Semi-Daily Journal

Any estimates of how much interest rates depend on the level of the government debt owed to the public?

None. Zip. Nada. Interest rates depend on what the fed does, and what people think the fed will do. That is all ye know, and all ye need know...

On a topic only vaguely related, there is a plan afoot to eliminate what I would guess is the most stimulative measure in the Bush tax plan. The Washington Post reports that House Ways and Means Chair Thomas wants to drop the expansion of the small business investment tax credit as part of an effort to simplify the tax plan. I don't know where or how this lines up with plans in the Senate to keep the total tax cut to $350 bln.

In looking at the short term deficit, it is clear that the drop in revenues due to the weak economy is the biggest contributor to the deficit. Even under Clinton, the budget would not have come into balance were it not for the surging economy and the very large increases in revenue. It is clear that we will run deficits as long as the economy remains stagnant.

The debate over Bush fiscal policy is whether his policy will contribute to long term growth as he claims, or give a too small jolt up front and suffer deficits as monetary policy takes over. Critics would prefer a larger short term stimulus followed by increased revenue collection when the economy moves forward more rapidly.

The obsfucation on the part of Hubbard and others in the administration indicates an unwillingness to address the positives and negatives of their proposal and instead accept and promote only the rosiest scenario. The suspicion of Bush critics is that Bush fiscal policy is a political strategy that lacks sound economic backing. The recent Time article on Bush election strategy for 2004 contains some interesting quotes that support that view:

http://www.time.com/time/magazine/article/0,9171,1101030505-447170,00.html

"His advisers also believe that elimination of this so-called double taxation can provide a quick "optimism boost" to the stock markets. White House officials point to forecasts of a quick rise in the Dow of between 5% and 20% if the measure is passed. "There is no more important measure of consumer confidence than the markets," says a senior adviser. If the markets go up, in other words, so do the odds of a second Bush term.

And if Bush doesn't get what he wants, advisers say, he will introduce another round of tax cuts in the fall, giving him a domestic political issue for 2004.

Despite the polls, the President believes that giving people their money back is a political winner.

For Bush, tax cuts are what the grand unified theory is to cosmologists: the secret to everything. Tax cuts create jobs, they boost spending, they lift the markets—they'll even paint your house for you.

the grumpy economy is still Bush's greatest vulnerability.

Bush has united his party by employing a strategy that Grover Norquist, a White House ally and the president of Americans for Tax Reform, describes as "delivering on first-tier issues." For the fiercely antitax crowd, Bush supplied his $1.1 trillion tax cut in 2001. By sticking with his core supporters on the issues they care most about, Bush has given himself leeway to disappoint them on what Norquist calls "second- and third-tier issues." That's what he did last year when he signed the McCain-Feingold campaign finance-reform bill, which conservatives despised. "Were we unhappy?" asks Norquist. "Yes. But I vote on taxes. Were gun owners unhappy? Yes. But they vote on guns."

Long-term fiscal stimulus does raise real interest rates according to a summary of the empirical and theoretical literature written by William Gale et al. and released in December 2002. It should be available at www.brookings.edu and it is a must read for all those who wish to discuss this issue honestly. Then again - this White House and friends are most likely trying to get folks to ignore this excellent paper.

"In looking at the short term deficit, it is clear that the drop in revenues due to the weak economy is the biggest contributor to the deficit.... It is clear that we will run deficits as long as the economy remains stagnant."

Sorry, I am puzzled. Given the President's initial tax cut, the budget will stay in deficit even when GDP growth returns to the 4% mark. The next tax cut will make the deficit all the more serious though the economy recovers well from this poor growth period. Folks, we have a deficit and will continue to have a deficit precisely because of the long term effects of the President's tax cuts. Am I wrong?

A number of White House economic and treasury types are the authors of text books or policy analyses prior to joining the administration. Few if any took the position that deficits don't affect interest rates. If CEA types, while in office or after moving to the CBO, admit this. Hubbard may have mislead, but he did not claim "zip. nada."

Anyone remember Ronald Regan campaigning on the evils of deficits?

Richard:

Hubbard's textbook specifically noted the standard classical model where an inward shift of the savings schedule from fiscal stimulus would raise interest rates. Mankiw's texts go further and discuss the Reagan years as a dramatic real world example. But then some would tell you that Reagan's original intent was to slash government spending to pay for those tax cuts. Bush on the other hand has increased Federal spending and has no proposals to significantly reduce spending.

