The Debt Ceiling Debate in Plain English

First off, what exactly is the debt ceiling? Most people seem to think it's a license for the federal government to take on deeper debt, but Bruce Bartlett has the clearest explanation I've read:

The debt ceiling is a cap on the amount of securities the Treasury can issue, something it does to raise money to pay for government expenses. These expenses, and the deficit they've wrought, are a result of past actions by Congress to create entitlement programs, make appropriations and cut taxes. In that sense, raising the debt limit is about paying for past expenses, not controlling future ones. For Congress to refuse to let Treasury raise the cash to pay the bills that Congress itself has run up simply makes no sense.

Failure to raise debt ceiling will mean:

• The US currency is no longer the world standard
• We'll have to pay much higher interest on everything we borrow as a country
• And after a short time juggling the books, government spending for everything will be instantly cut by 44%.

Despite this, the GOP has insisted that any vote to raise the debt ceiling be accompanied by huge cuts in federal spending and they are adamantly opposed to raising any taxes to increase federal revenues (this extends to ending any existing tax cuts as well). On June 23, House Majority Leader Eric Cantor (R, VA) walked out of the talks due to the inclusion of some revenue increases. There was then some talk about returning to the earlier plan involving $2 trillion in budget cuts, but again, the GOP was insistent that no new revenues be included in the package while Democrats were adamantly opposed to cuts in Medicare, Medicaid and Social Security.

On July 7, Obama changed the equation. According to the Washington Post,

Obama and Boehner have emerged as the most enthusiastic proponents of a big deal that would save as much as $4 trillion over the next decade by overhauling the tax code and tackling all the major drivers of federal spending, including the Pentagon and health and retirement programs.

However, resistance to revenue increases in the proposed package led to abandonment of the idea by the GOP.

Today, Obama announced that Social Security payments would be delayed if the debt ceiling was not raised, and 470 CEOs of many of America's largest corporations signed a statement urging Congress to end the impasse. This afternoon, Senate Minority Leader Mitch McConnell (R, KY) announced a new plan to give the President authority to raise the debt ceiling himself. Congress would then be free to vote on a resolution of disapproval, which the President could then veto, after which President Obama would raise the debt ceiling in three increments over the next year. Essentially, this would pass responsibility for raising the debt ceiling to the President and would draw attention to the raise throughout 2012, an election year. As Kevin Drum put it, "This is possibly the most juvenile, most buck passing, most transparently mendacious proposal I can recall from any party leader in recent memory."

What’s behind the political battle over the debt ceiling?

Since most people’s eyes glaze over when the subject is economics, here’s a plain English explanation of the ideas and interests underlying the debt ceiling debate.

Does Deficit Reduction Stimulate the Economy?

1. Would it be safe to say that progressives believe that if the government spends money, the economy will be stimulated and grow, and more people will have jobs?

Well, not just that it spends money, but that it does so in targeted ways. According to Mark Zandi, chief economist at Moody's, the most effective government spending to counteract a recession is food stamps & unemployment insurance (see chart below). Why? Because people who get that aid need it, so they spend the money right away & it starts circulating through the economy.

Zandi found that among the least effective government spending would be the Bush tax cuts (see chart below). Why? (i) The Bush tax cuts were never targeted to boost the economy. They were set up, quite literally, to reward Bush's biggest donors (i.e., fat cats). (ii) Nobody spends money they don't need to in a recession. Our natural tendency is to hunker down. Do rich people have to spend the money they get in tax cuts? No. Do they? No. Ergo, no additional money circulates through the economy, so it doesn't grow.

2. Government spends on people, people spend money, other people receive that money, the economy is stimulated. This is good.

Basically, yes. In economic terms, government spending in a recession starts the process. The rest of the process you mention is called the multiplier effect.

3. Republicans believe that we have to reduce the deficit by cutting government spending in order to reduce the deficit because we have to reduce the deficit because....you get the point.

Republicans SAY they believe that, but they're the ones who created 90% of the current deficit, directly or indirectly, in the first place. They held an extension of unemployment insurance hostage over their demand for continuation of the Bush tax cuts at the end of 2010, further deepening the deficit. And they're now insisting that (a) no taxes be raised to reduce the deficit and (b) any increase in government revenues via elimination of tax loopholes be offset by additional spending cuts. So there's no reason to take seriously any statements they make about their supposed concern about the deficit. They love deficits. So if they're not concerned about the deficit, what are their ulterior motives for all the posturing?

