Reader CoRev, in commenting on this post, advises me to look at the actual data for October (instead of the CBO estimate) before declaring a trend deterioration in the budget balance. Well, the data are out.
Here’s what the deficit looks like, using Treasury’s Monthly Treasury Statement data for October, and historical data.
Figure 1: Twelve month moving average of budget balance divided by nominal GDP (blue, left scale) and in billions of nominal dollars (red, right scale). Budget balance (on balance sheet and off balance sheet), as recorded by Treasury (October statement), divided by GDP interpolated using quadratic match. October GDP assumes 5% nominal GDP growth, in line 1.4% real GDP growth and 3.6% inflation in 2007Q4 (see WSJ survey). NBER-defined recessions shaded gray. Sources: Treasury’s Monthly Treasury Statement data for October, and historical data, BEA October 31 GDP release, NBER, and author’s calculations.
It turns out that the $55.6 billion deficit is not that different from the CBO’s estimate of $59 billion. But it is the trend that is of greatest interest to me.
In addition, nominal receipts are slowing their ascent, while as a share of GDP, they have clearly plateaued.
Figure 2: Twelve month moving average of receipts divided by nominal GDP (blue, left scale) and in billions of nominal dollars (red, right scale). Receipts (on balance sheet and off balance sheet), as recorded by Treasury (October statement), divided by GDP interpolated using quadratic match. October GDP assumes 5% nominal GDP growth, in line 1.4% real GDP growth and 3.6% inflation in 2007Q4 (see WSJ survey). NBER-defined recessions shaded gray. Sources: Treasury’s Monthly Treasury Statement data for October, and historical data, BEA October 31 GDP release, NBER, and author’s calculations.
Seems to me a fair bet that, given current estimates for a slowdown to around 1.4% GDP growth SAAR in 2007Q4 (see this post), receipts will fall as a share of GDP.
Hence, I stick with the conclusion from my previous post on this subject: A balanced budget is far off.
Technorati Tags: budget deficit,
receipts.
OK, Menzie, next question.
How far is far off? It’s a little hard to have a discussion with these kinds of predictions.
I see CoRev is doing here what he’s done over at Angrybear for a long time. His question was asked and answered by Menzie quite well – and he yey CoRev keeps acoming with his excuses for the fiscal fiasco from this Administration. CoRev works so hard for this Administration, one has to wonder if he’s getting paid by them.
CoRev: I dunno. But I don’t think it’s going to be before the May 2009 date suggested by the straight-line extrapolations in the Skeptical Optimist post you mentioned approvingly last time around.
However, if you do want a conditional forecast, I’d say if the tax cuts are made permanent, you’ll see a path closer to the “alternate” path laid out by the CBO in the second figure in this post. I.e., no balanced budget for the next four years.
pgl: I don’t want to impugn anyone’s motives. For me, I’ll be happy if people stop basing arguments using straight line projections on arguably cyclical and/or I(1) variables.
Thanks for the response, Menzie. Regrettably, I am less sanguine, but don’t think the CBO prediction will actually represent the reality. We’ll just have to wait and see. As far as Steve’s straight line projections, it makes for an easily understood trend, especially for us more stat/math challenged old fogies.
If 2007Q4 growth is 1.4%, why would receipts fall as a share of GDP?
Correct me if I am wrong, but 2007Q1 and Q2 growth was in this range, yet receipts as a share of GDP did not fall.
As long as we’re making predictions, I will predict that Q4 is going to be a lot better than 1.4%. Closer to 3.9% than 1.4%, in fact.
Buzzcut: Your guess could turn out right. For reference, your forecast is 3.9 standard deviations above the mean forecast from the Wall Street Journal survey, or in the top 0.1% of the distribution.
Receipts will fall as GDP growth decelerates and corporate profits decline. I was using GDP growth as a shorthand for overall economic activity. Apologies for not being more specific.
Speaking of Skeptical Optimist, did he ever make that bet with Mark Kleiman? I hope so as I know Mark and his wife would soon likely to become homeowners again. Winning that bet would help Mark make a large downpayment – even in his pricey part of Los Angelses.
No point in worrying about it. Reagan proved that deficits don’t matter — at least according to Dick Cheney. When Treasury Secretary Paul O’Neill protested otherwise concerning the effects of the second round of tax cuts, Cheney said “We won the midterms. This is our due,” and then personally fired him a month later.
