Congressional Testimony on the Costs of Rapidly Growing Government Debt

Yesterday I testified at the Committee on the Budget of the House of Representative.  John Yarmuth chaired, and Steve Womack was the ranking member. The Committee titled the hearing “Reexamining the Economic Costs of Debt,” which was quite different from the title “Why Congress Must Balance the Budget” of a hearing of the same House Committee at which I testified only a few years ago in 2015.

At the earlier hearing I showed that basic economic theory grounded in real world data implies that high federal government debt has a cost: it reduces real GDP and real income per household compared to lower debt levels. At yesterday’s hearing I reported that a reexamination of the economic costs yields the same results. A fiscal consolidation plan which reduced debt to GDP would lead to an immediate and permanent increase in real GDP according to model calculations.

Recently the Congressional Budget Office (CBO) reported similar results. They compared their “extended baseline” in which the debt goes up to 144 percent of GDP by 2047 with an “extended alternative fiscal scenario” in which the federal debt goes to 219 percent of GDP.  CBO found that real GNP is 3.6 percent lower when debt is higher. So, the higher level of debt has real economic costs.

The CBO also analyzed scenarios in which debt is lower as share of GDP: 42 percent and 78 percent. In the 42 percent scenario, real GNP would be 5.8 percent higher; in the 78 percent scenario, real GNP would be 3.7 percent higher.

With the CBO currently projecting large increases in the federal debt relative to GDP in the United States, this reexamination implies the need for a credible fiscal consolidation strategy. Under such a strategy spending would still grow, but at a slower rate than GDP, thereby reducing debt as a share of GDP compared with current projections. Such a fiscal strategy would greatly benefit the American economy. It would also reduce the risk of the debt spiraling up much faster than projected by the CBO.

This conclusion is robust. Olivier Blanchard also testified at the hearing emphasizing that if the growth rate of the economy is greater than the relevant interest rate on the public debt, then there will be a tendency for the debt to GDP ratio to decline over time. In most of Blanchard’s simulations, the primary surplus is held to zero.  However, the primary deficit is far from zero, and, according to CBO, it is growing. Moreover, the economic costs do not distinguish between the primary and the total deficit.

Another view of the economic costs of debt is related to what is sometimes called “Modern Monetary Theory.”  It is difficult to determine how this approach would work in the future, and it is frequently associated large spending programs and wage and price controls. Model simulations would be useful, but history can be a valuable guide:

In the 1970s the United States imposed wage and price controls and the Fed helped finance the federal deficit by creating money.  The result was a terrible economy with unemployment and inflation both rising. This ended when money growth was reduced in the late 1970s and early 1980s. As explained in a forthcoming book by George Shultz and me, it is an example where poor economic reasoning led to poor economic policy and poor economic performance. It was reversed when good economics again prevailed, and policy changed.

Posted in Budget & Debt

9/11/2001 and the 18 Years Since Then

Today we remember September 11, 2001 and all that has happened in the 18 years since then.

I was in a hotel room in Tokyo when the first plane hit the World Trade Center, recently sworn in as Under Secretary at Treasury. We immediately cancelled our meetings and by the next morning we were on a C-17 military jet Flying Back to Treasury on 9/11. When we got back, the city was on alert. DC was a logical place for another attack, and the secret service was particularly concerned about security around the White House. The United States then launched its first post-9/11 attack on terrorists from a very unusual Financial Front in the War on Terror. As President George W. Bush put it, “the first shot in the war was when we started cutting off their money, because an Al Qaeda organization can’t function without money.”

We cannot forget that the New Greatest Generation  was, and is, essential. They helped lead us, and are still helping to lead us, out of those difficult times. In his speech last year at Shanksville President Trump spoke of incredible security challenges and sacrifices: “Since September 11th, nearly 5.5 million young Americans have enlisted in the United States Armed Forces. Nearly 7,000 service members have died” he said, adding “And we think of every citizen who protects our nation at home, including our state, local, and federal law enforcement.  These are great Americans.  These are great heroes.  We honor and thank them all.”

Posted in Uncategorized

Economics 1: Now More Important Than Ever

Two weeks from today, I start teaching Economics 1, Stanford’s introductory economics course, and the namesake of this blog and my twitter account.   I am looking forward to it, and for the same three reasons that I gave years ago when I started teaching the course: (1) “I love to teach.” (2) “I love to do economic research” and teaching is “a natural extension of research.” (3) “I love economic policy—the application of economics to government as well as to decision-making in business.”

But things have changed dramatically since I started teaching this course decades ago.  In many ways, it is like a whole new course. And that’s exciting for me and for students.  Economics 1 is more important now than ever as the world becomes more computerized and quantified. The course now shows how ignoring economics as we consider the latest ideas in artificial intelligence, machine learning, deep learning, or big data is a recipe for disaster.