Republicans believe several different things that underlie what they say they believe about the economy, all of them wrong:

a. The smaller the government, the greater the individual freedom. Conversely, the bigger the government, the greater the encroachments on individual freedom: This sounds straightforward. In fact, it has deep roots in American culture, having been expressed directly by Thoreau in the early 19th century. More recently, Friedrich Hayek enunciated it when he predicted that the development of Britain's National Health Service (universal health care to you & me) would turn the UK into another Soviet Union. His prediction obviously was wrong, but that didn't stop conservatives from continuing to believe it with their typical fervor. There are lots of other problems with this (what measure is used to determine the size of government? i..e, how do we know if a government is too big or too small?), but limits of space & time preclude further elaboration.

b. Tax cuts pay for themselves by increasing economic activity: Reagan tried it with huge tax cuts in 1981. The enormous resulting deficits led him to pass 8 consecutive tax increases (yes, increases), but nobody in the GOP seems to remember that part of the story. Bush, as we know, gave us the closest thing to a pure scientific test of this we're ever likely to have: With the GOP in control of all 3 branches of government, he passed enormous tax cuts & didn't subsequently offset them. He had the worst economic growth record of any president since Hoover. Conversely, Clinton raised taxes & had the biggest economic expansion in our country's history. So much for tax cuts stimulating growth. Again, the evidence has had no influence on GOP thinking.

c. Starve the beast: Grover Norquist famously said he wanted to shrink government to a size that would enable him to "drown it in a bathtub." Again, see Bush. He cut taxes, waged two wars without paying for them, & passed the Medicare Part D unfunded mandate. Money was drained from the Treasury, but did government shrink? No, it grew. The only president to preside over a shrinkage in the size of government was Clinton, who raised taxes, as previously noted. Again, no correlation backing up the claim, and no acknowledgment of the fact by the GOP.

Lastly, remember who funds their campaigns. The GOP always knows which side their bread is buttered on.

4. Obama believes that we have to reduce the deficit by cutting government spending because ________?

See my answer to #7 below.

5. Obama wants the economy to be stimulated because if more people have more money they will vote for him. Also theoretically he does actually want people to have more money.

One would think...

6. Does Obama think that cutting the deficit is going to stimulate the economy?

I guess he must, but I don't know.

7. Does deficit reduction stimulate the economy?

For an economy stuck in a severe recession? Hell, no. See #1 above. Just as there's a multiplier effect, there's also a negative multiplier effect. Think about it like this: As rain falls on crops, the water circulates into the soil, around the roots of plants, and the plants are fed, enabling them to grow. Imagine what happens when there's a drought. Water no longer circulates, plants are not fed, and they die.

Right now, not enough money is circulating through the economy--at least, not to ordinary people (the banks have oodles of the stuff--much of it from the bailouts--but they're not issuing much credit, businesses are not expanding & hiring, unemployed people are not making ends meet, so they're not spending, so there's little demand, so businesses aren't expanding & hiring, rinse & repeat). Since interest rates are near zero, the Fed can't lower interest rates any more to stimulate the economy. And the consensus in Washington is that we don't dare--no, no, no--do further stimulus spending to boost the economy. So we're stuck.

All deficit reduction will do in this context is remove more money from an economy that already has too little circulating through it. Take a look at what's happening to public service employees. State employees are being laid off right & left. All of them have families, most have houses, cars, bills to pay, etc. but there's no money to be had. All this is creating enormous strain on state budgets because the demand for Medicaid is going through the roof due to all these people becoming unemployed. So what are the GOP & now Obama talking about? Making enormous cuts to the federal budget (including aid to the states, which is already failing to meet the exploding need). But all the Very Serious People to whom Obama seems to be listening in DC make 6- or 7-figure salaries. None of them know anybody who's unemployed, I'd venture to guess. Economists have declared the recession over (that's the recession defined in technical terms, not in terms of what's actually happening to ordinary people). So I guess Obama thinks that if the technocrats say it's over, it's over, & it's time to start reducing the deficit. Now that I think of it, this brings to mind a recent thread about epistemic closure among conservatives that appeared in blog posts by Henry Farrell, Julian Sanchez & some other smart people. But obviously, conservatives are not the only ones susceptible to that dynamic (of course, reasonable people may disagree about whether Obama is a liberal, a conservative or something else).

