Ed Dolan's Econ Blog

By One Key Budget Indicator, the Structural Primary Balance, Even Greece Is Doing Better Than the United States. Why That Should Worry Us.

We in the United States know that we have a deficit problem, but when we hear news of the ongoing crisis in Europe, we feel a little better. At least we’re in better shape than Greece, Italy, and the other Eurozone basket cases. Aren’t we?

Think again. By one key measure of fiscal health, the structural primary balance (SPB), we are in worse shape than any EU country. In fact, among the members of the OECD, only Japan is deeper in deficit as the following chart shows.

Not just Greece and Italy, but even the Portugal, Ireland, and Spain, the other derisively styled “PIIGS,” score better better than the United States on this chart. That does not mean that their economies are in better shape overall. They have a lot of problems that we do not, which we will come back to later. What their structural primary balances do show is how far they have come in making the fiscal adjustments needed to make their budgets sustainable in the long run . The United States has barely started those adjustments, and Japan has not even thought about them. Let’s look more closely.

Just what is the structural primary balance?

The budget measure that usually makes the headlines in the United States—a deficit of 8.7 percent of GDP for fiscal 2011—is the federal government’s current balance. That is the difference between the government’s total spending and its total income in a given year, expressed as a percentage of the GDP that the economy actually produced. The structural primary balance differs from the current balance in two main ways.

First, the term “structural” means that it is adjusted to remove the part of the deficit or surplus that is attributable to the state of the business cycle. Right now, partway through an incomplete recovery from a deep recession, the U.S. economy is operating well below its potential level. When output drops below its potential, tax revenues fall, unemployment benefits rise, and certain other automatic stabilizers move the current balance toward deficit even if there are no changes in policy. Similarly, during a boom, when output is above its natural level, automatic stabilizers cause the balance to move toward surplus. The structural balance is the surplus or deficit that would prevail, with given policies, if GDP were right at its potential level. Some economists prefer the term cyclically adjusted budget balance.

Second, the “primary” part refers to the fact that the SPB, on the spending side, considers only program expenditures. Program expenditures include all government purchases of goods and services and all entitlement outlays, but not interest on government debt. The logic is that policies governing program expenditures, along with tax policies, are causes of budget imbalances, whereas interest on the government’s accumulated debt is a result of past policy imbalances.

For completeness, we should add that the OECD methodology on which the chart is based makes two other adjustments to facilitate international comparisons. One is to include all levels of government in order to allow for differences in the centralization of government from country to country. That adjustment is less important for the topic at hand than it might seem. The U.S. federal government accounts for nearly all of the total government deficit, while most states operate under balanced budget rules. Also, the OECD data adjust for the effects of one-off budget operations like tax amnesties or privatization revenues. Those are important for some countries, but much less so for the United States. The OECD uses the term underlying primary balance to refer to its version of the SPB.

Some basic budget arithmetic

To understand why the SPB is a key indicator of long-run fiscal sustainability, we need to review some basic budget arithmetic. In order to be sustainable, the government’s debt must not grow endlessly as a percentage of GDP. If it did, eventually it would get to a point where interest payments alone used up all available tax revenue. Well before that happened, the government would face the stark choice of either defaulting on its debt outright or defaulting indirectly through hyperinflation.

However, as long as the economy is growing, sustainability does not require that the government stop borrowing altogether. It can issue new debt without increasing the debt-to-GDP ratio up to the point where the rate of growth of the debt equals the rate of growth of GDP.

To take the simplest case, consider a government that has debt equal to 100 percent of GDP. If nominal GDP grows at 5 percent, and the government finances a current deficit equal to 5 percent of GDP with new borrowing, the debt-to-GDP ratio will not change. If it has less debt to start with, the maximum borrowing consistent with a constant debt-to-GDP ratio is lower. If we assume an initial debt of 50 percent of GDP and leave the rate of GDP growth at 5 percent, the current deficit must be held to 2.5 percent of GDP to keep the debt-to-GDP ratio from growing. More generally, if the debt-to-GDP ratio is D and the rate of growth of nominal GDP is Q, the maximum permissible deficit is D times Q.

