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IMF Chief Economist Calls for U.S. Debt Reduction Plan

donsutherland1

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From CNBC:

The US Congress should focus on a medium-term plan to cut government debt to dispel fears about the world's biggest economy, Olivier Blanchard, IMF chief economist, told CNBC Thursday...

"I think it is very important that the US, over the next few months or a year, puts in place a very credible, medium-term plan so we can see what happens to the debt five years out, ten years out," Blanchard said. "That plan, I think, is essential. It's not quite in place yet."

It remains to be seen how the new Congress will respond to the need for fiscal consolidation. However, a credible response may well hold the key for establishing credibility on fiscal matters. There is some possibility that the environment could be more favorable for fiscal consolidation than in the recent past due to a combination of growing concern over U.S. debt levels, the IMF's increasingly highlighting U.S. fiscal imbalances, commitments made during the 2010 campaign, and bold efforts already underway in the UK.
 

Kushinator

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From CNBC:

It remains to be seen how the new Congress will respond to the need for fiscal consolidation. However, a credible response may well hold the key for establishing credibility on fiscal matters. There is some possibility that the environment could be more favorable for fiscal consolidation than in the recent past due to a combination of growing concern over U.S. debt levels, the IMF's increasingly highlighting U.S. fiscal imbalances, commitments made during the 2010 campaign, and bold efforts already underway in the UK.

The question is, will private sector investment spending take up the slack left by government? It is projected that spending cuts will cause the UK to lose somewhere in the neighborhood of 1.6 million jobs. If such a projection is accurate, unemployment will spike unless private hiring instantaneously begins hiring at an equal rate of public decline (in terms of absolute value).

Do you believe the private sector (here in the US) is capable of not only job creation, but job creation in a manner in which the total labor market increases as well? E.g. growing labor market and decreasing unemployment?
 

Orion

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The damage is too far gone right now and neither party seems up to the task. The U.S. has spent too much money that it doesn't have on its house, just like individual lendees did with their homes. The country has become a macro version of California. Everyone wants to have their cake and eat it too. Major cuts need to be made yet due to the celebrity and popularity contest of politicians, no one wants to do it. Added to this, you have a private banking system that is only in it for itself and prints money out of thin air.

The mighty few get rich... the rest join the bread line.
 

kwickymartkidd

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The argument that the US federal debt is causing economic problems is the most ridiculous argument I've ever heard. Clearly no one in this god-forsaken country other than the "private banking system only in it for itself" is well versed in finance and economics.

Firstly, what would you cut? Social Security? Defense spending? Name something that's "waste" before you tea party your way into an election win. Frankly, yes, these programs should be cut, and replaced entirely by the private market. If you don't agree with my anarchist pro-capitalism point of view, then point out how you'd do it.

Secondly, debt is a GOOD thing. Anyone who even moderately understands finance can explain that debt is just the reallocation of future money to present money, so you can spend money you don't have now to do something you want to do now, usually with the idea that whatever you're doing will generate returns, and any returns in excess of the rate you pay on your debt are gains. For example, if you're still following me, one could open a lemonade stand with 100% equity or 10% equity (meaning 90% is financed by debt). Say your lemonade stand costs $100 dollars to open. That means in the first case, you invest $100 and in the latter, $10, with the rest coming from the lender. Now suppose the lender charges 10% annual interest on your loan, to be paid back in 10 years. That means in 10 years you will owe $233.44. Oh boy, how will you ever pay that back?! Now lets say in both cases that every year your company's value grows by 12%. At the end of 10 years, your company is worth $310.58, regardless of the method of financing. What does change, however, is the rate of return on your investment. In the first case, using 100% equity, your return is simply 12%. In the latter case, after having paid back the debt, you're left with $77.15, which annualized represents a 22.7% return on your investment.

Ok, now if you're still with me, we're going to go over the most important part - taking it to infinity. Say your debt is never going to go away - you always owe 10% every year. By the same token, you never sell your business - you always make 12% every year.
Suppose P represents what you keep, g is your growth rate and r is your debt interest rate. E represents the equity in your firm, and D represents the amount of debt.
P is equal to the sum, with t representing times 1 to infinity, of (D+E)(1+g)^t -D(1+r)^t.
Simplifying the equation, we get
P = sum t 1 to infinity ( E(1+g)^t + D((1+g)^t - (1+r)^t)

so, as long as g is greater than or equal to r, taking on debt can only help you.

So what's the United State's growth rate? The growth rate of GDP! So, as long as GDP growth is greater than the interest rate we pay on our debt, we're leveraging up our GDP with debt financing.

real GDP growth over the last 20 years: 5.6797625%
average US debt rate adjusted for inflation: 3%

And that's after a recent recession with interest rates probably going to decrease and with increased inflationary pressure.

