Question About Debts, Spending, Revenue, and Deficits

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?

11 comments… add one

  • daleb

    “The Congress authorizes levels of spending and taxation. The Treasury”

    Huh?

  • Left over from a discarded draft. Thanks.

  • Random Blowhard

    Right now that’s around 10% of GDP. Can we do that indefinitely?

    NO, we are spending 40% MORE than we earn and are printing money out of thin air in order to fund it. Look at Zimbabwe for where that path leads to.

    When will the bottom fall out? When the US dollar is no longer the worlds reserve currency. When WILL this happen? Sometime in the later stages of Obama’s second term.

    The United States of Argentina 2001, that is the change we are all getting…

  • 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?

    I take it here you are asking is there a point where deficits get so large that they lead not only to a fiscal crisis but possibly a currency crisis? To that, I’d say, it depends. The research on currency crises look at deficits incurred to bailout failing banking systems[1]. Marini and Piersanti [2] generalize this a bit and argue that if fiscal deficits become large enough then they can trigger a currency crisis as well. Of course their research is for emerging markets and may not apply to a country like the U.S. Still with a large enough deficit it there could be a problem, even for a country like the U.S.

    An optimum?

    An optimum deficit? If there is one, it is likely not a constant, but instead fluctuates as various aspects of the economy changes. In other words, it is much like the tax rate that maximizes revenues based on the Laffer curve, it exists but finding it is damn near impossible.

    What is it?

    See the above.

    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.?

    Well, if the Fed is creating money to buy the bonds, then that might make the issue worse in that it is expanding the money supply which is what people are worried about when it comes to this issue. It could be seen as a way to monetize the debt.

    Right now that’s around 10% of GDP. Can we do that indefinitely?

    If productivity improvements are at a rate of 10% sure. If not, then you will likely have a problem at some point.

    [1]Craig Burnside, Martin Eichenbaum, Sergio Rebelo, “Prospective Deficits and the Asian Currency Crisis”, NBER Working Paper No. 6758 Issued in October 1998
    [2] Giancarlo Marini, Giovanni Piersanti “Fiscal Deficits and Currency Crises”, working paper.

  • If productivity improvements are at a rate of 10% sure. If not, then you will likely have a problem at some point.

    We haven’t had productivity increase at that rate in decades, see here, so I’ll take that as a “no”.

  • We haven’t had productivity increase at that rate in decades, see here, so I’ll take that as a “no”.

    Well, even at 5% you’d still have a problem, you’d just take longer to get there.

    Think of it this way, if your income is growing at x% and your debt is growing at x% then you can likely maintain that indefinitely. Of course, if at some point the interest rates go up, that debt accumulation could go to (x+a)% which would eventually lead to a problem.

    So idea that we could run perpetual deficits is, to some extent true so long as we don’t accumulate the debt too fast. Right now we are well on the too fast track, and it is likely to speed up before it slows down.

  • Andy

    A lot probably depends on debt servicing. It seems to be human nature for people to assume all is well until it becomes difficult to pay the bills.

  • Zachriel

    Deficits should be equal to or less than the economic growth rate (averaged over the business cycle). That’s typically about 2-3% of GDP for developed economies.

  • That’s typically about 2-3% of GDP for developed economies.

    Or, said another way, if the president got everything he’s asked or the Republicans got everything they’ve asked for or the president got his tax increase on the wealthiest and the cuts he’s outlined and the Republicans got the cuts they’ve outlined, it still would be a drop in the bucket compared to what is actually needed.

    I think it also implies that, if you plan on doing counter-cyclical Keynesian pump-priming, you should be running pro-cyclical surpluses, which if I remember what Lord Keynes actually wrote correctly is closer to his prescription that what’s being done in his name these days.

  • PD Shaw

    The UK seeks to keep its national debt under 40% of GDP. Its been as high as 180% following WWII.

  • I think it also implies that, if you plan on doing counter-cyclical Keynesian pump-priming, you should be running pro-cyclical surpluses, which if I remember what Lord Keynes actually wrote correctly is closer to his prescription that what’s being done in his name these days.

    And has pretty much never been done, at least in manner that was planned ahead of time. That is, the Clinton surpluses were more of a lucky event than something that was pre-planned.

Leave a Comment