Looking at the primary deficit instead of the entire deficit simplifies the calculation of the maximum borrowing consistent with a constant debt-to-GDP ratio. The reason is that for most countries, the long-run average rate of growth of nominal GDP tends to be about equal to the average nominal rate of interest on government debt. (You can do the calculation in real terms if you prefer, by subtracting the rate of inflation from both the interest rate and GDP growth.) If that is the case, the debt will remain constant as a share of GDP as long as the primary budget is in balance, regardless of the initial level of the debt.

In practice, the average rate of interest is not always exactly equal to the rate of GDP growth, but the difference tends to be small when averaged over a long period. To the extent that the two are different, the interest rate tends to average slightly higher than the rate of growth. When that is the case, the country needs a slight surplus on the primary budget balance to keep the debt-to-GDP ratio constant.

For example, from 1988 to 2007, the relatively stable 20-year period leading up to the recent financial crisis, nominal GDP in the United States grew at an average rate of about 5.6 percent and the average rate of interest on federal debt held by the public was about 6 percent. If those numbers were to prevail in the long run, the structural primary balance would have to be in surplus by 0.4 percent of GDP in order to keep the debt-to-GDP ratio from growing. For some shorter periods, as in 2004 through 2006, the rate of growth has slightly exceeded the rate of interest. When that happens, the debt-to-GDP ratio can be held constant with the primary balance slightly in deficit. These differences of a fraction of one percent one way or another do not significantly undermine the usefulness of the SPB as a measure of fiscal sustainability.

Finally, we need to take into account the possibility that a country may not want just to hold its debt-to-GDP ratio constant over time, but actually to reduce it. In the case of the EU, budget rules require that countries have a debt-to-GDP ratio of 60 percent or less. A dozen countries, including France and Germany, now exceed that limit. To get their debts back down to the 60 percent mark, those countries will have to keep their SPB well in the surplus range. At least one country has already done so. From 1996 to 2011, Sweden reduced its debt-to-GDP ratio from 84 percent to 49 percent by keeping its SPB in surplus by an average of just under 2 percent of GDP.

The United States, of course, is not subject to EU rules, but many economists think it would be desirable to reduce the net federal debt from its current level of nearly 80 percent of GDP. Doing so will take even greater spending cuts or revenue increases than would be needed just to stabilize the ratio.

Looking for patterns in fiscal policy

We have seen, then, that the SPB must be held at or close to long-run balance to make the debt sustainable and in surplus to reduce the debt over time. However, that does not mean that sustainable policy requires the SPB to be unchanged from year to year. There are three patterns for the SPB that are consistent with the long-term goal of holding the debt-to-GDP ratio constant over time or gradually reducing it.

  1. Under a cyclically neutral pattern, the government would hold the SPB constant year after year, regardless of the state of the business cycle. Automatic stabilizers would produce moderate current deficits during recessions offset by current surpluses during expansions. As discussed in  this earlier post, Chile has achieved excellent fiscal health by following the cyclically neutral pattern.
  2. Under a countercyclical policy, the government would undertake discretionary fiscal stimulus in the form of tax cuts or spending increases during recessions, which would move the SPB toward deficit. The stimulus would be offset with discretionary tax increases or expenditure cuts during expansions, leaving the SPB in balance or slightly in surplus on average over the cycle. That is the pattern Sweden has followed to get its debt under control. Such a policy has the potential to improve economic performance by moderating excessive cyclical booms and busts, but it requires a high level of political maturity and budget discipline.
  3. In theory, a country could follow a third pattern under which the current budget would be kept in balance each and every year. Such a policy would require procyclical tax increases or expenditure cuts during recessions, moving the SPB toward surplus and making the downturn more severe. It would then call for tax cuts or expenditure increases during expansions, adding fuel to the upturn. Proposals to amend the Constitution to require an annually balanced budget are a recurrent feature of U.S. political life. However, for reasons explained in this earlier post, mainstream economists tend see such proposals as counterproductive.

How the United States has gotten into its budget mess

The United States has gotten itself into its present budget mess by not following any of the sustainable patterns just outlined. Instead, it has followed an unbalanced discretionary policy that cuts taxes and increases expenditures to stimulate the economy during recessions, and then cuts taxes and increases spending again for short-term political gain during periods of prosperity. That pattern is evident in the following chart.

