Public Affairs Forum
May 16, 2017
Dave Altig: I'm Dave Altig, director of research at the Federal Reserve Bank of Atlanta. I'm joined today by Thomas Sargent, the W.R. Berkley Professor of Economics and Business at New York University and corecipient of the 2011 Nobel Prize in Economics.
Welcome, Professor Sargent.
Thomas Sargent:Thank you very much.
Altig: We're going to talk a little bit about fiscal policy today, something that's on everyone's mind. Currently, the ratio of debt held by the public to GDP is about 77 percent. According to the Congressional Budget Office, if tax policy or expenditure policy doesn't change, that will rise to about 87 percent at the end of 10 years, which will be the largest since the end of World War II. At the same time, we've got states like Illinois that apparently are on an unsustainable fiscal path with no clear resolution in sight.
All of this has led some people to believe that we're living in unique and unprecedented times, with unique and unprecedented fiscal challenges. Are these challenges really all that unique and unprecedented?
Sargent: Yes, they really are, for a couple reasons. One thing is the numbers that you stated actually understate how big our federal debt is, because of the way we do accounting. The federal government has promised many of us IOUs that they don't formally account as debts—and I have in mind Social Security, Medicare, and Medicaid. We call them entitlements. Congress, in the past, has taken them very seriously. Those should be regarded as debts, and they have to be paid for by taxes on somebody.
So if you added those debts to the formal numbers that you described, the debt-to-GDP ratio would rise markedly—double or triple, or maybe more. In terms of being unprecedented—yes, it is unprecedented, and for various reasons.
During the 20th century, Americans started living longer, and we started doing things we didn't do before. People in the 19th century—basically, few of them retired. They basically didn't live long enough to retire; they worked until close to when they died. And if they retired, many of them lived on farms. They stayed with their family, and they did a few jobs around the house. Also in the 19th century, people didn't spend very much on medical care, and one reason is you were probably better off not, because doctors in the 19th century weren't like doctors in the 20th century.
So we live longer and we spend more on medical care, and we've chosen to finance some of that medical care—much of it, for large parts of the population—through the government. That's the reason that it's not a coincidence that it's unprecedented, because we're in the fortunate position of living longer, and that's forced some choices on us.
Altig: When you think about meeting the challenge that that represents, is there a difference between simply raising taxes and, in effect, repudiating the debt that is owed to Americans?
Sargent: Well, that's a great question. This is what people like the Congressional Budget Office, and the Committee for a Responsible Federal Budget, tell us over and over again. If you look at what's in the laws of the United States federal government today, promises have been made—either explicit or implicit; explicit in the form of entitlements, implicit in the forms of some taxes that are on the books now, and what they're forecast to be—some of those promises are going to have to be broken.
And why are they going to have to be broken? Not because anyone is mean or dishonest—it's because of arithmetic, and it's completely nonideological—Democrat, Republican, I don't care whether you are a communist, or an anarchist—government budgets have to balance in the long run. What the government spends, the public is going to have to pay for.
Those don't add up now, so something's going to have to give. If you want to have a government as big as the entitlements that the Congress has made in entitlement promises, taxes are going to have to go up, or those promises are going to have to be revised.
Altig: Some not unsubstantial fraction of the explicit debt is held by foreigners. What would be the consequences of essentially taxing away the value of that debt held by foreigners—again, either explicitly or implicitly? Is that a way out for the country?
Sargent: It may seem at first glance that because a substantial fraction of our explicit debt is held abroad—especially by the Chinese and people in the Middle East and other people in Asia—you could repudiate that in various ways. You could inflate it away; you could formally renegotiate it—those are all things you could do. That would have huge consequences. The United States gets huge advantages right now by being a country that's regarded as a country with the hardest currency. We earn that privilege—and it is a privilege, by which we earn substantial revenues—by having a record of not repudiating our debt and paying foreigners.
During the War of 1812, James Madison continued to pay British owners of U.S. debt even though we were at war with them. He took that seriously. Our founding fathers Hamilton and Madison took seriously paying debt—that would be a big departure. And would it get us that much? A big part of our debt problem is the debts that we owe our own citizens aren't accounted for properly, the entitlement debt. Financing our entitlement debt is a problem that Congresses have chosen to kick the can down the road. But by kicking it down the road, it doesn't solve it. It actually makes it worse.
You know, if you talk to young people—I talked to a young person at a drugstore the other day. She told me she's never going to get her Social Security. She told me she's going to pay her taxes to pay for mine, but she was never going to get hers. That was her expectation. You'll hear that over and over with young people. A big part of the American public knows about this and they know something's going to have to give, and they have their own bets about how it's going to give.
I actually think professors and journalists are like teachers, and we're supposed to tell people—you know, educate them—about what their choices are. And I actually think that's the job of politicians in both parties, too.
