A Tale of Two Crises: One We Missed and One We Can’t Afford To

The current economic crisis seems to be waning, largely due to effective federal government and Federal Reserve responses. Economists deserve credit for helping to avoid the abyss, but we failed to predict the crisis and warn policymakers so that the crisis could have been mitigated or avoided. We must not miss predicting the next crisis, however, as it is staring us in the face. We can see clearly that federal debt will severely damage the U.S. economy within several decades under current policy. Moreover, simulations that take into account the effect of debt on interest rates indicate that the depressing effect on the U.S. economy will be even worse than official projections suggest.     

Government spending or deficit financing: which causes crowding out?

Economists have different opinions about the impact of federal deficits on interest rates. One reason for this difference is confusion about the effects of changes in government spending and the effects of how the spending is financed. A simple dynamic model is used to demonstrate that although increases in government spending increase interest rates, increases in the bond stock, by themselves, do not. In addition, the response of the monetary authority to the fiscal change is incorporated in the model.     

‘Credit Constraints and Determinants of the Cost of Capital in Vietnamese Manufacturing’

This paper examines the extent to which borrowing constraints restrict firm access to credit and identifies individual, firm, and loan characteristics, which determine the cost of capital in Vietnamese manufacturing. Using direct information from a Vietnamese enterprise survey the paper shows that between 14 and 25% of the enterprises are credit constrained, and these enterprises would increase their debt holdings by between 40 and 115% if borrowing constraints were relaxed. Moreover, it emerges that informal credit markets play an important role for fast growing firms. Enterprises do not appear to have the necessary time to go through the many administrative difficulties in the formal credit system if they want to “seize the day”. Finally, collateralized loans face larger interest rates, explained by the significant influence of “policy lending” in Vietnamese credit markets.     

Altschuldenentlastung der Bundesländer: Verteilungswirkungen ausgewählter Vorschläge

Due to large public deficits in the past, many German states face high interest payments in their budgets today. Therefore, a restructuring of this outstanding debt will be a major topic in forthcoming negotiations on the future design of the fiscal equalisation scheme. This article presents some proposals that are currently being discussed and calculates their redistributional effects between the federal government and the states. It is shown that all models would lead to a significantly higher burden for the federal budget. The only way to afford this is either to increase the value added tax rates or to keep the so-called solidarity surcharge that was originally introduced to finance transfers to East Germany.     

CBO’s Outlook for the Economy in February 2014

These remarks summarize the economic forecast and budget outlook that the Congressional Budget Office (CBO) published in February 2014. The discussion has not been updated to reflect subsequent economic and budget data or subsequent projections by CBO. Under an assumption that current laws governing federal taxes and spending remain in place, CBO projects that real GDP will expand by roughly 3 percent between the fourth quarter of 2013 and the fourth quarter of 2014—the largest rise in nearly a decade. Similar annual growth rates are projected through 2017. Nevertheless, CBO estimates that the economy will continue to have considerable slack for the next few years. To a large degree, the slow recovery of the labor market since the official end of the recession in 2009 reflects slow growth in the demand for goods and services. To a smaller degree, that slow recovery is the result of structural factors that stem from the recession and the subsequent weak growth of output but that are not directly related to the economy’s current cyclical weakness. The unemployment rate is expected to remain above 6.0 percent until late 2016. Moreover, labor force participation is projected to move only slowly back toward what it would be without the cyclical weakness in the economy. Beyond 2017, CBO expects that economic growth will be well below the average seen over the past several decades, primarily because of slower growth in the labor force arising from the aging of the population. Inflation, as measured by the change in the price index for personal consumption expenditures, is expected to remain at or below 2.0 percent throughout the next decade. Interest rates on Treasury securities are projected to increase in the next few years as the economy strengthens. The federal budget deficit has fallen sharply during the past few years, and it is on a path to decline further this year and next year. However, if current laws remain unchanged, the deficit will increase again after a few years because revenues are expected to grow at roughly the same pace as GDP whereas spending is expected to grow more rapidly. Federal debt held by the public is expected to equal 74 percent of GDP at the end of this year and close to 80 percent a decade from now.     

The Decline in the Natural Rate of Interest

With the Federal Reserve widely expected to begin normalization of monetary policy in the wake of the Great Recession—perhaps in 2015—an important question for public policy and private-sector planning is what the “new normal” for interest rates is likely to be. In particular, are real interest rates likely to be lower in the future than in recent decades? An investigation through the use of the Kalman filter shows that the natural rate of interest—the real federal funds rate consistent with the economy operating at its full potential—has declined since 1980, especially after the Great Recession. This will have important implications for monetary policy and for the private sector, including recognition that the natural rate of interest is not fixed.     

