US Fiscal Problems Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth Harvard Kennedy School Historic Role Reversal: Public finances in Emerging Markets have become much stronger since 2000 Historic Role Reversal: Public finances in Emerging Markets have become much stronger since 2000 Brief US fiscal history: The 1980s US fiscal history, continued: The 1990s

US Fiscal Problems Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth Harvard Kennedy School Historic Role Reversal: Public finances in Emerging Markets have become much stronger since 2000 Historic Role Reversal: Public finances in Emerging Markets have become much stronger since 2000 Brief US fiscal history: The 1980s US fiscal history, continued: The 1990s www.phwiki.com

US Fiscal Problems Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth Harvard Kennedy School Historic Role Reversal: Public finances in Emerging Markets have become much stronger since 2000 Historic Role Reversal: Public finances in Emerging Markets have become much stronger since 2000 Brief US fiscal history: The 1980s US fiscal history, continued: The 1990s

Black, Shannon, Host has reference to this Academic Journal, PHwiki organized this Journal US Fiscal Problems Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth Harvard Kennedy School CEO/WPO Presidents’ Seminar Harvard Business School January 29, 2013 3 different US fiscal problems The long-term debt problem, dominated by rapid growth in entitlements, without tax revenues to pay as long as them. The short/medium term problem: severe recession in the aftermath of the 2007-08 financial crisis called as long as dem in addition to stimulus; which fiscal policy would have been suited to deliver, far more so than monetary policy. The short-term political problem: A succession of artificial “cliffs” in addition to shutdown deadlines. The US has mismanaged its finances as badly as Europe. without excuse of 17 legislatures, just 2 deadlocked political parties. National debt/GDP is the highest since WWII spike. Source: CBO, March 2012 The US has a long-term debt problem.

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The US has a long-term debt problem, continued “Long-term” in the sense that debt/GDP will rise alarmingly after the 2020s unless entitlements are put on a sound footing: Social Security & Medicare are due to run big deficits as the baby-boomers retire (predictably) in addition to the cost of health care rises rapidly (unpredictably). Definition of debt sustainability: regardless the level of the debt, it is sustainable if the future debt/GDP ratio is as long as ecast to fall indefinitely. US long-term debt problem, continued Not sustainable The problem is not short-term: Far from tiring of absorbing ever-greater levels of US treasury securities, global investors continue happily to lend at record-low interest rates (2008-): The US enjoys safe-haven status; the $ enjoys “exorbitant privilege.” There is no fiscal crisis. The US is not Greece. We just want to be sure not to become Greece in 20 years. Indeed the federal budget deficit is coming down from 10 % of GDP in 2009 to 7 % in 2012. despite the continued weakness in the economy. Recent steps will bring debt/GDP down over 2014-18. 2011-13 $1.5 trillion in spending cuts + $0.6 tr. 1/1/2013 tax “increase” (relative to having let all Bush tax cuts expire). US long-term debt problem, continued

Debt/GDP will probably decline over 2014 -18. Center on Budget in addition to Policy Priorities, Jan.9, 2013 http://www.cbpp.org/cms/index.cfmfa=view&id=3885 CBPP recommends a further $1.2 tr. in spending cuts & tax rises to stabilize debt out to 2022. But there is no need as long as it to hit this year. That would send us back into recession, as the January 2013 fiscal cliff would have. The debt problem is also “long-term” in the sense that we have known about it a long time. “For decades we have piled deficit upon deficit, mortgaging our future in addition to our children’s future as long as the temporary convenience of the present We must act today in order to preserve tomorrow. And let there be no misunderst in addition to ing: We are going to begin to act, beginning today.” Inaugural address, Jan. 20, 1981 US long-term debt problem, continued E.g., Ronald Reagan, on taking office: Other advanced countries have the same long-term problem: Rich countries’ Debt/GDP is the highest since the WWII spike.

