That’s the implication of a James Pethokoukis post linked to here by Reihan Salam.  Let’s assume for the sake argument that a federal budget surplus does emerge in 2015 (yesterday’s CBO report projected the 2015 deficit would be a mere 2.1% of GDP).  Salam expresses concern that such a scenario would leave Republicans, who have been banging the austerity drum since inauguration day 2009, in a political and policy bind.  It would allow Democrats to declare “mission accomplished,” as Salam puts it, leaving Republicans with no agenda.

One problem with this analysis is that it assumes the voting public would even recognize/concede the existence of a budget surplus.  If you’ve been paying any attention to US public affairs, you’ll have observed that the realm of empirical fact is a fiercely contested battlefield (see warming, global).  And on budget matters, as Dimitri Papadimitriou has pointed out, the battlefield is tilted in one direction:  “The deficit has arguably gained the distinction of being the single most widely misunderstood public policy issue in America. Just 6% (6!) of respondents in a recent poll correctly stated that it had been shrinking, which has in fact been the case for several years, while 10 times more, 62%, wrongly believed that it’s been getting bigger.”

Now, it ought to be mentioned that no one should get any credit for a budget surplus in 2015 (or for a deficit as low as 2.1% of GDP, as the CBO predicts).  Under current economic conditions, this would represent the continuation of an inexcusable fiscal policy error — and the reason it would be an error points to another problem with Salam and Pethokoukis’s political concerns. continue reading…

Here are today’s big pieces of economic policy news:  (1) net job creation in the month of March (+88,000) was too low to keep up with population growth; (2) the president’s budget proposal will reportedly include cuts to Medicare and Social Security (or as the latter will be described in most newspapers, “adjustments to the way inflation is calculated for the purposes of determining Social Security benefits”).

These two items may seem unrelated, but in reality they form the basis of an unhappy remarriage.  continue reading…

An update on some developments on the fiscal-trap front:  After a Levy brief on fiscal traps was issued in November, events continue to bear out the fears expressed therein that budget cuts and tax increases being implemented in Europe and the US would lead to disaster.  For example, recent news coverage of events surrounding the announcement of the UK budget confirm that the trap can hit nations that possess their own currencies, particularly in a region such as Europe where recessionary forces are dominating at the moment. Martin Wolf notes that owing to disappointing growth figures, the UK deficit surprised again on the high side. As the fiscal-trap theory asserts, governments implementing austerity policies have run into unexpectedly low growth in their attempts to reduce government debt.

Meanwhile, despite the warnings of macroeconomists, including those here, the austerity measures that together make up the fiscal cliff in the US were only partly averted.  Among these policy changes are the loss of the 2-percent partial payroll-tax holiday and the sequester cuts to discretionary spending. The latter unfortunately went into effect at the beginning of this month, following a two-month Congressional reprieve. Based on unofficial data from the Bipartisan Policy Council in this New York Times article, which are similar to those in a recent and more detailed CBPP report, the cuts for the remainder of the fiscal year are large as a percentage of planned spending, as seen in Table 1:

Dollar amounts shown in billions.

continue reading…

How much fiscal stimulus would the government need to inject into the economy over the next two years in order to get the unemployment rate into the 5.5–5.9 percent range?  In their newest strategic analysis, Dimitri Papadimitriou, Greg Hannsgen, and Michalis Nikiforos provide us with some harrowing answers.

The authors lay out a scenario (“scenario 3″ in the analysis) featuring some favorable macroeconomic tailwinds in the form of higher private sector borrowing and increased exports.  As they explain, such developments are not entirely unlikely (and policy changes could help contribute to such an export boost).  Nevertheless, even in these relatively rosy circumstances the government would need to pitch in a spending increase of 6.8 percent* (after inflation) in each of 2013 and 2014 to bring the unemployment rate below 6 percent by the end of 2014.  That would amount to a stimulus program worth around $600 billion over the next two years.  Without these tailwinds from private sector borrowing and exports (“scenario 2″), spending would need to increase by 11 percent per year — or roughly over a trillion dollars of stimulus over two years — in order to bring unemployment down to around 5.5 percent.