The chart shows a healthy surplus of the structural primary balance—1.7 percent of GDP, on average–from 1994 to 2001. Over that period, net government debt, by the OECD’s measure, fell from 54.4 percent of GDP to 34.6 percent. Countercyclical considerations could justify the sharp reduction in the surplus during the brief and mild recession of March to November 2001, but after that, things went badly off course.

Instead of moving back into surplus as the economy recovered, the SPB moved strongly into deficit during the cyclical expansion of 2002 to 2007. Two unfunded wars, substantial tax cuts, and new expenditure programs like Medicare Part D moved the SPB into an average deficit of 2.4 percent of GDP in those years, a swing of more than 4 percent of GDP from the surpluses of the 1990s. By 2007, the debt-to-GDP ratio had risen back to 48 percent of GDP.

The increased debt and deficit left the government with reduced room for maneuver when the economy again fell into recession at the end of 2007. Nevertheless, faced with an alarming global crisis, the government undertook vigorous stimulus measures. In 2008, the last year of the Bush administration, a tax rebate and other programs increased the structural primary deficit to 4.6 percent of GDP. Further stimulus measures during the first two years of the Obama administration sent it soaring to over 7 percent.

We are now well into the third year of a tepid cyclical recovery. Real GDP has been above its pre-recession peak for a year already. Most of the money from the 2009 fiscal stimulus has been spent, although some countercyclical tax cuts remain in force. And still, the OECD expects the United States to show a structural primary deficit of 5 percent of GDP for 2012. We are not on a sustainable policy trajectory.

Where to next?

Discussion of what lies ahead focuses mostly on two scenarios.

One scenario is that of the dreaded fiscal cliff, a combination of mandatory spending cuts and tax increases that would amount to an adjustment of about 4 percent of GDP in 2013. That would reverse most of the slippage of 2002 to 2007 in a single year. Many observers think that path to adjustment is too strongly front-loaded, although it is not quite as stringent as what Greece has gone through. According to the OECD, Greece will have moved from a structural primary deficit of 10.1 percent to a structural primary surplus of 3.2 percent just from 2009 to 2012. That is the equivalent of four fiscal cliffs in a row. Theoretically, the adjustment is enough to put Greece on the path to long-run fiscal sustainability, but in the short run, it has meant rioting in the streets.

True, the United States today is not in quite as bad a fiscal condition as Greece was in 2009. Still, the CBO forecasts that the cliff would put the U.S. economy back into recession. Furthermore, it would not fully erase the 5 percent structural primary deficit as measured by the OECD. For the United States to achieve the 3 percent structural primary surplus that Greece is aiming for would require two consecutive fiscal cliffs.

The second scenario is that Washington’s warring factions will reach a comprehensive budget deal during the post-election session of Congress—a deal that is not so strongly front-loaded and would therefore pose less threat of recession. A recent New York Times article tells us that negotiators are aiming at a package of revenue increases and spending cuts that would total $4 trillion over ten years. Such a deal would be very welcome—but even that might not be enough.

What would be enough? The most detailed calculations I have seen recently are those in an update of the Simpson-Bowles plan (or Bowles-Simpson, if you prefer) that has just been released by the Center on Budget and Policy Priorities. The CBPP version of Simpson-Bowles foresees a total of $6,257 billion in spending cuts and tax increases over the ten years from 2013 to 2022. Of that, about $1.5 trillion of spending cuts have already been enacted, leaving about $4,750 billion to go. That is significantly more ambitious than the hypothetical post-election deal outlined by the New York Times, which aims for $4 trillion of cuts including those that have already been made.

The CBPP analysis allows us to project the debt-to-GDP ratio and the primary budget balance over a ten-year time horizon, as shown in the next chart. A world of caution: The primary balances shown there are only roughly comparable to the OECD numbers given earlier. First, they are estimates of current primary balances for each year, not the structural primary balances. Second, they use somewhat different assumptions both for baseline policy and economic growth than those used by the OECD. Even with those caveats, the results offer a dramatic contrast to the large structural primary deficits of our earlier charts. If you want to know what an economically adequate fiscal consolidation plan would look like, this is as good a blueprint as you will find.

