A “Fiscal Cliff Scenario” – A Symposium of Views in The International Economy

Released today, in The International Economy  symposium:

“At some point, the federal stimulus checks will stop coming. Consumer sentiment could continue to be affected by fear of further Covid related complications. The world economy hardly looks trouble-free. Is it possible that U.S. policymakers fired all their fiscal stimulus cannons too soon? Will they be short of ammunition in the event the economy in 2022 significantly underperforms? Some economists, using a different metaphor, describe the danger as “running head-on into a fiscal cliff.” To what degree should U.S. policymakers be concerned? The economy was already rebounding. Should policymakers have held back on sending out the checks until 2022?

Comments by Joe Gagnon (PIIE), John Taylor (Stanford), Mohamed el-Erian (Allianz), Steve Kamin (AEI), and Bill Dickens (Northeastern), and myself. Here’s my comment:

First, while federal debt held by the public has risen quickly, and is projected by the Congressional Budget Office to further rise from 100 percent in 2020 to 106 percent of GDP by 2031, the maximum debt-to-GDP ratio that can be sustained (and hence the gap between the two, sometimes considered a measure of “fiscal space”) is unknown, particularly for a country that issues debt in the global reserve currency. Add to that the fact that the real
interest rate that we are paying on that debt is likely to be lower than the growth rate of GDP for a sustained period—the real ten-year interest rate has been stuck at about minus-1 percent for a year, and was close to 0 percent on the eve of the pandemic—then we have much more room to run a primary deficit (and stabilize the debt-to-GDP ratio) than if one thought real rates were going to rise back to 1.5 percent.

Second, another metric for assessing the amount of fiscal space—the debt-to-tax base—seems low if one takes the observed tax revenue as a measure. However, if tax revenues could be raised so that we collected the same revenue-to-GDP ratio as in 1979, then the deterioration in the fiscal space would be somewhat less worrisome; the debt-to-tax revenue would then be only a bit greater than at the end of the great recession. Of course, raising tax
rates to raise tax revenues is difficult. In other words, fiscal space is partly a function of political will.

Third, what we spend our fiscal ammunition on matters. Spending on infrastructure has a bigger multiplier effect, in both the short and particularly the long term, than other types of spending. Given the current configuration of real government funding costs, it’s unclear whether greater expenditures on infrastructure investment would actually reduce fiscal space.

Finally, returning to the first point, the federal government funds in the U.S. dollar, which is  the global currency. It can expect that a large portion of that debt will be readily purchased by foreigners, both central banks and private entities. That’s likely to be true despite rising federal debt, if only because governments around the world are also issuing much more debt in the wake of the Covid crisis.

The real danger is that we will retrench too quickly in response to perceived, but illusory, constraints, thereby derailing growth. We’ve been there before, and we shouldn’t repeat that experience. For now, the United States has a ready reserve of ammunition, and we should be prepared to use it.

(Written at the end of August).


See also Barry Eichengreen’s insightful “Balanced, Nuanced Story on Debt”.


31 thoughts on “A “Fiscal Cliff Scenario” – A Symposium of Views in The International Economy

  1. pgl

    One defense witness in the Rittenhouse trial did not work out as the defense attorneys wanted. Here is a summary of his testimony:

    Defense witness: Jacob Marshall
    Gaige Grosskreutz’s friend and former roommate Jacob Marshall was called to the stand. He was questioned about a post he made on Facebook after visiting Grosskreutz in the hospital after he was shot.

    In the post, Marshall said Grosskreutz said he regretted “not killing the kid” in reference to Rittenhouse. Marshall said he lied in the post and said he 100% made up the statement. He said Grosskreutz never said those words.

    The defense seemed surprised and immediately dropped the line of questioning.

    Marshall told Binger he took down the post after backlash. He said it was in “bad judgement.” The post was made out of pure anger, Marshall said.

      1. pgl

        He certainly is a good actor. The jury felt sorry for him after his fake emotional break down. I almost threw up.

  2. Barkley Rosser

    Your comment looks reasonable, Menzie. I would add two points.

    One is that indeed passage of the hard infrastructure bill means that there will be some substantial government spending that will also increase the productive capacity of the US economy. That should provide some offset to the ending of those checks being sent out.

    The other, which cuts several ways, is that we still do not know what will be in the BBB, assuming it does eventually get passed. Its size seems to have been scaled back somewhat, but also some of the revenue enhancements that were supposed to be in it look to have been removed due to political pressure. But there may be some further stimulus from that one as well, assuming it passes.

    Offhand the case for some kind of “fiscal cliff” looks weak.