even while weakening in advanced economies. World Economic Outlook, IMF, April 2012 Historic Role Reversal: Public finances in Emerging Markets have become much stronger since 2000 Historic Role Reversal: Public finances in Emerging Markets have become much stronger since 2000 Country creditworthiness is now inter-shuffled “Advanced” countries (Formerly) “Developing” countries AAA Germany, UK Singapore, Hong Kong AA+ US, France AA Belgium Chile AA- Japan China A+ Korea A Malaysia, South Africa A- Brazil, Thail in addition to , Botswana BBB+ Irel in addition to , Italy, Spain BBB- Icel in addition to Colombia, India BB+ Indonesia, Philippines BB Portugal Costa Rica, Jordan B Burkina Faso SD Greece S&P ratings, Feb.2012 updated 8/2012 The US public discussion is framed as a battle between conservatives who philosophically believe in strong budgets & small government, in addition to liberals who do not. Democrats, Republicans, & the media all use this language. (1) The right goal should be budgets that allow surpluses in booms in addition to deficits in recession. (2) The correlation between how loudly an American politician proclaims a belief in fiscal conservatism in addition to how likely he is to take genuine policy steps < 0. [1] Never mind that small government is classically supposed to be the aim of “liberals,” in the 19th century definition, not “conservatives.” My point is different: those who call themselves conservatives in practice tend to adopt policies that are the opposite of fiscal conservatism. I call them “illiberal.” “Republican & Democratic Presidents Have Switched Economic Policies” Milken Inst.Rev. 2003. It is not the right way to characterize the debate. [1] Brief US fiscal history: The 1980s The newly elected Reagan complained of the inherited debt: “Our national debt is approaching $1 trillion. A trillion dollars would be a stack of 1,000-$ bills 67 miles high.” address to Congress, Feb. 18, 1981. Reagan’s actions: sharp tax cuts & rise in defense spending. The claim: budget surpluses would result. The reality: record deficits that added to the national debt a 2nd trillion in his 1st term a 3rd trillion in his 2nd term a 4th trillion when G.H.W. Bush initially continued the policies. (“Read my lips, no new taxes.”) US fiscal history, continued: The 1990s The deficits were gradually cut, in addition to then converted to surpluses by the end of the 1990s. How was this accomplished Regime of “Shared Sacrifice” - 3 key policy events. 1990: GHW Bush bravely agreed spending caps, taxes & PAYGO 1993: Clinton extended the policy. 1998: As surpluses emerged, “Save Social Security 1st.” Strong growth in late 1990s. Fiscal history, continued: The 2000s The Shared Sacrifice regime ended on the day G.W. Bush took office in Jan. 2001. He returned to the Reagan policies: Large tax cuts together with rapid increase in spending (triple Clinton’s) not just in military spending (esp. Iraq & Afghanistan), but also domestic spending: discretionary + Medicare drugs benefit. Just like Reagan, he claimed budget surpluses would result. Just like Reagan, the result was record deficits: The national debt doubled. I.e., GWB incurred more debt than his father + Reagan + 39 predecessors The question “What is the right fiscal policy, Austerity or Stimulus” is as foolish as the question “Should a driver turn west or east” It depends where he is in the road. Sometimes west is the right answer, sometimes east. “The boom, not the slump, is the right time as long as austerity at the Treasury.” - John Maynard Keynes (1937) Collected Writings Cyclicality & Fiscal Policy: They took advantage of the 2002-07 boom to strengthen their budget positions, allowing them to run deficits when the global recession hit in 2008-09. Some examples: China was able to respond with big stimulus. Chile, Korea, Malaysia, Botswana, Indonesia. Another respect in which many EMs have improved their policies since the crises of the late-1990s: A shift from pro-cyclical fiscal policy to counter-cyclical Cyclicality of Fiscal Policy During the same period when some EM governments finally learned counter-cyclical fiscal policy (2000-12) , many Advanced-Country politicians as long as got how to do it. Most conspicuously, Greece & other euro members failed to reduce budget deficits during years of growth, 2001-08 in addition to were then as long as ced to cut spending & raise taxes during the euro debt crisis of 2010-12, exacerbating recessions, even raising Debt/GDP. But the United Kingdom did the same, despite no euro-constraint as long as cing austerity in 2010-12. Source: IMF, 2011. I. Diwan, PED401, Oct. 2011 Greece let its deficit rise during the growth years, 2001-08, despite the 3% of GDP limit set by the Stability & Growth Pact & then was as long as ced into sharp austerity in 2010-12. SGP floor Some US politicians have pursued pro-cyclical (i.e., destabilizing) fiscal policy 1st cycle: 1980-81: Reagan’s speeches pledging action to reduce the national debt “beginning today” came during a period of severe recession. Boom: profligacy. 1988: As the economy neared the peak of the business cycle, c in addition to idate George H.W. Bush was unconcerned about budget deficits: “Read my lips, no new taxes.” Recession: austerity. Some US politicians have sought pro-cyclical fiscal policy, continued 2nd cycle 1990: Predictably, the first President Bush summoned the political will to raise taxes & rein in spending (PAYGO) at precisely the wrong moment - just as the US entered another recession. Boom: profligacy. 1993-2000: Despite the most robust recovery in US history, 1993: all Republican congressmen voted against Clinton’s legislation to continue PAYGO etc. 2000: Even after 7 years of strong growth, with unemployment < 4%, George W. Bush campaigned on a plat as long as m of tax cuts. 2003: After his fiscal expansion had turned the inherited surpluses into deficits, GWB went as long as a 2nd round of tax cuts & continued a spending growth rate 3 x Clinton’s. VP Cheney: “Reagan proved that deficits don’t matter.” Recession: austerity. Some US politicians have sought pro-cyclical fiscal policy, continued 3rd cycle 2007-09: Predictably, when the new worst recession since the Great Depression hit, Republican congressmen suddenly re-discovered the evil of deficits, deciding that retrenchment was urgent. They opposed Obama’s initial fiscal stimulus in February 2009. 2011: Subsequently, with a majority in the House, they blocked further ef as long as ts by Obama when the stimulus ran out, despite still-high unemployment. Recession: austerity. Thus, through 3 cycles, the ef as long as ts at tightening came during recessions, followed by fiscal expansion when the economy was already exp in addition to ing. Why do leaders fail to take advantage of booms to strengthen the budget People don’t see the need to “fix the hole in the roof when the sun is shining.” They do see the mistake when the storm hits, but then it is too late. Official as long as ecasts are over-optimistic in periods of expansion, rationalizing the failure to act. Black, Shannon Max, Shannon and Porkchop - KIIM-FM Host www.phwiki.com

