October 18, 2011
William Emmons: Okay. So at that I will stop, and I'd like to invite Julie and Chris to come up. And so if you have questions, comments, we would welcome those. As Julie mentioned, each of you has a microphone fairly near where you're sitting. So, okay, if you would turn on your microphone?
Q: Could you tell us at what point the relationship of debt-to-GDP starts impacting the growth of the economy?
William Emmons: Anybody want to jump in? I think, you know, it's not the case that the debt-to-GNP/GDP ratio itself effects economy. It's through its effect on interest rates or through its effect on confidence. And as I said, it's something I'm puzzled about. I think probably Julie and Chris are puzzled why the Treasury market apparently is not more worried about the longer term trajectory. So a long way to say, wherever that point is, where the debt-to-GNP ratio starts to effect the economy, I don't think we've hit it yet. Even though there has been a big increase in debt recently, Treasury interest rates are still very low. Any other...
Chris Waller: Well, I would just say that, you know, roughly over the last 150 years in the U.S. the growth rate of GDP has been approximately 3 percent, and that's from going with zero budget deficits to World War II over 100 percent—excuse me, zero debt-to-GDP because you had no budget deficits, to over 100 percent debt-to-GDP ratios. All the way back down, all the way back up. It doesn't seem to have that big of an impact. We look at Japan to give you an idea. Japan's got a debt-to-GDP ratio of 200 percent. No problem. Now, Japan's got other problems, but it doesn't seem to be that when they doubled their debt over the last decade, trying to stimulate the economy to do things, that it caused any collapse of the economy or whatnot.
A large part of debt is just, it comes back to the sort of things that Bill was stressing, it's not a technology problem. It's not like it's something we have to send off to engineers to figure out. You either cut spending or raise taxes. That's it. It's do you have the political will to do it? And a lot of countries have defaulted on their debt when they had debt-to-GDP ratios of 30 percent. They just didn't want to pay it. Take California. Guess what California's debt-to-GDP ratio is. 4 percent. They want to renege. It's not like they don't have the income to pay. Just put 4 percent sales tax for one year, you've paid off your state debt. It should do it. So it's not about&mdsah;at the end of the day it comes down to political will as Bill was stressing. That's it. You just have to make a decision to do it, and if you don't do it, you're going to be in trouble.
Q: What is your opinion of short-term debt financed stimulus?
William Emmons: Anyone?
Chris Waller: Well, this has always been an issue. I'll say the following. There is no clear consensus in economics that this kind of short-term stimulus spending has a huge impact on the economy. The issue is if you borrowed a dollar, spent it on government spending, what would you do to GDP? The answer is for every dollar you spend, the amount you increase GDP is less than a dollar. And it could actually be zero. Right? Because if you borrow a dollar and spend a dollar, you took a dollar from somebody else that could have spent it already. So you're just substituting who is spending it, it doesn't actually mean you change anything. So there's a lot of evidence that it's not that powerful of a tool to get the economy going. And now on the other hand, a lot of economists think that it actually has huge effects. But that's in the data, and so far we don't seem to see it in the data so I'll leave it at that.
Q: What would be your opinion of doing away with income tax entirely and going solely to a national sales tax? Kind of like a fair tax program, if you've heard of that.
William Emmons: I don't know that that would be easy to do in a short period of time. And I don't know that there—Are there any countries that have entirely consumption-based taxes? I don't think so.
Chris Waller: I...
William Emmons: I think one of the issues is, I mean, in a sense, it should be feasible. But I think probably one element is the progressivity in that it is possible to make an income tax—I think this is a fair statement—it's probably easier to make the income tax more progressive because with a consumption tax there may have to then be some adjustments, some transfers. So that would be my guess. But I think if you just put a bunch of economists together, they would probably start with a consumption tax. And it would only be later in the game, for other reasons, they might start thinking about an income tax. That would be my guess.
