Fiscal Stability or Dire Straights: John Cochrane’s Latest Rant

At times John Cochrane babbles on incoherently on what should be a straight forward issue. This post is one example:

Once you net out interest costs, it is interesting how sober US fiscal policy actually has been over the years. In economic good times, we run primary surpluses. The impression that the US is always running deficits is primarily because of interest costs. Even the notorious "Reagan deficits" were primarily payments, occasioned by the huge spike in interest rates, on outstanding debt. On a tax minus expenditure basis, not much unusual was going on especially considering it was the bottom of the (then) worst recession since WWII. Only in the extreme of 1976, 1982, and 2002, in with steep recessions and in the later case war did we touch any primary deficits, and then pretty swiftly returned to surpluses.

I too advocate looking at the primary surplus. Cochrane is a finance professor so let’s make this simple. Let g = the ratio of Federal expenditures excluding interest payments to GDP and t = the ratio of Federal taxes to GDP. If we assume a steady state model, the present value of future primary surplus is simply V = (t- g)/(r – n), where r = the real interest rate and n = the long-term growth rate. As long as V is at least as great as the debt/GDP ratio, we are not on the bankruptcy path that economists were talking about when Reagan initiated his 1981 fiscal fiasco. Tax rates were massively cut and defense spending spiked and had this fiscal stance continued forever, then the debt/GDP ratio would have exploded. Of course it didn’t as there were future tax increases and the peace dividend. Cochrane takes us through the Great Recession:

Until 2008. The last 10 years really have been an anomaly in US fiscal policy. One may say that the huge recession demanded huge fiscal stimulus, or one may think $10 trillion in debt was wasted. In either case, what we just went through was huge. And in the last data point, 2017, we are sliding again into territory only seen in severe recessions. That too is unusual.

The Great Recession did demand huge fiscal stimulus – we got a tempered version of what was really needed. The last decade has taken the debt/GDP ratio to 100% but we have returned to near full employment so I do not get his 2 last sentences quoted. In 2017, g was 19.5% and t was 18.5% so maybe we should be more concerned especially since we have had another tax cut for the rich as well as a call for a larger defense budget. But then comes his update!

“The US fiscal situation is dire. The debt is now $20 trillion, larger as a fraction of GDP than any time since the end of WWII. Moreover, the promises our government has made to social security, medicare, medicaid, pensions and other entitlement programs far exceeds any projection of revenue.”

He went from fiscal policy being sober to we are in dire straights just like that! Oh my the sky is falling. We have to take away those Social Security benefits that my generation have been paying into for 35 years. We cannot afford Federal health care spending. After all those tax cuts for the rich can never be reversed. Yes John Cochrane is part of the Starve the Beast crowd even if granny starves from these supposedly required reductions in transfer payments. Give me a break!