Sunday, September 30, 2018

Fiscal Recklessness, 2018 Edition

I was invited to present a lecture at Middlebury this past week on "Income Tax Policy and Economic Growth." I wanted to present a picture of just how bad the projected federal deficit is for the next decade. The following graph, which shows the last 50 years of data on the unemployment rate and the federal deficit, is what emerged:

Sources: CBO, BLS
The horizontal axis is the unemployment rate, as a percentage of the labor force, and the vertical axis is the federal deficit, as a percentage of GDP. Other things equal, we would expect the line to be downward sloping -- the higher is the unemployment rate, the worse will be the deficit, as both automatic stabilizers and additional stimulus efforts kick in. Each blue dot represents the year indicated over the last 50 years, 1968 - 2018. The best-fit linear relationship indicated by the blue dots is about -1.2: for every additional percentage point of the labor force that is unemployed, the federal deficit widens by about 1.2 percentage points of GDP.

Departures from that general tendency indicate budget policy that was unusually strict (toward the Northeast direction) or unusually loose (toward the Southwest direction). The orange dots are the next 10 years of projections, based on CBO data. Note that there is no recession projected in these data -- the unemployment rate is projected to remain below 5 percent over this decade. Despite this rosy economic projection, the deficit is always about 4 percent of GDP or larger. We will have never had deficits that large as a share of GDP with unemployment that low. Relative to where we were 20 years ago with similar unemployment rates, we are running deficits 5-6 percentage points of GDP larger. That's President Trump's fiscal record.

That is the mess we are in. My main concern is intergenerational equity -- there is no ethical reason to pass along the burden of financing structural deficits to future generations. And then, eventually, there will be further concern if and when the rest of the world decides it is no longer content to allow us to roll over our debt at such favorable interest rates.


Benjamin Cole said...

I think in general I agree with this post.

But the recent experience with quantitative easing does raise questions.

In Japan, of course, the Bank of Japan has purchased 45% of sovereigns outstanding and yet they still do not have inflation to speak of. I hate to say it, but it appears that Japan has monetized its debt without inflationary consequence, in fact perhaps saving the economy from a deflationary recession.

I see no reason to shrink the Fed's balance sheet now, although that seems to be a sacralized goal.

Going forward, can the Fed simply indulge in QE and reduce the national debt to make up for those years that it is too high?

mulp said...

Given government accounting, deficits once meant high investment, with war being an investment, seeking to add capital assets, or protect assets from capture by competitors. Hoover and FDR borrowed to build assets, taking over from States that balanced budgets but borrowed to fund building capital assets, all reached credit limits.

Since 1980, the GOP ran deficits to fund consumption, while cutting taxes AND INVESTMENTS.

Trump promised investments and tax cuts, but without any borrowing to pay for investments, other than more tax cuts to those doing the investment. No one can figure out how to have tax cuts be big enough for corporations paying no taxes to get them to pay for investments, so, the decades of underinvestment continues.

So, what we have is the visible deficit to fund consumption plus the hidden deficit in investment.

Part of the public investment deficit is funded privately by real estate developers, but they pay for it with higher real estate prices and higher rents.

Cutting taxes or not hiking them, e.g. gas tax, is a deficit that causes homelessness, but the lost productivity is not quantified and added to the Federal deficit, for example.

The cost of building housing is unchanged in 70 years. Ignoring the monopoly pricing of accessible by transportation landed, the housing is just as affordable today to build for the working class.

California has lots of land, but you can't get to it. A century ago, big cities built subways and elevateds to enable lots of new single family housing, row houses and detached. But such investments eliminates capital scarcity, causing price cuts, wealth destruction. Imagine Elon boring Hyperloop to vacant land for workers, reducing housing demand, million dollar houses then fall to $500,000. Detroit housing fell quickly because highways provided access to the same size lots with only a few minutes more commute time.