A nice historical note, Joseph. I wonder if that mind set is a serious impediment to the current growing crisis as “protesting” Secretaries of any sort are just not staffed by this administration. Politicization of the policy making process seems to have this self-snuffing result.
Menzie,
In principal are you for or against tax cuts for the individual?
Menzie, one point I ignored, in my previous comment. Falling revenue as a ration of GDP is bad? Not if you are a fiscal conservative. It actually is our aim.
Why I am less sanguine has to do with the election campaign. If the Dems win, and they appear destined, then the spending side of the equation is going to go up dramatically. And, I am tracking the deficit, not necessarily the GDP. So, with the internecine congressional wars, spending up but taxing not so much. Add to that the end of this business cycle during the next administration, we have a deficit in acceleration again.
The straight line extrapolation courtesy of the Skeptical Optimist has been extended to August 2009 from May 2009 with publication of the October monthly Treasury Statement.
And, yes, Steve Conover did make the $1000 bet with Mark Kleinman.
Receipts will fall as GDP growth decelerates and corporate profits decline. I was using GDP growth as a shorthand for overall economic activity. Apologies for not being more specific.
Menzie, I understood your point. I just think that, excepting Q3, growth this year has been pretty poor. In the range of 1.4%, in fact. Yet receipts did not fall.
I think that there is going to be a sizable surprise to the upside of your 1.4% growth forcast. There are a lot of drivers for growth out there (the 10 year is at 4.01%!?!?! The falling dollar is driving the formerly moribund export sector, gas prices are NOT outrageous considering that WTI is at $99, etc.)
What happens to the housing crisis when people can get 30 year mortgages under 6%? The AVERAGE 30 year fixed rate conventional mortgage is under 6.25%. The average 5/1 I.O. is at 5.75%.
These are low rates. They’re not going to bail out the subprime market, but then that market is in turmoil because of FRAUD, not market fundamentals.
The falling dollar is key. FINALLY it is starting to hit the yen. I saw that the yen is trading 108 to the dollar. That’s more like it, although it has some more to fall. 100 would be good, 80 to 90 would be ideal.
The falling dollar has yet to really hit China’s currency. So far, the Chinese have been willing to eat the internal inflation that their currency has caused. But there was a story in the Sunday Trubine about how
Sorry, I mistakenly posted before I finished my thought.
There was an article in the Sunday Chicago Tribune about how Chinese consumers are starting to get upset about the serious inflation that they’re seeing (17.6%, according to the Tribune).
So how long can the Chinese eat all the inflation that they’re seeing without it impacting their political situation?
What so-called fiscal conservatives want is a question of which brand of fiscal conservative one asks. When my father was in the legislating business (at the state level) the arguments used by today’s so-called fiscal conservatives would have been laughed out of the caucus room. A fundamental goal of fiscal conservatism, as it was understood then, was to balance spending with revenues. It was never the case that lower taxes for the sake of lower taxes was a hallmark of what then was understood to be fiscal consservatism. Lower taxes in the context of budget balance and a state that could meet its obligations to the public was an element of fiscal conservatism.
In more recent times, people with very different goals and very different motives have adopted the fiscal conservative label, for whatever reason.
http://www.chicagotribune.com/services/newspaper/printedition/sunday/chi-china_osnos_bdnov25,0,932866.story
kharris, your uunderstanding is outdated.
Most fiscal conservatives believe in lower taxes relative to expenditures. Keeping them balanced is not possible and still reducing the deficit. So, lower spending relative to revenues is the current fiscal conservatives’ goal. Which BTW, has happened for the past few fiscal years.
That is also the reason to ask Menzie for more detail in his predictions. Unless something changes, balancing the budget will eventuate. The when or how long things will continue and their pace of change is the set of issues under discussion.
Keep this in mind as well. Growth has occured since the 2003 tax cuts. The Dow roughly doubled, for example. We are all a lot richer than we were in 2003.
As long as our income and wealth is increasing faster than our debts, what’s the problem?
My son keeps asking me the same question. I keep trying to get him to understand that it is what we are getting or not getting for our increasingly larger debt that poses the problem.
bncthor, so how do we answer the inevitable question? How much value is there in prosperity and security. Are we getting sufficient value for our annually diminishing borrowing to obtain them?