QED.
 

donsutherland1

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The question is, will private sector investment spending take up the slack left by government? It is projected that spending cuts will cause the UK to lose somewhere in the neighborhood of 1.6 million jobs. If such a projection is accurate, unemployment will spike unless private hiring instantaneously begins hiring at an equal rate of public decline (in terms of absolute value).

Do you believe the private sector (here in the US) is capable of not only job creation, but job creation in a manner in which the total labor market increases as well? E.g. growing labor market and decreasing unemployment?

Goldenboy219,

My guess is that a medium-term fiscal consolidation plan will need to be weighted toward a few years into the future due to the present economic fragility. To be credible, the revenue/spending measures would need to be specific and there would also need to be a mechanism in place to assure that those measures would be carried out. Aggressive deficit reduction in 2011 would be risky. A small symbolic downpayment on deficit reduction might not be a bad idea. The hand off from stimulus to private sector demand is tricky, so that situation will have to be watched carefully. Hence, I believe 2012 would probably be a better time than 2011 to begin to implement more significant deficit reduction, but such reduction will have to be carried out over 5 years or more.

In short, I don't believe a credible deficit reduction plan requires immediate significant reductions in the deficit. Instead, it needs to be specific, reductions over the medium-term need to be significant, and mechanisms have to be in place to assure that the tax/spending measures set forth would be carried out. It cannot contain provisions that allow for an easy waiving of the deficit reduction measures.
 
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donsutherland1

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The argument that the US federal debt is causing economic problems is the most ridiculous argument I've ever heard.

Right now it isn't. The concern is for the longer-term where there are substantial imbalances. Leverage, by itself, is not necessarily bad. Over leverage is. The history of private sector financial distress and sovereign debt crises illustrates that there is a threshold of debt, beyond which crises can erupt.

Firstly, what would you cut? Social Security? Defense spending? Name something that's "waste" before you tea party your way into an election win. Frankly, yes, these programs should be cut, and replaced entirely by the private market.

Over time, there is little doubt that entitlement reform will be needed to address the fiscal imbalances. Social Security offers a relatively straightforward actuarial exercise: raise the retirement age and then peg it to life expectancy, slow the growth of benefits over a period (possibly holding current retirees and near-term retirees harmless) to further reduce the actuarial imbalance, and raise the payroll tax to cover the rest. Medicare presents a much larger challenge, both in terms of magnitude of the imbalance and in terms of complexity. A large part of the challenge involves addressing the excessive cost growth problem plaguing U.S. medicine. Ultimately, such costs cannot continue to grow at a multiple of national income. How to address that problem remains a subject of considerable debate, though research published by the IMF has suggested that dramatic changes in technology introduction/utilization could generate some substantial savings. Defense, like any other program, will have to grow more slowly (relative to GDP) unless there are compelling reasons for faster growth. Right now, the U.S. does not face the kind of existential threat that confronted it during the
Cold War. Hence, arguments for Cold War-level Defense spending are baseless.

So what's the United State's growth rate? The growth rate of GDP! So, as long as GDP growth is greater than the interest rate we pay on our debt, we're leveraging up our GDP with debt financing.

Two quick things:

1. The IMF's concern is focused on the medium-term and beyond where U.S. debt would wind up increasing faster than GDP due to structural issues concerning the nation's mandatory spending programs.

2. Not the IMF nor any member in this thread has advocated eliminating the nation's debt.
 

washunut

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Goldenboy219,

My guess is that a medium-term fiscal consolidation plan will need to be weighted toward a few years into the future due to the present economic fragility. To be credible, the revenue/spending measures would need to be specific and there would also need to be a mechanism in place to assure that those measures would be carried out. Aggressive deficit reduction in 2011 would be risky. A small symbolic downpayment on deficit reduction might not be a bad idea. The hand off from stimulus to private sector demand is tricky, so that situation will have to be watched carefully. Hence, I believe 2012 would probably be a better time than 2011 to begin to implement more significant deficit reduction, but such reduction will have to be carried out over 5 years or more.

In short, I don't believe a credible deficit reduction plan requires immediate significant reductions in the deficit. Instead, it needs to be specific, reductions over the medium-term need to be significant, and mechanisms have to be in place to assure that the tax/spending measures set forth would be carried out. It cannot contain provisions that allow for an easy waiving of the deficit reduction measures.

What you are saying may sound good, but is not a real life solution in the United States. Talking about the medium term means never as when the medium turns into near term the politicians down the road say we never signed off on that.

As we have seen from prior problems with social security we have been able to solve this problem pretty well and my sense is we will fix it again. Medicare is more problematic and we will have to have some real health care reform to reign in costs.

Republicans will attack certain domestic spending which may produce $100 billion. Then we will have to get real about our role in the world and really cut back on defense. Farm subsidies also need heavt review as well as federal payroll and pension costs.

Clearly this will cost jobs. But deferring it for some other congress down the road is what has gotten us in this mess.