Chris Waller: Yeah, I mean, let's see, income tax revenue, you'd have to replace roughly 14 percent. I don't know the number right off the top of my head, but something like 14 percent of GDP. So the national sales tax-consumption is 70 percent of GDP, so you have to take it by about 1.3 so your consumption sales tax would have to be about 16, 17, 18 percent to replace it. And I think the bigger problem here is the top 5 percent of the income distribution generates 65 percent of the revenue that the federal government receives. So if you eliminate the income tax, they don't consume at the same rate as everybody else. They save a lot more. So that's why it's a regressive tax. So it's not obvious that just putting a consumption tax on evenly is going to replace the revenue from the low end that you're getting up at the high end.
William Emmons: Yeah.
Chris Waller: So I think it's got to actually be higher than that.
Q: What were the rates of inflation that were in the two scenarios by CBO?
William Emmons: 2 1/2 percent, I think, CPI, I believe. And the economic growth was about the same. And interest rates, the 10-year Treasury had about 5 percent, I think. So the 10-year Treasury rate was a bit above nominal GDP growth.
Male: Excuse me, Bill. We have a question in the River Room.
William Emmons: Yes?
Q: We have these progressively enlarging deficits but no inflation. Why do we not have inflation as we pile up more and more debt? And is it inevitable that we are going to get some inflation? And if so, when do you think this will happen?
Chris Waller: Well, I'll give you an example. Japan, 200 percent debt-to-GDP, they run deflation. So there doesn't seem to be any correlation between inflation and that. The only time that you tend to get it is if in fact countries have to pay off their debt by printing money and just replacing cash. We call that monetizing the debt. So if it comes time you present your debt and say give me something, they say good, here's some cash. I went and printed it off in the back and here you go. That's Zimbabwe.
William Emmons: Right. That's another version of what you were saying, Chris. That's a political decision to convert debt into inflation, just as default…
Chris Waller: Yeah, that's a political decision.
William Emmons: ...is a political choice to stop paying interest.
Chris Waller: Right. So, you know, we kind of ask this question. If Japan can run the highest debt-to-GDP ratio in the world and nobody is worried about it, why is that the case? One claim is it's all internally held. The other claim is they actually believe they'll pay it off. They have credibility or the political will to do it.
William Emmons: Yeah. And it does raise the point, the very first question, I don't know. No one knows if the United States could go to such a high debt ratio. It's possible. Could it go higher? It's possible. We don't know. But, I mean, in terms of, do you want to take that chance?
Chris Waller: Right.
Q: I apologize. This question may not interest everyone in the room. But you mentioned California, and deficits are occurring at a state and local level as well. A lot of times those are financed with municipal taxes and bonds. I know a few members of the Congress have tossed around maybe eliminating tax exemption on its bonds. And I was just wondering if, one, you think that's a real possibility? And two, if you have seen anything on what that would do to the deficit or if it would have any affect at all?
Chris Waller: Yeah, I don't know exactly what the quantitative impacts of that would be. Clearly if you eliminated the tax deduction, the price of the bond would fall and you'd end up paying a higher potential interest rate. But you'd get the tax revenue. So you pay a little more interest but you get more tax revenue. It's not clear, it's just a wash. So I don't know that. I don't know that right off the top of my head. But I know for state and local municipalities, they kind of like this thing. But you'd have to sit down and do a full-scale quantitative exercise to see how much the net effect would be.
William Emmons: And I think, you know, again, it's the same point Chris and I are making that ultimately California's fiscal problems are a political problem. It's not the cost of borrowing right now.
Julie Stackhouse: Why don't we check and see if anyone in Memphis has a question. Martha?
William Emmons: Okay, if not, how about Cheryl?
Cheryl: I was just curious about the extended baseline and this notion that the tax rates are going to keep increasing or tax revenues increasing, and I was wondering where that's coming from? Because I know that there was a one-time increase when the tax cuts expire, so those things bump up.
William Emmons: Right.
Cheryl: The bracket creep it seems to me is adjusted for inflation, so that shouldn't be accounted for too much of it. So is it all from the AMT and the fact that the AMT is not inflation adjusted? Or is it coming from somewhere else?
William Emmons: In the long run, it's the AMT. That's the big one. In the medium term, the bracket creep. Because real incomes will push you into higher brackets. Even brackets that are adjusted for inflation, if real incomes grow, you will go in higher brackets unless they're adjusted also. But you're right, in the long run, the AMT is the monster that eats everyone. Yes?