Moreover, how do we change the fact that a large portion of the debt is intra-governmental? The SS Trust Fund, don’cha know?
Did the CBO and OMB predict this improvement in the budget deficit a long time ago, regardless of the Bush tax cuts? I find this argument a bit vexing. Look at the $9 Trillion in debt that has been accumulated, and the improvement in the deficit seems to still be wasteful, considering that there would still be a more balanced budget without all the increased debt.
Buzzcut said:
“As long as our income and wealth is increasing faster than our debts, what’s the problem?”
I happen to be in agreement that more taxes is not the answer; less spending is required. That, however, is not going to happen in any of our lifetimes. Americans – all of us – are addicted to the things the government(s) provide from mortgage deductions to farm subsidies to pork barrel roads to corproate largesse. To that end we are probably doomed to deficits until the final collapse. However re comment above, it’s not clear to me that either of those conditions have been a result of the cuts. There’s certainly been growth in the economy but it clearly is nowhere near double. In fact, as pointed out by a lot smarter people than me, the argument could be made that it is pretty much all monetary growth and little actual growth. In Euro and Pound terms (let alone gold) we might be even have lost ground. The cuts may have increased tax revenues but it is arguable that they have increased neither the wealth nor income of the “bottom” 90% of Americans.
Separately, on the debt issue, if the above is true regarding income then clearly the enormous amount of public and private debt taken on over the last several years is unsustainable – perhaps helping explain what we are seeing in the credit markets. Just a thought.
Holy crap! I just checked the 10 year: 3.92%.
I know that the rate is a bearish signal (flight to quality), but come on! It is a bullish signal in that it makes stocks more valuable, lowers mortgage rates, etc.
I have to say that 6 months ago, I didn’t expect to see rates this low ever again.
Buzzcut, it’s like a school of fish. Zip, they go left. Zap, they go right. Whoosh, they go down. And for no apparent reason they go left again. No leader. No reason, just movement.
Footwedge,
Credit markets are like the fish analogy above. Definitely not related to the Fed Debt. However, when we talk about the sustainability here’s a few FACTS:
1) The current Federal Debt started in 1861. We are still paying off the Civil War. Feel threatened?
2) As a percent of GDP, the Fed debt is not out of norm.
3) The Fed deficit is actually going down as a percent of GDP.
4) less spending in relation to revenue is what lowers the Fed deficit. We have achieved said lowered spending for the past four fiscal years. And, it appears it will do so again in FY08.
5) Only eight years of the past thirty have had a surplus. Feel any better?
For the liberals here, I always ask this question. Why do we need to raise taxes? We have been paying down the deficit with the current policies and tax scheme. What are we going to spend the added revenue on? Don’t say the debt, because we all know it won’t happen.
CoRev –We do not have to raise taxes. All we have to do is allowed the tax cuts to expire in 2010 as the Republicans wanted.
CoRev asks..
“How much value is there in prosperity and security.
Both are subjective, and vary from one person to the other. I doubt if such can be aggregated in any meazninful way.
And, he further asks…
“Are we getting sufficient value for our annually diminishing borrowing to obtain them?”
I guess I am wondering…What annually diminishing borrowing?
Lasty, CoRev writes…”Moreover, how do we change the fact that a large portion of the debt is intra-governmental? The SS Trust Fund, don’cha know?
Obviously, I don’t know as much as you CoRev. In my ignorant condition, I have been thinking that the heavy recent borrowing in general and from the Social Security Trust Fund specifically was largely for the purpose of reducing taxes and to pursue the Administration’s objective of greater U. S. security by creating the prerequisites for democracy taking hold throughout the Middle East. It never entered my mind that government borrowing during the last few years was for the purpose of reducing taxes – especially for those with high incomes and for corporations.
Gee, I have so much to learn.
10 year closed at 3.85%.
CoRev, the bond market may be random or reactive, or whatever. But that bond number drives mortgage rates. Mortgage rates are going down.
Are you guys ready to refi? I am.
The next great wave of mortgage refinancings is around the corner. Everybody like me, who isn’t happy with the rates they’ve gotten over the last 2 or 3 years, and remembers the insane rates of ’03, is chomping at the bit to get back to those rates.
