Monday, October 07, 2013

The Debt Limit and Default

One thing that puzzles me about the current controversy is that almost everyone talks as though hitting the debt limit means that the federal government must default on interest payments on its debt. So far as I can tell, there is no reason that should be the case. Federal revenue is about eleven times net interest payments, seven times interest payments including intergovernmental interest (such as the interest the government pays the social security fund for "reserves" that the government has borrowed and spent). So there is more than enough revenue to continue paying interest on the debt—provided it isn't all spent for other things.

Not only is default on the debt not necessary to deal with the debt limit, it is not sufficient, not nearly sufficient. Net interest payments are about 220 billion dollars a year, the current deficit is running about 750 billion a year, so if the government stops paying interest it would still have to cut other expenditures by more than half a trillion dollars a year to balance the budget. On the other hand, total federal expenditure is running a little under four trillion dollars a year. So if the government continued to pay interest on the debt and reduced every expenditure other than interest by about 20%, the budget would balance.

I don't expect it to happen and am not terribly interested in arguments about whether it ought to happen, since they rapidly turn into arguments about macro-economics, which is not my field. But simply as a matter of logical possibility, the government could balance the budget while continuing to pay interest on the debt and it cannot balance the budget by defaulting on that interest unless it also sharply reduces other expenditure. Facts which seem to be ignored in almost all public discussions of the situation.

12 Comments:

At 2:22 AM, October 08, 2013, Anonymous Anonymous said...

i have done many masters level macro. the reason why the debt limit matters is because the macro-economy works not on realities but on expectations and reality. if everyone believes that reaching the debt limit is a disaster, then when it does happen it will be a disaster.

 
At 6:11 AM, October 08, 2013, Anonymous Anonymous said...

I'm not an American and I don't know if this is true or not, but it would answer your question:

http://www.slate.com/blogs/moneybox/2013/10/07/debt_ceiling_breach_default.html

 
At 6:39 AM, October 08, 2013, Anonymous Daublin said...

As an additional option, Congress always has the ability to pass some legislation that does not raise the debt ceiling but does provide the executives with a clearer way to prioritize its spending.

As a thought about pragmatic reality, an executive branch receiving more mandates than funding just has to pick and choose which of its accounts it will pay. That is, unfunded mandates are not mandates.

 
At 7:32 AM, October 08, 2013, Blogger lelnet said...

Besides...the entire discussion is ultimately beside the point. The argument over the budget is ultimately about "can we afford it?". To which the answer is pretty much always going to be "yes, we can afford anything we choose to, if we're willing to make the necessary trade-offs, which we inevitably aren't, which is why we just keep going ever-deeper into debt instead".

A 20% cut in everything but interest would indeed balance the budget. But across-the-board cuts really only paper over the real problem. We'd do far better to _zero out_ expenditures which the US Government is making without legitimate Constitutional authority. Do that, and we could easily fund what's left at 100% and still be in massive surplus, given current tax revenues.

And unlike the 20%-cut strategy, the advantages of that course wouldn't be limited to the budget.

 
At 10:44 AM, October 08, 2013, Blogger RJM said...

Germany (and probably every modern social welfare state) faces similar problems. I, too, feel that there is a strawman involved in these discussions. For me it was quite insightful to look on the spending/debt issue in the following simplified manner: Imagine a black box including a government and a central bank. This way the black box can be reduced to a money-printing-press. All these numbers like debt, ceiling, interests, Maastricht-Criteria may have some function in the bizarr world inside the black box but the nature of the black box is not affected. It's just governments spending by printing money.

 
At 12:53 PM, October 08, 2013, Anonymous Anonymous said...

What is the legal or moral justification for the President to prioritize interest payments on the debt?

 
At 1:22 PM, October 08, 2013, Anonymous Laird said...

"the legal or moral justification for the President to prioritize interest payments on the debt" is that it is a contractual obligation of the government. Most other spending is not. (Not even Social Security or other "entitlements", which are generally classified as non-discretionary. The Supreme Court long ago ruled that there is no legal right to such payments, which Congress can change or eliminate at its pleasure.) Interest is one of the few government expenditures which is truly mandatory.

 
At 4:48 PM, October 08, 2013, Anonymous Anonymous said...

David is there anyone in Macro who you trust? (and is alive?)

 
At 5:04 PM, October 08, 2013, Anonymous Anonymous said...

Outlays and receipts are lumpy. Coupon payments may not line up with tax receipts so you'd need excess capacity just like the power lines do, which means running a surplus.

And if you hit the debt limit, the markets will tank and people will lose a chunk of the retirement savings.

 
At 6:58 PM, October 08, 2013, Blogger David Friedman said...

Anonymous 1: I don't do macro myself, so am not competent to say which current macro theorists are most likely to be correct, which is what I assume you are asking.

Anonymous 2: You might need to run a brief surplus, or alternatively to cut spending a little before you run out of money, so as to have a cushion to deal with fluctuations in obligations, but you don't need a continuing surplus for that.

So far as markets tanking, I don't see why. Are you assuming that for the government to stop running a deficit would have dire economic consequences? That's the prediction of 1960's Keynesianism, which a lot of people seem to take as orthodoxy at the moment, but I don't know of any reason to believe it is correct.

 
At 10:54 AM, October 09, 2013, Blogger Will McLean said...

Here's a post describing some of the problems with the "Just pay the interest" strategy:

http://www.theatlantic.com/business/archive/2013/10/republicans-dont-think-they-have-to-raise-the-debt-ceiling-theyre-dangerously-wrong/280409/

 
At 1:46 PM, October 09, 2013, Blogger David Friedman said...

Will:

Thanks for the link--did you find the arguments persuasive? They struck me as pretty feeble, and I expect I'll do another post on the subject.

 

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