The debt debate is relevant now

Take a look at the chart below.  I suspect it might generate a couple reactions in many of you.

The first could be, wow those are some ugly colors right there.  Fair point. Green for go and red for stop is pretty cheesy.

The second might be, stop trying to scare the shit out of us: you sound like Larry Kotlikoff or –even worse — Stan Druckenmiller before Trump got elected and it was all ok for some weird reason.

But please bear with me. I am not one of those guys.  In my view, the US has plenty of fiscal capacity, and I was actually down with attempts at fiscal stimulus when the US economy was in liquidity trap, and stimulus would not all predictably be just offset by the Fed.

Screen Shot 2017-05-30 at 10.13.39 AMThe point of the chart is only to say that the question of fiscal capacity is relevant now, particularly with the US Congress debating whether to implement fiscal “stimulus” — to Fed rate hikes 😉 — which may or may not be be offset by cuts to entitlement programs.  We could easily imagine a combination of policy changes that would push the federal debt/GDP ratio to a record high within a decade. Is that ok? Opinions vary.

Some economists will tell you that this does not matter and that obsessing about the path of the debt/GDP ratio just reflects a misunderstanding of how the payments system works. For example, MMT holds that the US fiscal capacity is not limited by the size of the debt per se, although the deficit may need to be tightened occasionally if aggregate demand growth is running too hot.

An alternative, weaker-form, argument to which I subscribe is that the US has plenty of spare fiscal capacity. Any mistakes made today are not likely to cause immediate trouble, but would be unhelpful from a longer-term perspective.

Moreover, we ought not rely on the bond market “vigilantes” to warn us if we are acting improperly.  Among other considerations, the bond market might easily price the (contractionary) effects of eventually dealing with the deficit through orthodox means. The bond market vigilante story is not only stupid and demonstrably wrong, but it is also an affinity fraud.  “Clients” like to hear how heroic and important to society they are.

MMT seems right, then, that the bond market will not freak out soon, at least not over the debt.  It is just that the reasons for this — and the implication – are different from what MMT would describe.

We can reserve that important debate for another time. The purpose of this brief post is just to point out that this debate is currently relevant. It is not some abstract academic thing that looms 20 years out.

One caveat here is that my take on the importance of this issue is not falsifiable, which I readily concede is a big weakness.  If I am right about this, and if we get the ill-timed fiscal stimulus — to Fed rate hikes 😉 — anyway, it is easily conceivable that the bond market stays serene, with yields backing up only by enough to stabilize the macro backdrop in the short to medium term. That result would be consistent with both MMT and my take.

I am not sure what to do about that. In real time, which is what matters for policy implementation, this stuff is just not falsifiable, at least if my view of the world is right. [1] But I will have some speculations and argument about this later.

[1] If the fiscal alarmists were right, then the rising debt would trigger an immediate crisis in the bond market, followed presumably the need for a correction, which would be painful. But, fwiw, I share with MMT enthusiasts the view that those guys are nuts and/or totally full of shit about what they even believe. They have gone utterly silent since the election, predictably.


Screen Shot 2017-05-30 at 9.17.20 AM

Here is a picture of CBO’s long-term baseline, out to 2040. I did not want to go out all the way to 2040 in my simulations because I did not want to appear alarmist. We all agree that such runaway debt is unlikely to happen, which is actually the serious point I want to make.  If the debt cannot run away, then we need to consider now what that means for  policy and not just pretend that the “payments system” will make it all ok.

But this chart gives you a sense of the longer-term history. And unsurprisingly, the CBO forecast numbers look like my second highest simulation.  No additional fiscal ease; passive widening of the deficit in response to “demographics” and real rates back to the economy’s growth rate.

One final point, yes, there is great uncertainty around these numbers.  But if the base case is both fair and troubling, then I am not sure that symmetrical uncertainty around that would be a feature.


The prevalence of “and” in this note is less than 2%. Drop the mic.