Archive for the ‘Sovereign Debt Crisis’ Category

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…



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.

Some Modest Good News About the Government’s Deficit

January 14, 2013 Leave a comment

The data is now available measuring the federal government’s deficit for the last calendar year. Here are the numbers for the last two years.

Calendar Year 2011: $1.25 Trillion

Calendar Year 2012: $1.06 Trillion

Source: Financial Management Service (

The data actually reveals an approximate 15 percent reduction in the deficit for 2012. Are we now going to hear politicians tell us that the deficit is no longer a problem?

Social Security and the Federal Government Deficit

December 20, 2012 2 comments

Richard Durbin is a senator from Illinois who recently commented on the connection between Social Security and the federal government‘s deficit. Here is a news quote that is easily found: “Social Security does not add one penny to our debt — not a penny.” To say that this is a distortion of the truth is an understatement. For a correct statement about Social Security and the deficit, read this article. The situation can be described as follows.

When the Social Security system was receiving more money than was paid out to Social Security recipients, the excess funds were to be invested into a trust fund consisting of marketable securities. Then, if a time arose where payments to recipients of Social Security exceeded funds received from Social Security taxes, the securities in the trust fund could be sold to generate the payments to Social Security recipients not covered by inflows of tax revenue.

But the government long ago spent the assets in the trust fund, replacing marketable securities in the trust fund with nonmarketable securities. These new securities are really just placeholders for marketable debt that was sold and these new securities cannot be sold to raise the cash needed to pay recipients of Social Security. In the event that Social Security payments are greater than Social Security receipts, the government must sell marketable debt, raising the cash needed to make payments, replacing the nonmarketable debt with the marketable debt newly issued. So when there is a net outflow of funds from the Social Security system, the government must borrow to make the payments that it is legally required to make.

Senator Durbin is superficially correct – there is no net change in the stock of debt since a newly-issued security replaces a nonmarketable older security, leaving the stock of debt unaffected (and, incidentally, this is why Social Security payments have nothing to do with the debt ceiling). But if the government is unable to borrow, say it finds itself in the same position as Greece, then the government will not be able to make all legally-required Social Security payments, unless it prevails upon the Federal Reserve to effectively buy the bonds needed to make the payments. This amounts to using money to finance the government deficit. If there is a debt crisis, defined to be a situation where the government is unable to borrow, then Social Security recipients would not receive their payments absent any action by the Federal Reserve.

To claim that there is no problem with the Social Security system is absurd. As baby boomers retire in greater numbers, the amount of government borrowing will rise correspondingly. Thus there is the risk that, in the future, lenders will be unwilling to lend the increasingly large amounts needed to cover Social Security payments.

The Looming U.S. Fiscal Crisis

February 3, 2012 Leave a comment

In a previous post (see Deficit Commission Fantasies), I argued that the Deficit Commission was an exercise in fantasy since their goal for reducing the deficit was much too small to eliminate the impending U.S. fiscal crisis.  Here I will provide some analysis designed to illustrate just how large the government deficit may be in the future without substantial policy changes by the government. To do this requires using a document provided by the Congressional Budget Office (CBO) on their web site (

The CBO is an organization created to advise Congress on various policy issues.  Consistent with its mission, CBO issued a document last summer entitled “CBO’s 2011 Long-Term Budget Outlook.” This document provides the CBO’s best estimates of what will happen to the government’s deficit and stock of government debt under two scenarios.

One scenario provides a forecast based upon the continuation of current law. So, for example, it assumes that tax increases imposed by Obamacare will occur and it assumes that increasing numbers of individuals will pay the Alternative Minimum Tax. Therefore tax revenues rise to the historically high level of 23 percent of GDP, well above the long-term average of 18 percent. And it assumes that government spending, aside from mandatory health care spending, interest payments, and Social Security, would decline as a share of GDP to levels not seen since before World War II.

The second scenario provides a forecast under the assumption that certain legislative changes will occur, changes which are widely expected to occur. These would include, for example, changes to the Alternative Minimum Tax to prevent more taxpayers from paying this tax, and it assumes that overall tax payments are about 18 percent of GDP, their historical average.  Further they assume that the the “doctor fix” will be made so that payments to physicians under Medicare will not decline as scheduled under the law. As will be seen, these and other assumed changes in the law generate a very different picture compared to the first scenario regarding debt and deficits.

One final bit of data is required. The CBO report provides forecasts as shares of GDP. To cast these numbers into dollar figures, I need to use a value for GDP for 2021 and 2035. I assume that GDP is twenty percent higher in 2021 than it was in 2011. I also assume a twenty percent increase in GDP between 2021 and 2035.  These twenty percent increases are in the range of GDP growth in recent years. Read more…

PIGS and the Eurobond

November 25, 2011 Leave a comment

The latest idea for dealing with the fiscal problems of the economies known as PIGS (Portugal, Italy, Greece, and Spain) is that bonds, backed by the entire Eurozone, be issued to finance government spending in the economies that are struggling to reduce their government deficits. One would think that the Germans would be opposed to this idea since the issuance of Eurobonds may result in the Germans paying for at least some of the spending by the PIGS.  However there seems to be some weakening in the German position as described in this article.

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A blog by John B. Taylor

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