Fiscal responsibility, and the Obamanomics Report for May 2009

"Fiscal responsibility" is a term nobody ever defines — until today.

I gave it a shot a couple years ago, in an article titled “'Fiscal Responsibility' defined at last" -- but even that definition turned out to be too mushy for my taste. If I had it to do over again, I'd add two words to the end of the title: "...sort of."

If you've read more than a few articles at this blog, you already know my position: Growing debt is nothing to fear as long as the economy is growing at or near the same pace as the debt. The proper measure for that was the debt-to-GDP ratio. Recently, I've had to amend that position: It is ALSO nothing to fear as long as we are using it in the short term to get the economy back on the growth track.

But the problem with using the debt/GDP ratio as the measure is that nobody can say how much is too much (or too little); consequently, nobody knows how much runway we have left. Debt/GDP was 120% after WW2, but would that be too much now? Or would we still have some slack even at that level? Who knows? (Not economists, I can tell you that with a lot of confidence.)

I found a measure I like better than debt/GDP. It's the "Net Interest share of Federal Spending." If our monetary policy is successfully controlling inflation, but we are not being fiscally responsible, the interest share of spending will grow in the long run, crowding out things like defense, justice, social security, and health care.

Some things that put upward pressure on the interest share of spending are:

• increasing federal debt
• increasing interest rates on the debt
• "investments" that don't boost the economy

Some things that relieve the pressure are:

• increasing GDP (by far, the best way)
• decreasing interest rates on the debt
• "investments" that succeed in boosting the economy

[I intentionally left "running surpluses" off the second list; for an explanation why, see this article from four years ago.] 

How much is "too much"? I think we have a better indicator with this new statistic. Interest required 15% of federal outlays in the Clinton years, which are loudly touted as a good example of fiscal responsibility. Because of falling interest rates and growing tax receipts during the Bush years, it fell to an even more fiscally-responsible range of 7%-9%. Now the Obama budget calls for a combination of spending, growth, deficits, and interest rates that will take it back up to the Clinton-era level of 14%. No sweat, in my judgment, IF the budget comes true. (Big if, huh?)

So, here's the new chart. I plan to update this one monthly.

Pay no attention to the huge drop in the last six months; it's temporary, and it's due to the huge spending increase that will soon cause the interest payments on the debt to rise, just as the budget predicts. We need to watch how the red line tracks against the budget line.

I will say that if it does level off at 14% in a few years, that will be sustainable, and it will match the level achieved in the Clinton years. But it will require most of the "investments" in the Obama budget to pay off in enhanced growth. We'll see it unfold fairly soon, in any case.

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Data sources:
Monthly Treasury Report

Treasury Debt Position Report

Obama budget[*]

[*] The only assumption I had to make was this: The avg interest rate "budgeted" for paying net interest on the publicly held debt will be the midpoint between the budget's forecasted rates for 3-mo T-bills and 10-yr T-notes. 

Comments

[jpniner]

what would the numbers look like if Bush had kept spending lower than he did? Say no Medicare Entitlement, things like that for example? Would that have made that Red Line even lower or higher?

politically the problem is that Conservatives don't care about the actual Financial Anaylsis, what they care about is growing Govt., paticularly nanny state govt. Which is what the spending represents

[jpniner]

Guess the question is, If Clinton had the Budget totals of today, would that 15% number not be alot lower?

[Bret]

Are the numbers in this post "nominal", "real", or a mix? And how does inflation fit in?

I would claim that virtually any nominal interest rate is, in theory, sustainable, but it's real interest rates that are the real concern.

[Optimist123]

Bret:

All are nominal. Deflation hurts debtors, helps creditors; inflation (above 2%) helps debtors, hurts creditors. Of the two, deflation is worse (if we had to choose), according to this article in The Economist, with which I agree:
http://tinyurl.com/cjzufy

In any case, preventing deflation and inflation is priority number one, and it's the job of monetary policy. Fiscal policy's job is to provide the goods and services we demand from government (via our elected representatives in both branches) -- and they can't do that if interest payments crowd out noninterest spending capacity, and inflation is not a "tool" available to the politicians.

[Jerry McInvale]

Steve,

I'm probably missing something here, but why compare interest to spending? That equation, probably oversimplified, would seem to be expressed as (interest expense)/(tax revenues plus deficit). If that is approximately correct, it would seem that the more the government spends, the lower the ratio as incremental interest will always only be a fraction of the debt incurred to fund the deficit. It would seem to me that a better measure of fiscal responsibility would be to compare interest expense to total tax revenues. That might more accurately reflect how responsible the government is being as regards tax and spending policies. I have no clue what the right ratio would be, but rapid changes in that ratio would clearly indicate imbalances that should be addressed by taxation or spending policies or both.

Jerry McInvale

[Optimist123]

Jerry:

I was onto that one (Times Interest Taxed) for a while, and I still think it's better than debt/GDP -- but not quite as good as (the inverse of) Times Interest Spent. Reason the latter has the edge, in my judgment: There are only three ways for the government to obtain the dollars it spends -- taxing dollars that already exist, borrowing dollars that already exist, and "printing up" dollars that do not yet exist. The third one is the job of the monetary authority (the Fed); therefore, the politicians can only control the mix of the first two. When the interest share of spending gets "too high" (and I would estimate that 15% gets us into the red zone), it's a more direct danger signal. I would have more difficulty drawing the red-zone line for the T-I-T statistic.

Not a big difference, but that's why I shifted to the latter.

[Bret]

Steve wrote: "Deflation hurts debtors, helps creditors; inflation (above 2%) helps debtors, hurts creditors."

Perhaps what you mean is that an UNEXPECTED decrease in the rate of inflation hurts debtors, helps creditors; and an UNEXPECTED increase in the rate of inflation helps debtors, hurts creditors. Expected inflation is more or less priced into contracts so as long as it ends up as expected, neither creditor nor debtor gains.

Also, Congress can change the Fed's mandate, no? So to assume that inflation won't be a factor in the future is, in my opinion, a mistake.

[jpniner]

speaking of the Fed, there are loads of the gutter stuff floating around at the moment as is expected.

thanks to that, Bernie Sanders and Ron Paul's Legislation to "Audit the Fed" has over 160 Co-Sponsors at the moment! These morons aren't really trying to Audit the Fed but place Monetary Policy back in the hands ot the idiots in Congress/politicians instead. What they think is what the Constitution calls for.

[Optimist123]

Yes, "unexpected" is correct. And yes, Congress can change the Fed's mandate; it wouldn't be easy, and there are proposals out there for making it even more insulated from the politicians. In any case, it's critical to keep it as independent of the politicians as possible.

[Optimist123]

Bernie Sanders and Ron Paul? Strange bedfellows.

Alexander Hamilton warned us to keep the money supply away from politicians. I hope we continue doing that -- otherwise, we'd be in much deeper trouble.

[jpniner]

the grassroots nutters are big on the Federal Reserve right now, supposedly the Fed can't account for $9 Trillion on its balance sheet right now. Thats both the far-left and Far-Right, they are one on the Fed and Foreign Policy. Rothbard was the link.

The Lew Rockwell crowd think Alexander Hamilton is an Evil Socialist and the worst Founding Father we had. They are taking a narrow view of Constitution, claiming that the only Constitutional approved Monetary powers are with Congress.