The course also shows how it’s possible—as never before in history—to make economic ideas work better in practice to improve people’s lives. Of course, we continue, starting in the first lecture, to stress the central idea that economics is about making choices with limited resources and about people interacting with other people as they make these choices. We show why free competitive markets can improve people’s lives and how such economic systems have removed millions of people from poverty, with many more, we hope, to come; we also discuss market failures, remedy to these failures, and government failure.  And as I wrote ten years ago on this blog severe set backs such as the global financial crisis are a vindication rather than a failure of economics, or more generally, we will see why good economics leads to good policy and good outcomes, and bad economics leads to bad policy and bad outcomes.

And now, and this is another big change, there’s a renewed interest in alternatives to market economics, whether you call it market socialism or more simply highly interventionist economic policy. These issues came up years ago when central planning was still used around much of the world including in Russia or China. With the demise of the Soviet Union, some case studies that showed the harms of central planning are forgotten and are not as relevant. It was helpful then to discuss, for example, how Soviet production plants could fulfill centrally imposed plans by producing, for example, one 500-pound nail rather that 500 one-pound nails, even though the giant nail was useless. Now we need new stories that take new ideas seriously.  The overall goal is to use the latest ideas in economics to understand the reasons for rising living standards and to deal better with inequality, crises, and unemployment.

In addition to the large lectures, I am happy to say that there will also be small discussion sections. There are also exciting special guest lecturers this term including Caroline Hoxby on the economics of education, Susan Athey on artificial intelligence and economics, Chad Jones on the latest ideas on economic growth, and even The Best Economics 1 Lecture Ever.

Posted in Uncategorized

Choice of IMF Managing Director Should Reflect 75 Years of Change

Last week Raghu Rajan and I coauthored an article for the Financial Times. We argued that the IMF should no longer continue the tradition that the Managing Director of the International Monetary Fund be a European. Instead, it should “break the mould by appointing the best possible candidate to the job, regardless of nationality,” and “hold an open competition” for the position.

As the G20 Eminent Persons Group on Global Financial Governance (on which we served) recommended, the IMF’s role needs to change to meet the requirements of a different word than existed in the year of its founding 75 years ago.

On this the 75th anniversary of the founding of the IMF and the World Bank, we need to recommit recommit to the spirit of Bretton Woods.  Indeed, this was the main message of the contributors (including me) to the recent book Revitalizing the Spirit of Bretton Woods@75 Compendium 2019.

But this is no longer a task for Europe and the US alone, or for the G7 alone, or for the G20 alone.  The economic ideas being debated are much the same, as I explained in this Truman Medal Lecture, but keeping the flame of open international trade and open capital market alive is harder than ever. It is a now fully global, multi-polar world. It is a task for all the members of the IMF. The choice of managing director should reflect that reality.

Posted in Uncategorized

A Beautiful Model Now Questioned

A few days ago, an amazing thing happened when Thomas Brand (@thlbr) tweeted about a short article I posted on my blog My post was old–posted 10 years ago on October 3, 2009–and I titled it “A Beautiful Model, A Clear Prediction.”

It was about the effect of the minimum wage on employment and the wage. The basic supply and demand model was displayed with the following graph. It was drawn from the Principles of Economics (Economics 1) course that I taught at Stanford in the Fall of 2009, and will still be teaching at Stanford in the Fall of 2019 (and in online form this summer).

The amazing thing was that Brand’s tweet resulted in a huge amount of renewed traffic and hits to the blog, many more in 2019 than in 2009.  Also, unlike 2009, much of the traffic in 2019 was very critical of the model. One of the several thousand tweeters changed the diagram as shown here for the case where the minimum was lower than market equilibrium and thus not binding.

It is encouraging that more people are interested in economic models and their policy implications. But I cannot help but think that fewer people understand or believe the basic supply and demand model than 10 years ago.  Yes, I know there are underlying assumptions, and these must be explained.

But opinion is shifting, even though the model is as accurate and as beautiful as ever.  I’ll have my work cut out for me next fall in Economics 1.

Posted in Teaching Economics

Central Bank Independence Is Not Enough

Four former chairs of the Fed  wrote in the Wall Street Journal today about the importance of Fed independence. I agree, but their article should have emphasized that independence is not enough.  Economic performance has been affected by large shifts between more rules-based and less rules-based policy by the Fed without any concomitant change in the legal basis for independence. De jure independence has not prevented the Fed from harmful departures from rules-based policies.

