金曜日, 5月 10, 2019

Interest Rates and Fiscal Sustainability by Scott T. Fullwiler Working Paper No. 53 July 2006

Interest Rates and Fiscal Sustainability by Scott T. Fullwiler Working Paper No. 53 July 2006 


Interest Rates and Fiscal Sustainability Scott T. Fullwiler∗ Wartburg College and the  Center for Full Employment and Price Stability As baby  boomers reach retirement age, concerns  over the future path of federal spending on entitlement programs grows among orthodox economists.   Researchers closely  tied to  the “generational accounting” literature (i.e., Kotlikoff,  1992) have been particularly  prominent here.  These  economists have developed a  measure that they  call the  “fiscal imbalance”—which  they  claim  measures the magnitude of an existing  unsustainable fiscal path.   They  argue that the fiscal path of the U.S. is $44 trillion  off course compared to a “sustainable” path (Gokhale and  Smetters, 2003a).  Others  within the circle have noted the $44 trillion “fiscal imbalance” in numerous opinion  pieces (e.g., Gokhale and Smetters, 2003b; Kotlikoff and Sachs, 2003) and in  other publications (e.g.,  Ferguson and Kotlikoff, 2003;  Kotlikoff and Burns,  2004).  An essentially  identical  measure expressing the imbalance  as a percent of future GDP—the “fiscal gap” (e.g., Auerbach, 1994)—shows it to be about 7 percent (e.g., Auerbach et al., 2003).   The “fiscal imbalance”  is  calculated as  the current  national debt plus the present value of future expenditures  less  the present value of future revenues; future expenditures and revenues are  estimated or predicted to the infinite horizon (Gokhale and Smetters,  2003a; Auerbach et  al.,  2003).  The widely-cited 2003 study by Jagadeesh Gokhale and Kent Smetters  was originally commissioned by  then-Treasury Secretary  Paul O’Neill in 2002, when  its authors were deputy  assistant secretary  for economic policy  at the Treasury (Smetters) and consultant  to the Treasury  (Gokhale), respectively.  However, the Bush Administration played  down the results  of the report  as  it prepared in late  2002  and early 2003  to  promote a second round of tax cuts  (Despeignes, 2003).  Nonetheless,  measuring a “fiscal  imbalance” via  an identical  methodology  has  since been promoted by  others in the  Office of Management and the Budget (2005), the Treasury  (e.g., Fisher, 2003), the IMF (e.g., Mühleisen and Towe, 2004), and has also been incorporated into projections of the Trustees  for Social Security  and Medicare.   A final example is worth particular  mention:   in  November 2003, Democratic  Senator Joseph Lieberman introduced  the “Honest Government  Accounting Act” that declared “the  most  appropriate way  to assess  Government  finances is to calculate its net assets under current  policies: the  net present value of all prospective receipts minus the net present value of all prospective outlays  and minus  outstanding debt held by  the public.”  The proposed Act specifically mentioned the study  by  Gokhale and Smetters  and held it  as an example of “honest government accounting.”  Had it been passed into law,  the legislation would have created a  “commission on long-term  liabilities and commitments” to  calculate  the federal  government’s “fiscal imbalance” at 75year and  infinite horizons; had the “fiscal imbalance” been determined to exceed pre-set limits in any given  year, the President  would have been required  to submit  a plan for reducing the imbalance.  In addition, all proposals for increased future spending or  reductions in  taxes would  have been required to  be “fiscally  balanced” at 75-year and infinite horizons.1 ∗  Email:   scott.fullwiler@wartburg.edu 1  In  Congressional  testimony  in  2003,  Smetters  went  a  step  further than  even  Senator Lieberman, proposing  much the same  as the latter’s “Honest Government  Accounting  Act” but  as an  amendment to  the  U.S. Constitution. 1

