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Austan Goolsbee, Stephen Colbert, And The Debt Ceiling…

May 25th, 2011 · 16 Comments
Macroeconomics · Policy

We’ve been hearing a lot about the debt ceiling recently, and yet I haven’t come across any news articles that really explain what the debt ceiling is. Perhaps this is because the debt ceiling is supposed to be self-explanatory, but I figure it’s better to be safe than sorry when it comes to educating. So I’ll start at the beginning.

Each year, the government can run either a deficit or a surplus. A deficit occurs when the government spends more than it takes in, and a surplus occurs when the government takes in more than it spends. If the government runs a deficit, it generally borrows in order to make up the difference. The government debt, on the other hand, is the accumulation of all of those deficits and surpluses- when a government runs a deficit, the debt level increases, and when the government runs a surplus, the debt level decreases. (Government surpluses are also sometimes referred to as public saving.) Easy, right?

People like to explain government spending by invoking an analogy to household spending, and I usually object to such analogies since there are important ways in which the government’s choices (and their consequences) differ from those of a household. In this case, however, the analogy works pretty well. As such, you can think of the debt ceiling as a government’s self-imposed credit limit. (Note later that Goolsbee says that it’s not like a credit limit because the government can agree to spend past the limit but then can’t pony up the cash when it comes time to spend. I equate this roughly with a situation where the credit card company lets you go over your credit limit but then charges you a fee and doesn’t let you do it again until you pay the balance down.) As with a credit card, when a government’s debt ceiling is reached, it can’t borrow any more money until it pays off some of its debt.

What does a household do when it maxes out its credit line and is still running a deficit? Well, it has a number of options: it could spend less, it could just not pay its bills on time, or it could declare bankruptcy. Clearly, the first of these options seems the most reasonable…but what happens when the household has consumption commitments such as a lease, car payments, etc.? Complete fiscal austerity is not usually an option for households, and it isn’t an option for the government either, since the government has committed to paying public employee salaries, making interest payments, honoring unemployment claims, and a whole host of other things. (This is the distinction between the discretionary and non-discretionary spending that you keep hearing about.) So what is a government to do?

This is where the debate about raising the debt ceiling comes in. Put simply, the government (in the longish term, at least) has the choice to either raise the debt ceiling or default on something. So what should it default on? If it defaults on its existing debt (i.e. doesn’t make interest payments), the government’s equivalent of a credit score will go down, and I don’t have to tell you what happens to people with bad credit scores. Well, maybe I do- they pay higher interest rates when they borrow in order to compensate for their riskiness. Therefore, defaulting on interest payments could make the situation worse, not better. So should the government just not pay people their salaries and unemployment instead? Let the mass rioting begin…

Austan Goolsbee, President Obama’s Chief Economic Adviser, explained most of this and more on the Daily Show. Granted, his preference for raising taxes as opposed to only cutting spending is very much a normative Democratic viewpoint as opposed to objective fact, but I very much appreciate that he tries to explain in reasonably normal-person terms what is going on. The video comes in three parts:

Now you know more than you probably ever wanted to about the debt ceiling. On the up side, at least you won’t be like the people who are somehow more worried about having debt than defaulting on said debt:

A new poll of terrified and economically illiterate Americans (“the public”) finds that more Americans are worried about our growing national debt than are worried about the prospect of defaulting on that debt, by failing to raise the nation’s debt ceiling. Americans! Always saying nonsensical things

In fact, fearing debt and fearing default are essentially the same fear: a fear of debt is simply a fear that we’ll be forced to default some time in the future.

It’s like if people said that they are afraid of the water rather than saying that they are afraid of drowning. Oh wait…

Tags: Macroeconomics · Policy

16 responses so far ↓

  • 1 Will Hayworth // May 25, 2011 at 7:44 pm

    Great discussion, but (and I don’t mean to be disagreeable) why no mention of recourse to inflation?

  • 2 Chuck Dolci // May 25, 2011 at 9:03 pm

    So let me see if I understand this whole thing:
    The Colbert Report is a program on the Comedy Channel, right?
    So Austan Goolsbee, President Obama’s Chief Economic Adviser, appears on a comedy show to explain to the American people the nature of our debt and our budget (let’s not call it a “crisis”) situation, right?
    Ergo, Americans get their economic news from a comedy show.
    This all may explain why our national debt (not including state and local debt and unfunded liabilities) is more than 90% of GDP and people are laughing.
    Alfred E (What me Worry?) Neuman

  • 3 econgirl // May 25, 2011 at 9:41 pm

    @ Will: Because default and hyperinflation are usually an either/or situation when a nation has its own currency and sovereignty regarding monetary policy. For more, see here:

    http://seekingalpha.com/article/264668-inflation-and-the-debt-default-paradox

    @ Chuck: If I were Goolsbee, I would march right on over to Fox News, but the huge posters of Glenn Beck and Sean Hannity in the elevator bank of the Fox building kind of scare me off.

  • 4 econgirl // May 25, 2011 at 9:46 pm

    @ Will again: Wait, I think I can’t read. Upon further inspection, it appears that you meant using inflation to get out of debt. The easy answer is that inflation happens (from a policy standpoint) when the money supply is increased, and an increased money supply goes together with lower interest rates. Have you seen how low interest rates are nowadays? There is a logistical minimum at a zero nominal interest rate, which limits the impact of such a policy in this case.