The absence of a rules-based policy at the Fed in the 1970s was accompanied by high inflation and high unemployment. The move to rules-based policy during the two decades starting in the early 1980s was accompanied by improved price stability and output stability. And a move away from rules-based policy starting around 2003-2005, was followed by poor economic performance including the Great Recession and the Not-So-Great Recovery, as shown in this article in Swedish Riksbank Economic Review

There, of course, have been swings in de facto independence. For example, the Fed sacrificed its de facto independence in the late 1960s and 1970s and regained it in the 1980s and 1990s. There is a close correlation between de facto independence and rules-based policy.

But within a given legal framework, the Fed has engaged in varying degrees of adherence to rules-based policy. We have seen major shifts in the effectiveness of monetary policy within a single framework of central bank independence. Monetary policy needs to focus more on ways to encourage more rules-based policy as well as on ways of maintaining independence.

Posted in Monetary Policy

Africa Meeting of Econometricians: History, Revival and Ways Forward

I just spent a wonderful few days at the 2019 Africa Meeting of the Econometric Society held in Rabat, Morocco with the central bank, the Bank Al-Maghrib, providing an excellent venue.  Congratulations to the Bank Al Maghrib for its 60th anniversary year and also to the Econometric Society for its upcoming 90th anniversary in 2020.

One sees positive economic changes coming to this part of Africa, and it is good that the Econometric Society is meeting here. Morocco is looking to join the Economic Community of West African States (ECOWAS) which includes, among other countries, Nigeria, Senegal, Côte d’Ivoire, Ghana, Liberia, Mali, Niger, Benin and Togo. I have travelled to these countries and worked on the US-Moroccan Free Trade Agreement a while back. The idea of an expanding free trade zone is breathtaking especially if combined with other pro-growth reforms. The Bank Al-Maghrib has widened the exchange rate band and capital controls are gradually being relaxed. Several years ago, I spoke in Casablanca about the promise of economic reform, and now it seems to be underway.

But most of all I was impressed by the many sessions of the Econometric Society which demonstrate how economic ideas are spreading throughout the region and the world. The latest econometric methods were evident throughout.  So was big data. One paper examined export and import data in Malawi from 219 countries, with tens of thousands of observations. Another examined the impact on net interest margins of 2,442 banks affected by negative interest rates. This transmission and global conversation is in marked contrast to days when I started out in econometrics, long before there were African meetings of the Econometric Society. It bodes well for the spread of technology generally as a means to improve people’s lives.

My keynote address at the conference delved into the history of the use of econometric models for monetary policy going right up to what has happened in the past few months.  I started out with “path-space” models such as the Tinbergen model which looked at the impact of different paths of the instruments on target variables.  Then “rules-space” approaches began with a major paradigm shift, and central bank models changed for the benefit of policy and performance. Then there was a retrogression, at least in major parts of central banking world, as central banks deviated away from more rules-based approaches, and economic performance deteriorated in the global financial crisis. The lesson learned from history is that we need to get back to rules-space.  Now, just in time, there is a revival of policy rules research, evident in papers, publications, actions, and statements by Fed officials and other central bankers.

The history shows that there are important benefits from a rules-based monetary policy, while it lasts, and that even expectations of a return to rules has benefits. The recent changes in research are promising, as are the other developments in Africa.  What can econometricians do to prevent the deviations and encourage rules-based policy. How can econometric research ideas help? My suggestions at the meeting included more robustness studies on different models and parameters, more development and use of international models to evaluate rules, more research with “quantitative easing” as an instrument in a rule, and a greater focus on the interface between research on rules in central bank research departments and the decisions of central bank policy officials.

Posted in Financial Crisis, Monetary Policy

A Decade of July 4th Debt Explosions: Are They Getting Less Spectacular?

Starting a decade ago, I’ve charted on Independence Day the most recent long-term projection of the federal debt by the Congressional Budget Office (CBO). Over the years the chart has continued to look much like the Fourth of July fireworks, as you can see here 2010, 20112012, 2013, 2016, 2017, 2018 .

The CBO just released its 2019 Long-Term Budget Otutlook  on June 25, and so it’s time for a July 4th update. The chart of the total deficit on the front cover of the report (reproduced here) is a sight to behold.  As CBO says: “If current laws generally remained unchanged, large budget deficits would boost federal debt to unprecedented levels over the next 30 years.”

What about the debt? I plotted in the next chart the forecast of the debt as share of GDP (solid blue line) along with the forecast of net interest payments on the debt as a share of GDP (dashed red line) and, for comparison, the debt as a share of GDP (solid red line) as projected through 2047 by the CBO in March 2017 before the Tax Cuts and Jobs Act of 2017.

The message, like the fireworks display, is still loud and clear: The debt is exploding, and net interest payments are rising rapidly as a share of GDP. No new news here.

