the CBO report said that the government will be running deficits increasing in size into the future and thus will have to issue increasing amounts of government debt to finance its spending.

But this table does not include the role of the Federal Reserve which is included in a related concept which we discuss now. Read more…

The Latest CBO Long-Term Budget Outlook

The Congressional Budget Office (CBO) is the research shop for Congress. It is their job to provide an analysis of many economic issues and one such task is the budget outlook. Their latest report on the budget contains a picture which speaks volumes about the fiscal position of the federal government. That picture is given below.

This picture is the ratio of the stock of government debt to GDP which the CBO expects to arise given their latest projections for the U.S. economy and the laws on the books which dictate government spending by the federal government. Note that the CBO expectation is that the debt/GDP ratio will rise to levels never before seen in the history of the U.S., even during wars. This picture concisely states the nature of the emerging entitlements crisis. Absent any changes in fiscal policy, there will be historically unprecedented levels of government deficits and spending that are implied by current laws.

But there is one hidden aspect of this picture which the CBO is making. The CBO is assuming that it will be possible to finance the deficits implied by this picture but there is no economist that is able to guarantee such a position. The reason is that deficits of the sizes implied here would be well above the trillion dollar range which would be completely outside our history of experience. Thus there is no way to know, since we have never seen these deficits, that a debt crisis would not emerge (the situation with Greece is instructive on this point). Put differently, we cannot guarantee that the federal government would be able to borrow the funds necessary to achieve the debt/GDP ratios in the graph above.

If the government cannot borrow all that is needed, then what? I will write about this in a follow-up post soon.

The Cost of “Bernie Care”

September 25, 2017 1 comment

Senator Bernie Sanders has expressed support for and formally introduced a plan for a health insurance system to be run by the federal government which has been called “Bernie Care” in some media outlets.  A number of other Democratic politicians have also expressed support for this idea. This is quite likely to be the Democratic Party response to the problems with Obamacare. Indeed Barack Obama expressed his own support for this national health insurance program before his first election as President (I saw the videotape of his statements at that time) but he claimed the country was not yet ready for such a health insurance program. What would such a program cost? The Urban Institute has published a study to answer this question. Read more…

The U.S. Tax-Income Ratio

August 17, 2017 1 comment

I recently saw a news report about federal government tax receipts and I began to wonder what trends, if any, have been present in the public’s support of government as measured by its tax payments. Most media reports that I have seen focus on the dollar amounts of federal government tax revenue but it is more informative to include state and local governments as well so that we can get a more accurate measure of public tax payments to the government.

But rather than looking at tax payments in dollars, it is more useful to look at tax shares of our incomes. The economy grows over time and so it is more informative to see what fraction of our incomes are paid to the government so that we can adjust for the size of the economy as it changes through time. For this post, I will use Gross Domestic Product (GDP) as a measure of our incomes and I will use Federal plus State and Local receipts to capture the revenues of all sorts that flow to the government. All of the data was drawn from the St. Louis Federal Reserve Bank FRED database which is freely available to the public. The data is annual and it covers 1929 through 2016. Read more…

The Government Deficit and the Fed

April 13, 2017 2 comments

The Federal Reserve recently announced an increase in the interest rate which it sets. This has implications for the government deficit which may not be well understood by the average person so I thought that it might make sense to discuss the connection between the Federal Reserve and the government deficit. What this discussion reveals is that the Fed has been helping to finance the government deficit in the U.S.

The Consolidated Government Budget Constraint

There is a relationship between the government and the Fed known as the Consolidated Government Budget Constraint that is written below.

Spending + Interest Payments + Net Transfer Payments =

Tax Receipts + Change in the Stock of Debt + Change in the Monetary Base

The items on the left side of the equal sign are the uses of the government’s funds. Spending refers to the fact that the government buys goods and services, it makes interest payments to the holders of government debt, and it makes transfer payments to individuals in the economy. The right side of the equation is the list of sources for the government’s spending. It receives tax payments, it issues or retires bonds, and the last item reflects bond purchases or sales by the Federal Reserve. It is these last two items that reflect the connection between the Fed and the government deficit. Read more…

Economists Running for Office

August 31, 2016 Leave a comment

I have tried to stick to economics on this blog, meaning that I do not get involved in expressing political opinions for any reason. But I learned something today that I felt should be passed on to my readers.  And that is that two economists, Lawrence Kotlikoff and Edward Leamer, are running for President and Vice President of the U.S. Their web site is kotlikoff2016.com.

These are two established and highly competent economists but, let me be clear. I am not expressing my endorsement of them. I am merely passing on the information to those who might be interested.

Given the turmoil that we are seeing in this election season, it is quite interesting to see two economists feel that they should get on the ballot. It really is true that the U.S. economy has extremely serious problems that are not being addressed by either of the two mainstream candidates running for President. I will be interested to see just how far these two economists get to the jobs they seek.

Economics One

A blog by John B. Taylor

The Grumpy Economist

One economist's views on economic policy.

The WordPress.com Blog

The latest news on WordPress.com and the WordPress community.

%d bloggers like this: