"We may avoid the fiscal cliff, but the fiscal pain is unavoidable..."

By Alex Raskolnikov

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What will happen if we go off the fiscal cliff? The answer is familiar to many: Tax rates will go up, tax holidays will expire, large cuts in military spending will take place, and social programs will lose some (and, perhaps, more than some) funding. And what if we avert the cliff and regain our balance? This time, the answer may be less familiar: Taxes will rise, military spending will be reduced, and social programs will be downsized. There are important differences between these two scenarios, however. If we go off the cliff, the spending cuts and the tax increases will take place by operation of the law that is already on the books. No new legislation will be required; no bipartisanship will be necessary; no wrenching decisions will need to be made. Relatedly, winners and losers in this scenario are well-known already. If we are to avoid the cliff, however, Congress and the president must join in making some of the most painful and far-reaching economic choices of our times. We cannot continue to run trillion-dollar deficits much longer, or we will become another Greece (with no EU to bail us out). Sooner rather than later, we will need massive spending cuts and major revenue increases to avert a fiscal catastrophe that would make the current fiscal cliff look like child’s play. The crucial question, then, is how the burden of higher taxes and lower social spending will be distributed, not whether higher taxes and smaller social programs are coming. We may avoid the fiscal cliff, but the fiscal pain is unavoidable.

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On November 28, 2012 at 3:43 PM, Rohan wrote:

What warrant do you have for the claim that we cannot continue to run trillion dollar deficits and that fiscal pain is unavoidable? The US, unlike Greece, has a sovereign currency. A nation with a sovereign currency, virtually no foreign denominated debt, and a floating exchange rate does not face the same bond-vigilante concerns as a nation like Greece. The Greek analogy is completely inapplicable, because the financial constraints of a non-sovereign currency are inapplicable to a sovereign currency. Greece has the financial constraints of California or Massachusetts, not the US, Canada or the UK. The real comparison to look to is Japan. Large debt:gdp ratio, persistantly high deficits, and they are suffering from deflation and have some of the lowest interest rates in the world.

On November 30, 2012 at 11:34 AM, JG HELLER Private Wealth wrote:

Rohan's comment is right in regards to a comparison to Japan. If we do not take action on the rising debit (fiscal pain), then we face a future like Japan...no growth, lost decades not years and no obvious way out. Our currency might be ok, interest rates might stay low, but unemployment also might stay high for years and we will no longer be the engine of growth for the world that we have been in the past.

On December 01, 2012 at 2:47 PM, Rohan wrote:

Why do you think we need fiscal pain? A US government debt is default risk-free, like a dollar bill. The difference is the interest rate, which is a policy variable controlled by the central bank. Bonds functions like a savings account at the federal reserve rather than like a private debt, and have value post-1971 only as a reserve-drain operation to enable the CB to hit its target interest rate. That is why QE is not leading to high inflation - it is merely an asset swap, and in fact reduces net financial assets in the private sector by removing interest income from investors and pension funds, etc. But the government could continue QE indefinitely, and then retire the debt once it's held by the CB. Not fiscal pain necessary. Then, to deal with the Japan issue, it could inject non-interest bearing debt (i.e. US Notes) and use them to employ people in direct public employment, non-profits, or in entrepreneurial models like the one proposed here: http://www.levyinstitute.org/files/download.php?file=pn_12_02.pdf&pubid=1508 Japan's problem is that the fiscal deficit is too small to deal with the private sector's desire to save, not that it is too large.

On January 18, 2013 at 6:34 PM, Jose Amoros wrote:

Dr. Duffy, you seriously need to reconsider this statement "a robust majority of 61 percent opted for statehood." That is not the case. One needs to consider the whole of the plesbicite and why there were abstention in the second part. Those numbers added that way are really a statistical fiction.

On January 30, 2013 at 5:08 PM, Peter Basilevsky wrote:

