Thursday, May 28, 2009

Jim Capretta on a fiscal wake up call

The Ethics and public Policy Center's Jim Capretta blogs at National Review on the danger that fiscal profligacy will cause a downgrade of U.S. treasury bonds:

At the end of 2008, our national debt burden stood at 41 percent of GDP. The Congressional Budget Office (CBO) expects the Obama budget plan to push it above 82 percent at the end of 2019.

And that's before the retirement of the baby-boom generation hits with full force. Between 2020 and 2030, the number of Americans age 65 and older will increase from 53.7 million to 68.9 million — a jump of 16 million over a decade.

But would a bond downgrade finally spur Congress to action? You'd like to think so. But as I argued here, under standard Social Security and Medicare accounting a financial crisis could actually make the programs' problems seem smaller and less urgent.


Brooks said...


Is there any significant probability under some scenario that we would ever default as opposed to monetizing it? In other words, is it plausible that we would prefer the harm of the spike in real interest rates and other harms associated with default over the harm of inflation caused by monetization?

Andrew G. Biggs said...

This is a bit tricky. If you could do it over a long period, then increased inflation would do the job. The problem is that markets aren't stupid, so once they know you're doing that they'll dump your debt. You'll need more borrowing to cover roll-overs but you won't be able to get it if people know you plan on montetizing, so then a default could happen. Monetizing seems the most likely path by far, but you can't say for certain.

Brooks said...


Thanks. Follow-up question: I assume that, at the extreme of full monetization (the Fed buying ALL our new debt), we wouldn't need to find buyers, so we could still avoid default (as long as we preferred extreme inflation), correct?

It seems that once we monetize to a significant extent, there is pressure to go all the way (for the reason you provided).

I have another, separate question: If borrowing (i.e., the deficit) in a particular year is particularly high and if that means that sales of 10-year Treasurys are particularly high, does that mean that in 10 years (when they mature) the amount we must roll-over (and thus the amount of new debt we need to issue) spikes accordingly, or does the Treasury somehow smooth it out?