Transcript 2012

Gross Federal Government Debt
$22
Source: Office of Management and Budget
Dollar Amount
Percent of GDP
20.5
20.0
19.4
18.9
18.4
17.9
17.4
$20
$18
2012:
130%
120%
110%
16.8
16.0
100%
Gross Debt
= $16 Trillion
Debt-to-GDP = 103%
$16
21.7
21.1
14.8
14.5
90%
$14
80%
$12
10.0
$10
7.9
7.4
$8
$2
60%
6.8
6.2
5.8
5.55.65.6
5.4
5.2
4.9
4.6
4.4
$6
$4
70%
9.0
8.5
50%
4.0
3.6
3.2
$84 Trillion
2.9
2.6
Implicit (unfunded) liabilities
2.3
2.1
1.61.8
1.4
0.91.01.1
0.8
0 .8
0.7
0.6
0.5
0 .5
0 .5
0.4
0
.4
0.4
0
.4
0
.4
0.3
0.3
0
.3
0
.3
0.3
0
.3
0
.3
0
.3
0.3
0
.3
0
.3
0.3
0
.3
0
.3
0
.3
0.3
0
.3
0
.3
0.3
0
.3
0
.3
0.3
0
.3
0.2
0.1
0 .1
0.1
0 .1
40%
30%
20%
$0
40
44
48
52
56
60
64
68
72
76
80
84
88
92
96
00 04
08
12
16
20
Percent
$ Trillons
12.9
Federal Government Debt
Held by Public
$20
$19
120%
Dollar Amount
Pe rce nt of GDP
> 90% => 1% GDP Loss
Source: Congressional Budget Office,
http://www.cbo.gov/doc.cfm?index=10014
$18
110%
$17
15.3
14.9
14.5
14.1
13.8
13.5
13.2
12.8
12.4
11.9
$15
$14
$ Trillion
$13
$12
2012:
$11
Public Debt
= $11.2 Trillion
Public-Debt-to-GDP = 72.5%
$10
11.2
100%
90%
80%
10.1
70%
9.0
8.5
$9
60%
$8
$7
5.8
$6
$5
$4
$3
$2
$1
50%
4.85.0
4.6
4.3
3.9
3.8
3.7
3.63.7
3.6
3.5
3.4
3.4
3.3
3.2
3.0
2.7
2.4
2.2
2.1
1.9
1.51.7
1.3
0.91.1
0.8
0.7
0.6
0 .6
0.5
0.40.5
0.3
0 .3
0 .3
0.3
0 .3
0 .3
0 .3
0.3
0 .3
0 .3
0.3
0 .3
0.2
0.2
0.2
0 .2
0 .2
0.2
0 .2
0 .2
0 .2
0.2
0 .2
0 .2
0.2
0 .2
0 .2
0 .2
0.2
0 .2
0 .2
0.1
0 .1
0.0
0 .0
40%
30%
20%
$0
40
44
48
52
56
60
64
68
72
76
80
84
88
92
96
00
04
08
12
16
20
Percent
$16
(Percent)
65
Employment-to-Population
Vs Debt-to-GDP
64
70
63
65
62
60
61
55
60
50
59
45
58
40
57
35
Recession
Employment-to-Population (LHS)
Employment Ratio Target = 62.5%
Debt-to-GDP (RHS)
56
55
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Department of Labor.
The level of the employment ratio determines direction of debt ratio:
•
•
•
75
Employment-to-Population > 63% =>  Debt-to-GDP
Employment-to-Population = 62-63% => stable Debt-to-GDP
Employment-to-Population < 62% =>  Debt-to-GDP
30
25
(Percent)
Unemployment Rate Vs
Budget Deficit-to-GDP
12
12
11
11
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
-1
0
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
-1
-2
-2
-3
-3
-4
Recession
Deficit-to-GDP
5% Unemployment Target
-4
Unemployment Rate
3% Sustaintable Deficit Target
In the short run, the deficit ratio is determined by the unemployment rate. When the unemployment rate
exceeds 6%, the deficit ratio rises above the 3% sustainable target. If unemployment falls below 6% the
deficit ratio falls below 3%. This will bring down the Debt-to-GDP ratio.