As the authors note, Washington is not in the mood for a trillion-plus-dollar stimulus program, or a program half that size.  Congress has consistently rejected a mere $50 billion for infrastructure repair.  If anything, the policy challenge of the moment is to temper the zeal for cutting spending.  Moreover, 5.5 percent unemployment is arguably still shy of what we ought to consider “good enough.” This level is around a full percentage point above where we were before the recession hit in 2007.  In other words, even if this Congress were to approve a stimulus package larger than the 2009 Recovery Act (ARRA) — which is unimaginable at this point — we would still not be back to pre-recession unemployment levels after two years (or even four years, as the strategic analysis demonstrates).

While we’ve been focused on phantom budget menaces derived from assumptions about the state of medical technology in 2080, the jobs crisis has continued to ruin real lives.  Without a dramatic turnaround in our fiscal priorities, it will continue to do so for years to come.  It’s become pretty clear that the actual needs of this economy far outstrip what the political system is willing to deliver.  (The authors actually favor direct job creation, in the form of an employer-of-last-resort policy, but they suggest that this is currently even further outside the realm of the politically possible as compared to traditional fiscal stimulus.)

Assuming no further stimulus is possible, the “best case” scenario over the next four years might be to merely hold off any new attempts at grand bargains or further budget cuts; to maintain the miserable status quo on the budget.  In that case, as the figure below illustrates (the authors’ “Baseline” forecast represented by the black line), unemployment would still be above 7 percent in two years, and above 6.5 percent by the end of President Obama’s term in office (which, as the authors point out, is still in excess of the threshold at which the Fed would consider tightening monetary policy).

The full analysis can be downloaded here.

* Specifically, the increase applies to “real government purchases of final goods and government transfers to the private sector.”

The Congressional Budget Office’s latest report on the budget outlook revealed (perhaps unintentionally) that fixating on Congress and the President as the central players in the federal deficit drama is a mistake.  According to the CBO, the path the federal budget deficit will follow over the next 10 years is just as much (if not more so) a question of Federal Reserve policy.

Here’s CBO’s latest 10-year outlook for the federal budget:

As you can see, the fastest rising category of spending is not “Social Security,” or even “major healthcare programs,” but rather “net interest,” which CBO projects will grow from 1.4 percent of GDP to 3.3 percent of GDP by 2023 (“a percentage that has been exceeded only once in the past 50 years,” they note). continue reading…

A couple of links worth sharing on the politics and policy of the budget debate.

First, the Wall Street Journal reports that Alan Simpson and Erskine Bowles are coming out with a new deficit reduction plan, worth $2.4 trillion.  If it’s anything like the last plan, every lawmaker will claim to love it, journalists will assume its goodness as a fact more established than the shape of the earth, no one will have a clue what’s in it, and it will go nowhere.

The details have not yet been released, but one initial question you might have is this:  where does that $2.4 trillion number come from?  Have they taken their original deficit reduction target from 2010 ($4 trillion) and subtracted the amount of budget savings already achieved ($2.5 trillion)?  Apparently not.  Has the deficit picture worsened since 2010?  Quite the contrary.  If you look at healthcare alone, the government is now set to spend almost $1 trillion less over the next decade than what was expected when Simpson and Bowles were coming up with their plan.  If their new plan takes these recent developments into account, it’s not clear how.  The question remains:  why this number?

We’ll  have to wait to hear what the justification is (if there is any).  Perhaps this is an issue of different budget windows, but it’s also possible we’re looking at another example of the asymmetry between deficit hawks and deficit doves (or owls) when it comes to budget targets.  For the dovish, the budget math is reasonably simple:  the right level for the deficit is whichever one will bring us back to full employment (likely a higher deficit than we have now).  For the hawks, it’s not quite as clear.  Stabilizing the public debt as a percentage of GDP (at 73 percent), the administration’s target, is apparently not sufficient.  If someone is consistently specific about means (in this case, cut spending on programs that benefit the elderly in such a way that benefits are reduced; shrinking healthcare providers’ profit margins doesn’t count) but a little vague about the ends, you should start to consider the possibility that their means really are their ends, and vice versa.