Our troubling fiscal situation

Business Economics - Federal debt is on an unsustainable path. Low interest rates mean that we do not need to reduce budget deficits immediately and that we should do more public investment....     

The Role of Federal and Private Student Loans in Homeownership Decisions

This paper examines the effect of student loans on the decision to become a homeowner. Analyses use the Baccalaureate and Beyond 2008:2012 (B&B) panel dataset collected by the U.S. Department of Education that surveyed a representative sample of four-year college graduates from institutions across the country. Whereas previous analyses of student loan debt rely on cumulative loan balances, the present research examines both federal and private student loan impacts separately. Private student loan data is often unavailable in major datasets, but the B&B data provide rich information on sources and amounts of debt for recent graduates. We instrument student loans using in-state tuition rates and find that for four-year college graduates, a $1,000 increase in a respondent's private student loan balance lowers the likelihood of buying a home by about 5 percentage points whereas a $1,000 increase in federal loans has no significant impact on homeownership during this time.     

Leases and Debt: Complements or Substitutes? Evidence from Belgian SMEs

This study investigates the lease–debt relationship for Belgian small and medium-sized enterprises (SMEs). Traditional finance theory suggests that leases and corporate debt are substitutes: both leases and debt are fixed, contractual obligations that reduce the firm's debt capacity. More use of leases should therefore be associated with less non-lease debt financing. However, some empirical studies find that for large firms, leases and debt are complements. A theoretical explanation for this so-called "leasing puzzle" is based on the tax advantage of leasing over debt. However, in Belgium, tax differences between lessor and lessee do not affect the choice between leases and debt, because the lessee is considered to be the fiscal owner of the assets. He may write off these assets for tax purposes, and the interest part of the lease payments are deductible from his taxable income. Leases and debt can therefore be expected to be substitutes. This hypothesis is tested for a sample of 5,595 firm-year observations for 1,119 Belgian nonfinancial SMEs in the 1995–1999 period. The results indeed provide strong support for the substitution hypothesis: more debt is associated with less leases.     

Interest rate uncertainty and corporate debt maturity

This paper presents an expected utility model of the corporate debt maturity decision to help explain the 20-year decline in the average maturity of U.S. corporate sector debt. Simulations of the model suggest that increasing uncertainty about future nominal interest rates caused the decline in debt maturity: managers substituted away from long-term debt to avoid rolling over the debt at highly uncertain future rates.     

The Federal Deficit and the National Debt

Using historical data from the Office of Management and Budget, the Congressional Budget Office, and the Organization for Economic Co-operation and Development, the author argues that that the current method of expressing the federal deficit and/or debt as a percentage of GDP obscures the danger posed by potentially higher interest rates. While the debt and deficit may still be at manageable levels, the situation could deteriorate much quicker than we might imagine, substantially raising the governments opportunity cost of servicing the national debt and diminishing the economic well being of American business and consumers.JEL Classification H62     

Federal policy and economic growth

I am quite concerned about the high and rising levels of federal debt we will have in the long term unless our policies are changed. But as I look out to the next several years, I am much more worried about the prospect of sharp cuts in federal spending that would be damaging to the country’s long-term growth prospects. We are on track to significantly cut federal investment in infrastructure relative to the historical pattern, and this would be a terrible mistake. There is no evidence that this administration’s policies will lead to faster economic growth, on balance, and setting expectations of 3 or 4% growth does not advance the national discussion. As we make changes in government policies, we should give distributional concerns significant weight. If we continue to support policies that are good for the economy as a whole but bad for lower- or middle-income people, we need to step up with practical policies to compensate those people for their losses.     

Gender Differences in Debt Repayment Problems after Divorce

Studies have shown that a growing number of divorced women were experiencing debt repayment problems during the 1980s. This study uses data from the Panel Study of Income Dynamics to (1) examine how debt repayment problems differ by marital status and gender and (2) investigate the role that supplemental income payments play in helping to mitigate repayment problems. The results show that divorced men and women are more likely to default on their debt obligations than married households. Further analysis reveals that increases in welfare payments significantly decrease the likelihood of default for divorced women but do not affect the probability of default for divorced men and married households. There is no evidence that payments related to child support and alimony affect default rates. The findings suggest that welfare benefits may help to mitigate the economic consequences of divorce for women.     

Monetary policy and U.S. long-term interest rates: How close are the linkages?

The effect of monetary policy on long-term interest rates has been a question of interest in recent years. A number of papers, relying on single-equation estimation techniques, have presented evidence that long-term interest rates exhibit sizable and significant responses to unanticipated changes in the Federal Reserve's target federal funds rate. This paper examines these findings in light of conflicting findings from VAR studies, which indicate negligible effects of innovations in the federal funds rate on long-term rates. To address the issue we use a single-equation approach where unanticipated changes in the federal funds rate are measured as residuals from policy reaction functions. We also estimate VAR specifications, which incorporate information about the timing of changes in the Federal Reserve's target federal funds rate. Our single-equation estimates provide evidence of strong responses of long rates to unanticipated changes in the federal funds rate both for the Greenspan period and for a longer period back to the mid-1960s. It seems likely that estimated VARs for the post-1987 years are less successful in isolating monetary policy surprises than was the case for earlier years.     

