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.

[This is the fourth part of a series (1, 2, 3) on sovereign deficits and debt.  The series was started in response to Ed Dolan’s original post detailing agreements and possible disagreements with the MMT approach.]

To recap very quickly, we agreed that sovereign government cannot become “insolvent” and forced to involuntarily default on commitments in its own currency. We moved on to “math sustainability” and agreed that so long as the interest rate paid on sovereign debt is below the GDP growth rate, then government does not necessarily face explosive growth of deficits and debts. And we agreed that the overnight interest rate is a policy variable, so that the central bank could keep it below the growth rate if desired. And we agreed that Treasury could use a “debt management” strategy to ensure that its average rate paid would be “low”—near to the Fed’s target rate, and if the Fed was pursuing a low rate strategy then on likely growth rates usually used in these types of models then the Treasury’s rate paid could be kept below the growth rate.

(Of course in recession the growth rate can go below zero but the interest rate would remain at zero or above; however this argument about sustainability is about the long term, not about cyclical problems.)

Now that always leads to the question: but if the Fed did pursue such a low interest rate policy, we’d get inflation that would force the Fed to raise its target rate above the growth rate to fight the inflation. Here was my one sentence response from last week:

“Here’s the preview: if deficits increase inflation rates, then “g” (GDP growth rate) rises so that even if the Fed raises “r”, we can keep g>r.”

Ed Dolan responded in the comments section this way:

“I think the part that will be more interesting to me is coming in Part 4. It will need to explain two things:
1. Even if it is possible always to keep g>r (both nominal) as inflation accelerates, would we really want to do so? Is there always some steady rate of inflation that guarantees g>r, or does it take continuously accelerating inflation? Are there any conditions under which accelerating inflation itself can undermine real output growth?
2. Suppose inflation is initially triggered not by monetary policy, but by an exogenous shock to real output (say, a natural or man-made catastrophe), or by attempts by the government to increase spending even after the economy has reached full employment (as in the “mission to Pluto” example of your MMT text). How can we be sure that the monetary policy operations needed to hold interest rates at an arbitrarily low nominal level will not induce further inflation?”

So let us begin to answer these questions. Today I’ll tackle question #1, or at least part of that question. continue reading…

Below is the video from the latest session of the Modern Money and Public Purpose seminar at Columbia University, featuring Jan Kregel and Forbes‘ John Harvey.  The session touched on the sustainability of fiscal and trade deficits, why economists need to study accounting, the risks of paying down the government debt, the real meaning of “fiscal responsibility,” and the assumptions about the appropriate size of government that are sowing confusion in the budget debate.

So far, a large part of the discussion of whether the Treasury should mint (or convincingly threaten to mint) a trillion-dollar platinum coin in response to the congressional threat to refuse to raise the debt limit (see here for background) hovers around questions of legality or ill-defined “seriousness.”  (On the political front, the administration’s press secretary passed up an opportunity on Wednesday to explicitly rule out the idea.  On the legal front, Matthew Yglesias suggests a theory in which the government is not just permitted but obligated to mint the coin.)

But the platinum coin discussion actually touches on fundamental issues that go beyond legality or political decorum; issues about the understanding (and misunderstanding) of money.  (Recently, both Joe Weisenthal and Paul Krugman moved the conversation in this direction.)

One suspects that some objections to the large-denomination platinum coin on the grounds of “silliness” are motivated by simple incredulity about the nature of money.  Behind a lot of the Dr. Evil-themed snickering there lurks a very common “metallist” conception:  an insistence that money must always be backed by something like gold, or in the case of the trillion-dollar coin, that its value is given by the value of the platinum in the coin; something other than the mere fiat of government.  To those who are moved by the argument that the US government has “run out of money,” the reality of money, as laid bare by the platinum coin discussion, must appear deeply unserious and fantastical (we might as well just grab a bunch of sticks and call those money!).

For many people, these themes take us beyond the realm of reasoned argument and well into what Krugman called “a collision of worldviews.”  Or as Stephanie Kelton put it:  “Money scares the bejesus out of people.”  To Randall Wray, a deeply entrenched misunderstanding of money underlies a host of views about debt and the role of government; successfully confronting this constellation of beliefs and assumptions, he argues, requires an exercise in meme-building.