Second, Dan Kervick at New Economic Perspectives argues that the debate over healthcare costs is very poorly framed as an issue of budget deficits: continue reading…

Here’s yet another way of representing the fact that to the extent the United States has a “spending problem,” it is a problem of too little spending.  From a speech by Janet Yellen, Vice Chair of the Federal Reserve:

… discretionary fiscal policy hasn’t been much of a tailwind during this recovery. In the year following the end of the recession, discretionary fiscal policy at the federal, state, and local levels boosted growth at roughly the same pace as in past recoveries, as exhibit 3 [below] indicates. But instead of contributing to growth thereafter, discretionary fiscal policy this time has actually acted to restrain the recovery. State and local governments were cutting spending and, in some cases, raising taxes for much of this period to deal with revenue shortfalls. At the federal level, policymakers have reduced purchases of goods and services, allowed stimulus-related spending to decline, and have put in place further policy actions to reduce deficits.

On this issue, the conventional wisdom is so far from the truth that it’s difficult to figure out how one might begin persuading anyone who isn’t acquainted with the data (lest one appear insane).  It would be one thing if current fiscal policy were merely in line with past expansionary practices in the wake of recessions (even arguing that much will get you some raised eyebrows and uncomfortable coughs).  But the dismal truth is that, after 2009—when discretionary fiscal support was a hair above the postwar average but well below the expansionary stimuli under Ronald Reagan and George W. Bush—the combined federal/state/local government fiscal response broke dramatically with the postwar pattern, in a display of record-breaking stinginess.  To borrow loosely from H. L. Mencken: if you want government to rein in its spending, you’re getting it good and hard.

Is the era of the “grand bargain” over?  That was the implication of a number of news stories that pre-framed last night’s speech.  “When President Obama delivers his State of the Union address Tuesday evening,” wrote the Washington Post‘s Lori Montgomery, “here’s one thing you won’t hear: an ambitious new plan to rein in the national debt. In recent weeks, the White House has pressed the message that, if policymakers can agree on a strategy for replacing across-the-board spending cuts set to hit next month, Obama will pretty much have achieved what he has called ‘our ultimate goal’ of halting the rapid rise in government borrowing.”

There was indeed a small change in emphasis in this year’s SOTU.  The president began by highlighting how much deficit reduction had already been achieved ($2.5 trillion, not including the ACA) and downplayed how much remains to be done to stabilize the debt.  He then spent the bulk of his address on job creation and other national priorities that have been languishing for years, including proposals to raise the minimum wage, invest in infrastructure repairs, create wider access to quality pre-kindergarten, reduce carbon emissions, and so on.  The key line, rhetorically, was this one:  “deficit reduction alone is not an economic plan.”

The deficit-reduction industry isn’t going to close up shop after this speech.  You’ll still get to hear from Alan Simpson and Erskine Bowles about how Washington’s budget cuts have been insufficiently “hard” or “painful.”  Morning cable news hosts, and everyone they know, will still be so convinced that spending is “out of control” that they will find the very idea of checking the data to be laughable.  But ever since the Obama administration announced their “pivot” to deficit reduction in 2010, they have been doing little to dissuade the public from believing that we are on the verge of a government debt crisis that demands our immediate attention, and the SOTU suggests that, going forward, the administration may be providing a little less aid and comfort to the deficit hawks.

Unfortunately, the substance of the president’s speech, the economic policy, was still hemmed in by a prioritization of the federal budget balance.  Obama pledged, for instance, that none of his proposals would add to the deficit (“nothing I’m proposing tonight should increase our deficit by a single dime”).  That’s an unfortunate (and arbitrary) limitation.  For policies such as investment in infrastructure repair that are meant to stimulate the economy and create jobs, deficit neutrality is going to be a significant hindrance.