The big question is whether any such plan is politically feasible. There is room for doubt. In last week’s first presidential debate, the candidates paid no more than the most lukewarm lip service to Simpson-Bowles.

GOP candidate Romney rightly characterized President Obama’s failure to embrace the plan when it first appeared as a failure of leadership. However, he refused to endorse it himself. Here is the key segment, taken from CNN’s transcript of the debate:

21:31:34: MODERATOR JIM LEHRER: Governor, what about Simpson-Bowles? Do you support Simpson-Bowles?

21:31:34: ROMNEY: Simpson-Bowles, the president should have grabbed that.

21:31:35: LEHRER: No, I mean, do you support Simpson-Bowles?

21:31:36: ROMNEY: I have my own plan. It’s not the same as Simpson-Bowles. But in my view, the president should have grabbed it. If you wanted to make some adjustments to it, take it, go to Congress, fight for it.

21:31:48: OBAMA: That’s what we’ve done, made some adjustments to it, and we’re putting it forward before Congress right now, a $4 trillion plan . . .

The Romney plan and the President’s adjusted version of Simpson-Bowles differ from each other and from the CBPP’s version in the way they divide budget adjustments between spending cuts and revenue increases. According to the CBPP, the Simpson-Bowles plan envisioned a ratio of spending cuts to tax increases of something between 1-to-1 and 1.4-to-1, depending on how you treat interest savings. President Obama suggested during the debate that he was aiming for a 2.5-to-1 ratio in his modified plan. Romney’s plan, although notoriously short on details, purports to achieve fiscal adjustment entirely through spending cuts.

The trouble is, no plan that is so heavily loaded toward spending cuts is likely to pass the Senate, and no plan that includes significant revenue increases is likely to pass the House, at least as those bodies are presently constituted. That leaves us with the prospect of continued political gridlock unless one party or the other takes over all three branches of government (unlikely) or both parties give up political posturing and get down to realistic compromise (only slightly more likely).

Meanwhile, if politicians in Washington do nothing, budget realities will continue to unfold according to their inexorable arithmetic. The structural primary balance will remain deeply in deficit and the debt-to-GDP ratio will continue to rise.

Does that make the United States the Greece of North America, with gasoline bombs in the street and laid-off civil servants digging for food in the dumpsters? Hopefully, not. The United States has many economics strengths compared with Greece. Despite what we hear from some commentators, our labor and product markets are less tangled in bureaucratic red tape. Despite the ugly realities of pay-to-play, SuperPacs, and the rest, our political system is arguably less corrupt. Above all, we have our own central bank, as much on the defensive as it might be, and our own sovereign currency.

Still, each year that we fail to make the needed fiscal adjustments, we are squandering those advantages. Greece caused itself much unnecessary pain by waiting too long to face up to fiscal realities. Will we do the same?

31 Responses to “By One Key Budget Indicator, the Structural Primary Balance, Even Greece Is Doing Better Than the United States. Why That Should Worry Us.”

BurkOctober 8th, 2012 at 2:14 pm

Let me preface this that I come from an MMT perspective.

Where to begin? Greece is not like the US in kind. It borrows from others, we print our own money and borrow largely from ourselves. The US and Japan have entirely different constraints, which boil down to inflation. If inflation is low, then the budget balance is OK, by definition.

How about a thought experiment.. we do not issue debt at all at the federal level, but just spend the money anyhow. Then savers may keep the cash in their mattresses rather than buying bonds.. the difference is minimal. But the Federal government can focus on what is really important.. keeping the inflation balance at a proper level. Suppose we didn't have this narrative of "bad debt", with the bad household analogy, etc. hanging over our heads? Then the government would be accountable on a proper basis for keeping the currency value stable, either by spending/printing more if activity was low and saving high, or by bringing the budget back into balance or even surplus if a boom was taking place. The criteria are not that complicated.