I think that we’re close. Real close. I can’t wait to pull the trigger.
And on the stock market side, declines like these suck for your net worth, but are wonderful buying opportunities. This downdraft is sucking down good companies as well as bad.
Bncthor, we have been borrowing from the public less each year for the past 4. Borrowing from the SS Trust Fund has been going on since its inception in 1935. It is the way it was supposed to operate as defined by the originating legislation. It is neither good nor bad. It is just the way it is.
Moreover, when the SS Trust Fund surplus is going UP, it usually means there are more workers making higher salaries. That’s a good thing? Yes?
BTW, how did we get to this statement?
Even if it was snark it seems from out of left field. Just wondering.
CoRev, I would disagree that debt is unimportant. The bigger the debt, the bigger the payments just to SERVICE that debt, let alone pay it down. Isn’t this already one of the top six or seven outlays? If you want to decrease spending, decrease the debt and you are saving yourself money that is otherwise wasted on interest, “wasted” insofar as you aren’t getting anything for the money.
I am curious what the deficit and debt would look like without the tax cuts. All of the CBO and OMB and CEA reports I’ve seen show little bang-for-the-buck, pointing to projections that showed revenue increases even without any supply-side miracle. I wonder what the federal government’s books would look like without the faith-based fiscal policy. I have no dog in this hunt politically, but on this particular issue I just find it ridiculous and duplicitous that the GOP pretended that they were serious about the sunset provisions, because you know for damn sure they won’t be allowed to “expire” without 3 years worth of bitching and moaning as though someone ran over their dog. I’d be more sympathetic to their cries if they were honest about their intentions up front.
Spencer-
The expiration of the reductions in tax rates will be a tax increase, no matter how you twist it. And, like the Clinton tax increases in 1993, it will not raise as much revenue as expected.
I hope we avoid the increase.
This thread gives me an occasion to ask economists about a part of practical macro orthodoxy that I have never understood. Namely, why do we always hear about the ratio of the budget deficit to GDP rather than the ratio of the national debt to Federal revenues? The latter ratio is more analogous to a conventional measure of financial leverage. Is it because, in some theoretical sense, the govt. could tax a much higher percentage of GDP and get more revenues if it needed them? The govt. can theoretically print more money also. But if the question is about how comfortable we are with the debt in the context of the current economic balance, my naive thought is that we should be looking at the ratio of national debt to revenues. Comments?
“The expiration of the reductions in tax rates will be a tax increase, no matter how you twist it. And, like the Clinton tax increases in 1993, it will not raise as much revenue as expected.”
>>>>>>
I suppose you have a point on the notion that taxes will increase, but I suppose the issue is whether the rates in 2000 were accepted as a baseline, and the rate reductions were sold as a temporary policy change that would “sunset.” Isn’t it at least a little bit disingenuous to play the “you want to raise taxes!” card at this point, when the policy itself was marketed as having a finite existence?
As for the Clinton tax increases not increasing revenues as expected, I’m afraid I can’t recall any specific predictions on revenue numbers. The only thing I can recall was the GOP leadership, Newt Gingrich in particular, smugly proclaiming that the economy would spiral back into a recession. What projections of revenue increases are you talking about that illustrate the failure of the Clinton 1993 policy?
Dean, you seem to be a little disingenuous here.
Obviously, by taking on me and Rich Berger, you do have a dog in this hunt, or at least strong opinions.
As to your point on the debt, yes it would be better to pay down the publicly held debt, but like all things that is not so simple a matter. When you pay off these bonds, or more likely just stop issuing new, you are taking opportunities away for retirees to invest safely. Even the intra-governmental bonds represent retiree savings. I suspect even some of the foreign held debt is put in foreign Govt’s retirement funds. Surely nearly all of the publicly held debt is in accounts designed for safety.
Touche’, CoRev. Perhaps I should have been more clear: on this issue I am certainly not sympathetic to the GOP. If you would care for me to list the myriad reasons I can’t stand the other side, I would be glad to. I just didn’t want to threadjack the comments.
I may not have regressions right in front of me, but I’m guessing those projections also included capital gains for 2007 in both stocks and real estate. Given the declines in both for the year (S & P is negative for 2007 as of today), I wouldn’t bet on those things happening. Much as the asset bubbles inflated revenues in the late ’90s and mid 2000s, why can’t it seriously deflate revenues for this year and next?
