Dollars and Jens
Tuesday, August 16, 2005
When the OMB revised its numbers sharply downward in July, to $333 billion, the doubting Thomases seemed to have a good case. Now, however, the CBO, which is generally seen as more level-headed, has followed suit. In its Budget and Economic Outlook, released on Monday August 15th, the CBO’s projections moved roughly into line with the administration’s, forecasting a shortfall of $331 billion, or roughly 2.7% of GDP.
The long-run (nominal) GDP growth projections I've seen are 5.2%. If the deficit stayed at 2.6% forever, the ratio of debt to GDP would asymptotically approach one half; this is somewhat higher than it is now, though on the same order. The debts of most industrialized nations seem to be in this ballpark as well, though Japan's is multiples higher.
More significantly, Douglas Holtz-Eakin, the CBO's director, gave a warning that the improvement, while welcome, seemed to be largely temporary.
This is more significant, and this is in a period when the economy is doing quite well, and deficits should be lower than their long-term average. On the other hand, I have trouble putting too much force behind the argument that making the deficit a lot smaller right now should be a big priority when interest rates all the way out on the curve are lower than that 5.2% I mentioned earlier. What does concern me more is the long-term, structural problem:
But there’s one prediction it is making with a high degree of confidence: Social Security and Medicare, America’s old-age programmes, will eat up an increasing share of federal spending and thus spell big trouble for the budget.
But you knew that.

The article goes on to mention the
"twin-deficit hypothesis", which argues that Mr Bush’s spendthrift ways are driving up the current-account deficit and putting the country in danger of a catastrophic revaluation of the dollar.
This hypothesis comes from the accounting identity that national savings — viz. private savings (which are negative) plus government savings (which are negative) — minus net exports must equal investment in the country; more or less, the money we're sending overseas in exchange for our trade deficit is going to be invested in dollar-denominated assets. The logical jump is to assume that a change in government deficits affects nothing else in the equation except net exports, which, therefore, must vary exactly with government deficits; in its exact form (as with many economic statements in their exact forms) it is untenable, but even approximately it seems to be at odds lately with data. Either way, the case can be made that
"Not catastrophic" seems a poor guideline for fiscal policy

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