Q: What's your opinion on Herman Cain's 999 Tax?
William Emmons: We don't have opinions about it.
Chris Waller: We don't touch things like that.
Q: Can you talk a little bit about the commission or the supercommittee, whatever it is, the Nov. 23 decision? Because as I understand it, if they can't come to terms, there are going to be mandatory cuts of 1.2 trillion which seems like the answer, according to your numbers. And there's a possibility that they get to a grand plan that's in the four trillion range. Could that really—is that going to solve our problems?
William Emmons: Julie, you want to...
Julie Stackhouse: I—Go ahead, Bill.
William Emmons: It's in the same spirit as the extended baseline generally. Yes, it solves the problem if all of those provisions are executed. All those numbers, you know, the 1.2 trillion, the $4 trillion grand bargain, those are all relative to that baseline. So in a sense, you have to adjust the fact that, well, the baseline probably is going to slide. But again, it's—As Chris said, it's not that difficult to figure out how to do it. The question is will you do it? And that's I think with the supercommittee it's the same. You know, it's a new version of the old game that we're going to promise to make these changes in the future, and we'll see if we actually make them.
Chris Waller: I just want to make one comment that a lot of the tax rates that Bill showed you that are going to go up, those are the tax rates that existed throughout the 1990s. And we had a pretty decent decade of economic performance from '92, 3, 4 on. We ran budget surpluses, so it wasn't, you know—and at the time those budget surpluses were, this is great, we're going to get rid of some of the debt, Social Security is going to be well-funded, all this was fine. Politics changed, surpluses were handed back, now we're kind of in a different boat, taxes are going to go back to the way they were in the 1990s. What I wanted to just point out is some of that surplus, it took a political compromise in the early '90s to limit spending and raise taxes. That was done, and it generated a 10-year period of very good fiscal performance. So Congress has the ability to do it. They've done it in the past. So we'll always get things right after we've tried everything else.
Julie Stackhouse: Can I just go back to—I saw your look on the 999, and I think that's probably worthy of mentioning, why don't we speak to specific plans? And I think that gets right back to what we talked about a month ago which is the role of the Federal Reserve. The Federal Reserve's role is monetary policy, it's not fiscal policy. And over the years, Fed chairmen in particular have been very careful not to comment on fiscal policy simply because the independence of the Fed is obviously something we value highly. And leaping over into the political circles tends to get you into some situations you might not want. In this situation, though, Chairman Bernanke has taken a very bold step of saying that there must be decisions made. And that is somewhat unique for a Federal Reserve chairman to say even that. And he's been very clear that whether it is a combination of tax increases or spending cuts, that's the choice of Congress. Having said that, if the choice is not made, then the scenario that Bill showed you would be the outcome, and that is, of course, something that we can't afford in our economy. So that's as far as a Fed chairman will go. But I thought it important, it's not that we don't want to answer that question based on personal opinions, but the Fed will not have an opinion on specific programs.
William Emmons: Yes, the next to last row.
Q: You indicated that healthcare is the big bad thing in the whole economy. Has the Fed done an analysis of what would happen if you went to single-payer healthcare? Does that have an impressionable impact in decreasing or do you know? Have you ever done the analysis?
Chris Waller: We typically haven't done much in the way of healthcare analysis. You could make a very simple comment that who pays the bill doesn't save anything. And potentially it's everything else. It's not whether you write a check for it or pay with a credit card or I pay for it or Bill pays for it. It's how much are you going to actually buy? We pay about 14, 15 percent of GDP on healthcare. And that's about, don't quote me on this, but it's roughly double to a third more than most developed countries in our same kind of income category. So the question is why do we spend so much and, say, European countries and Japan and other countries do not? So somewhere on that is we've made a decision on what we're going to give people in terms of care. We're not going to ration care, the quality of care that we give people. And that's just a choice of what kind of healthcare we want to provide to people. You can always cut healthcare expenditures by just rationing. Guess what? We're going to close the emergency doors at the hospital and you're just going to die. That will save a lot of healthcare costs. It's probably not a good social choice, and I don't think anybody in here would like that one. But if you want to cut healthcare costs, that will do it.