Ed Dolan EdDolanOctober 8th, 2012 at 2:52 pm

Sorry, I'm not really a MMT guru, but I think what I hear you saying is that let's consolidate the balance sheets of the treasury and the central bank, and let's treat all government liabilities as equal whether bonds or currency. Then, you say, the government either issues or withdraws liabilities depending on whether it wants to boost to damp down aggregate demand to keep inflation steady. Is that it?

If so, it seems to me that is pretty much the same intertemporal constraint that is described by the SPB, except that if government liabilities are all noninterest bearing, the equations are simplified because the rate of interest is zero.

It is still the case that the government's balance sheet poses a constraint, over time, on its spending. The government would have to reduce program expenditures when it needed to damp down a boom and boost them when there was a slump. It is not conceptually different.

The problem is when the government, for political reasons, does not want to limit its program expenditures to what it can afford. (I don't know how you handle taxes in MMT, maybe you assume no taxes and all government expenditure is financed by issuing money? That's just a detail, I think.) So really, what is the difference between a government that issues too many bonds and violates the SPB constraint, and one that issues too much money and violates the inflation constraint, except for the details of the equations that pertain to interest payments.

The long and the short of it is, I don't see that your MMT approach changes the concept that the government has a budget constraint and gets in trouble if it tries to ignore it.

Maybe you can spell it out for an MMT novice like me.

SchofieldOctober 10th, 2012 at 7:23 pm

How does a government ever clearly know what it should spend? You are trying to view economies as static when they are clearly dynamic and non-government financial sector credit will fluctuate to affect the volume of money in active circulation and therefore demand. It seems not unreasonable that a society should attempt to maximize incomes of all its citizens by aiming at full employment and that it should aim to have the goods and services it requires be they private or public subject to competitive market forces since this encourages more effective use of resources.

mrtnOctober 11th, 2012 at 5:03 am

My friend, there is such thing in economy called the Philips curve. It claims that full employment is never going to happen. Countries will need to face the trade off between higher employment or higher inflation. Only solution is to reduce the real rate of unemployment to a minimum.

I do not say there is something wrong with society trying to maximize the incomes of its population. Far from it. Im saying its wrong when the motives for it are driven by political populism.

Why do you think the FED didnt deliver a QE3 in June when there was clearly a buzz and manager wanted it. They waited until September to have a 7.8% unemployment just before elections 🙂

ThomasGrennesOctober 9th, 2012 at 12:58 pm

Approximately half of the US government debt is currently held by foreigners. The government does not "largely borrow from ourselves".

GordonOctober 10th, 2012 at 11:59 am

Approximately half (48%) of the US government debt held by the public ($11.3T) is currently held by foreigners.

The US debt held by the public is approx 70% of total US govt debt.

So the fraction of total US govt debt held by foreigners is 33%.

That means 2/3 of it is "borrowed from ourselves". Is that "largely"? Could be.

John WilkinsOctober 10th, 2012 at 1:14 pm

Burk is correct. The EU countries are using a foreign currency over which they have no control. It is the same as being on a constraining gold standard. Those countries are currency-users and they can run out of money and go bankrupt. Only the ECB has the power to create fiat euros. The United States and Japan (and Canada, Australia, the UK and a host of others) are fiat currency -issuers. Those governments have the sole power to create their fiat currencies and their central banks can control their interest rates. As such these currency issuing nations can't run out of the fiat money they create and they cannot go involuntarily bankrupt. There is no operational necessity to sell debt. The treasury can spend by computer keystrokes and the Fed can add to excess reserves which are not counted as debt. As Burk points out the only limitation is inflation and with a huge economic output gap, high unemployment and underemployment, and stagnant real wages, inflation is not a problem. The debt is not a problem (except in some people's minds) but unemployment and economic misery is.

GordonOctober 10th, 2012 at 1:29 pm

Your comment about no operational necessity to borrow speaks to a question I have been pondering: If it is as you say, why all this brouhaha about the debt ceiling? Why couldn't the President simply order the Treasury to spend what had already been approved by Congress?

Elsewhere, I have heard that the Treasury cannot do what you say, they must at least sell debt to the Fed in order to have the dollars to spend, which is why the debt ceiling is an issue.