Glen Hubbard was not appointed to advise the President on economic policy, simply to prepare the way for policy already decided. Administration policy makers will tell economic appointees what issues to address and when. So much for advice. This Administration has a clear agenda and appointees all get it.

Anne, The long term budget deficit over the next 10 years is primarily caused by Bush tax cuts. However, the 2001 tax cuts were back loaded and do not fully take effect until after 2004. As originally conceived, the tax cuts would have taken the non-Social Security portion of the budget to roughly a break even point. However, a slow economy with less revenue than expected pushed the non-Social Security budget into a slight deficit in 2001. Continuing low revenue plus a large increase in spending on defense, homeland security, the war in Iraq, etc. have further deteriorated the budget picture. This deterioration has occurred even though the bulk of the Bush tax cuts have yet to be implemented.

However, our period of slow growth means that the economy will not generate enough tax revenue to cover the increased spending over the near future. Thus, the tax cuts are no longer affordable. It is not a bad idea to run some deficit during a recession if the money is being invested wisely in job training or infrastructure that will be needed when the economy rebounds. However, to run long term structural deficits adversely affects the national savings rate.

bakho -

Absolutely.
Thank you, I am awfully slow today.

Apparently, Robert Barro's latest Economic Viewpoint will make the case that these tax cuts will not raise interest rates. Part of his reasoning is that they will not stimulate consumption or aggregate demand per his Ricardian Equivalence. But that runs directly contrary to the Bush spin and is based on the implicit premise that the tax cuts will be later reversed and offset by tax increases. Barro also pulls out the small economy in a large pool of world savings argument which Glenn Hubbard loved to pull out. OK - fiscal stimulus does not lead to higher interest rates and investment crowding out per this Mundell thesis, but at least Mundell pointed out that it would lead to net export crowding out. So foreigners invest in the U.S. and keep all the profits. Real NNP growth still declines (even if NDP growth does not). I'm sure the Bush supporters will carry around Dr. Barro's commentary - even if they really don't fully understand what it really means.

My apologies for not being internet savvy enough to do this proper linkage but the Barro piece on deficits and interest rates can be found at:

www.businessweek.com/magazine/content/03_18/b3831029_mzoo7.htm

IMO - this is old spin. But read for yourself.

My apologies for not being internet savvy enough to do this proper linkage but the Barro piece on deficits and interest rates can be found at:

www.businessweek.com/magazine/content/03_18/b3831029_mz007.htm

IMO - this is old spin. But read for yourself.

My apologies for not being internet savvy enough to do this proper linkage but the Barro piece on deficits and interest rates can be found at:

www.businessweek.com/magazine/content/03_18/b3831029_mzoo7.htm

IMO - this is old spin. But read for yourself.

My apologies for not being internet savvy enough to do this proper linkage but the Barro piece on deficits and interest rates can be found at:

www.businessweek.com/magazine/content/03_18/b3831029_mz007.htm

IMO - this is old spin. But read for yourself.

We keep insisting, these "compassionate" polciy supporters are really fine economists because they have positions at the right schools. But, I listen to Feldstein or Hubbard or Barro or Mankiw and all I hear is dressed up policy to further enrich the rich and to hell with the rest. Blah....

http://www.businessweek.com/magazine/content/03_18/b3831029_mz007.htm

you only need to put "http" and "://" without any space at the beginning of the URL, thew ret is done by the server.

DSW

Thanks Antoni. That might have saved me for the quadruple posting mistake I made too. I've sort of let what I thought of this Barro piece out of the bag - other thoughts?

Multiple post are a bug/feature of the server, once posted a text, I usually click on another comment thread, that avoids most instance of duplication, unless I get distracted like today allowing for the self duplication of one post.

DSW

The Barro article:

The interest rate argument concerning deficits is less important than the effect of deficits on national savings. Deficits borrow money from future taxpayers, money that eventually has to be paid back. Deficits always decrease the national savings.

Barro does a lot of hand waving but never explains why the Bush tax cuts should lead to a new era of economic expansion. He forwards that as a statement of fact. Barro certainly does not address how we get past the current point of excess capacity and how increasing investment dollars is supposed to stimulate demand.

Many economists would agree with bakho's assertion that the Bush fiscal stimulus (like the Reagan fiscal stimulus) lowers national savings. Barro does not as his Ricardian Equivalence suggests that households will not consume the tax cuts. However, consumption did jump after the 1981 tax cuts and consumption today is very high. Barro's argument has two problems: (a) this empirical record that households may not be as ultrational as he assumes; and (b) even if they are - they realize these tax cuts are deferred tax liabiliities. So households expect higher tax rates in the future. Barro once sensibly argued for "tax smoothing". How is a tax cut that will later be increased considered a rational policy move by an advocate of tax smoothing?

