Mind the fiscal gap?

By Robert H.

Is fiscal gap accounting something I shouldn't think is stupid?

Basically the idea behind fiscal gap accounting is that you get the best estimate of our fiscal situation not by looking at US debt held by the public and maybe projecting it out over x years, but rather by adding up all our future obligations and subtracting all our future income, holding policy constant.

I've always thought it's dumb for three reasons:

1. It operates on an infinite timeline.  Assuming we are going to, to pick random examples, keep paying out SSI obligations and keep taking in gas taxes at current rates forever strikes me as an ahistorical and useless way of thinking.

That said, this may be stupid on my part.  The social discount rate means that a dollar spent on SSI 700 years from now doesn't count very much in assessing the current fiscal gap.  But that means fiscal gapers have to estimate the social discount rate for America over a decades long timeframe, and that also strikes me as crazy and impossible.

2. Related to 1, the fiscal gap gyrates from year to year in ways that don't seem helpful for policy makers.  I can't find a chart of the fiscal gap that goes back to the war (a bad sign in and of itself), but here's a chart showing the projected fiscal gap rise by 300 percent over the last ten years.  Should I be 4 times more concerned about the deficit than in 2003?  Really?  How many fiscal gapers were only 25 percent as concerned about the deficit ten years ago?

3. The market for US debt appears to be totally unrelated to the fiscal gap.  Again, the fiscal gap says our fiscal situation is four times worse off than 2003, but treasuries have significantly lower yields than ten years ago.  Fiscal gapers  seem to fail the market test.

I could use more info, though.  Has anyone correlated fiscal gaps and debt yields over time across countries?

***

So all that said, accounting is related to math and I am about as numerate as a puffin.  Is the fiscal gap more useful than I give it credit for?

To be clear, my current strategy is to figure that the markets especially and democracy less so are better than me at figuring out how worried to be about the debt, and using them to guide my thinking.  People who buy treasuries and elected politicians don't seem very worried.  As a check, I note that fiscal crises have been extremely rare over a century plus of modern welfare states.  So I'm pretty confident we will eventually get around to dealing with the deficit before it is a big deal.

Then the fiscal gapers start screaming no, every second of delay costs us 400 billion dollars, or whatever, and my equanimity gets perturbed.  Should I listen to them?

The Lion Kings

By Robert H.

Matt Yglesias has really pioneered doing cutting edge policy analysis on Westeros, but I think his latest posts have been way too skeptical about house Lannister's power base.  The argument, in short, is that the main Lannister assets are gold and people owing them money.  House Tyrell, on the other hand, is rich in fertile land.  Fertile land feeds people and armies; unleashing stores of gold just inflates the money supply, so House Tyrell for the win.

It's an interesting argument, but far too modern.  He even uses an early modern example -- The Hapsburgs -- when he should be thinking along medieval or classical lines.  In the world before 1453, the race was not always to the swift, nor political power to the highest NGDP.  Some reasons House Lannister has real power and a real chance to win the throne:

Meow!

1. Medieval and Classical armies foraged.  Caesar, a logistical genius, sent his legates *ahead* of the army to negotiate grain supplies, he didn't amass grain *behind* the army and ship it to the front (with rare exceptions).  Shipping food to armies is just too hard with medieval or classical technology (especially organisational technology).  So in that context being relatively rich in fertile land is sort of bad -- it makes it easier to fight on your land, where the foraging is good, and harder to fight on the other guy's land, where the foraging is bad.

2.  It is easier to defend gold than grain.  Build a big castle on a big rock, station a big army there, and put the gold under it.  Defended!  Grain wealth, on the other hand, is tied up in diffuse, hard to defend fields. You can store some of it but

3. Medieval crop yields were not the best.  Much of your grain has to be reinvested in planting the next year's harvest or in feeding the peasants.  Which makes being a super populous region a mixed blessing: more people to enlist, but also more people to feed.

