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Ricardo Reis on debt sustainability

Summary:
David Beckworth has an excellent podcast where he interviews Ricardo Reis. Here Reis discusses four options for paying for government debt (and by implication government spending): What is Fiscal Sustainability and Why is it Important?Reis: Look, there’s a simple flow constraint, which is, in order to pay for the current debt, and particularly the interest that’s due on it both principal and interest, you can only do one of four things. You can either issue more debt. You can either default on the debt and say, “Forget it, I’m not paying.” Or you can collect fiscal surpluses, more taxes than revenue, say, or finally, you can inflate away some of that debt that is have enough inflation so that even though you pay nominally in real terms you do less. Notice that while

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David Beckworth has an excellent podcast where he interviews Ricardo Reis. Here Reis discusses four options for paying for government debt (and by implication government spending):

What is Fiscal Sustainability and Why is it Important?

Reis: Look, there’s a simple flow constraint, which is, in order to pay for the current debt, and particularly the interest that’s due on it both principal and interest, you can only do one of four things. You can either issue more debt. You can either default on the debt and say, “Forget it, I’m not paying.” Or you can collect fiscal surpluses, more taxes than revenue, say, or finally, you can inflate away some of that debt that is have enough inflation so that even though you pay nominally in real terms you do less.

Notice that while only the third option mentions “tax”, all four of these involve taxes. Pilling up debt means higher future taxes. Default is like a tax on bondholders. Inflation is obviously a tax on moneyholders (and bondholders if the inflation unanticipated, or if nominal interest is taxed.)

Here’s a discussion of debt sustainability:

In the end, the debt has to be held by someone, and that person is either consuming, buying debt, or having income. That’s just a constraint. Well, at best, we can see the debt to GDP of the US going up to, I don’t know, 300% of GDP, which is the total assets in the US net are roughly 300% of GDP. Maybe that could increase but it can’t increase that much more. Well, with an R minus G of 2%, and with 300% debt, then you end up with a 6% persistent deficit that you potentially could run.. .

Again, this is in the absolute limit, David. We all have no firms, no capital stock, all we do is put in the debt, and we have a 6%. Indeed, I actually argue that 5% is a better number. Well, what is the CBO projections before 2020 for the deficits in the US all the way to 2050, 5% already. So, all of whatever bubble R minus G, R minus N existed, we already spent it in the last 10 years. So there’s nothing new about this in R minus M that says, “Oh, now in 2021, I can completely reconfigure the government and exploit my R minus M revenues.” 

I’ve made a similar argument. The fact that the interest rate on Treasury debt (R) is below the marginal product of capital (M) is certainly nice for the federal government. The recent decline in risk free interest rates is sort of analogous to a family that had a big debt it could not pay, and then found a box of exactly that much money hidden in the cellar of their house. The money would allow them to pay the existing debt, but is not a good argument for running up even further debts.

Speaking of Reis, I noticed this tweet:

Ricardo Reis on debt sustainability

While I understand the point he’s making in this thread (13 entries), I don’t agree. Supply-side economics is simply EC101. If you tax something, you reduce the quantity of the thing being taxed. Reis correctly points out that the term ‘supply-sider’ was applied to a group that made some wildly unrealistic predictions about tax cuts back in the 1980s, but the underlying model was completely uncontroversial among economists.

In contrast, the MMT textbook that I recently read (by Mitchell, Wray, and Watts) represents an almost complete rejection of mainstream macroeconomics. It’s not that they have a sound model that they take too far, they have a completely unconventional (and false in my view) model of the economy, and occasionally make a few predictions that happen to be accurate in a sort of “broken clock is right twice a day” sense.

My hunch is that if mainstream economists like Reis were to become fully immersed in MMT (something I strongly recommend they not waste time doing!!) they’d be horrified by what they saw. It’s wrong, but in a completely different way from how certain 1980s supply-siders (not all) were wrong.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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