I still think everybody's missing something. What if they want you to believe that interest rates will have to rise. What if it's important to up your expectations to avoid getting stuck - Japan style - at zero. What if you're all being too knee-jerk in your responses. And what if that is exactly what they want, to use you to changes expectations. Ever had the feeling you were 'sleeping with the enemy'?

Does it ever occur that this may be precisely why Hubbard had to go: he was telling the wrong story.

BTW all these numbers on % changes in interest rates consequent on debt, which model of central bank behaviour are they based on, discretionary, committed, or compromised?

Waniting people to expect higher interest rates is a terrible strategy for getting out of a liquidity trap, it will depress spending and keep you mired in the trap for a lot longer. What you want people to expect is higher INFLATION not higher interest rates. And you want them to expect higher inflation now, not 10 years into the future. I can't see that being the explanation.

Besides even if your theory was right it seems like youa re saying that someone in the Bush administration understood how to get out of a liquidity trap and that someone was not Glenn Hubbard! So that leaves us with Andy Card, Paul O'Neill, Karl Rove, Mitch Daniels???????

>>I still think everybody's missing something. What if they want you to believe that interest rates will have to rise. What if it's important to up your expectations to avoid getting stuck - Japan style - at zero. What if you're all being too knee-jerk in your responses. And what if that is exactly what they want, to use you to changes expectations. Ever had the feeling you were 'sleeping with the enemy'?

I'm with achilles on this one for three reasons.

a) "Japan style" rather exposes the (ahem) Achilles heel of this argument. If building up deficits in order to raise expected long-term expectations worked, surely it would have worked in Japan right now?

b) Got to remember that there is a fundamental asymmetry between debtors and creditors. If the world expects interest rates to rise then borrowers will want to bring projects forward in time while lenders will want to postpone them. And the decision to lend is at the option of the lender, not the borrower. Your scheme would work in a Social Credit, Silvio Gesell type economy, where borrowers had a right to credit, but not in our own.

c) Following on from the above, I don't think that your argument is particularly Keynesian in spirit, even though it's clearly based on a Keynesian view of the world. The way that you get into liquidity traps is through a shortfall in investment demand (the proportion of demand which is not related to current income) rather than consumption. Cheap money now and more expensive money later doesn't alter the attractiveness of investment projects all that much.

What cheap money is doing, as it did between 1991 and 1994 is supporting a "carriage trade." Borrow short and lend long. Notice the rise in high yield bond prices these past 6 months. There is much professional speculation just now, relying on the Fed to keep rates at current levels for some time to come.

"There is much professional speculation just now, relying on the Fed to keep rates at current levels for some time to come."

Let me add that there will be considerable warning before interest rates go up again. Interest rates will only go up if the economy is close to overheating. We have quite a way to go before unemployment returns to 2000 levels. Many assume that the Fed would have lowered interest rates to stimulate the economy were it not so close to zero. That means that growth will have to increase a lot before the Fed will put any braking action in place. The Fed would probably like to see interest rates pushed back out to around four percent so they have room to maneuver without being so close to the liquidity trap. This means that interest rates will stay low.

Running deficits now will be unlikely to affect the interest rates. However, deficits will matter once full employment returns.

As I recall Clinton economic policy recognized this and the deal was made with Greenspan to keep interest rates low if the administration kept a tight fiscal policy. That seems to have worked.

The administration is sticking to its numbers, with some minor adjustments. The White House Council of Economic Advisers calculated in February that the president's full, $726 billion package would create 1.4 million jobs through 2004. The House's trimmed down, $550 billion package would create just over a million jobs, by the White House's calculation. A $350 billion package would create 425,000 fewer jobs, White House spokesman Ari Fleischer told reporters last week.

"To the extent that the package is limited, we create fewer jobs," White House spokesman Claire Buchan said yesterday.

White House economists placed some important caveats on the 1.4 million jobs figure when it was first released. Although the Council of Economic Advisers projected that the original Bush plan would create 510,000 new jobs this year, the employment level, on average, would only be 192,000 jobs higher than it would be without the proposal. And that is in an economy losing 92,000 jobs a month.

A White House paper also cautions that virtually all of the jobs "created" by the package by 2004 would be hiring that would have happened anyway in 2005 through 2007.

http://www.washingtonpost.com/wp-dyn/articles/A50898-2003Apr28.html

The White House documents when accurately reported show that Krugman was right.