One Final Note

As Kevin Drum and others have remarked tonight after Mitch McConnell's plan was announced, it seems that the GOP may have boxed themselves in with their insistence on drastic budget cuts with no revenue increases under any circumstances. Speaker of the House John Boehner himself told fellow House Republicans earlier today that they were going to lose leverage steadily as the August 2 deadline drew nearer. Judging by McConnell's announcement, that leverage may be ebbing more quickly than they'd anticipated. It's always a stretch to try to read the minds of others, and some of my comments above may go further in that direction than the evidence supports. Whether Obama is a fool or a genius (or both) is probably best evaluated with greater temporal and emotional detachment than I possess. My own perceptions of him are susceptible to changes in the political winds so I'm probably well advised to restrict my analyses to the economics and politics of the issues at hand. That said, I do think that allowing the entire debate over the budget to take place on GOP terms--i.e., with a focus on the deficit rather than on job creation--is a huge unforced error on Obama's part. We still don't know how the whole debt ceiling debate will play out; nor do we know what will happen vis a vis the deficit. But it's hard to see how we get from our current situation of high unemployment and low job growth to one that returns our economy to health. This short-term deficit obsession is a detour that doesn't help us get where we need to go, and may actually make the situation far worse.

An earlier version of this was cross posted at http://www.greaternycforchange.org/?p=676.

What's Ron Paul's Beef with the Federal Reserve?

[LENGTH WARNING]

My, it has been quite a while, hasn't it.



A friend posed the following question:

...And I am truly trying to wrap my brain around the Federal Reserve information I want so much to understand, but I can't get any 'good' out of it, only criminal mischief. And I never trusted Ron Paul, but a lot of people I know are ready to put him in the White House. Why do I mistrust him? Can you tell me, because I don't know exactly why, BUT I KNOW...

I'll try to give something like an answer; hopefully, it'll be coherent.

Ron Paul (like his son, Rand) is intensely devoted to libertarianism. I don't know if you're familiar with that particular ism. Basically, the underlying idea of libertarianism is that the only frame of reference for analyzing society is that of the individual. Collective behavior of any kind is inherently suspected. Culture, history, sociology, psychology--forget it. There's only the individual & the only question worth asking is whether any social program, idea or phenomenon increases individual freedom. For a number of libertarians, this dovetails neatly with the writings of Ayn Rand, the creator of a "philosophy" called objectivism. Rand posited in Atlas Shrugged that the smartest, most individualistic people in society are carrying a vast majority of sheeplike wastrels on their backs, giving more to society through the results of their hard work & taxes than they receive from the masses of shirkers. Her hero, John Galt, and other producers decide to withhold their labor in protest, thereby bringing society to its knees. You can see that same sense of indispensibility & entitlement among today's hedge fund managers & bond traders as they howl along with Rick Santelli on MSNBC about how they're paying the mortgages of all those lazy people who sit around expecting handouts, blah blah.

You can see how this almost hysterical exaltation of the individual is a very attractive notion. After all, we're products of the most extremely individualistic culture on earth. But the problem is that by essentially ruling out every other way of looking at society except the individual & his/her freedom, libertarians exclude the vast majority of evidence available to our sense organs (not to mention research libraries). That denial of context leads to weird positions such as Rand Paul's statement that he would have voted against the Civil Rights Acts of 1964 & 1965 as encroachments on the individual rights of segregationists (OK, in Rand's case there's clearly something else at work here. He certainly doesn't consider infringements on the individual rights of black people caused by discrimination, for example). To be fair, some libertarians are very good on first amendment rights issues (after all, individual rights is their sole obsession), but on everything else, you get this weird prezel logic based on denial of everything beyond the individual & his or her rights. In their denial of the importance of power differentials in society, libertarians, whether intentionally or not, open the door to Social Darwinism.

The libertarian obsession with the individual leads to economic ideas hostile to government & to collective activity of any kind. Thus libertarians like Ron Paul find congenial economic theories that rationalize the elimination of government action & programs. Paul is an adherent of what's known as the Austrian School of economics, an approach that's rejected by mainstream economists, both liberal & conservative. Essentially, the Austrian School argues for laissez-faire economics with government involvement in & oversight of the economy reduced to the barest minimum. Austrian School adherents also argue that mathematical modeling, statistics & testing are basically useless in the study of economics & argue instead for the use of logical deduction based on first principles instead. And ouija boards (just kidding).

One of the heroes of economic libertarians, Friedrich Hayek, was a member of the Austrian School. Hayek argued that Britain was going to become another Soviet Union due to the creation of its National Health Service. (Hayek is often cited for saying that the bigger the government, the greater the encroachment on human freedom. What exactly is meant by "big" & "small" in this context has always confused me. Does this mean that the US, for example, is less free than Chile under Augusto Pinochet?) Needless to say, Hayek's prediction didn't work out very well, but that hasn't dulled the ardor of his adherents. (After all, who needs evidence when you've got first principles?)