Ed Dolan EdDolanOctober 10th, 2012 at 2:16 pm

I'm trying to get a handle on this argument. Yes, the Fed and the Treasury working together can issue money and pay the government's bills with it. No argument there. The money is a liability of the government, but I suppose the logic of "not counting it as debt" is that it is bears no interest and is not redeemable, so it never has to be paid off, serviced, or rolled over. In that sense I agree that the government of a country with a sovereign currency can pay its bills without issuing debt.

However, your argument does allow that inflation is a constraint. I agree that right now there seems to be little limit on the amount the Fed can add to the monetary base without inflation. But does that mean we have a free lunch situation in which we can issue new money and buy goods with it until we add enough to aggregate demand to bootstrap the recovery, and then, once we get back to potential real output, turn off the money spigot and from that time forward live happily ever after with a balanced budget, never worrying about the monetary liabilities we issued during the slump? I am not convinced.

Even though the very large money base we have accumulated during the slump has not caused inflation so far, would it really be possible to leave that money in the system indefinitely without causing future inflation? In other words, can we be sure that even when real output and inflation return to their equilibrium levels, the money multiplier and/or velocity will remain far below their historic values? Why would that be?

If we do expect the monetary base and NGDP to return to their historical relationship, then doesn't the Fed need an "exit strategy" to retire all the money recently issued? What I can't figure out is what kind of exit strategy you have in mind if it does not take the form of putting debt (redeemable, interest bearing liabilities) in circulation to replace the excess money.

Let me put it another way. If you don't have a debt-based exit strategy, then issuing money to pay the Treasury's bills today is not, after all, consistent with the inflation constraint, and if you do have an exit strategy, then all you have done is postponed, not eliminated, the need to issue debt.

Let me put it still one other way. The only reason the Fed's QE is not causing inflation now is that it has told us it has an exit strategy under which it will replace the excess money with debt as soon as NGDP gets back on trend (that is not quite how they express it, but it is what it amounts to.) If the government promised never to issue more money that it would be able to leave in the system indefinitely, it wouldn't be able to finance much real spending that way–only an amount equal to noninflationay seigniorage, that is, the rate of growth divided by the velocity of the monetary base, an that only a fraction of a percent of GDP.

Am I missing something? What?

GordonOctober 10th, 2012 at 2:36 pm

As I understand MMT, the way you take dollars out of the system is with taxes.

Spending creates dollars, taxing disappears dollars.

Ed Dolan EdDolanOctober 10th, 2012 at 9:04 pm

Well, I am glad to hear you say it is that simple. Taxing is certainly a great way to get money out of the system (provided, of course, you don't yield to the temptation to spend the revenue). I even have a slide in one of the presentations in my central banking course that presents balance sheets showing just how it works. I also explain that the taxation/money nexus is what lies behind the sovereign wealth funds that some oil producers use to stabilize their economies over the oil price cycle. So I guess I have been teaching MMT without knowing it.

Now I have to perform that great Professorial Pivot and learn something about the stuff I've been lecturing about, I guess.

GordonOctober 10th, 2012 at 11:27 pm

Well, I'm just a novice, with MMT or any other economic model. It's an interesting subject for sure, and I wish I had started reading it earlier in life.

My information about MMT comes almost exclusively from Bill Mitchell's blog.

ThomasGrennesOctober 10th, 2012 at 5:10 pm

Except for possible inflation, there is no reason for the government to issue debt rather than print money. But except for possible inflation, there is also no need for governments to impose taxes to pay for their spending. They could eliminate conventional taxes and finance all spending by printing money. Inflation is not a current problem in the US or EU, but there exists a level of quantitative easing at which it would become a problem.

GordonOctober 10th, 2012 at 5:33 pm

The state requiring that taxes be paid in the fiat currency is what makes people want to do business in the fiat currency.

RationalistOctober 8th, 2012 at 6:20 pm

Sobering. Thank you very much for a very interesting post. Any thoughts how high the US total debt or debt service percentage would need to be before buyers of US government would start demanding damagingly high interest rates?

Ed Dolan EdDolanOctober 8th, 2012 at 11:42 pm

I don't want to have this interpreted as an interest rate prediction or forecast, because I'm not in that business, but I think for the United States, interest rates are not the biggest constraint, at least not in the short term.

