Wednesday, April 8, 2015

Brian Romanchuk — The Budget Constraint Does Not Mean The Government Will Pay Off Its Debt


Something to chew on.
Professor Brad DeLong made some assertions about Modern Monetary Theory (MMT) in this article about bond bubbles, which drew responses on the Mike Norman Economics web site (here and here). Professor DeLong's points have a lot of embedded assumptions, and I cannot deal with all of them here. But I do discuss one assumption in my upcoming eReport: Understanding Government Finance. This is the idea government 'has to pay back its debt'.

DeLong's thesis is built around theories that 'bond vigilantes' exist and are powerful. This was a dominant theory when he was at the U.S. Treasury in the early 1990s. However, this was exactly the investment thesis that lead to the humbling of the JGB bears in the 'Widowmaker Trade'.
He writes:
'Why? Suppose people start to fear that the government will not raise enough in taxes to pay off its debts. They will then try to dump government liabilities for real goods and services." 
This is a throw-away comment in a blog post, so I do not want to stretch the textual analysis of this too far. I think he is referring to the concept of 'fiscal sustainability', which is standard in mainstream economics. Or he may be referring to some version of the Fiscal Theory of the Price Level. But 'sustainability' has nothing to do with a common sense interpretation of the phrase 'pay of its debts'.
A government 'paying of its debts' seems to imply that the debt-to-GDP ratio will go to zero at some point. In fact, the inter-temporal governmental budget constraint, which defines 'fiscal sustainability' for the mainstream, says almost nothing useful about what will happen to the debt-to-GDP ratio. Why DeLong uses such a misleading phrasing is unknown to me.
The rest of his article revolves around whether a default can be forced by the bond market. The MMT response is no, but it is a fairly complex topic, which I do not think I can cover completely even within my upcoming report.
The rest of this article is an unedited first draft of an excerpt from my upcoming report, which has the working title: Understanding Government Finance. The estimated publication date: Before the Fed hikes rates. I will attempt to reduce the complexity of this text, possibly by moving material to other sections. (Those sections are not yet complete, so I cannot judge where is the best place for material to be relocated.)....
Bond Economics
The Budget Constraint Does Not Mean The Government Will Pay Off Its Debt
Brian Romanchuk

9 comments:

Anonymous said...

DeLong isn't talking about the USG paying off it's debt entirely. He knows that never happens. He is talking about the possibility that it won't pay off existing debts as they come due.

Now he knows very well that the government can always pay its existing debts by issuing either money or bonds that are re-purchased by the central bank (and probably always will, as long as the debt ceiling crazies don't win the day.) But what he is arguing is that if the bond vigilantes start to worry that the government will resort to higher than anticipated inflation (rather than a more price-stabilizing fiscal and monetary policy path) to reduce the real level of debt service and the real rate of return on government bonds, they will begin to dump bonds to buy real goods and services, and this will create inflationary pressures on those goods and services.

Matt Franko said...

He's probably just trying to get back on the Rubinite bandwagon so he qualifies for a potential Hillary administration....

Tom Hickey said...

And we know from recent experience that when they sell bonds to the central bank, they will not buy "goods and services" thus driving up the price level, as the central bank had desired, but rather other financial assets like equities, commodities that are considered asset classes like precious metals, collectibles, etc., and luxury real estate. OK, luxury goods and services might benefit too. Is this going to trickle down driving up the price of goods and services. Again, experience says no.

Tom Hickey said...

@ Matt

Bingo.

He was deputy assistant secretary of the Treasury under Clinton I. He is probably trolling for consideration as Treasury secretary under Clinton II.

Anonymous said...

Yes, I agree about the Hillary business. DeLong is definitely embedded with team Hillary. If Sanders continues to gain traction, expect to see Brad bringing out the hatchets to damage him by going after Stephanie.

Tom Hickey said...

Could be the hidden agenda for the recent trolling wrt to MMT. when I read the post, I immediately thought WTF?

Brian Romanchuk said...

Dan,

I still have no dea what he was going on about. He seems to have the Fiscal Theory of the Price Level in mind, but that has nothing to with "paying off the debt", it is a way of determining the price level.

How "bond holders" can sell, without creating a new group of "bond holders" is also a mystery.

NeilW said...

"they will begin to dump bonds to buy real goods and services, "

Which happens every day. They are called pensions.

But to dump bonds somebody has to buy them. They have to mature *and* balance sheets have to shrink for them to disappear.

In the same way that people can't see stocks and flows there seem to be a category of people who can't see the difference between exchange and conversion.



NeilW said...

'And we know from recent experience that when they sell bonds to the central bank, they will not buy "goods and services"'

That's because everybody is looking at the wrong driving point.

People who sell bonds *were selling anyway*. They already had in mind what they were going to do.

The fact that the central bank showed up is irrelevant. That just changed the price a bit. It didn't change the behaviour (other than to cause some front running by the speculators).

The people that changed their behaviour were those that were *buying* and were outbid by the central bank. They *had* to choose to do something else.

So you end up with a portfolio reconfiguration around things that are seen to be stores of value - including things like London real estate.

But nobody really bought anything - because the people doing the shuffling don't really need anything.

I'm not redoing my kitchen because I can't find an investment I like. I'm redoing it because it is worn out.