“The US, unlike Greece, has a sovereign currency. A nation with a sovereign currency, virtually no foreign denominated debt, and a floating exchange rate does not face the same bond-vigilante concerns as a nation like Greece.” The notion that a country can run unlimited deficits in perpetuo verges on the silly. Even before the advent of globalization you have had numerous examples of countries who have tried this, either knowingly or involuntarily, while hoping to avoid disastrous economic consequences. For example, you had the WWI reparation payments triggering Weimar Germany’s hyper-inflation and in more recent memory you had the example of Argentina. In both cases they faced “bond-vigilante concerns” (Argentina now for the second time, cf. NML Capital Ltd., et. al. vs. The Republic of Argentina currently in the Second Cir. Ct. of Appeals). Were we completely self-sufficient and not running a consistent trade deficit there might be some merit to the thought although there are other potential consequences such as misallocation of resources and black markets and you have the Soviet Union as an example of the down side to trying to run a totally closed economy. The first thing that happens is that the currency depreciates which prompts capital flight which typically results in exchange controls (i. e., there goes the floating exchange rate out the window). The fact is that if we want to continue to buy tomatoes from Mexico, cars from Japan, jeans from China and basket ball shoes from Viet Nam and we have to borrow money to pay for them in increasingly worthless currency our creditors will simply refuse to continue lending or, alternatively and more likely, charge much more for our privilege of borrowing from them. Erskine Bowles has recently pointed out that we currently are paying about $250 to $300 billion in interest on our government debt at a time when interest on 10 year notes is hovering around 1.8%, the lowest ever based on the Fed’s efforts to artificially depress rates. Were interest rates simply to revert to their normal historical rates of 4-5% we will be paying $650-$700 billion annually (at current debt levels). One doesn’t need to be a mathematician to see what effect that would have on the disposable federal budget (not counting ripple effects throughout the economy). By the way, with $4 trillion on its balance sheet (and growing) the Fed isn’t necessarily in a position to continue to fund government debt unless you contemplate an inter-governmental Dawes Plan, e.g., simply reneging (“cancelling”) on the debt, in which case, if I was a Mexican tomato farmer I would ask to be paid in gold. As the old Asian proverb goes, there is no such thing as an iron rice bowl or in terms that may be more familiar, a “free lunch”.

On June 03, 2013 at 1:07 AM, Rohan wrote:

Peter, you are referring to disanalogous examples. Weimar Germany had debts denominated in another currency, not to mention a large loss in its own productive capacity due to handing over the industrial Ruhr region to France, and large labor strikes at the time. Argentina also had a currency peg, which the US does not have, and which forced it to print currency in a way that was inflationary. By contrast, the United States has run virtually continuous deficits for over 200 years. Contra to your analysis, the fact that the US runs a trade deficit is even more reason to run deficits, as trade deficits leak currency out of the American economy and exert a deflationary pressure that, if not counteracted by greater stimulatory spending (i.e. deficits), will lead to recessionary unemployment. Moreover, contra to your idea of the Soviet Union, the US today has a floating currency, so any currency depreciation – were it to occur – would be reflected in fx markets, which may alter trade conditions, but is completely distinguishable from a “completely closed economy”. In terms of the idea of “capital flight”, you are 1) assuming currency depreciation, which is not going to be the case if the stimulatory spending improves economic conditions by putting people back to work, and 2) you are assuming that there are better places for capital to fly to. Remember, other countries like China are trying to keep their currency artifically low to remain competitive. Given the huge, huge, demand for the US dollar, the claim that there would be large capital flight is quite unwarranted, and moreover, there is no reason why it could not be responded to by other alternatives to exchange controls. The fact you refer to “borrowing money” from other countries like China and Vietnam suggests you don't undersand how central banking operations work. In order for those countries to purchase treasury securities, they must first gain access to reserve deposits held at the Federal Reserve. So they are not “lending” us currency, they are exchanging non-interest-earning currency they already own for interest-earning securities as an investment strategy. The truth of the matter is that China and other countries want export-led growth, and so are willing to sell the US goods and services in exchange for dollars – i.e. reserve deposits on the Fed's computer that are currently earning 0.25% interest – and once they have them, it makes logical sense to invest in bonds, which are really just higher interest-earning accounts at the Fed (known as securities accounts to bond traders). These countries cannot “charge more for the privilege of borrowing from them” because they do not participate in treasury auctions – that privilege is reserved to primary dealers (see: http://www.newyorkfed.org/markets/primarydealers.html) who are legally required to participate in bond auctions at a rate considered reasonable by the Federal Reserve. Your numbers about interest rate payments are scaremongering at best – the US government cannot run out of dollars, and the fact that the Fed has $4 trillion on its balance sheet has no impact on whether it can continue to create new reserves to fund government debt. It can do so indefinitely – where is the limit, in your opinion, and why? Why is $4 trillion ok, but not $5 trillion? $10 trillion? You are welcome to ask to be paid in gold, but since gold is a traded commodity, all you're really asking is to be paid in $US at whatever rate gold is trading. I would suggest learning some central bank accounting before continuing this line of discussion, as your understanding of how federal budget operations work is underdeveloped for the claims you are making.

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