These examples are the most recently influential  applications  of one of the core themes of orthodox macroeconomics:   fiscal sustainability.   Indeed, most will  recognize that fiscal sustainability  as presented in  the fiscal imbalance  literature is  essentially  an application of the orthodox concept of  a government’s intertemporal budget “constraint.”  Consequently, this  paper is not as concerned  about the particulars of the “fiscal imbalance” or related “generational accounting” literatures; nor, for that matter, does it deal directly  with the supposedly  looming financial “crises” facing Social Security  or  Medicare.   Instead, the paper is  most  concerned with understanding and critiquing the assumptions or beliefs  at the core  of  these literatures and measures, and  then  with  providing an alternative view.  Fiscal  sustainability, when defined via an intertemporal budget “constraint” as the “fiscal imbalance” literature does, relies heavily  upon assumptions regarding the relative rate  of interest  paid on the national debt.  Several heterodox economists, particularly  Post  Keynesians  such as  Arestis and Sawyer (2003), have  also noted this fact.  This  paper expands upon  heterodox research in this area by  referencing the actual operations of the Federal Reserve (hereafter, the Fed) and the Treasury as set out in their own research and regulatory publications and as  consistent with  their own balance sheet operations.   In short, the orthodox concept of fiscal sustainability  is flawed due to its assumption that a key  variable—the interest rate paid on the national debt—is set in private financial markets as in  the orthodox loanable  funds framework.  On the contrary, as a  modern or sovereign money  (Wray,  1998, 2003) system  operating under flexible  exchange rates, interest  rates on the U.S. national debt are a  matter of  political  economy  (Fullwiler, 2005, 2006).   This has significant implications for the appropriate “mix” of monetary  and fiscal policies, particularly  if full employment and financial stability  are considered fundamental goals of  macroeconomic  policy. Fiscal Sustainability:  The  Orthodox View As  mentioned, orthodox treatment of fiscal  sustainability  is understood by  most already.   It is nevertheless  useful to  discuss this in  some  detail  in order to  better understand how  together the key assumptions  frame  the orthodox view of fiscal sustainability.   This section begins by deriving the government budget “constraint,” then turns to some  of the most  recent orthodox research on long-term interest rates.  Next, the government’s budget “constraint” and interest rate determination together set the government’s  intertemporal budget “constraint.”   Finally, recent concerns  regarding additional, “nontraditional” effects of anticipated  future deficits are reviewed.  Also, throughout  the section, the obvious consistencies  with recent fiscal imbalance literature are noted and referenced.   1. The government’s budget  constraint and monetization It is worth replicating Walsh’s (2003,  pp.  136-137) derivation  of the government’s budget constraint (hereafter, GBC) for a few reasons.   First, the book  is a standard  text for graduate-level orthodox monetary  economics courses.   Second and  third, this derivation of  the  GBC combines cash-flow identities of the Treasury  and central bank into  that of  the “government sector,” while an understanding of the interrelation of  the  operations of  both is also  central to the  heterodox critique of the GBC presented below.  Following Walsh (ibid.),  the  derivation begins with that he calls the “Treasury’s  portfolio constraint” (though, much  like the GBC, it is in fact  a  simplified cash flow identity—somewhat analogous to a company’s statement  of cash flows—in the  sense that it  combines balance  sheet  and income statement identities).  In (1) below,  G  denotes non-interest government spending,  T  is total  tax revenue, iBTotal  is the interest paid on the entire national debt outstanding, and  ∆BTotal  is the total increase/decrease in government bonds outstanding.  Also, Walsh (ibid.) uses  RCB  to denote  Treasury  receipts from  the central bank to the Treasury.  All variables are for the  current year. (1)  G + iB Total = T + ∆ B Total + RCB Assuming that only a negligible portion of  the central bank’s  interest receipts from  the Treasury (iBGovt) are not returned to the Treasury  (the Fed is legally  obligated to return any  profits beyond  its own imputed cost of capital), then 2

government domestic, or foreign—has a persistently  negative  financial balance, which will not  be uncommon since the three balances always  net to zero. Concluding Remarks The sustainability  of fiscal policy as determined  via the orthodox  IGBC framework is irrelevant for understanding the workings of a modern money economy.   The orthodox framework’s  assumption that interest rates are determined in  a loanable funds  market for interest  rate determination and the related assumption of differing  inflationary impacts of “monetization” versus the “financing” of  deficits are both fundamentally  flawed.  Instead, the orthodox view that  fiscal deficits or international forces might have large effects on interest rates could be appropriate  only for a non-sovereign-currency-issuing  government operating under fixed exchange rates, not for a  modern  money  regime  with flexible exchange  rates (Wray, 2006a).  Consistent with the  monetary  nature of interest rates  in a  modern  money  regime, rates on Treasuries have followed the stance of  monetary  policy,  not fiscal  policy, and have only  risen above the rate of GDP growth during times when  high interest  rate policies were set in  place by monetary  policy makers.   And because  interest  rates on  the national debt in a  modern  money  regime  are a  matter of monetary  policy, it follows that the stance of monetary  policy has  much to do with whether a  given fiscal path is “sustainable” or not.   The “sound finance” view of fiscal policy  is obviously  central to the orthodox view of fiscal sustainability.  As Blanchard et al. (1990) argue, “Sustainability  is  basically  about good housekeeping.  It is essentially  about whether, based on the policy  currently  on the books, a government is headed towards excessive debt accumulation” (p. 8).  By  contrast, the  functional finance view argues that it is involuntary unemployment and excessive unutilized capacity  that  a government  and a nation cannot “afford.”  Much as the theoretical foundations for fiscal policies consistent with the  philosophy  of  functional finance have been detailed  by  other researchers (e.g., Arestis  and  Sawyer, 2003; Bell, 2000; Forstater  and Mosler, 2005; Mosler, 1995, 1997-8; Nell and Forstater, 2003;  Wray, 1998, 2003) this  paper contributes to the theoretical foundations for  a  monetary  policy  complement  to these fiscal policies.  The corollary  here is the importance of recognizing that a nation similarly  cannot “afford” high-interest-rate  monetary  policies if it also wants to pursue true, full employment policy  while ensuring that whatever fiscal deficits incurred in the  process are not inflationary.  The  monetary  policies implemented by the Fed during 1979:4 – 2000:4 stand out as being remarkably “unsustainable” in this regard.  Another necessary—though, admittedly,  not sufficient—hurdle to  overcome in  the progression toward a functional finance-based macroeconomic policy  is  to abandon analyses based  on the flawed IGBC framework currently employed by  numerous government offices.  In short, if it  is  true that involuntary  unemployment is a frequent—if not  persistent—characteristic of a modern capitalist  system  as Keynes, Minsky, and many  others have concluded, then the nation most certainly cannot “afford” to  have its policies run according to such a mistaken  analytical framework as the  one at the  heart of the  misguided and tragically  mislabeled Honest Government Accounting  Act. References Anderson, Richard G. and  Jason Buol.   2005.  “Revisions to User  Costs for the  Federal Reserve Bank of St. Louis Monetary  Services Indices.”  Federal Reserve Bank of St. Louis  Review, vol. 87, no. 6 (November/December):  735-749. Anderson, Richard G. and  Robert H.  Rasche.  1996.   “Measuring the Adjusted  Monetary Base in an Era of Financial Change.”  Federal Reserve  Bank of St. Louis  Review, vol. 78,  no. 6 (November/December):  3-37. 31