In the long run, the unemployment rate is influenced be the nation’s debt-to-GDP ratio.
Automatic Stabilizers: government spending and tax rules that counteract the business cycle
Low Unemployment Scenario => high tax revenues and low transfer payments => low deficit &
contractionary fiscal policy.
High Unemployment Scenario => low tax revenues and high transfer payments => high deficit &
expansionary fiscal policy.
Options to Reduce Public Deficits to 3% of GDP by 2014
Persistent deficits lead to:
Rising interest rates which crowds out private spending
Future tax uncertainty which reduces business/consumer confidence/spending
Spending Options:
$ bn
Raise Social Security retirement age to 70 (eligibility of 67 by 2027 currently)
4
Change benefit inflation index to one less upwardly biased
10
Reduce starting Social Security benefit for most workers
7
(initial benefit indexed to wages for low income, inflation for others)
Raise Medicare age to 67 from 65
3
Convert Medicaid share to block grants (to reduce distorted state cost incentives) 47
Reduce Medicaid share to wealthy states (eliminate 50% floor on federal share) 22
Reduce highway funding and farm assistance
8
Total:
$101
Options to Reduce Public Deficits to 3% of GDP by 2014
Eliminate Tax Deductions for:
Employer-provided health insurance (to reduce Cadillac plans and spending)
Mortgage interest (to reduce excessive borrowing and leverage)
State & local taxes
Capital gain on homes (to reduce distorted incentives and behavior)
Property tax
Municipal-bond interest
Total:
215
147
65
60
33
32
$552
Options to Reduce Public Deficits to 3% of GDP by 2014
Other tax options:
Implement 5% VAT (Value Added Tax at each stage of production)
324
Cap employer health-insurance deduction to average premium
70
Raise federal fuel tax by 50 cents a gallon to 68 cents
62
Carbon-emissions tax (or Cap-and-Trade system)
National sales tax (to reduce dependence on income tax which penalizes work and
investment)
The U.S. tax system needs less complexity, more bias towards taxing consumption and
elimination of loopholes to broaden income-tax base which will allow for the lowering
of tax rates.
Employment Cost Index
(Most Comprehensive Measure of Labor Costs)
Web address: www.stats.bls.gov/news.release/eci.toc.htm
Annual revisions with release of first quarter data which can go back several years.
The employment cost index (ECI) is an early warning system for rising inflation which can push interest rates higher and stock prices lower. ECI is
the best harbinger of pricing pressures and is a forerunner of inflation.
Labor costs typically make up 70% of a firm’s operating costs. Employment costs = wages/salaries and fringe benefits.
Rising compensation costs can result in various responses by firms:
Raise retail prices => inflation.
Absorb expense and maintain prices => falling profits => falling stock prices.
Increase capital investment to raise productivity and reduce workforce.
Reallocating production facilities by decreasing domestic production and increasing foreign production => increasing unemployment and
unemployment insurance costs => increasing government spending and deficits.
Wage-price spiral (a vicious cycle the Federal Reserve will try to stop)
 labor expenses =>  retail prices =>  workers demand for wages/salaries =>  retail prices (self-perpetuating inflation escalation)
Every quarter the BLS surveys 8,500 private and 800 public sectors (local and state only) on labor cost issues. Survey is done for the pay period that
includes the 12th day of March, June, September, December.
Wage and salary data include bonuses, incentive pay, commissions, and cost of living adjustments.
Benefits data include insurance benefits, retirement savings benefits, paid vacations, sick leave, holidays, premium pay for overtime, shift
differentials, social security, Medicare, federal-and state mandated social insurance programs.