Paul is also extremely hostile to the Federal Reserve, which he wants to eliminate (Paul Ryan, another libertarian, shares this view). Another big institution, and therefore threatening to human freedom. Have I told you how oppressed I feel when I hear that the Fed has lowered interest rates? The irony is that the Federal Reserve was set up in 1913 in response to the extreme concentration of economic power, lack of regulation of banking activities, and the absence of a central bank to bolster the economy in the case of a crisis, all of which was exposed in the aftermath of the Panic of 1907. The Fed provided the latter, but it was far too weak to deal with the other two problems, as was illustrated by the Great Depression. Now, you may be wondering, in the aftermath of the deepest economic crisis since the Great Depression, with extreme concentrations of economic power in a highly unregulated financial system, why Ron Paul wants to do away with the institution that provides the bulwark for that system. Why, you might ask, does he not instead focus his efforts on strengthening regulation of the financial sector (creating an institution that would provide training & advancement to successively higher levels of regulatory complexity & responsibility, a la the training program at the State Department, for example, and working to make the salaries of regulators comparable to those of their counterparts at banks, thereby removing the incentive of regulators to go to work for the firms they regulate)? Why, in short, does Paul not work to prevent a recurrence of the crisis we’ve just experienced, rather than weaken one of the institutions responsible for minimizing the damage when such crises occur? That question applies to the GOP in Congress, almost across the board. It’s one of the questions of the age.

Misleading Uses of Statistics, Chapter 57,942

A conservative interlocutor on a facebook thread challenged me the other day:

...Let's just use numbers without liberal or conservative pundit spin, okay? Here's how things stood at the end of 2006, no commentary:

Economic expansion was in its 74th month. The country had a rolling average of 103,000 job increases for the last three months of 2006. Unemployment stood at 4.7 percent. The household job count, which picks up small businesses, posted a 303,000 average gain.

Worker wages rose 3.8 percent in 2006, a full percentage point ahead of inflation. U.S. productivity surged 6.3 percent in the third quarter, its best pace in four years. Business inflation fell from 3.5 percent a year ago to 1.5 percent.

U.S. household net worth hit a record high of $58.6 trillion, and household wealth increased 43 percent from 2001-2005.

Now give me numbers showing me how "delusional" I am. No spin, just facts.

No problem...

First, I have to say I find your periodization of data bizarre. Aside from anything else, no government spending makes its presence felt in the economy for about a year, regardless whose it is. It just takes a while to get the ball rolling. This was noted in the Obama team's projections when they introduced the stimulus plan, by the way. It is absurd to draw any conclusions about the efficacy of the stimulus plan (or any of the others, for that matter) 5 months into a new administration.

Secondly, your reliance on 2006 data (I'd like to know your sources, by the way--I'm relying on the Bureau of Labor Statistics and several economists, as noted in the links below) is a bit odd, given that Bush was in office for 8 years. I think it's much more objective to compare apples to apples, so I'm comparing 8 years of Clinton to 8 years of Bush. Surely with 8 years of data for each, there can be no question as to the onset of the economic policies of each president or responsibility for same. Sound fair to you? I knew it would...

One last point: I also think it's unreasonable to compare the economic performance of any president in the midst of a major economic crisis (this one's generally considered the worst since the end of the Great Depression) with that of a president not facing a similar situation. Compare Obama in a few years to FDR if you like. Or if you really want to stretch way back and account for lots of data problems, try the panic of 1873 or, even worse, the economic crisis of the early 1820s. But again, apples to apples seems a reasonable approach.

1. Employment Rates:

Here’s the Employment-Population Ratio, 1992-2009:

Type of data: Percent
Age: 16 years and over

1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006	2007	2008
62.0	63.1	62.7	63.4	64.0	64.3	64.4	64.4	62.9	62.4	62.2	62.4	62.8	63.4	62.7	61.0

The graph and data above show remarkable growth in the employment-population ratio from 1993 (61.4%) through 2000 (64.4%), followed by a sharp drop in employment from 2001 (64.4%) through 2004 (62.4%). This was followed by a modest increase in employment from 2004 (62.4%) through 2007 (62.7), followed by a dive off a cliff from 2007 (62.7%) to present (59.7%) coinciding, of course, with the economic crash.

Incidentally, the reason I use the employment-population ratio instead of raw employment numbers is that, unlike the latter, the former illustrates the extent to which employment rate changes reflect, by lagging, equalling or exceeding population growth rates, actual increases or decreases in the availability of jobs. The economy gained somewhere in the neighborhood of 22 million new jobs under Clinton. I forget offhand how many jobs we lost under Bush, but it was a lot.

2. Wages:

From 1993 to 2001, wages were flat for the first 2 years, followed by net changes in percentage points of .4%, .3%, 2.6%, 2.1%, .9%, .7% and 2.0%. From 2001 to 2007, net changes in wages in percentage points were .6%, 0.0%, -1.0%, -0.4%, 1.8% and -0.7%. By any measure, net increases in wages were greater from 1993-2001, than from 2001-2007.