But there are two pieces of news in the debt chart. First, the debt is now projected to be 11 percentage points lower as a share of GDP in 2047 compared to the projection at this time last year. That’s an improvement. Second, the 2017 Tax Act did not increase the debt to GDP ratio going forward: The projected trajectory of the debt to GDP ratio is lower after the tax cut than before, except for a small increase at the start of the projection.  The debt problem is still due to rising spending growth not the tax reform. Maybe less spectacular, but no reason for complacency.

Posted in Budget & Debt, Fiscal Policy and Reforms

Recent Decisions and Rules of the Fed

Last week, after attending monetary policy conferences at Stanford, Chicago and Frankfurt, I put forth evidence in of a revival of research on monetary policy rules for the instruments, whether at the conferences, in research papers, or in Fed publications. I offered possible explanations for the revival, also with evidence, including revealed preference by policymakers, the need to deal with the effective lower bound, disappointments with past departures from rules, threats of legislation, and concerns about political pressure.

This week, Peter Ireland posted an article with a carefully worked-through analysis of recent actual monetary decisions, which takes the idea of the Fed using policy rules for the instruments a significant step further, well beyond research papers and into policy arena.

In the article, entitled A Rule That Makes Sense of the Fed, Peter examines recent changes in the Fed’s interest rate target, and he shows they are consistent, according to the Taylor Rule, with changes in real GDP, inflation, and r-star. Going line-by-line through the table below (which I draw from his article)

he shows the Fed’s Summary of Economic Projections (SEP) and demonstrates how a change in the federal funds rate from September 2018 to June 2019 can be explained, via a Taylor Rule, by changes in real GDP, the core PCE inflation rate, and r-star over the same period.

Peter thereby demonstrates that the Fed could be more explicit that these decisions are rules-based. In this way, he shows that “policymakers could explain more easily that the substantial downward adjustment to their expected interest-rate path represents a deliberate response to changes in their outlook for economic growth and inflation, together with their best judgement that r-star is considerably lower than previously thought. Even more important, they could use the Taylor Rule to demonstrate that their interest rate decisions are driven by economic analysis alone and not influenced by political pressure.”

It is another reason for Fed policymakers and other central bank official to strive to make their decisions within a rules-based framework, which can be analyzed with economic models, checked for robustness, and integrated internationally.

Posted in Monetary Policy

Let’s Twist Again with Online Econ 1

This summer we will be offering Stanford’s Principles of Economics course online.  As explained in this Wall Street Journal article, “A Twist in Online Learning at Stanford,” the twist again is that we’ll offer it both (1) to the general public and (2) for credit to matriculated Stanford students, incoming freshman, and visiting students in the Stanford Summer School.

Those seeking credit can register here for the for-credit course, which is just starting with the first week’s videos and other course content posted on Monday, June 24. This is the same as the on-campus course, Economics 1, which I give at Stanford during the academic year, and it fulfills all the same requirements. Getting credit requires regular homework, a mid-term exam, and a final exam, all of which are taken online.

The open online course for the general public is also based on my lectures in the on-campus Stanford course. It begins one week later, on July 1, and next week information will available here. People who participate in the open online course and take the short quizzes following each video will be awarded a Statement of Accomplishment, or a Statement of Accomplishment with Distinction.

The on-line courses cover all of economics at a basic level.  They stress the key idea that economics is about making purposeful choice with limited resources and about people interacting with other people as they make these choices. Most of those interactions occur in markets, and this course is mainly about markets, including the market for bikes on campus, or labor markets, or capital markets.  We will show why free competitive markets work well to improve people’s lives and how they have removed millions from people from poverty around the world, with many more, we hope, still to come.

The textbook for the course is Principles of Economics by John B. Taylor and Akila Weerapana and it is available online as well

I am looking forward to another great summer quarter. Here is a sampling of views about the online course, either for the general public or for credit, which have been posted on Twitter:

  • Russell Roberts‏ @EconTalker: Great class. Great teacher. No charge. Get your basics right here.
  • Ike Brannon‏ @coachbuckethead: The most entertaining economist I know.
  • Brian Wesbury‏ @wesbury:  If you want to learn Economics from one of the best, click on this link!  What great news!
  • Juan Carlos Martinez‏ @juank700410: Educación gratuita y de calidad
  • Tom Church @TomVChurch Interested in economics? Take Econ-1 online. Pass the quizzes and get a statement of accomplishment! Plus, you’ll learn a thing or two.
  • Chris Pippin @ChrisPippin This is the class and the professor that made me an Econ major. Thanks to the generosity of @EconomicsOne and the miracle of the internet, now anyone can take it.
  • Nicolas Petit  @CompetitionProf Great course by terrific teacher, comprehensive & more than all eye opening on real world problems like trade wars and monetary policy.


Posted in Teaching Economics