FIGURE 1 FIGURE 2 FIGURE 3 TABLE 1

FIGURE 1

FIGURE 2

FIGURE 3

TABLE 1 Fiscal Variables Projected 2049 (%) EB d 144 x -3. 0 total surplus -8. 7 change in: x to reach 2019 d x to reach ave. d entitlements/GDP Source: Congressional Budget Office 2019 and author's calculations 4. 1 6. 0 6. 1 AF 219 -6. 1 -15. 5 NA NA NA

Traditional View of Deficits and Debt • Three main economic issues: effect on short-run aggregate demand, inflation and long-run growth • Desirable: 1) as counter-cyclical device, at least allow automatic stabilizers to work; additional discretionary policy in deep, long-lived recession iff designed and implemented to help at reasonable long-run cost; 2) to finance productive public investment; 3) for tax smoothing of large, temporary spending swings, e. g. WWII; • Harmful, in extreme dangerous: 1) if crowd out investment and decrease future income; 2) if cause central bank to monetize enough debt to cause serious inflation problem; 3)if so large for so long they lead to elevated risk premiums, self-fulfilling of “bad” equilibrium, risks of severe inflation, capital flight, financial crisis; • Incidence primarily on younger generations, via smaller capital stock, a lower income, higher taxes; equity depends on productivity growth rate; • All need to be conditioned on economic and financial conditions, expectations thereof and leavened for some partial Ricardian behavior, account for the extent and duration of foreign capital flows and any feedback on spending and taxes.

Efficacy of Counter-Cyclical Fiscal Policy • Methods we use: 1) Macroeconometric models; 2) stylized analytical models; 3) Estimation of key parameters, e. g. expenditure multipliers; 4) Structural vector autoregressions; 5) Historical case studies. • Conclusions differ and depend heavily on assumption wrt nature, timing , financing and duration official actions; assumed monetary policy path; degree of nominal rigidities, including probability and duration of ZLB; and variability of labor supply and capital stock; all studies have strengths and weaknesses. • Modern research 1) decisively rejects Old Keynesian notions of large spending multipliers larger than tax multipliers; 2) PV multipliers below one, well below in models with variable labor and capital; 3) peak multipliers. above one, but declining rapidly, at the ZLB, but potentially negative if spending expected to last beyond the ZLB period (in Dec. 2008, expected ZLB was nine months), possibly at high d with flexible exchange rates, turn negative year 2 -4; 4) not settled whether larger in recessions than expansions; 5) tax cut multipliers considerably larger than spending increase multipliers, turning the Keynesian balanced budget multiplier negative; 6)recent studies suggest ARRA spending multiplier of about 0. 5. , similar to Cogan, Cwik, Taylor Wieland (2010).

Deficits, Debt and Long-Run Growth • Merging New Keynesian and Neoclassical Growth Models can produce large cost of deficit financed recession spending, e. g. PV cost of $3. 40/$1 spending; • To extent debt substitutes for tangible capital, can approximate income loss with simple production function plus assumption on % substitution: CBO EB case and full implies 15%+ loss in generation (almost 30% of baseline); IMF study, larger; Reinhart and Rogoff large; capital augmenting technical change, larger; but medium term, some foreign capital inflows—supply of foreign capital to US has been quite elastic far longer than often assumed, but eventual upper limit a la Sargent and Wallace; • Mechanism of higher interest rates; Laubach 3 -4 basis points per point of d, Greenlaw et al larger, especially as d gets high (at about current US level) and with large current account deficit; so interaction of d, r and g important;

A Few (of many) Issues With Blanchard Analysis (1) • Blanchard generalizes iconic Diamond OLG model of public debt to allow for risk; theoretical analysis plus simulations of four 25 year generations • He concludes debt financed transfer increasing consumption may have little or no fiscal cost and may increase welfare, which depends on two effects, partial equilibrium effect depending on safe rate and general equilibrium effect depending on risky MPk • Many other current arguments for increased deficit spending are to finance public investment, e. g. for infrastructure; reconciling would require a neo-Galbraithian argument plus public investment being more complementary to pri C than pri I • In most realistic case, welfare effects turn negative, in some cases substantially so, for future generations, so need a high discount rate to justify the transfer; but low r and g suggest low discount rate

A Few (of many) Issues With Blanchard Analysis (2) • Usually we assume economy is dynamically efficient, with MPk above g • Historical relationship: safe rate r on average below g, but long periods of the reverse as well, which implies risk of exploding d • CBO projections have EVEN the safe rate above g, the debt exploding, which suggests the possibility of a “bad” high risk premium equilibrium • Extremely problematic assumptions by Blanchard (to his credit, he discusses many, although he dismisses them) • Nonwage endowment of young far too large, wildly so for the lower (threefourths + ) of the lognormally distributed wage distribution • Minimization of the relationship among r, g and d, and therefore of exploding d

A Few (of many) Issues With Blanchard Analysis (3) • Unrealistic empirical estimates, especially of MPk estimates in the literature showing it is 3 x higher, relative to g, half of which destroys his case; would need monopoly profits to be a huge share of measured profits throughout the ENTIRE economy; • Reasonable estimates of r, g and MPk, and capital income relative to investment, easily show economy is dynamically efficient, with or without risk considerations; • Political economy considerations, e. g. extending Buchanan-Wagner case elected officials/voters believe price of deficit financed spending zero, is likely to lead to d exploding to is