4. And can you enlist them?  For one thing, if you march your people away to fight they can't plant or harvest the next crop and you starve.  This is one of the reasons nomadic societies (or people who can afford to pay nomadic societies) were often so much better at conquering.  For another, Westeros seems to have a pretty primitive sort of feudalism in which lords call on vassals to produce troops in times of war.  The actual power of House Tyrell to mobilize its people hinges on convincing dozens of minor lords to honor feudal obligations to the house.  But the Lannisters can make competing offers to get them to change sides -- possibly even with some moral force behind them, if the Lannisters occupy the iron throne.  So who do people choose?  This gets us to point five:

5. Medieval and classical societies often didn't have super-strong institutions, meaning that PEOPLE mattered a lot more.  Like, individual dudes.  King Richard is king and everything in England is relatively fine.  Then John is king and French armies are marching all over English soil and barons are revolting and magna carta and the Pope now owns England and it is a mess.  Then Henry III is king and everything goes back to being fine again (for a bit).  The lannisters being rich helps them in the person power dimension along several fronts:

A. "A lannister always pays his debts."  Their gold has let them make and keep an enormous number of contracts, building a universal reputation for keeping their end of bargains.  In contrast, their money lending and easy attitude towards debtors has ensured that countless houses have publicly made and *failed* to keep contracts them.  In other words, the Lannisters have the most important thing you can have in an anarchic environment where you can't count on good institutions to make people abide by a contract: you can trust them to keep a deal.  Even better, they've worked hard to make sure you can't trust anyone else.

B. Their wealth is liquid.  In an anarchic free-for-all war, the guy who can pay you gold *now* is a lot nicer to work with than the guy who can promise to pay you grain *later*, when it gets here/is grown.  Later the promissor may be dead or change his mind.   And while, sure, paying everyone in gold can lead to inflation, that will take a bit of time to become apparent.  In the meantime, you are negotiating with medieval sell-swords and minor lords firmly enchanted by that most powerful of spells, the money illusion.

C. Gold is much more practical for making ransom payments.  Combat in Westeros often involves poorer houses taking richer lords hostage.  The minor lord then has a choice -- will they execute the prisoner, ransom him back to his house, hand him over to their liege  what?  Ransoming a Lannister is easy and attractive: you hand him over, you get gold gold.  Not so much with ransoming a Tyrell: moving vast sums of wheat in exchange for a body would be a much more complicated transaction (and harder to hide from your lord).  Indeed, Lannisters throughout the books are often eager to get captured and confident of the likely outcome (though equally often they are disappointed by their hosts lack of greed.   This is less for socioeconomic reasons and more for "having what the character expects to happen happen is boring" reasons).  People matter, keeping your best people alive and active matters, and having the gold to pay any ransom makes that happen.  Have I mentioned Richard I and John yet?

6. Think of all this in terms of Yglesias's own model for politics in the seven kingdoms: A. most of the time things are stable and everyone agrees on a king.  B. Occasionally the king loses legitimacy or there is a succession dispute and everything goes haywire.

Being able to store your wealth through the good times and quickly mobilize it in the bad times is key.  Being able to build a reputation that will make people trust you when society is falling apart is key.  Worrying about the long term inflation rate is not key.  It took the Hapsburgs decades to seriously disrupt Europe's prices, it only takes a few years to win the iron throne.  Especially when

7. In an anarchic war type environment, the demand for gold will skyrocket -- food is maybe more valuable, but durable and easy to hide wealth in the form of gold is more valuable than your home, your fields, your clothes, and all your other stuff with a "loot me" sign on it.  You'd gladly trade that loot-able wealth for hide-able gold.  Sure, if your city is actually being besieged food prices will skyrocket.  But everywhere, prices for things that aren't food will plummet as the market is flooded with sellers (people who looted wealth and people looking to sell wealth before it is looted).    The lannisters unleashing a river of gold in that environment might just counteract deflationary pressure and not be inflationary at all. 

Hear me roar!

8.  The Lannisters can sell the chance to slap Joffery.  That is more valuable than food, even to a starving man.

Warning: I am only about half way through the third book.  Some of this may be silly and wrong if I am missing key facts.

What Magic Tricks do People Actually Use Smoke and Mirrors For?

by Robert H.

The Washington Post declares that much of 2011's austerity was "not real," simple budgeting tricks, mostly consisting of programs that were already scheduled to be cancelled anyway.  Tyler Cowen, who is fond of being pessimistic when it comes to balancing budgets, exults.