Rates start to go up when lenders think there is a risk of default or inflationary monetization of the debt over the time horizon of the securities they are buying. That can vary hugely. Interest rates started rising sharply in Spain when the net debt/GDP ratio was only 40 percent; in Japan it is now 125 percent and rates are flat on the floor. For the US net debt by OECD methodology is about 80 percent of GDP as of 2011, and no sign of higher rates on the horizon.

The US is more like Japan in having an independent currency, so there is no threat of Argentine style default or even Greek style haircuts. It is also more like Japan in having a monetary base that is completely decoupled (for the last few and next few years) from the rate of inflation.

Remember, not long ago people were saying that if China ever stopped buying our debt, rates would soar. Now suddenly China is a net seller of US Treasuries, and rates are still at historic lows.

Having said all that, it does not mean we can pile up debt forever without worry. First of all, even a return to historically normal levels of interest rates would be very expensive, it would put pressure on non-interest expenditures of something on the order of magnitude of "half a cliff" (a convenient unit of measure), and that is not trivial when the budget is already as stressed as it is. Second, even if a sharp spike in US interest rates is still a tail risk, if we have been taught one thing by the recent crisis, it is not to ignore tail risks.

The real problem is that the current budget is so far out of balance even with the very low rates we do have. The rapid growth of the debt means that the goal posts are moving very rapidly. Every year that we do not start on an orderly medium term fiscal consolidation that is not excessively front loaded, it becomes more difficult to do so.

Martin VidoevskiOctober 11th, 2012 at 4:46 am

I agree with you on the level on independence that the sheer size of US gov debt and GDP provide to it in terms of its policies for reducing the debt. However, all the cases that you pointed out are different for a reason. All the Eurozone countries might have had a different response to the crisis (and would have, for sure) if they werent held hostage to a single currency (an artificial gold standard as someone pointed out in one of the posts earlier). Japans response to the overdebtness seems like a 20 vol. book series. Since 1992 when they had their last supluses they have recorded consequtive deficits that took the GDP to over 200% as it is today. Japan`s government debt is held 95% by Japanese banks. The historical saving rates of a country prior to the period when it entered the crisis allowed the Japanese this luxury of having a 200% debt -to-GDP ratio.

Unfortunately , I am not familiar with the amount of interest payments that the US pays from the budget, not its overall budget structure. But I believe the crashing point for US, being one of the major world-currencies, is not so far off. The reason why 1/2 of the T-bills are held by foreigners is because you have a bunch of Araps stuck with a lot of US dollars and they have no idea what to do with it. Therefore, trust in US dollar is way more fragile among a mix of foreigners and US banks, than just a group of Japanese in their national currency.

I fear , that in case US takes a firm policy that would give clear stance on the fiscall cliff and the Bush tax cuts, there`d be a massive amount of capital back into the market that would lead to a stagflation.

The political populism that the politicians of today adhere to is disgusting. If US is to become more competitive at international level, they will have to teach their people what internal devaluation is, just like Japan dioes.

ThomasGrennesOctober 9th, 2012 at 1:04 pm

Interest rates on U.S. government bonds are kept artificially low partly because of Federal
Reserve policies that purchase bonds and promise to keep interest rates near zero to 2015. Historical evidence on this kind of financial repression has been provided by Reinhart and Rogoff.

TobinOctober 9th, 2012 at 3:20 am

There is absolutely no link between the USA and Greece, Spain or even Italy. The US economy is a healthy economy. Stop wars like those with Iraq and Afganistan, tax the very rich Americans, the private equity funds etc. and you will not have a primary deficit any more…

AnthonyOctober 9th, 2012 at 12:04 pm

Sorry, but I require some numbers. How much will be saved by getting out of Iraq and Afganistan? How much will have to be taxed from the "very rich" Americans in order to eliminate the primary defecit? By making such a statement, you must have some numbers in mind. Please enlighten me.