  • 5 Tristan T. // May 25, 2011 at 10:05 pm

    It’s scary because I’ve been having conversations with people and they think having government debt is worse than defaulting on that debt.

    Who needs wool to pull over people’s eyes when they’re already blind. (~_~)

  • 6 Tristan T. // May 25, 2011 at 10:15 pm

    I guess what is really bothersome is that people think defaulting on national debt is some magic bullet like declaring bankruptcy… And when did we get in the mindset that bankruptcy was a social acceptable way to get out of debt except in extraordinary circumstances?

  • 7 econgirl // May 25, 2011 at 11:07 pm

    About 3 years ago, by my calculations. =P

  • 8 Punditus Maximus // May 25, 2011 at 11:51 pm

    Colbert and The Daily Show are massively superior sources of analysis to anything other than maybe Krugman. They aren’t beholden to the “balance” meme and are therefore allowed to note when one or more parties is lying.

  • 9 Will Hayworth // May 26, 2011 at 3:02 am

    @Jodi: but government debt (outside of TIPS, which IIRC can have their inflation-protection suspended anyway) is specified in nominal, not real, terms, which makes it pretty easy (absent a debt ceiling) for the government with a non-convertible sovereign (i.e. completely unpegged) currency to sell a bond to the central bank, which simply issues new liabilities to fund its purchase. Am I missing something?

  • 10 Eat The Babies! // May 26, 2011 at 10:27 am

    Don’t you think there is one other fear? That the service on the debt is so overwhelming that you can’t get anything else done? It makes up like 1/3 of annual spending, right, which makes the fear of debt more than just fear of default. It’s also fear of servicing the debt.
    No?

  • 11 econgirl // May 26, 2011 at 1:38 pm

    @ Will: Actually yes. The point you make is about the supply of money only. In order for money to actually stay in circulation, the public has to be willing to hold the extra currency. This is where the demand for money comes in. If people want to hold a certain finite amount of currency (as opposed to less liquid stores of wealth that actually pay interest) at nearly zero interest rates, it’s very difficult to get them to want to hold more currency, since nominal interest rates have a zero lower bound. The interest rate is the opportunity cost of holding money, and if you can’t lower the cost than you can’t encourage holding.

  • 12 Marc C. // May 26, 2011 at 5:55 pm

    The biggest problem I see is the current tendency to equate the debt ceiling to an automatic guarantee of default. This is disingenuous. Default is a choice that the could be made, as you point out in the your household credit limit example. But spending less is probably a better one, this obvious for a household or the US federal government. The main difference really being that the house hold doesn’t have votes to buy.

    Currently, cuts equal in size to the interest payments are the choice that adverts a default. That being said, americans are not used to government cut backs. And this makes the political will needed hard to imagine.

    There a big problem with not cutting, and that everyone seems to be ignoring, interest rates.

    If we default, interest rates go up. That being said, if the debt ceiling is not raised then any responsible person would agree that we should be putting debt payment ahead of all else. We definitely do not want to default.

    If we do raise the debt ceiling, there’s interest rate risk associated with doing so. First, all the political banter about the US only be able or willing to make interest payments contingent to be able to borrow more, puts us the in the realm of a giant ponzi scheme. Not good for investor confidence. When creditors confidence goes down interest rates go up. Second, even minus the almost childish demand the “we won’t pay you back in less you keep lending us more”, as the debt continues to grow to ever larger percents of GDP it’s makes lending look riskier. And when lending risk goes up so does interest rates.

    And then comes the all too predictable response “the fed can keep the rates down”. But the fed does this by monetizing the debt aka inflation. And when we push that policy far enough we all loose.

  • 13 econgirl // May 26, 2011 at 6:12 pm

    You seem to be willfully ignoring the fact that the government already committed to a level of spending that would put it above the debt ceiling, and now the bills are coming due. (For the record, I do find it problematic that the government can pass a budget that potentially conflicts with the debt ceiling.) While I agree that cutting spending is certainly an option for the future, it is no longer an option for the past, and the government doing the bureaucratic equivalent of a dine and dash is in fact a form of default. (Or, to put it another way, paying for current expenses would be accomplished by not making required interest payments, which is clearly default.) That is why I amended my point about the credit limit based on the explanation that Goolsbee gave in his interview.

  • 14 Will Hayworth // May 27, 2011 at 2:49 am

    @Jodi: not to go all weird post-Keynesian on you, but…it’s not that difficult to increase demand for government liabilities: raise taxes and magically decrease the opportunity cost of holding them! (a la tax-driven money/neo-Chartalist thought)

  • 15 Punditus Maximus // May 27, 2011 at 10:41 am

    I think every student who cannot afford an education should follow the debt-ceiling partisans’ lead and not go into debt in order to pay for tuition, housing, or food.

  • 16 Punditus Maximus // May 27, 2011 at 10:42 am

    Of course, no policies should be changed — they should still attempt to go to school (fight two overseas wars), etc. They should just get kicked out and starve on the street, too.

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