Sorry, deficit scolds, but you don't get to have it both ways on this.  If a department is only helping balance the budget on paper, not making "real" cuts, I can think of two ways to think about it:

1. It is real deficit reduction.  Spending less money is spending less money, it doesn't "not count" because the decision to do so was already in the pipeline.  Just so, congress letting programs die and not routing their funds to new programs is a significant political victory, and a blow to people who claim that bureaucracies never shrink and congress is never responsible for public choice reasons.
2. It is gimmicks, but that's good.  Much of the deficit was caused by smoke and mirrors and/or bad accounting, so we can get rid of it with smoke and mirrors and/or good accounting.   Turns out the deficit wasn't as bad as we thought, we just needed some better accounting practices.

Deficit scolds seem to want to reject one but not fully think through two.  If I can reduce our deficit with an accounting trick, it means that part of the deficit was the result of dumb accounting.  Whoever drew up the baseline didn't realize that that program was slated to be cancelled anyway, so I get to make a reduction vs the baseline just by letting a program that was going to die die.  And that is just as good of news as actually enacting austerity, because it has the same basic result: we are closer to balancing the budget.   Basically the lesson here is either "the deficit wasn't as bad as we thought, some of it was mostly the result of poor accounting and we've cleaned that up" or "hooray, congress was able to exercise real restraint and reduce the deficit!"  Neither result is "fake," it's either a political victory or accounting innovations getting us meaningfully closer to a balanced budget than we thought we were.

Now a deficit scold can respond with, "Maybe, but this is still low hanging fruit.  There won't be many more accounting innovations that will reveal the budget situation to be better than we thought, and/or there won't be many more ways congress can save money just by letting programs die."  And I agree!  But did anyone on earth think the first round of deficit reduction wouldn't go after low hanging fruit?

Climate Change vs. Fiscal Crisis

There has been a spirited debate about whether people should compare the long-term debt to climate change.  Here's  former Treasury official Steve Rattner, quoted by Joe Scarborough:

"We are putting millions of tons of carbon in the air every day; we are also adding billions of dollars to our future entitlement obligations every day. We are borrowing (stealing?) from our children to pay far more in benefits to seniors than we are paying into the system.We have something like $60 trillion in unfunded liabilities to Medicare and Social Security. Paul Krugman would like us to just wait until those programs run out of money, at which point those unfunded liabilities would be just that much larger."

In other words, just like Krugman doesn't want us to wait when it comes to addressing climate change, he shouldn't want us to wait when it comes to addressing the deficit.

Krugman has responded to these types of arguments, and you can read that, but I think he's a little too clever and subtle to thoroughly convince the economically ignorant (aka, me) .  So I propose a simpler distinction that can illuminate the difference between climate change and the deficit: you can put off a future problem until it is a present problem, but once a problem shows up and bad things start happening, it is impossible to ignore the problem.  It will affect you.

And that's climate change.  Climate change is here.  Global temperatures are up.  Extreme weather events are up.  Climate change is doing bad things, to us, right now (key words in that article, "which has already begun to cause trouble").  You simply can't argue that climate change won't have bad consequences, it is having them.

That's not true with the deficit.  Fiscal crisis is not here (in America).  Inflation is not up.  Interest rates are not up.  Yields on treasuries are not up.  Etc.  For the time being, the deficit isn't doing anything bad.  If you are worried about America having a fiscal crisis because of its deficit, you are worried about the future.  We don't have that problem yet.  And even if you disagree with that, you have to acknowledge that Krugman thinks the deficit isn't doing anything bad right now, just like he thinks climate change is.

So yeah, that's the distinction.  When a bully is threatening you from across the playground, you can ignore him.  When he's punching you in the face, you've got to deal with it (or at least, have a really good reason why you should still ignore himt).  That's not proof that Krugman is right -- sometimes you shouldn't ignore the bully across the playground -- it's just proof that the comparison is dumb.

You Can't Spell "Balanced Budget Amendment" without "A Damnable, Dumb, Decent Gent"

I agree with Arnold Kling that the Keynsian reasons for government running a deficit (IE, to stimulate the economy in a downturn) aren't very convincing.  But I strongly disagree with his conclusion that we should, therefor, adopt a balanced budget amendment.  I have five reasons for opposing a balanced budget amendment, in order from what I think is the worst to the best reason:

1.  Even if balanced budget amendment is a great idea in theory, I have some practical problems with it..  For one, the Republican party keeps wanting the balance budget amendment to cap the size of government and impose a super-majority requirement on tax increases.  I have opinions about how big government should be and about whether we should raise taxes, but I think future generations should get to make those decisions for themselves without the constitution tipping the scales.  I don't expect democrats, if they ever get around to wanting a balanced budget amendment, will be any better at keeping their other partisan goals out of it.