And the people who both say “We’re heading toward a balanced budget” (based on the tax cuts sunsetting and no expenses for Iraq) and then turn around and call for the tax cuts and the war to be made permanent are cynical at best, naive fools at worst, and shouldn’t be taken seriously in either case.
The U.S. Budget Balance
This graph from Econbrowser shows the budget surplus or deficit of the U.S. federal government as a…
Sorry to all for the absence. Today was a teaching day.
The key equation to remember is:
d-dott = dt-1(r-g) + deft
Where d is the debt to GDP ratio, dot is the time differential operator, def is the deficit to GDP ratio, r is the real interest rate, is the real growth rate of GDP.
So far d-dot is negative, since real growth is (due to expansionary monetary policy, lax regulation of housing financing sector, and tax cuts and increases in discretionary spending) exceeds the real interest rate and the effect of deficits.
As g falls, if r does not fall sufficiently, and as def rises due to the procyclical nature of tax receipts and tax revenues (i.e., tax revenues decline in recessions and slowdowns, ceteris paribus), then one can see d-dot rising in the near future, in terms of the Federal debt held by the public.
The picture is a little more complicated for external debt, because our assets are largely denominated in foreign currencies, while liabilities are mostly in dollars. So the rapid depreciation against the euro (1.50 $/euro or bust!) will tend to revalue our debt upwards. But if the depreciation becomes more widely-based, we lose that advantage, and the asset-revaluation effect is reduced. Then falling g may become much more important along this dimension.
Oh, and don’t forget about what I once wrote about: contingent liabilities — as the financial sector sinks into greater distress.
So I, for one, am more worried than some of the readers.
Buzzcut: Look at the Libor-Treasury spread… Then think about what interest rate is closer to required rate of return on equities that is used to discount the stream of future dividends that is in theory equal to the price of stocks.
Menzie, I’m not entirely sure what the heck you wrote.
Let’s start here: http://www.bankrate.com/brm/ratewatch/other-indices.asp
Which of these rates are you talking about, and what’s the spread you calculate?
menzie, worried?
About what? Business cycles? Their height and length? We have another year of a positive economy. Then a down turn? Deep? Long?
Youll only be able to refi youve still got enough equity, might be problematic for many.
Remember Reagan raised Social Security taxes saying it would solve the Social security problem, so predicitons dont always work out, especially since they use that money to cover the budget.
And all those people who say the Democrats are going to spend so much are the same people who said that Bush and the OGP Congress wouldnt. They were wrong. And they were mostly the same people who said Clinton tax increases would throw us into a recession, but he came within a whisker of balancing the budget even the off budget stuff, that the deficit is coming down people miss including Iraq, Katrina, etc
Also, Clintons economy grew faster with those slightly higher tax rates than Bushs
And heres the up to date word on Bushs stock market performance. Pathetic
http://online.barrons.com/article/SB119222886742057828.html?mod=9_0031_b_this_weeks_magazine_main
Just the data.
Buzzcut: See this post by Michael Shedlock, who’s figured out how to circle things on graphs.
CoRev: Worried about the trajectory of the deficit-to-GDP ratio (the original point of the post) and hence the debt-to-GDP ratio.
who’s figured out how to circle things on graphs
Now who’s that a dig at?
” the falling dollar is driving the formerly moribund export sector ”
This statement is patently false. The falling dollar causes foreign investors to dump the dollar – it is that simple. The TIC flows show this to be the case. Just because you’d LIKE exports to rise doesn’t mean they WILL – contrary to everything Cheney tells you to think. [ As a tip, go check out Caterpillar’s q3 report. ]
Menzie posted on this just recently, and I’ll take his analysis. Flame-baiting won’t make Republicans suddenly appear interested in the 99.95% of the population they currently don’t care about.
Buzzcut : He’s a professor. Furthermore, it’s his blog.. deal with yourself.
” Are you guys ready to refi ” – That’s funny stuff, given that cutting the ffr has actually RAISED mortgage rates.
In the coming year, due to the implosion of CDO’s and the knock-on effects (more capital against bad loans required to be held by banks on balance sheets, fewer lenders available, more stringent loan requirements, less regulatory understanding of the refi take-out effect of subprime lenders) 4 trillion dollars less will be lent than 2007. Pick your percentage or absolute value measurement.. in ANY case, that’s worse than the Great Depression.