We have had an economy on the debt drug for the last 20 years. The deficit as a percent of GDP is running about 10% while our economy is growing about 2%, not sustainable. We have the Fed monetarizing this year's deficit which should be a sign we are running out of wiggle room. Just think if governments lending us money demanded interest rates like being charged to Greece or Ireland. The interest costs would then go up by several hundred billion.

I think the results of the election of just two days ago says that the game is up for congress and the President. Either get out house in order or you get fired.
 

ARealConservative

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The argument that the US federal debt is causing economic problems is the most ridiculous argument I've ever heard. Clearly no one in this god-forsaken country other than the "private banking system only in it for itself" is well versed in finance and economics.

Firstly, what would you cut?

how about we cut the amount fo spending our troops currently engage in in the 120+ nations we occupy around the globe?

you can call be a total dufus if you like, but I'm pretty sure if the same people we are paying to live overseas lived here instead, it would be a boon for our economy. We can certainly argue about how much of a boon it would be, but I find it hard to believe you don't see a benefit in having that money being spent in this economy.

so let's start with little baby steps as you intellectual superiors finally see a little sanity coming your way.
 

kwickymartkidd

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Two quick things:

1. The IMF's concern is focused on the medium-term and beyond where U.S. debt would wind up increasing faster than GDP due to structural issues concerning the nation's mandatory spending programs.

2. Not the IMF nor any member in this thread has advocated eliminating the nation's debt.

Debt should rise faster, as per argument above. Mandatory spending programs making US debt increase faster is also a good thing. Since the federal reserve basically controls the real rate we pay on our debt, we are a borrower who gets to choose the interest rate that we pay, and so we can leverage ourselves to phenomenal GDP growth.

The IMF objects to this practice, since it would also lower the value of the dollar relative to other currencies.

1. The IMF can't do anything. There is no enforcement mechanism. So why care.

2. Markets are equilibrating - if the United States did spend itself into oblivion, the rate we'd have to pay on our bonds (determined by the price that we can sell them for now) would have to rise, which then tells the United States that it's no longer a good idea to leverage finance our GDP. Also, as this process continues we lose the need to leverage finance our GDP because as the dollar falls, the relative cost of doing business in the United States follows, and so our export markets become more competitive.
 

kwickymartkidd

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how about we cut the amount fo spending our troops currently engage in in the 120+ nations we occupy around the globe?

you can call be a total dufus if you like, but I'm pretty sure if the same people we are paying to live overseas lived here instead, it would be a boon for our economy. We can certainly argue about how much of a boon it would be, but I find it hard to believe you don't see a benefit in having that money being spent in this economy.

so let's start with little baby steps as you intellectual superiors finally see a little sanity coming your way.

You ignored the rest of the post...

And no, if the people we "pay to live overseas" lived here instead, you wouldn't necessarily see a rise in GDP. Firstly, they'd be unemployed veterans. Good luck finding a job in this market.

Secondly, costs for soldiers based domestically and foreign aren't very different, seeing as those costs are the costs of base operations. Tear down the base too, you say? Good idea, but that's going to take quite a lot longer than this recovery is going to last.

And even if you did manage to cut the *entire* defense budget and spend that 685.1 billion dollars here, you'd be doing barely anything more than QE2 did. And QE2 lowered interest rates, while your policy would crowd out private spending.

And that is why us intellectual superiors do not see a little sanity coming our way :cool:
 

donsutherland1

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What you are saying may sound good, but is not a real life solution in the United States. Talking about the medium term means never as when the medium turns into near term the politicians down the road say we never signed off on that.

That's exactly why there would have to be automatic mechanisms in place to assure that the fiscal consolidation takes place. The so-called "doctor's fix" which waived an extremely modest measure of fiscal discipline--an almost completely painless one in the larger context of the budget--highlights the need for credible mechanisms. Were a supermajority required to waive such measures, it would be more difficult for policy makers to retreat from even modest measures of fiscal discipline.

As we have seen from prior problems with social security we have been able to solve this problem pretty well and my sense is we will fix it again. Medicare is more problematic and we will have to have some real health care reform to reign in costs.

I'm reasonably optimistic that the Social Security issue can be resolved. At this time, I see little appetite for meaningful effort to attack the excessive cost growth problem that continues to undermine the fiscal viability of Medicare/Medicaid, not to mention the larger U.S. health care system.

Republicans will attack certain domestic spending which may produce $100 billion. Then we will have to get real about our role in the world and really cut back on defense. Farm subsidies also need heavt review as well as federal payroll and pension costs.

IMO, all discretionary programs, including Defense, as well as the mandatory spending programs need to be the focus of a careful and rigorous review. Policy outcomes--how well programs actually achieve their intended benefits--needs to be given greater weight. So does long-term benefits from programs e.g., education, with investments that yield actual benefits being given greater weight than other programs that amount to consumption with no future benefits.

