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The Government Deficit and the Fed

April 13, 2017 1 comment

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…

The Unfunded Liabilities of the Social Security System

March 24, 2016 Leave a comment

The Trustees of the Social Security System issue a report each year on the overall state of the system.  The 2015 report is available publicly (https://www.ssa.gov/oact/tr/2015/trTOC.html). Consider the following statement in the Overview section of this recently-released report.

The open group unfunded obligation for OASDI over the 75-year period is $10.7 trillion in present value….

In the above statement, OASDI stands for Old Age and Survivors Disability Insurance, the formal name for the Social Security program. The statement seems shocking because it suggests an enormous payment of benefits owed to individuals for which there is no funding source. This staggeringly large number is what is often reported in the media. But my guess is that most readers have no way of knowing how this number arises. With a bit of arithmetic, it is possible to show how it is obtained. Read more…

The Wisdom of a Balanced-Budget Amendment

December 4, 2015 2 comments

I read in the local newspaper today that there is some discussion going on in the Michigan state legislature regarding the federal government deficit. Specifically, there is a coalition of states that has begun to form that would force the federal government to convene a constitutional convention only concerned with the adoption of a balanced-budget requirement imposed on the federal government. Michigan is apparently discussing whether the state should be a part of that coalition. This development is a very good one for reasons that I will sketch below.

By allowing government deficits to exist, there has been a perversion of government policy that may well destroy our country in the future. It is all too often observed that government programs exist mainly to line the pockets of politically-connected groups, thereby enhancing the reelection prospects of the politicians handing out the subsidies. There is an enormous list of these programs. The Export-Import Bank, farm subsidies, ethanol programs, and many more (see a previous post for others) do nothing for the welfare of the country but the recipients of these programs benefit mightily. As the late Milton Friedman said many years ago, the benefits of these programs benefit a few who lobby furiously to get them, but the costs are diffuse, spreading across many people. And so the cost to each person is small and may not even be recognized by the individual bearing these costs. As a result, it is all too easy for the government to borrow to finance yet another vote-buying scheme. All it has to do is borrow to finance any new such spending program since raising tax rates may anger taxpayers.

The problem is that the United States is heading for an explosion of its entitlement costs that has been noted many times by economists (I wrote on this previously here). No economist that I know thinks that the U.S. can finance several trillion dollars in deficits and so, when these occur in the future, what is to be done?

Read more…

Greece

February 20, 2015 Leave a comment

Greece has a newly-elected government which campaigned on the promise that, if elected, it would renegotiate the bailout terms that previously were imposed upon the Greek economy by a previous government and its financial bailout partners. The reason for the desire to renegotiate terms is that Greece has been in recession with high unemployment and declining output for some time and the terms of the bailout require higher taxes and reduced spending, among other things, as a requirement for loans to keep the government from defaulting on its debt.  This drama seems to me to offer a number of lessons for the U.S. and other countries running persistent government deficits.

The Fallacy of Composition

Economists know that what is true for an individual in an economy is not necessarily true in the aggregate economy.  This fact is known as the Fallacy of Composition.  So if Greek politicians promise transfer payments to some Greek citizens, this does not imply that those politicians can promise such payments to all citizens.  Once you add up all the promises, one needs to ask how this will be financed and in many countries, such as the U.S., the answer is borrowing to keep these promises. Each individual wants what he or she has been promised but, if a government is unable to borrow, then what is true at the individual level cannot be true in the aggregate. Greece cannot keep all of the promises that it has made because it will not be able to continuously borrow to do so.

Greece and the EU

Greece is a member of the EU and so it cannot print money to cover its deficits if it is unable to borrow.  The reason is that Greece does not control the EU Central Bank.  If it did control its own money stock, it would undoubtedly be in the throes of a hyperinflation because it would be printing money to finance its deficits. Since it cannot print money, it sought loans to keep the party going but reduced spending and higher taxes were the price it paid for its bailout. The recession resulting from these terms are what has prompted the desire to renege on its previous agreement.

Ultimately, structural reforms are needed to promote economic growth, much like those discussed previously in this blog in connection with Italy which has problems similar to Greece (see Why Italy Declines). These reforms are so-called supply-side policies that remove regulatory and other impediments that reduce economic growth. These reforms appear not to be part of the bailout requirements but these reforms are the only way that the Greeks can achieve real economic progress.

The Corruption in a Democracy

October 9, 2013 1 comment

In watching the reporting on the government shutdown, I could not help but be reminded of a comment made by a friend that the ancient Greeks did not regard democracy as a viable form of government. The reason for this view was that the Greeks believed that democracies were inherently corrupt because members of the public would gain access to the public purse by bribing politicians, in one way or another, for subsidies that would line the pockets of the public. The Democrats, and many Republicans, regard all of government spending to be untouchable. In my opinion, many of the spending programs of the government are vote-buying schemes and these are excellent examples of the corruption described by the ancient Greeks. Consider just a few of these spending programs that politicians defend. Read more…

Interest Rates and the Government Deficit

News reports on the federal government‘s deficit have informed the public that the deficit has declined (go to the Treasury’s Financial Management Service for the actual numbers). There are two issues that the public should bear in mind when thinking about these press reports.

One is that a major fundamental driver of the deficit is the demographic change in the country, specifically the aging  and retirement of the baby boomers. That process continues and so the deficit will continue to grow as more of the boomers retire. The deficit’s decline is only temporary and due to the tax increases imposed by Obamacare among other reasons.

Second, it has also been reported that U.S. interest rates have increased although they are still below historic levels. Short-term interest rates, meaning the interest rates on borrowing by the government over short time periods such as six months, tend to have lower interest rates than borrowing done over longer time periods. So when the government borrows short term, it makes lower interest payments to bond holders and thus reduces the deficit from what it would otherwise be if borrowing were done longer term. However, the risk to the government is that if interest rates go up, then when the short-term bonds mature and must be paid off, the government will need to issue new short-term bonds paying the new higher interest rates so the government’s deficit will rise. If the government borrowed longer term, it would not need to issue new bonds at the higher rates and so the deficit would not increase, at least for a time, until the long-term bonds mature and must be paid off. So this scenario tells us that the decline in the deficit is temporary and will be reversed when the government borrows again.

The message to the public is clear; the deficit is still going to grow. The federal government’s fiscal crisis is still with us, no matter the temporary decline that has occurred.

The February 2013 Deficit

March 26, 2013 Leave a comment

The deficit for the federal government in the month of February is now available – $203.5 Billion, the fourth largest monthly deficit since October 1980 (go here to check out the numbers). Combined with the small surplus in January 2013, this puts the federal government on track to run a $1.2 Trillion deficit for the entire year. It is amazing that in the face of these numbers, Senate Democrats voted out a budget which advocates a deficit increase (note that they always overestimate the additional tax revenues that come from increases in tax rates). Looks like we are on track for a debt crisis – more on that in a future post.

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