But hey, that could never happen here.. the republicans are smrt, Dow 100,000!!
Buzzcut: Let me be clear. It’s not a dig. It’s a compliment, since I have no clue how to do it on jpg’s and gif’s, and it’s a nifty trick for highlighting things that one figures are important. (Sort of like how I haven’t figure out how to do this in PowerPoint).
“kharris, your uunderstanding is outdated.”
CoRev,
That is more or less my point. The question is, why is it outdated? My understanding is that this is propoganda as usual. The term “fiscal conservative” once mean something very different than it does in many cases today. Rather than find new, unambiguous language, a group of people who wanted to sell a new idea wrapped it in a term associated with a view that already had wide support. Rather than honestly say “we do not stand for what you stand for, we stand for something new” and then honestly lay out the new idea, proponents of cutting taxes without regard to the impact on government balances or national savings, cutting taxes regardless of whether tax rates are high or low, cutting taxes as a solution to every problem have simply masked their intentions by adopting an opportune label.
It is not my “understanding” that is outdated. My understanding is quite up to date and quite clear. It is my prefered definition of the term you have used that is outdated. I think pointing out the effort to hijack the term “fiscal conservative” is a valuable addition to the discussion, and I will continue to make the point. I would also note that the term “conservative” as it is traditionally used does not apply to people who change things – like the definition of words or fiscal standards – when ever it suits them.
well put, k harris. I think that being able to define the terms, and manipulate the language, of a debate has proven key to winning the policy battle, regardless of whether the facts get abused in the process….
Menzie,
Are you worried the debt/GDP ratio is getting lower or going higher?
It is my understanding govt debt is issued in the form of Treasury Securities – such as U.S. Savings bonds. I consider the few I have to be an asset to me. I also checked a few company balance sheets and they list Treasury Securities on the asset side. So why is it individual entities consider govt debt to be an asset but collectively we consider it to be a liability? And does a growing economy require growing financial assets (govt debt) held by the public?
markG,
Every financial asset is a liability to somebody. The fact that you own an instrument that pays a coupon means you have an asset. The fact that Treasury (on your behalf) has to pay the coupon and will someday have to pay off the face value means Treasury (on your behalf) has a liability.
I have no clue how to do it on jpg’s and gif’s, and it’s a nifty trick for highlighting things that one figures are important. (Sort of like how I haven’t figure out how to do this in PowerPoint).
Actually, I usually start with powerpoint. Insert the jpeg into a blank powerpoint page. Then there’s a draw toolbar at the bottom of powerpoint that contains the autoshape button that lets you draw circles. From there, I generally ctrl-printscreen to copy it, paste it into MS Paint, cut just the graph from MS paint, open a new doc in MS Paint, and paste in the modified graph. Save it as a JPEG from there.
What exactly am I calculating? Spread between 1 year LIBOR and 10 year T-bill? That’s been pretty stable since ’05.
kharris
So if the public’s balance sheet shows an equal asset (the Treasury Securities held) for every liability (Teasury’s liability) what’s the problem with govt debt? I understand the public must pay taxes to cover the interest payment, but since the public owns the asset the public receives the interest payment. Sounds like a wash in the aggregate.
I don’t like excessive govt spending. It takes away real resources from the private sector. But all the talk and worry about govt debt is overblown. Japan’s debt to GDP ratio is much higher. Has it caused high inflation or the Yen to fall or the govt to become bankrupt or insolvent?
My biggest worry is the debt/GDP ratio falling like it did in the late 1920s, the 1970’s and late 1990’s. Yea, good economic times followed those periods.
Buzzcut: As Shedlock notes in the post, it’s the change in the 1 month Libor/Fed Funds rate rate; 6 months ago, it was 7 bps. Now it’s 30. For more up to date information on the drying up of liquidity in the money markets, see this Bloomberg article.
I’m not sure that “fiscal conservative” is outdated, but I think it is misleading. Conservatives used to favor restraining the expansion of government, including government programs and spending. Now it seems to be used for groups such as the Concord Coalition, whose priority is balancing the budget, rather than cutting spending. The Concord Coalition is not a conservative group. I think the typical fiscal conservative emphasizes increasing taxes over cutting spending.