    Also, I think the news about inflation from last month is in fact likely to pass. It was led by sharply rising energy and gasoline prices. I have already commented about hnow gasoline prices rose sharply in VA last month, helping the Youngkin campaign. As it is, today crude prices were down sharply again, and where I am gasoline prices have stopped rising since the beginning of this month, and indeed I have seen a few decline. Next month’s report is likely to look a lot different from the one just ended.

  3. macroduck

    ” it possible that U.S. policymakers fired all their fiscal stimulus cannons too soon?”

    The sentence quoted above is a classic case of petitio principii, of “begging the question”. The authors assume that the U.S. government has a spending or borrowing constraint so that fiscal stimulus now is likely to preclude more stimulus at a future date. They haven’t bothered to show why that would be true.

    It has long been asumed that either law makers or savers have a sort of Puritan streak that will require far higher borrowing rates as deficits rise. That assumption is built into the authors’ argument, but has not proven true for the U.S. since Volcker, if ever.

    Neither side knows the future. Good policy making requires an assessment of the balance of risks. Menzie, who has never failed as a restauranteur, is arguing that erring on the side of doing too little to support the economy presents greater risks than erring on the side of doing too much. Gagnon and friends beg to differ by begging the question.

    There is another issue which is only sometimes addressed directly but which is implicit the discussion of fiscal policy: who benefits? There is a trade-off between monetary and fiscal policy. The less we rely on fiscal expansion, the longer interest rates will remain low. Low interest rates work through asset prices and the wealth effect, as well as through capital spending. Fiscal policy works through household balance sheets, as well as through paying directly for goods and services. Wealth holders gain most from monetary policy in the first round. Fiscal policy benefits workers and households across the range of incomes in th first round. A first round in confers advantage in future rounds.

    Gagnon and friends may honestly intend only to argue for preserving future policy flexibility, but they are tacitly arguing for a mix of policies which benefits the wealthy over the rest. Along with thinking about the balance of risks, we need also to consider the balance of benefits. At the risk (not the certainty) of somewhat reduced policy flexibility in the future, we can have the (high) likelihood of a more equitable distribution of benefits.

    Balance, not question begging. Two balances, not one.

    1. macroduck

      Shouldn’t have cited “Gagnon and friends”. The question begging came from the intro to the discussion, not from Gagnon.

  4. Moses Herzog

    I love when you share this kind of stuff Menzie. You are “duh man”. Or whatever a super-cool guy would be called in a Quentin Tarantino movie~~~that’s what you are Professor Chinn.

  5. Moses Herzog

    My personal favorite part of many gems here. It reminds me of James Kwak type writing, something which may be “obvious” but not enough people are articulating it:
    “Of course, raising tax rates to raise tax revenues is difficult. In other words, fiscal space is partly a function of political will.”

    I could go on my extended tirade about how this nation of America (more so Republicans) lie about their supposed desire to pay their fair share of their federal bills, but even I have grown tired of typing it, so I’ll give you a link to one of my tirades from roughly mid-year 2019, which is largely a copy of tirades I gave on the old BaselineScenario blog, some years before that:

    Feel free to watch the Mondale YT link, since Menzie already let it through the blog filter, I assume Menzie won’t mind you viewing it now. All of Mondale’s great wisdom (ZERO sarcasm) rings just as true in the year 2021, as it did 37 years ago. I believe near to the time, Menzie got his Bachelor’s.

      1. Moses Herzog

        I think we lost all ability to solve this mystery when Dave Thomas died.

        Of course I could give you the smart aleck answer and say it was in Gary Hart’s pants the entire time.

        BTW, since I’m going off on one of my infamous tangents on this blog. this “sexist” thinks that Geraldine Ferraro would have made an excellent Vice President and done a better job than most of her predecessors as VP. She would have been an adequate Secretary of State had she put her mind to it. Although, as she proved with her husband long ago, she needed to improve the people she hung out with and should have improved her social circle, as proven with this photo:

        But she was a great woman with a razor sharp mind. Just bad at choosing friends.

  6. joseph

    In a post earlier today I wrote:
    “6.2% year on year inflation means that the value of the national debt was reduced by over $1.5 trillion. The austerians should be rejoicing.”

    Barry Eichengreen in “Balanced, Nuanced Story on Debt” in your link said:
    “The next three sentences are of course subject to change. But as you and I speak, the inflation rate has been rising but interest rates on U.S. government debt have not. That means that U.S. public debt is becoming more easily sustainable, not less. Inflation is raising the denominator of
    the debt-to-GDP ratio, in other words, rendering that debt less worrisome for the moment.”

    It seems we agree.