In the Levy Institute’s last strategic analysis, Dimitri Papadimitriou, Greg Hannsgen, and Gennaro Zezza showed how you can do “deficit neutral” economic stimulus:  this is mainly due to the different “multipliers” associated with various budgetary changes.  However, their simulation of a deficit-neutral stimulus demonstrated that while such policies can boost economic activity (a $150 billion increase in government investment that is “paid for” could reduce the unemployment rate by almost 0.5 percentage points), a deficit-financed stimulus would be more effective.  (Their newest strategic analysis and projections for the US economy will be coming out in late February/early March.)

It remains to be seen how these SOTU proposals get fleshed out, but a true pivot away from prioritizing the deficit would mean, instead of promising not to add a dime to the deficit, pledging not pass a budget that removes even one-tenth of a percentage point from growth until the unemployment rate dips below some target level.

Over the last few years, there have been significant changes to the federal government’s finances—changes that have had barely any perceptible impact on the budget debate.  The federal deficit has been shrinking (from 2009 to 2012) at a faster rate than in any other period since 1937.  Most Americans have never lived through more rapid budget tightening.  A lot of this has to do with the fact that the budget deficit is automatically stabilizing as the economy recovers, just as it automatically grew due to the Great Recession, but it’s not all automatic changes.  You wouldn’t know it from the Sunday news shows, but policy changes over the last two years alone have resulted in roughly $2.4 trillion in scheduled deficit reduction—and that doesn’t even include the budget savings from the Affordable Care Act (“Obamacare”).

These facts have had a difficult time breaking through to the public consciousness.  Last week, the genuinely level-headed Michael Kinsley wrote an article in Bloomberg that proceeded on the basis of the (common) assumption that while we’ve had “plenty of stimulus,” the political system is incapable of delivering significant budget tightening:

We’ve all done a great job of barely cutting spending, barely raising taxes, not reforming entitlements, and all told spending about a trillion dollars a year more than we bring in. Plenty of stimulus… But is there a shred of evidence that the citizenry and our political leaders are ready for Step No. 2? That’s where everyone agrees to enough spending cuts and tax increases to close the budget gap. I’ll believe that when I see it.

Our problem, however, appears to be the opposite of the one Kinsley suggests.  Currently, the political system seems unable to resist shrinking the budget. continue reading…

Since the outbreak of the global financial crisis and recession, we’ve seen some renewed interest (and angst) regarding the role of the central bank and of treasury-central bank cooperation.  (The most recent example comes out of Japan, in which Japanese PM Shinzo Abe has been pushing for the Bank of Japan to accommodate his relatively ambitious fiscal stimulus program.)

In the US context, many of these issues bring us back to the 1951 Treasury-Federal Reserve Accord, establishing the parameters of the Fed’s independence.  In a new working paper and one-pager, Thorvald Grung Moe of Norges Bank (and a research associate at the Levy Institute) offers an alternative reading of the history and significance of the ’51 Accord—and of central bank independence in general—through an analysis of the career and views of Fed Chairman Marriner Eccles, and of his supporting role in the events leading up to the Accord in particular.

Moe stresses that Eccles’ support for the Accord has to be understood in the inflationary context of the time, and that a portrait of Eccles’ views that doesn’t also include his 1930s-era support for deficit financing and accommodative monetary policy is seriously incomplete.  “The history of the Accord,” Moe writes, “should teach central bankers that independence can be crucial for fighting inflation, but also encourage them to be more supportive of government efforts to fight deflation and mass unemployment.”

Moe also highlights Eccles’ positions on the sustainability of public debt, some of which would place him in stark opposition to most deficit hawks today (and some doves, for that matter).  Here is Eccles, speaking in 1934:

“If a man owed himself, he could not be bankrupt, and neither can a nation. We have got all of the wealth and resources we ever had, and we do not have the sense, the financial and political leadership, to know how to use them.”

Read Moe’s one-pager here and his working paper here.