I would rather see a deficit at a lower level of spending than a balanced budget at a higher level of spending. I could get by with less government.
Menzie, I just calculated the spread between the 1 Month LIBOR and the 10 year yield from 2001 to now.
There was a HUGE increase in spreads from early ’04 to late ’06.
I would characterize the spread since then as stable. Yes, there was a blip in about September, where the spread almost hit 1bp. But we’re down to 0.45, which is less than the average over the last year.
Compare that to ’04, when LIBOR was 3bp LESS than the T-bill! That’s a huge difference. Compared to that, the volatility in the spread over the last 3 months has been miniscule.
So… I guess I don’t understand the point of even bringing up LIBOR.
Technical question for you guys… can I post my excel graph here in the comments?
Buzzcut, I don’t know how to make charts appear in the comments. But if you’d like to email it to me, I can give it an Econbrowser URL that you could link to from comments here, if you’d like.
Buzzcut: I’m trying to use close to the same maturities to control for the term premium, so one can look at the risk spread. Comparing a short term Libor to a 10 year Treasury yield conflates term and risk spreads.
Now I am completely confused.
Menzie said:Look at the Libor-Treasury spread…
I did. I don’t see anything of note.
Now, maybe you meant to look at the Libor-Fed Funds spread. But I don’t see how that has any bearing on mortgage rates.
I can see that the risk premium for mortgages has gone up a lot, which means that mortgage rates won’t drop as much as the 10 year has fallen. But that doesn’t mean that rates won’t fall. Falling mortgage rates drive growth. There’s no denying that.
Menzie, may I ask a question that is indirectly related to the US federal deficit?
On of the effects of a deficit is, apparently, to worsen the current account deficit. Well, I seem to be getting the understanding that the use of the dollar as a reserve currency has meant that that the US has in effect been exporting dollars, and historically raised the value of the dollar, hurt exports, and “hollowed out” US manufacturing through off-shoring.
There seems to be an analogy to the Spanish 17th century empire finding and spending New World gold, and hollowing out their economy, kind’ve a currency version of the Dutch disease. I’m told something similar happened to the UK before WWII.
This would seem to be reversing itself right now, with the implication of short-term austerity and longer-term economic benefits.
Does this make sense to you?
Nick: I’m going to defer to economic historians on your question. In the case of Spain, gold was flowing in. In the case of the US, we print fiat money, which governments and agents overseas are willing to hold, exchanging goods in return. Not certain the analogy holds.
Buzzcut: The whole point of the financial accelerator literature (associated with Bernanke, Gertler, etc.) is that sometimes yields do not tell the whole story — i.e., there is something called “credit rationing”. So even if mortgage rates go down, it’s not clear that will be the same as when mortgage rates went down in the past.
markg
Japan finances its entire public sector deficit out of Japanese household and business sector savings. In Japan’s case, the assets and liabilities are held by rough the same crowd of people. In the US, the public sector deficit is not financed entirely domestically. It is not the case that “the public” owns the asset and receives the interest payment, unless we include Japanese households, China’s central bank and Mid-East public sector investment funds in our definition of “the public.” One simple way to look at the US federal deficit (to the extent that it is financed abroad) and the US current account deficit is that they represent foreign claims on future domestic production. Since we also face a demographic bump which represents future claims on production, the prudent thing to have done over the past decades is to run a government surplus so that there is less competition among future claims.
I’d also advise against crude assertions of causation based simply on chronology. It is hard to see how the tiny dab of surplus run in the 1990s stands to account for the modest recession that followed. Overinvestment due to Y2K? Nasdaq bubble?
Menzie,
Spanish gold flowed into Spain, and then out to the rest of Europe. In effect, Spain was printing money with found New World gold and spending it. Doesn’t that seem like a pretty exact parallel with printing fiat money and spending it?
there is something called “credit rationing”. So even if mortgage rates go down, it’s not clear that will be the same as when mortgage rates went down in the past.
No doubt there will be very few no document, interest only, payment optional, 40 year mortgages to people with sub-600 FICO scores this time around.
However, that doesn’t change the fact that I can get a superior rate, and a lot of other “normal” people can too. Rates ARE going down, and that DOES increase growth, all else being equal.
Whether it can make up for the subprime crisis, who knows.