A Temporary Federal Discount Program to Stimulate Consumer Spending

In this paper, we evaluate a new proposal to stimulate recovery from the current recession: a temporary federal price discount on consumer goods. An attractive feature of the temporary federal discount program is that it gives consumers a price incentive to purchase more rather than simply giving consumers more disposable income, which they might choose to either spend or to save. According to our simulations with the Fair macro-econometric model, a temporary 20 percent federal discount on all consumer goods in a severe recession would significantly reduce the unemployment rate while causing only a small increase in federal debt as a percentage of GDP.     

Will It Take a Crisis to Fix Fiscal Policy?

The U.S. national debt is on a trajectory to reach 185 percent of gross domestic product by 2035 unless there is a drastic change in federal fiscal policy. The main drivers of this situation are Social Security and health care programs, whose growth is amplified by an aging population and increasing medical costs, a dysfunctional Congress and an unwillingness to tackle the increasing burden of Social Security and the medical programs. The National Commission on Fiscal Responsibility and Reform and the Bipartisan Policy Center's Debt Reduction Task Force have produced thoughtful and sound plans for debt reduction but have produced little political traction. Reluctance to come to grips to the U.S. federal debt problem has increased the risks of a sovereign debt crisis, and the paper spells out potential responses, should one occur. Given the obstacles to a major overhaul of fiscal policy, it is difficult to see how it will be avoided.     

The Effect of Government Spending on the Debt‐to‐GDP Ratio: Some Keynesian Arithmetic

According to the standard approach to the issue of public debt sustainability, fiscal austerity is the route that many countries must currently follow to reduce their debt‐to‐GDP ratios back to sustainable paths. We challenge this conventional wisdom and argue that, below full employment, an increase in government spending may paradoxically reduce the debt‐to‐GDP ratio. This claim is particularly relevant today because with Central Bank interest rates near zero there is no alternative to fiscal policy, and the only argument against increasing government expenditure as a way to fight unemployment is its supposed negative effect on the state of public finances.     

Credit cards,new technology and consumer debt*

There has been a rapid expansion in consumer indebtedness in the U.K. The amount of consumer debt has doubled in real terms during the last 10 years. The majority of consumers are able to cope with their debt repayments, but there are a significant number of credit casualties, often burdened with multiple debts. Credit cards have played a significant but not overwhelming part in this increase in debt. There are now 62 bank credit cards for every 100 adults in the U.K., a much higher incidence than in any other European country. Credit cards have been aggressively marketed and sold, and it is possible that they will now move downmarket, to consumers in lower income groups. This possibility highlights the need for a major consumer education campaign on the cost of credit. U.K. consumers' knowledge of and ability to compare credit interest rates is poor, especially among lower income consumers who are most at risk.     

Patterns of international capital raisings

This paper documents several new patterns associated with firms issuing stocks and bonds in foreign markets that motivate the need for and help guide the direction of future research. Three major patterns stand out. (1) A large and growing fraction of capital raisings, especially debt issuances, occurs in international markets, but a very small number of firms accounts for the bulk of international capital raisings, highlighting the cross-firm heterogeneity in financial globalization. (2) Changes in firm performance following equity and debt issuances in international markets are qualitatively similar to those following domestic issuances, suggesting that capital raisings abroad are not intrinsically different from those in domestic markets. (3) Firms continue to issue securities both abroad and at home after accessing international markets, suggesting that international and domestic markets are complements, not substitutes. Existing theories do not fully account for these patterns.     

Between debt and the devil: beyond the normalization delusion

Since 2008, we have found it incredibly difficult to achieve adequate nominal demand growth. I think a fundamental reason we found it so difficult focuses on debt overhangs, if we first allow private leverage to grow too high, we end up in a situation where the debt doesn’t go away, it just moves around the global economy. Total global debt to global GDP is now higher than it ever was before. When interest rates are already low, further reductions of interest rates have very little influence on investment and consumption. Ultra-loose monetary policy does produce increases in asset prices. But if that’s driving an increase in inequality on top of slow growth of real wages. There has been inadequate focus in economics on the different functions that credit creation plays within the economy. We have to think about control of the credit cycle as an end, per se. Our orthodoxy before the crisis was that private credit and money creation is just fine. We have to understand that both governments can fail and be dangerous, and that markets can fail and be dangerous.