I have a question that I’ve been stewing over in considering the hassling over the “fiscal cliff” or, rather, a series of interrelated questions. Let me just blurt them out and then try to explain what I’m talking about a bit:
- Is there a maximum percentage of federal spending to revenues, presumably as a percentage of GDP, which if exceeded produces a loss of confidence in the dollar?
- An optimum?
- What is it?
- Does it matter whether the difference is resolved by selling bonds to the Federal Reserve or to others, e.g. private individuals, foreign banks, etc.?
I’ll answer the last question first. I don’t see any reason there should be other than that it should other than that the latter would be most costly.
As to the rest I think there’s some level at which the shortfall in revenue relative to spending, whether resolved as debt or simply by issuing credit, shakes public faith in the currency and produces hyperinflation. I have no idea what level that might be. I think there’s at least some reason to believe that spending could exceed revenue by 5% of GDP indefinitely. That’s how I read the historical record. During much of the postwar period we’ve run a deficit of between 2% and 5% of GDP.
Right now that’s around 10% of GDP. Can we do that indefinitely?