    1. Steven Kopits

      That depends. If interest rates stay low, that’s true. If not, then the federal budget will blow up.

      1. pgl

        It is correct to say that the behavior of nominal interest rates matters but this notion something will blow up is stupid even for you. If both nominal rates and inflation rise by the same amount, the impact on the path of the real debt is unaffected. Anyone who gets basic finance would know that. But of course we all know your flunkey Finance 101.

        1. pgl

          When the CBO made its forecast of the debt/GDP ratio will evolve over the next 10 years – Stevie insisted that there was no way it would not blow up even as the CBO made crystal clear what its detailed modeling and forecasts were. But Stevie kept saying he did not understand how they got their figures – even as we pointed out over and over where the CBO was clear.

          You see either Stevie refused to read what CBO wrote or he is truly this incredibly dumb.

          So your question is a bit over his limited head.

  7. Steven Kopits

    I think one should be cautious about using a price, rather than volume, analysis of debt. If those funds used for the deficit were instead used for some better purpose, then presumably we’d be better off. Price is important, but it is not everything.

    1. Menzie Chinn Post author

      Steven Kopits: Well, “volume” would be in real terms. At least in economics, we write about series that way — compare how GDP deflator and real GDP are described in statistical releases. Don’t know about in your discipline.

      1. pgl

        His discipline clearly is not financial economics. Maybe Steve is trying to emulate rsm in using terms he does not understand.

        1. Barkley Rosser

          Well well well, clearly none of you have any idea what you are talking about, as rsm would inform you all. I mean without standard errors, all these numbers are just meaningless, being cooked up by Deep State bureaucrats hiding in DC basements while they cook the innards of children and transcribe numbers provided to them by Satan.

  8. Steven Kopits

    Still a classic:

    Like Japan, the US now runs structural fiscal deficits, even at the top of the business cycle. These deficits are coming in higher than forecast, just as America’s 65+ age cohort is set to increase by half to 2025. The Obamacare repeal and replace dilemma reflects just this tension. On the one hand, ‘compassionate conservatives’ – and voters – want universal healthcare coverage. On the other hand, the funding for such coverage is not readily available from tax revenues. Thus, the US social safety net appears to be at a turning point, with enormous pressures to solve the problem by resorting to ever-increasing debt. If inflation and interest rates are low, why not borrow more? That’s what they did in Japan. Like Japan, the US may find itself in a trap of unrealistic expectations meeting the reality of a thinning workforce and a slow-growing economy. This is already visible in states like Illinois, New Jersey and Connecticut, which are finding that they are unable to meet the pension promises made in the last thirty years. Within a decade, these pressures may be manifest on a national level, too.


    1. pgl

      More your shameless self promotion of your worthless blog? OK genius, if Japan is the poster child of irresponsible long-term budgets, please man splain why Japan not only has such low inflation but also low interest rates.

    2. pgl

      Princeton Steve loves to promote his own worthless blog. He just call some bloviating about Japan being fiscally irresponsible a “classic”. It is classically STUPID. After all if Steve’s bloviating had any real substance we would see high long-term interest rates in Japan. But here FRED tells us that Japan’s interest rates are virtually zero:


  9. joseph

    It’s ironic that Kopits brings up Japan in his argument about the danger of exploding debt burden. Japan’s debt is twice the U.S. and it still has lower interest rates. Is ironic the right word or just backwards?

    1. pgl

      I made the mistake of actual reading Steve’s stupid post. Among his various forms of fallacious reasoning – two things really jumped out. He laments the fact that if population growth slows, real GDP growth slows even if productivity continues to rise. In other words this economic midget does not get that we care about GDP per capita. I guess this moron thinks the average Chinese citizen is richer than the average American as their GDP has past ours. Never mind it is spread over a population that is four times ours.

      But note he is comparing Japan’s gross government debt/GDP not realizing that net debt/GDP is less than 170%:


      Now we have pointed this out to Steve many times but I guess he is too stupid to read even basic stuff.

  10. rsm

    Why is growth the goal, when it is correlated with rising suicide and overdose deaths?

    Why do you think GDP represents anything more than an arbitrary political-value-laden imputation, whose only reality is reflexive, i.e. GDP only has value if you convince everyone it’s not actually a statistically dishonest magically thought up fantasy number?

    1. pgl

      “Why is growth the goal, when it is correlated with rising suicide and overdose deaths?”

      Now this is brazen claim without a shred of evidence to back it up. No research paper. No data. And of course what are the standard errors to that evidence you present – which is none.

      1. baffling

        rsm lost a brother due to suicide. he has been projecting blame on anything and anybody. my guess is his brother worked in the financial industry.

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