It’s Not About the Deficits

I was going to write something about tonight’s debt-celing deal. “Reduces Domestic Discretionary Spending to the Lowest Level Since Eisenhower,” says the White House in triumphant title case. Yay! No more EPA, no more civil rights enforcement, no more federal spending on housing or child care or clean energy. They didn’t need them in the Eisenhower era, so why should we?

It makes me mad. And it’s not good to write when you’re mad. As the man says,

Hatred, even of baseness,
Distorts the features.
Anger, even against injustice,
Makes the voice grow hoarse.

So instead of this appalling deal, let’s talk about the trajectory of the debt historically. Specifically, this very interesting take from the always-interesting Willem Buiter:

The last time the US sovereign radically lowered the ratio of public debt to GDP was between 1946 (the all-time high for the Federal debt burden at 121.20 percent) and 1974 (its post-World War II low at 31.67 percent). Arithmetically, of the 89.53 percentage points reduction in the Federal debt burden, inflation accounted for 52.63pp and real GDP growth accounted for 55.86 pp. Federal surpluses accounted for minus 20.51pp.

Longer average maturity and occasionally sharp bursts of inflation helped erode the real burden of the Federal debt between 1946 and 1974, but so did financial repression – ceilings on nominal interest rates. … Until the Treasury-Federal Reserve Accord of March 1951, the Federal Reserve System was formally committed to maintaining a low interest rate peg on Treasury bonds – a practice introduced in 1942 when the Fed pegged the interest rate on Treasury bills at 0.375 percent. This practice was continued after the war despite a 14 percent rate of CPI inflation in 1947 and an 8 percent rate in 1948. The rate on 3-month Treasury Bills remained at 0.375 percent until June 1947 and did not reach 1.40 percent until March 1951.

Even after the Treasury-Federal Reserve Accord, there remained financial repression in the form of ceilings on bank lending and borrowing rates like Regulation Q, which prohibited the payment of interest on demand deposits. Without financial repression and with a relatively short average debt maturity, it would take high US rates of (unanticipated) inflation to bring down the burden of the debt appreciably.

This is the key point that comes out of the relationships that govern the evolution of the federal debt: Deficits/surpluses are just one factor, along with growth rates, interest rates, and inflation, that determine the trajectory of the debt. There’s no a priori reason to think that long-term shifts in the debt-GDP ratio are more likely to come about through changes in the government’s fiscal stance rather than one of the other three variables; and there’s historical evidence that in practice growth, inflation and interest rates usually matter more. At some point I’ll do an exercise similar to Buiter’s. But in the meantime, I’m happy to take it from him — the dude is the chief economist at Citibank — that, in the the postwar decades, growth and inflation contributed about equally to the very large reduction in the US debt-GDP ratio, while fiscal discipline contributed less than nothing.

So if you wanted to follow the postwar US in reducing the debt-GDP ratio over a long period — it’s not entirely clear why you would want to do this — you should be thinking about faster growth, higher inflation and policies to hold down interest rates (aka “financial repression”), not higher taxes and lower spending. Anyone who says, “The growth of the debt is unsustainable, therefore we need to move the federal budget toward balance” doesn’t know what they’re talking about.

Or, they’re talking about something else.

You can interpret Obama’s relentless pursuit of defeat in the budget-ceiling fight in psychological terms. But it seems more parsimonious to at least consider that he’s simply an honest servant of the country’s owners, who see the crisis as a once-in-a-lifetime chance to roll back the social wage. Raising the Medicare eligibility age wouldn’t have done anything much to reduce the long-term debt-GDP ratio. But it definitely would reduce the number of people with Medicare.

UPDATE: This post is evidently the kind of thing Matt Yglesias has in mind when he says he’s

frustrated by lefties who seem to see the unprecedented Republican obstruction the President is dealing with as part of an 11-dimensional chess game through which Obama “really” wants his progressive initiatives to be frustrated at every term. 

 But this gets the n-dimensional chess metaphor backward, I think. The whole reason people claim Obama is playing a deeper or more complex game is to argue that even when his actions don’t seem to get him closer to his supposed goals, he really is getting there but by some devious route. But if your theory, as here, is that the actual outcome was the intended outcome, you don’t need to assume any deviousness. If I sacrifice my knight for no apparent gain, then maybe I have some complex plan you don’t see — that’s the extra dimensions. But if I’m playing to lose, no extra dimensions are needed to explain my bad move. Yglesias’s frustration here would apply to lefties who argued that Obama’s big progressive victories were really serving a conservative agenda. And there are certainly people who would argue that — if there were any big progressive victories to argue about.