Secondly, I think the balanced budget requirement should be phased in.   I don't really want to see what happens if we force congress to cut a lot of spending or raise a lot of taxes over night; it's a body that works better over time.

2. I thinks sovereign debt promotes international peace.  If people invest in each others' governments, there is suddenly an international constituency for promoting stability in other countries, not going to war with them, and for promoting sounder budgetary and economic practices in your debtor nations.  If I loan a lot of money to Iran, I suddenly have strong feelings about war with Iran.  This doesn't always work to preserve peace and insure good policies, obviously, but I've got to think it has some sort of effect, and on balance I think the effect is positive (especially as the world gets more democratic, since a main negative effect is creditors propping up debtor dictatorships).  Balanced budgets means no government debt means (at the margin) more war.

3. I like the idea of a government not having to radically reform itself every time there is a downturn. Imagine we are in the great moderation and have a mild one year downturn, hurting tax revenue and increasing welfare expenditures   Is it really good to make the government  raise taxes and/or slash spending in order to keep the budget balanced?  Then come back a year later and undo their work?  That seems, to me, like 1. It would increase uncertainty a good deal, and 2. It would create a bonanza of lobbying.

Borrowing through recessions lets us keep the laws constant regardless of the business cycle.  That is probably a good thing.

4. I just don't see the harm.  The welfare state is well over a century old, but fiscal crises and default, especially in large, developed nations, are really rare.  I think Kling's article is especially telling here: his big example of why balanced budget amendments are good and not having them is bad is showing how much more indebted Canadian provinces (who can borrow) are to US states (who often can't).  This, according to Kling, makes them more likely to default.  But Canada is 146 years old.  When, exactly, are these provinces going to get around to defaulting?  When is the debt going to make something bad happen?

Don't get me wrong, countries can mismanage their debt, and healthcare costs/demographics are putting big pressures on debt to GDP ratios.  But "pressure" doesn't mean inevitable default.  Historically, countries have done a decent job of reforming and rolling back the welfare state when it starts causing major problems (See Thatcherism.  Over 25 years British government spending as a percent of GDP fell by over 15 percentage points), and there is every chance countries will rise to this challenge (see the trillions of dollars in deficit reduction over the next ten years we've already enacted, and the fact that both parties want to enact more).  

The story I think Kling wants to tell is, "for political economy reasons, welfare states that can borrow will get more and more indebted until there is a fiscal crisis.  So we can't let welfare states borrow."  To me, reality looks more like, "For over a century now, the the vast bulk of welfare states have done an effective job of managing their debt to gdp ratio and avoiding fiscal crises.  They might screw up their power to borrow, but they might screw up any power we give them."  

5. Keynesians could be right!  It's a big step to go from thinking people are wrong to making their policy recommendations unconstitutional.

As a final matter, it makes intuitive sense to me that borrowing let's governments shift costs into the future, when the public will be richer and able to bear costs with less loss of utility.  Even though future people are paying more (thanks to interest), they might suffer less (because they are richer).  I worry that this is one of those things in economics that seems intuitively right but is in fact wrong, though, so I don't list it as a reason.  

The Fish Call Cliff

Rule of thumb: anyone trying to simultaneously make you scared of both

 1. the fiscal cliff and 2.  not getting the deficit fixed in the next few years

has a bad underlying model of how the economy works.  The "fiscal cliff" is a bunch of tax hikes and spending cuts that get rid of the deficit real fast.  Since the "fiscal cliff" is just sharp deficit reduction, if going off the fiscal cliff is a bad idea right now, by definition sharp deficit reduction is a bad idea right now.

You should also be wary of people who oppose stimulus but support the fiscal cliff. If cutting a lot of government spending and raising taxes is a bad idea right now because it will hurt the economy, maybe lowing taxes and raising spending is a good idea because it will stimulate the economy?  As near as I can tell, if the fiscal cliff is a bad idea it's a bad idea for pretty Keynesian reasons.

That said, it is possible to be worried about both the deficit and the fiscal cliff, but you should expect those people to talk about the deficit as a long term problem we have some time to fix.  If we have to fix it now now now, then the fiscal cliff does that.  If we have some time and if we want to keep spending up and taxes low now to stimulate the economy, then the fiscal cliff is too abrupt and should be avoided.