Friday, May 4, 2018

Fiscal Crisis and Political Economy, Part 2

In my April 18 article about methodological errors in mainstream economic analysis, I used Cato Institute economist Jeff Miron as an example of how conventional-wisdom economics fails to understand the problem of fiscal crises. Political economy, by contrast, offers a good methodological platform, using an institutional approach rather than standard statistical analysis.


That does not mean that political economy in itself offers a plug-and-play ready understanding of how and why a fiscal crisis happens. There is a great deal of work still needed on that front, to which I am making two contributions this year in the form of conference papers.

More on those papers when we get to the conferences. For now, let me elaborate on the need for this new analytical work in political economy. It is not just on the academic side of the issue that people fail at systemic crisis analysis: the problem is endemic in policy-making circles. As a case in point, consider how American politicians reacted to Standard & Poor's downgrading of the federal government's credit score in 2011. The reactions that followed from President Obama and both parties in Congress are schoolbook examples of why there is such great need for more research - and methodologically sound research - on the causes, nature and effects of fiscal crises.

The ink was not even dry on the downgrade before the usual suspects in Washington began blaming each other for it (as opposed to heeding the warning and starting a serious conversation about how to solve the problem). For example, on August 7, 2011, one day after the downgrade, the Wall Street Journal reported that President Obama’s administration challenged the credibility of he decision by Standard & Poor’s decision to downgrade the U.S. government’s gold-standard credit rating, saying the credit-rating firm relied on faulty math and acted in haste.

The Journal also explained that Obama’s Department of Treasury
found a $2 trillion error in the firm’s calculations that made the firm’s debt projections appear inaccurately high. S&P went ahead with its downgrade with an alternate rationale, officials said.
In his motivation of the downgrade, David Beers, Standard & Poor’s head of government debt rating, noted that the downgrade was based in part on a concern that the federal debt might be as high as $20 trillion by 2021.

According to the Department of Treasury’s own “debt to the penny” account, total federal government debt passed the $20 trillion mark in September 2017, a full four years earlier than the Standard & Poor projection that led to the credit downgrade. In other words, the Treasury was correct in that the S&P downgrade was based on an inaccurate estimate. The only problem is that the S&P debt projection that was too radical for Obama’s Treasury, was too conservative for reality.

It is not hard to see what this controversy says about the ability of the economists at the Treasury to forecast the federal debt. They should probably not try a career in meteorology.

The Treasury’s concoction of arrogance and ignorance was not the only response that Standard & Poor got from the statist machine in Washington. Democrats and Republicans both put their best denial foot forward. The August 7, 2011 Wall Street Journal article, again, quoted Congressman Steve Israel (D-NY) blaming the downgrade on “Roadblock Republicans” who did not want to give President Obama exactly the tax hikes that President Obama wanted in order to slow down the debt growth. The Journal also quoted Christopher Lehane, a long-time Democrat presidential campaign strategist, as turning the downgrade issue into a matter of voter opinions. The downgrade, Lehane concluded, would be “a challenge for all incumbents, including the president”.

In other words, the downgrade was a party politics problem.

Things were not much better on the other side of the aisle. Senator Jim DeMint (R-SC) suggested that the economic policies of Obama and the Democrat Congressional majority would result in “a loss of America’s credibility around the world”. Mitt Romney, the 2012 Republican presidential nominee, contrasted Obama withPresident Truman:
“It seems that they would substitute Harry Truman’s ‘the buck stops here’ with the new motto of the White House, which is ‘the buck stops somewhere else,’ ” Romney told reporters in New Hampshire. “The truth is, the buck does stop at the president’s desk and he needs to exert the leadership necessary to restore America’s financial foundation, the credibility of our fiscal capacity and restore once again the balance sheet upon which our economy rests.”
Congresswoman Michele Bachmann (R-MN), a 2012 GOP presidential candidate, came closest to actually understanding the underlying mechanisms behind the downgrade:
That rating has endured the great depression, World War II, Korea, Vietnam and the terrorist attacks on 9/11.
With the exception of the 9/11 attacks, Bachmann refers to events that took place before the egalitarian welfare state threw the federal budget permanently into the red. She could easily have pointed out that the journey to out-of-control debt and the eventual credit downgrade began with the paradigmatic shift in the role of government in the 1960s. That, however, was too much to ask for: the good Congresswoman from the Great State of Party Politics did not last long in the sunshine of intellectual clarity. President Obama, she continued,
has destroyed the credit rating of the United States through his failed economic policies and his inability to control government spending by raising the debt ceiling.
By 2011 Obama had already added almost two trillion dollars to the national debt, so if one wants to look at the debt crisis from the perspective of a two-dimensional swamp creature, Bachmann and her fellow Republicans are correct. However, Obama was not responsible for the debt that had already been raked up when he took office, nor was he responsible for the design of the egalitarian entitlement programs that drove spending under his presidency, and continue to drive spending to this day. That responsibility is equally shared between Democrats and Republicans of every Congress since Lyndon Baines Johnson, with his 1964 State of the Union speech, declared War on Poverty.

The one thing Obama was responsible for, though, was his denialistic response to the credit downgrade. Shooting the messenger is a popular pastime among people in power, and while it threw cold water on the debt crisis debate back in 2011, probably preventing it from becoming a major issue in the 2012 election, it did not solve the problem that led to the downgrade.

Congress played its usual game of kicking the debt can down the road. Or, in this case, up the hill. The longer they wait with picking up the can and actually dealing with the debt crisis, the bigger the risk will be that the debt can itself starts rolling back down the hill. When it does, it will steamroll everyone in its way.

The one common denominator to all parties involved in Washington – the president, the Republicans and the Democrats – is that they chose not to heed the warning signal that was the credit downgrade. Instead of blaming each other they should have sat down, thrown away partisan politics and started with a clean slate. They could easily have devised an anti-debt strategy like the one outlined in the last chapter of this book. They chose not to do so, suggesting they will not respond in a more productive way when the debt can actually comes thundering down the hill.

As if to really drive home the point that they are never going to deal with the government debt, Congress is now working its way back to trillion-dollar annual deficits. If they add just paid family leave to the roster of egalitarian spending programs – a program everyone including President Trump wants – the deficit will grow close to $1.5 trillion per year.

In short: as revealed by their reaction to the red-flag credit downgrade in 2011, we have a political leadership in Washington, DC that has not even begun to understand the nature of the crisis we are steaming for, full force. That should worry everyone.

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