Failure to take advantage of booms to strengthen the budget, continued Budget balance rules are in fashion. EU: SGP, Debt brake, Fiscal compact. US: State budget limits; Debt ceiling, Proposed Balanced Budget Amendment. But they worsen the problem of over-optimistic as long as ecasts. E.g., when euro members go above the 3% deficit ceiling, they adjust their as long as ecasts, not their policies. The US has its own version of biased as long as ecasts. Failure to strengthen the budget in booms, continued Official US as long as ecasts in the 2000s White House as long as ecasts were over-optimistic all along. OMB in Jan. 2001 as long as ecast rapid rise in tax revenue, in effect assuming there would never be a recession. Four tricks to justify tax cuts, dating from the 1980s: The Magic Asterisk Rosy Scenario Laffer Hypothesis Starve the Beast Hypothesis Congressional Budget Office as long as ecasts are honest. But the Bush Administration adopted new tricks, so that “current-law budget” would show future surpluses: continuation of Iraq & Afghan wars treated as a surprise each year phony sun-setting of tax cuts Where are we now, in January 2013 The political crisis: repeated partisan st in addition to offs in Congress. To reduce the budget deficit: how far can we get by discretionary spending cuts Where are the right places to squeeze, politics aside

Repeated partisan st in addition to -offs in Congress have each ended by “kicking the can down the road.” In the summer of 2011, “fiscal conservatives” at first refused the usual debt ceiling increase, recklessly threatening government default. Political dysfunction led S&P to downgrade US bonds from AAA. “Fiscal cliff” deadline at the end of 2012 risked fiscal contraction sharp enough to cause a new recession. Repeated partisan st in addition to -offs, continued More self-inflicted deadlines coming up: Mar. 1: Postponed sequestration of discretionary spending hits $1.2 tr. over decade, ½ defense, ½ domestic. Mar.27: Government shutdown, unless Congress passes Continuing Resolution (like 1995). Apr.15: Both houses supposed to pass budget resolutions, to allow: May 18(+): New debt ceiling, postponed from January 23, 2013. Grounds as long as hope: each time, the hostage-takers lose a little more credibility. The game of “Chicken” In the 1955 movie Rebel Without a Cause, whoever jumps out of his car first supposedly “loses” the game. James Dean does; but the other guy miscalculates in addition to goes over the cliff. I think the Republicans miscalculated, in part because they asked as long as something impossible.

Jan. 2013 fiscal cliff: Letting the Bush tax cuts expire on schedule would have stabilized debt/GDP CBPP, May 2011 If we opt as long as short-term fiscal stimulus, or at least on counteracting the current fiscal contraction, what as long as m should it take U.S. fiscal policy in 2013 Renew some elements of the Obama stimulus such as infrastructure investment (roads & bridges) & giving money to the states so that they can re-hire laid-off teachers, policemen, firemen, subway drivers & construction workers as in the Jobs Bill that the Congress voted down. US Fiscal Problems Jeffrey Frankel Harpel Professor of Capital Formation in addition to Growth Harvard Kennedy School

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