The platinum coin debate is helping lay bare a set of facts that is proving to be uncomfortable for many observers:  that the debt ceiling, and the rules requiring the US Treasury to issue debt rather than money when it spends more than it raises in revenue, are merely contingent rules, not reflections of the scarcity of some finite commodity.  But moving back to the level of operational end-arounds, we need not fixate on the platinum coin.  As Wray suggests, there is an additional way of getting past debt limit hostage-taking.  continue reading…

Relative to what might have been, one shouldn’t be too depressed about the fiscal cliff deal.  There are no cuts to the country’s most successful anti-poverty program, Social Security, and no rise in the Medicare eligibility age.  Relative to the basic macroeconomic logic of the situation, however, the fiscal cliff deal is a policy mistake.

Contrary to a wildly successful marketing campaign, the fiscal cliff was a crisis of too much austerity.  The deal approved by the House last night either cancels or delays for two months much of the austerity that was planned for 2013, but in the end we are still left with austerity-lite.

If you insist on looking at it from the old “current law” baseline (which is to say, the law as it would have been if we had “gone over” the cliff), this deal expanded the deficit by some $4 trillion.  However, from the perspective of the baseline that matters for economic growth and employment, fiscal policy in 2013 will be more contractionary than it was in 2012.  Some already-existing measures like the expanded unemployment insurance benefits and a number of tax credits benefiting those with low incomes will continue, but there is no new stimulus in this deal; no infrastructure investment; no move to shore up public payrolls.  And relative to 2012, the government will be sucking even more demand out of the economy in 2013.  The most significant item in this respect is that the payroll tax holiday is set to expire, raising the rate on the employee side from 4.2 to 6.2 percent, meaning substantially reduced purchasing power this year for those who earn less than $110,000 (incomes above that level are not subject to the payroll tax).  Given the still-high unemployment rate—and the fact that this budget constraint is purely self-inflicted—this should be considered a big policy failure.

And this is only the beginning.  At some point, issues other than the budget deficit will be permitted to occupy the policy stage—but not just yet.  The across-the-board “sequester” spending cuts have merely been delayed for two months.  Moreover, the debt ceiling standoff has already begun, and in all likelihood it will produce a deal that leads to an even larger dose of austerity (the executive branch is insisting they will not negotiate over raising the debt limit, but congressional Republicans, quite reasonably, are assuming that the administration will blink first).

Paul Krugman points out today that once you take into account the lingering effects of the recession, it may very well be the case that there is no significant near-term budget shortfall at all. Once the economy has recovered, the budget may already be destined to come in at a level that would stabilize public debt as a share of GDP.  The real problem we have in the short-run is that budget deficits are too low—and shrinking—not that they are too high and growing.

The least unpersuasive case for worrying about the federal budget deficit focuses on the long-term increases in Medicare and Medicaid that will result if health care costs follow their projected, steep upward pathway.  If you accept this case (which should not simply be accepted as gospel), then you can stop listening to any purported “grand bargain” plan that does not address this projected rise in health care costs.

Yet, if the news reports have any validity, the “entitlement reform” side of the fiscal cliff negotiations has become focused on a proposal to increase the Medicare eligibility age by two years.  This would deliver roughly $5 billion in savings to federal government in 2014.  You might say that, given the hardship it would cause to so many near-retirees, this seems like an awfully small sum.  But it’s worse than that.  While this policy change might save the government $5 billion, it would increase health care spending system-wide by twice as much.  In other words, the grand deficit bargain is centered on a proposal that makes the problem of rising health care costs worse.

There is a tried-and-true method of controlling health care costs—but it requires moving in precisely the opposite direction as this proposal.  Many other countries are facing shifting patterns in government spending due to aging populations, but the United States is unique in the developed world in the amount of money it spends, per person, on health care; all in order to obtain slightly inferior health outcomes.  Pick any wealthy country at random, and if the United States were to spend the same amount, per person, as this randomly selected country, the projected long-term US budget shortfall would disappear—completely.  Why?  The answer is that many other countries (with universal coverage) use the bargaining power of a government payer to control the per-unit cost of health care services. Raising the eligibility age for Medicare, making the government insurance pool smaller and sicker, moves us in the opposite direction.

You can either commit yourself to “reducing the size of government,” or you can commit yourself to getting health care costs under control, but you’ll have a hard time doing both.

Stephanie Kelton appeared on NPR’s “On Point” this week with Paul Krugman and Stan Collender to discuss (do I really need to finish this sentence?) the fiscal cliff.

You can listen to or download the podcast here.  (Kelton enters at roughly the 13.20 mark)

Levy Institute Senior Scholar James Galbraith was interviewed for a six-part series on the fiscal cliff by the Real News Network’s Paul Jay.

Video of the first two parts of the interview are below; transcripts can be found here.