Altig: There have been some proposals to explicitly measure the future liabilities implied by things like Social Security and the Medicare program, thinking of generational accounting that was familiarized by Larry Kotlikoff and Alan Auerbach. Do you think it would be a good idea to make that a formal part of our...
Sargent: I think the answer is a resounding "Yes!" That's a big part of transparency—making those obligations explicit is a part of being transparent. I think it also could change the politics of how you think about raising taxes, because one of the reasons we're going to have to raise taxes is to service our debts. The way the accounting is done now, lots of elderly Americans or poor Americans—they think, well, they don't own any government debt, so why should they have to pay any taxes? The fact of the matter is, they do own government debt. It just hasn't been accounted for.
So, one proposal is, it's a proposal I heard of—it's actually a left-wing Democrat who made this—and his proposal was, what the U.S. should do is privatize Social Security in the following sense: it should issue everybody who owns Social Security entitlements government bonds, [they] should give them government bonds. [The government should] say, "These are yours, [but] they're only going to be paid if the taxes sufficient to service them are levied." It's a way of making the accounts inform people about what the public finances are, and what their interests are in the public finances.
Altig:That's somewhat reminiscent of schemes that have been tried, for example, in Chile. Do you think there are examples in the world where countries have found their ways successfully out of a similar case?
Sargent: That's interesting. That's a good question. My friend who said this—as I said, he's a liberal Democrat; he actually believes in the Social Security system that the United States has now—when he says "privatize," he wants to do the accounts so that my children know that what they're buying, eventually, is government bonds. And he wants to give them an interest in paying those government bonds.
The Chilean scheme was different. The Chilean scheme—and there's a version of it in Peru, there's partial versions of it in some other countries. For example, there's a big version of it in Singapore. The scheme is this: there's a social security system. When I pay my social security tax in Singapore, I have to pay it, but the government doesn't turn around [and] give the money to old people. It doesn't buy government bonds, it buys private securities, it buys private bonds, private equity. And I am, in effect, through the government forcing me, buying shares in the private economy. And when I retire, what do I live off of? Those shares. I get those shares back.
So that's an effort to basically get the government out of the business. My Democratic friend's proposal is not that much. It's basically to do what we're doing now, but account for it in a way that informs people to what's really going on. My poor mom, who passed away—she thought that there was a fund that she had invested in, and that's what she was getting in social security. And when I told her that was not true. It was basically a Ponzi scheme, where the money that she paid in was paid to older people then, and then there was no money. And they were waiting for people who were younger when she was old to pay. She said, "That's not true." She got very upset. Well, it is true.
We ought to do the accounting so people understand the scheme that we have. And what it depends on is a society, is the contract that we make with other people to get benefits from the government, and to pay for them. If most of the people are going to benefit from government programs, most of them are going to have to pay in some way.
Altig: Let me ask you one last question: you mentioned earlier the issue of potentially inflating away—basically, taxing away—liabilities through inflation. We're sitting in a central bank, part of the central bank of the United States—if these problems that you have delineated aren't resolved, is monetary policy—effective monetary policy—at risk?
Sargent: Monetary policy and fiscal policy are closely related. The chairperson of the Federal Reserve is obligated by federal legislation to testify a couple of times a year before Congress about monetary policy. And if you go back to Volcker—a great chairman—if you go back to Volcker, go back to Greenspan, Bernanke, and now Yellen—you know, she's more cautious and polite about it. Volcker and Greenspan, when congressmen asked them about monetary policy, they were very quick to say, "Well, let me ask you about fiscal policy, because if you manage your fiscal policy correctly—where you basically have close to a balanced budget over the business cycle—then I can run monetary policy well. I can deliver low inflation."
And then they'd say, "If you don't do that—if you run systematic government deficits over long periods of time—sooner or later, no matter who's in my position as chairman of the Fed, I can't run a good monetary policy." They put it that way over and over again.
If you go back and look at Greenspan's [testimonies], he wasn't being political. He was just—everything's political, I guess—but his purpose was to remind them that monetary and fiscal policy are necessarily interconnected. And if you go back to why the Treasury and the Congress set up the Fed so that it would have some kinds of independence—it was a device to take certain temptations away from the Congress, because they basically didn't trust themselves, and they wanted to create some people—basically, a bad guy or policeman—who would not do the things that they were tempted to do. It's an old story.
But your job at the Fed is to resist those temptations, and to not get your feelings hurt when congressmen and senators and presidents say, "You're not doing what I want."
Altig: So I guess the bottom line here is, no matter where we sit, we have some stake in getting these fiscal issues addressed promptly.
Sargent: Absolutely.
Altig:Professor Sargent, thanks for joining us.
Sargent: Thank you.