3. Productivity:

Percentage changes in productivity from 1993 to 2008 were as follows:

1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006	2007	2008
0.4	1.1	0.5	2.7	1.6	2.8	2.9	2.8	2.5	4.1	3.7	2.8	1.7	0.9	1.4	2.8

In other words, productivity increased almost continually from 1993-2002, then declined consistently until 2008.

4. Business inflation:

Business inflation rose slowly from 1993-2001, increasing faster from 2001-2007, then experiencing a levelling out.

1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006	2007	2008
124.4	126.6	129.3	132.9	131.4	131.3	135.2	140.5	138.0	139.7	145.1	151.4	159.7	161.4	171.8	169.7

5. Household Net Worth:

As far as household net worth is concerned, let’s disaggregate your statistics. The wealthiest 1% of the population experienced a 40% increase in wealth during the Bush years; everyone else either had level net worth or lost ground. Adjusted for inflation, the real wages of the average American worker has actually decreased slightly since the 1970s. Use of an aggregate household net worth number obscures these differences.

To understand why consider a hypothetical case in which you have 5 income levels: $10,000, $20,000, $30,000, $40,000 and $1,000,000. Assume the number of households at each level is, respectively, 10, 30, 50, 40, 10--a very rough bell curve. Multiplying the number of households at each income level by its income, then adding up the subtotals (140 households, $13,800,000) and dividing the total income by the number of households yields the average income of the whole group: $98,571.43. Now consider another group with the same number of households, but with these 5 income levels: $10,000, $18,000, $29,500, $39,000, $1,500,000. For the sake of simplicity, lets keep the distribution of incomes at each level the same as before. We still have 140 households, but the total income is now $18,675,000--solely because of the increase in income in the highest quintile. The average income per household is now $133,392.90, simply because the highest quintile value is so much higher than it was in the previous example. Did most households experience an increase in income from the first example to the second? Of course not--only those at the highest quintile did, but their increase was so great it pulled up the average for the whole group. The numbers I used were obviously not taken from the U.S. Census, but the phenomenon I've explained in simplistic terms is roughly what has happened to American households since the 1970s--those in the highest income brackets experienced a dramatic increase in income, especially over the past 8 years, while the average working household (I'm referring here to the median, or midpoint value in an index of U.S. incomes) either experienced no change or a slight decline in income during that period.

(Additional source data available at U.S. Department of Commerce website—fee required for access.)

Commentary

By the way, the contrast turns out to be even more stark than the numbers above indicate. It turns out that, no matter how you slice it, the economy always has done better under Democratic than Republican administrations—with the exception of every 4th year of a GOP president’s term in office (the exception to the exception being, of course, 2008 under Bush).

It’s interesting, by the way, to see how heavily my conservative challenger relies on 2006. Bush was in office for 8 years—why not data for his whole term in office? His economic record was anemic compared to Clinton’s (see charts above), and it was topped off with a global economic collapse, which, contrary to claims from the right, was not caused by Fannie Mae and Freddie Mac, but by wildly irresponsible behavior by mortgage brokers, ill-informed consumers, many of this country’s biggest investment banks, and the insurance company they relied on to hedge their bets via credit default swaps, AIG. (The latter, incidentally, didn’t think it necessary to back those financial instruments with their own money. And of course, they were unregulated (thanks largely to GOP Sen. Phil Gramm), so who was going to notice?) And yes, it’s true, Bush didn’t cause the collapse all by his lonesome, and some Democrats were complicit in the mess, but any honest measure of the economic history of the US from 1980 to present will unavoidably conclude that the GOP was the prime mover in the rush to deregulate, reflexive hostility to government, and the near-religious devotion to the idea that unfettered “free” markets would naturally police themselves. We’ll all be living with the results of that folly for a long time to come.

And people who try to blame Obama for the mess are being disingenuous. Sorry—5 months just isn’t enough time for any president to have a significant effect on the economy. It just takes time for programs to start & for money to flow through the pipeline. I realize my conservative challenger is a libertarian and particularly aggressive in his belief in the sanctity of the marketplace. But fair is fair—and if anyone attacked a conservative or libertarian politician with the intensity, obsessiveness and peculiar one-sidedness he exhibits toward Obama, he’d have no trouble recognizing how unreasonable that sort of behavior really is.

Incidentally, while I can't speak for your sources, not knowing what they are, I don't look to pundits when forming my opinions. Nor do I have one iota of patience for spin, regardless who does the spinning.