Clearly this will cost jobs. But deferring it for some other congress down the road is what has gotten us in this mess.

I wasn't sufficiently clear. I was not arguing to defer addressing problems, but to defer the larger share of spending reductions/tax hikes for another year so as to assure that the economy is on a sustainable growth path. Modest deficit reduction should be plausible in 2011. More significant deficit reduction should probably commence in 2012, and a credible plan should lay a path for tackling the imbalances associated with the mandatory spending programs.

We have had an economy on the debt drug for the last 20 years. The deficit as a percent of GDP is running about 10% while our economy is growing about 2%, not sustainable. We have the Fed monetarizing this year's deficit which should be a sign we are running out of wiggle room. Just think if governments lending us money demanded interest rates like being charged to Greece or Ireland. The interest costs would then go up by several hundred billion.

I don't disagree. Household debt (slowly being reduced via deleveraging but still at near-historic highs) and public sector debt (particularly when the long-term imbalances are considered) are challenges. While the U.S. is more debt tolerant than many other countries, meaning its debt burden relative to GDP can be higher than in those other countries before a crisis erupts, it is not immune to the effects of excessive debt. The risk of a full-blown debt crisis or partial default (possibly via inflation and/or currency debasement) will begin to increase in the medium-term if the U.S. remains on its present policy trajectory. In fact, Germany, China, and Brazil already worry that the new round of quantitative easing is actually a backdoor dollar devaulation strategy.

I think the results of the election of just two days ago says that the game is up for congress and the President. Either get out house in order or you get fired.

Although the public cast its vote seeking a better economy (exit polls) and expressing concerns over fiscal policy (exit polls), the big question remains as to whether the public would be willing to bear the sacrifices that would become necessary for efforts that actually would eliminate the nation's long-term fiscal imbalances. More often than not, it takes a crisis to bring about a fundamental change (a worrying lesson of history). Already, even as the financial crisis fades into the recent past, its lessons are also fading. As the oil price spike of 2008 is some two years into the past, neither political party is serious about addressing the nation's energy-related vulnerabilities. Of course, exactly the same kind of amnesia resulted when each of the 1970s' oil shocks faded into the past, so that kind of bipartisan neglect is not surprising. Even when it comes to trade imbalances, the popular but incorrect narrative that China is to blame rather than a closer look at emergent comparative disadvantages prevails. The bottom line is that although the electorate expressed its wishes at the ballot box, there remains no assurance that the electorate will actually be willing to entail the sacrifices necessary to address some of the nation's major problems. History does not offer a great deal of assurance on that front. Public opposition to austerity in Greece and a small increase in the retirement age in France is the norm. Lack of serious opposition in the UK is more often than not the exception, and it still remains to be seen how the UK's public will be reacting a year or two down the road when austerity has been underway for some time.
 

donsutherland1

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Since the federal reserve basically controls the real rate we pay on our debt, we are a borrower who gets to choose the interest rate that we pay, and so we can leverage ourselves to phenomenal GDP growth.

That is a fallacy. The Fed's control over interest rates is far from absolute. Monetization at a given level would precipitate an inflation crisis and/or currency crisis. Either form of crisis would have a substantial adverse economic impact. The lack of real economic growth and real decline in living standards in countries that suffered such crises highlight the futility of such a policy. Even countries in which external debt is limited, sovereign debt default (partial or full) is not unknown.

The IMF objects to this practice, since it would also lower the value of the dollar relative to other currencies.

Currency "wars" where each country seeks to devalue its way into competitiveness have proved harmful to global economic growth in the past. The body of empirical literature on that subject is extensive.

1. The IMF can't do anything. There is no enforcement mechanism. So why care.

Because the U.S. is not a closed economy, outside trade and capital flows have an impact on the U.S., etc.

2. Markets are equilibrating - if the United States did spend itself into oblivion, the rate we'd have to pay on our bonds (determined by the price that we can sell them for now) would have to rise, which then tells the United States that it's no longer a good idea to leverage finance our GDP. Also, as this process continues we lose the need to leverage finance our GDP because as the dollar falls, the relative cost of doing business in the United States follows, and so our export markets become more competitive.

Market rationality is not assured. Market "discounting" is far from perfect. Markets can sustain irrational situations e.g., excessive asset valuations, for extended periods of time before they correct. Furthermore, the transition during corrections isn't always smooth nor benign. Panics can result. The long rise and rapid collapse of the nation's housing bubble and financial crisis that followed provide just a recent illustration. When high amounts of leverage are involved, financial sector crises can erupt (as happened following the U.S. housing bubble during which total mortgage debt exceeded 100% of GDP, a figure well beyond the previousl record of under 70% of GDP) and recesions can be prolonged and post-recession growth shallow for a sustained period of time.
 
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