Data is converted to index where June 1989 = 100
Labor Costs relative to Productivity
If annual compensation costs are rising (tight labor markets) faster than annual changes in non-farm productivity (falling marginal product of labor),
then economy may be facing inflationary pressures.
Strong productivity growth =>  profits =>  wages and salaries.
The monthly Employment Report’s average hourly earnings (AHE) is another good indicator of wage inflation. But AHE covers only workers who
receive hourly pay (not salaries) and does not include benefits, whereas the ECI covers both hourly and salaried workers.
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Market Analysis:
Bonds: Unexpected big  ECI without big  in productivity => (DP/P)Et+1=>  DBonds =>  iBonds
=>  fed funds rate by Fed to stop wage-price spiral
Stocks: Unexpected big  ECI without big  in productivity and economy operating above potential =>  business costs =>  profits =>  PStocks
Dollar: Unexpected big  ECI without big  in productivity and economy operating above potential =>  interest rates => capital inflows => increase value of dollar.
But an  ECI =>  U.S. export competitiveness =>  exports/ imports=>  trade deficit =>  exchange rate.
Employment Cost Index
(% change from quarter one year ago)
Civilian Workers
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
Recession
Total Compensation
Wages & Salaries
Benefit Costs
0
83Q1 85Q1 87Q1 89Q1 91Q1 93Q1 95Q1 97Q1 99Q1 01Q1 03Q1 05Q1 07Q1 09Q1 11Q1 13Q1
Source: http://w w w .bls.gov/new s.release/eci.nr0.htm
1
0
Federal Government Surplus/Deficit
(Billions of Dollars)
$500
236
$250
126
69
128
$0
80
82
-74-79
-128
-$250
84
86
88
90
92
94
96-2298
-107
-150
-153
-155
-164
-185
-203
-208
-212
-221
-221
-255
-269
-290
00 02
04
06
-158
10
12
-161
14
-459
-585
-$750
•Bank stock purchases (TARP)
•Stimulus plan
•Mortgage bailout plan
•Income-support programs
•Recession-induced falling revenues
-$1,000
-1,079
-$1,250
-1,294
-1,296
Source: Congressional Budget Office.
-$1,500
16
18
20
22
-196
-220
-258
-269
-280
-279
-302
-339
-345
-248
-318
-378
-413
-$500
08
-1,400
Fiscal Austerity Versus Economic Growth
Question: Should government cut spending and raise taxes in the short run to reduce our deficit-to-GDP
ratio or should we wait and allow economic growth to reduce the ratio in the long run.
Short-term fiscal austerity can be self-defeating:
•
•
This paradox can be explained with the “Fallacy of Composition”: What is true for an individual in not always
true for the whole.
Recall the economic principle - one person’s spending is another person’s income.
Micro level
When a household reduces their current spending, they can use the funds to pay down their debt (deleverage). Assume
a household income is not affected by their spending.
Household Budget Constraint
Income + Change Debt = Taxes + Debt Interest + Consumption + Savings
Macro level
When a government reduces their spending, household incomes drop which reduces tax revenues and increases transfer
payments (unemployment insurance, food stamps, medicaid). This could increase the nation’s deficit.
Government Budget Constraint
Tax Revenue + Change Debt = Government Spending + Transfer Payments
The Political Decision
Short-Run Economic Growth versus Long-Run Fiscal Sustainability
Two Goals:
1.
Avoid a recession in the near term
2.
Achieve fiscal sustainability in the long run
Fiscal Sustainability
•
•
•
•
•
Constant Debt-to-GDP ratio
Achieved when the national debt grows in line with GDP
Keep the Debt-to-GDP ratio below 90% to avoid triggering a financial crisis.
Keep deficits below 3% of GDP. Given the expected pace of GDP growth, that will stabilize the
debt-to-GDP ratio.
Unemployment must be below 6% to see the deficit-to-GDP ratio below 3% and therefore a
stable and falling Debt-to-GDP ratio.