ThomasGrennesOctober 9th, 2012 at 3:11 pm

The U.S. budget showed a small surplus around 2000, and the debt/GDP ratio was not far from its long-run average. But in the last decade, major war spending, tax cuts, and the most severe recession since the 1930s have generated large and persistent budget deficits and the largest debt/GDP ratio since 1945. A healthy economy has been transformed into an unhealthy one.

mrtnOctober 11th, 2012 at 4:48 am

Tax rich American, like Warren Bufet and Mitt Romney, right? The guys that pay less tax rates than their secretaries 🙂

LululaluOctober 11th, 2012 at 3:38 pm

No link because the USA creates funny money, and because rating agencies are anglo-saxon.
Market economy is collapsing, it's a too short-term solution to the word's problem.

John CardilloOctober 9th, 2012 at 12:47 pm

Choosing the right indicator(s) to drive policy is a delicate thing. Debt-to-GDP ratios and "(SPB)" are interesting to analyze and talk about, but I'm not sure they'd make a wise target for policy makers. For example, what good is it to Greece if their SPB is "doing better" than the U.S. when their unemployment rate is ~ 3 times greater and their productivity (GDP/hour worked ) is ~ half of that of the US.


ThomasGrennesOctober 9th, 2012 at 12:54 pm

Numbers are available at the website of the non-partisan Committee for a Responsible
Federal Budget: <a href="” target=”_blank”> They have a calculator that allows one to change specific
fiscal polices and find the effect on the total budget.

ThomasGrennesOctober 9th, 2012 at 3:23 pm

This an excellent post by Ed Dolan on an important topic. It is informative to separate out the business cycle components and the interest payment components of the budget deficit. It is also useful to examine the stock of U.S. government debt relative to GDP, and to see how it has increased dramatically since 2000. The gross debt in 2011 was103% of GDP and ther net debt (outside the government) was 80%, and both doubled since 2000. Projections for future debt/GDP are less favorable for the U.S. than for Europe.

dwbOctober 10th, 2012 at 3:47 pm

at the end of the day, you either need to collect taxes directly, or indirectly through inflation. Only difference is who pays the tax. The bad news, as the Japan example shows, is that it seems you can go for a very very long time. But is that bad news? I am unconvinced there is a threshold or point of no return. debt:gdp (comparing a stock to a flow) implies what – how many years or how much inflation I need to pay it off? I have never been clear why this was a meaningful number.

Isn't what we are really saying here that government debt is bad because at some point we may be unable to make the political compromises needed – either to reduce spending, raise taxes, meaning that the government will have to be financed solely through the default option of the printing press? that is, isnt the root cause of the skyrocketing interest rates in the loss-of-confidence tail risk scenario, really a *political* loss of confidence? If so, do we really expect politicians to prepare for their own irrelevance?

The place i get to when i think about this issue is really that there are not enough checks and balances in the constitution, because the crisis we are talking about is not an economic one but a political one, and what we need is a constitutional amendment that limits government expenditures to an average x% of gdp (over say a rolling 5 year period).

ThomasGrennesOctober 11th, 2012 at 9:09 am

The government's ability to spend is ultimately limited by their ability and willingness to impose some kind of tax. Some kind of fiscal rule, such as limiting spending, the budget deficit, or the debt relative to GDP over a five year period, has some merit. However, there are problems of implementation, as most members of the EMU are now violating their budget defict and debt rules with impunity. There are also accounting gimmicks that include defining certain spending as "off-budget" and not subject to the limit.

ChrisFromGreeceNovember 14th, 2012 at 7:00 pm

So what you are asking in effect is to cause negative growth (recession) which would have to be less than the reduction of deficit during the same period in order to sustain (or reduce) the debt to GDP ratio. In your argument what you are asking is a slash in spending or tax hikes that need to be so severe in order to bring down deficit a lot faster than the recession they will cause. The problem is that this will never occur in the real world because it ignores the multplying effect of the under-employment (slack) of productive factors. This is why Sweden was successful. They managed to maintain a level close to full employment and then introduce SPB surplus measures to prevent their economy from a burn out. In addition, they have used SPB deficit to finance innovation and technology which marginaly increased the productive capacity of their economy.
Your suggestion may avoid Greece but end up like Guatemala the poster child for strong macroeconomic indicators and children famine ranking them in the top 10 UN poverty index.