William Emmons: Okay. Why don't we take three more questions. I saw one here.
Q: Okay. I'll be darned if I can remember who said it now. But we were talking about political will and the compromise it took in the early '90s. But the quote goes something like, "Men in nations act wisely when they’ve exhausted all other alternatives." I think we're kind of there right now. But my question goes to piggyback from the healthcare question. If healthcare is the big enchilada, wouldn't it be easier—I wrote this down to make sure I get it right—wouldn't it be easier to remove employer-based healthcare and release it to the market? One. Two, release the restrictions on insurance sales and purchases across state lines. I think everybody agrees on healthcare reform being necessary, but I don't know that everybody agrees that government funded or single-payer healthcare is the catchall. I mean, I think if anything, Social Security, Medicare and Medicaid have proven that not to be the case because it's not that efficient, but it is very expensive. So could you speak to that boogeyman being healthcare, would those solutions work?
William Emmons: That's such a big question. I don't think I can even think of that.
Chris Waller: I'll just make one observation. Again, we're not health economists. I do monetary theory. But again, same thing. You go to most European countries, they're single-payer national healthcare, they pay 7 to 10 percent of their GDP. So it's not so much the way that it's paid, whether it's single-payer, federal government, private market; it's what you want to do with it. Now, we all kind of typically think there's a lot of efficiencies that get done by going to the market, getting certain incentives going, removing a lot of healthcare distortions that exist, but I have to leave that to people that know a heck of a lot more about it than I do.
William Emmons: Yeah, I think that's the right thing for a Fed economist to say. That's not really for us to say. Okay, maybe one or two more. Back row?
Q: I'm confused about the role of the Social Security and Medicare trust funds. It didn't seem that the CBO figures include those. Or am I missing it altogether?
William Emmons: They are excluded from the net debt or the debt held by the public, that is true.
Julie Stackhouse: Bill, but in the projections that you showed, those costs are included in those projections.
William Emmons: The future costs of benefits, yes, absolutely is included.
Julie Stackhouse: Right.
William Emmons: So really, those trust funds, it's an accounting thing. It's a timing issue. We're collecting taxes a little bit in advance of the spending. But ultimately all of these projections are tracking the spending, tracking the outlays and tracking the revenues, and the timing is less critical. And that's what the trust funds are about is just adjusting timing.
Julie Stackhouse: So in your projections, I think what the line showed is that Social Security continues to grow in terms of its cost, but as the aging of the population stabilizes then that becomes less of a factor. Whereas with healthcare it continues to grow. And so that's why although Social Security is not unimportant, if you have to compare it to healthcare costs, healthcare is going to be a bigger chunk.
William Emmons: Right, exactly. And again, it fits in that category with Social Security as opposed to healthcare. With Social Security, you get three economists in a room, you could hammer this out in 15 minutes, you could solve this problem, you know, a two-to-one vote. We're going to adjust on this margin.
Chris Waller: You know, we could just do it with one.
William Emmons: Or one, yeah. But what I'm saying is you've just got two levers essentially, and the two-to-one will decide which levers you push or pull more. But it's not a complicated problem. Whereas healthcare is very complicated. Okay, last question.
Q: Thank you. I believe Bernanke made a statement several months ago that this country needs a little more inflation. And I believe he even said that we need to increase the target inflation from 2 to 3 percent or something in that area. Well, it seems to me that if we increase the target rate even further to, say, 7 or 8 percent, we could have cut our national debt every 10 years, cut it in half. Wouldn't that take care of our so called alternate situation?
William Emmons: That's got your name on it, Chris.
Chris Waller: Well, that's what Zimbabwe is doing. I wouldn't say it's a very good strategy. No, I mean, in a way, if you go that route, you're defaulting on your debt, partially defaulting. I promise you I'll give you X today in terms of what that dollar will buy today. And then I give it to you in five years or 10 years and it's worth half of what you gave me. That's implicit default. That's why we don't advocate anything that looks like default in terms of U.S. policy. So we leave that to third world countries that don't seem to have any problem with it.
William Emmons: Okay, thank you all very much.