Debt held by the public net of financial assets— the measure I find to be most meaningful

TO BE NOTED: From the OMB:

"IOU, an Explanation

Peter R. Orszag, Director

How much does the federal government owe? It might seem like a simple question to ask those of us wearing the green eyeshades, but there are lots of different concepts used to answer it. For example, at the end of fiscal year 2008:

• Debt held by the public net of financial assets— the measure I find to be most meaningful — stood at $5.3 trillion (37 percent of GDP).
• Debt held by the public was equal to about $5.8 trillion (41 percent of GDP).
• Gross debt equaled $10.0 trillion (70 percent of GDP).

What do each of these concepts represent?

Let me proceed in reverse order, and begin with gross debt. Gross debt has two components: debt held by the public—which I will discuss more in a moment— and intragovernmental debt. Intragovernmental debt is, essentially, debt that the government owes to itself—as of the end of last year, it totaled $4.2 trillion. The majority of this debt is issued to the Social Security Trust Fund, and most of the remainder is issued to other trust funds, such as the Civil Service Retirement and Medicare Trust Funds. These trust funds are required to invest their surpluses in government bonds. While the federal government will certainly make good on the IOUs issued to these trust funds, they should not be counted when assessing the financial state of the federal government as a whole.

One branch of the government issuing debt to another branch may make one branch poorer relative to the other branch—but it does not affect the overall financial state of the government. For example, when I tell my daughter and son that I owe them each $10 for their allowances, I am poorer, and they are richer—as a family, though, there is no change in our overall finances. That’s why the Congressional Budget Office, the Office of Management and Budget (including under the prior administration), and the Government Accountability Office all agree that gross debt is not a meaningful metric for assessing the government’s current fiscal position. Yet, the world being what it is, this number is quoted often.

If gross debt isn’t a useful concept, debt held by the public gets us closer. Debt held by the public measures the amount that the federal government owes to others, so it is a meaningful concept when gauging the government’s fiscal condition. If I hand an IOU to my neighbor’s son in exchange for mowing the loan, my family’s finances become poorer, and the same is true of the federal government.

That’s not the end of the story, however. As I said at the beginning of this post, I think the most meaningful measure of federal debt is debt held by the public net of financial assets. If I take a $100 loan from my bank and stick that amount into my bank account without spending any of it, my family and I aren’t poorer, because even as I owe $100 to my bank, my bank owes $100 to me. On net, and as long as the new asset is equal in value to the new liability, there’s no change in my overall financial state. There’s a similar effect when the federal government borrows money in order to invest in financial assets.

As the federal government has acted to stabilize the financial sector amidst the worst financial crisis since the Great Depression, the federal government has purchased significant financial assets—such as preferred equity stakes in Fannie Mae and Freddie Mac. The federal government will likely take a loss on these purchases, but the assets have value. And just as what my bank owes me should be netted against what I owe the bank in determining the health of my personal finances, the value of these assets should be netted against publicly held debt in determining the health of the government’s finances.

I end with a word of caution. Debt held by the public net of financial assets is the most meaningful measure of current federal debt, but it has its limitations. In particular, it does not capture the federal government’s fiscal position going into the future. The federal government’s obligations aren’t limited to paying off federal bonds. It also has future obligations to continue defending our country; investing in education, energy, and infrastructure; and paying Social Security and Medicare benefits. On the other side of the ledger, the federal government has future assets beyond those currently carried on the books—namely, the future tax revenues it will collect.

So even as debt held by the public net of financial assets is the best measure of where we are now, the long-term fiscal gap provides the best measure of the underlying imbalance between spending and revenue. That is why this Administration is so committed to cutting the deficit in half by the end of the President’s first term and reforming the health care system – and bending that cost curve – this year."

"Then a stimulus of about 4 ppts of GDP -- roughly $580 billion -- will bring output up to about potential. "

Menzie Chinn on Econbrowser with some thoughts about the stimulus:

"Then a stimulus of about 4 ppts of GDP -- roughly $580 billion -- will bring output up to about potential. The bigger the tax cut element skewed toward higher income deciles, the larger the required stimulus. (However, I'm optimistic that with the new economic team of Summers, Orszag, Romer and Geithner that's been selected, the package will indeed hew to the idea of maximizing the stimulative impact, which is consistent with targeting the lowest and middle income groups for tax cuts/rebates [5], [6].)

And if stimulus across countries can be synchronized, then so much the better (especially since it would be hard to spend at $580 billion in one year).

By the way, the reason why I don't say "coordinated fiscal policy" is because, in the lexicon of academic economists, this would mean commitment to some sort of rules so that Nash outcomes can be avoided. See Frankel and Rockett (1986). In this discussion, I have in mind a more modest, one-shot, event, since I'm not sure a coordination is feasible over the longer term.

On a side note, I've just been watching Nancy Pfotenhauer on Larry King characterizing the new Obama economic team as "not change" because they are centrists. I think she misses the point entirely (not surprising). The "change" is not a matter of the economic ideology of the new team members -- rather the "change" is bringing in people who value expertise and evidence-based policymaking over ideology and dogma. That is, the end of PoMo Macro policymaking."

Her figure is probably close to what will be spent, over two years. At least, as of today.

"committing the government to actions that would bring deficits under control once the economy recovers."

President Obama on Budget Savings in the NY Times:

"President-elect Barack Obama vowed on Tuesday to scour wasteful spending from the federal budget to help offset an investment in a huge recovery plan to jump-start the ailing economy, a pledge that he called part of his “mandate to move the country in a new direction.”

For the second straight day, Mr. Obama called a news conference to explain how his administration would respond to the nation’s financial crisis. He named no specific government programs to be eliminated but said tightening the budget was part of the sacrifice he would ask Americans to endure.

“We can’t sustain a system that bleeds billions of taxpayer dollars on programs that have outlived their usefulness or exist solely because of the power of politicians, lobbyists or interest groups,” Mr. Obama said. “We simply can’t afford it.”

This is good news. I understand that he's not being very specific, but at least he keeps saying it over and over. That's a good start.

"With an eye on the economy, Mr. Obama announced that he would nominate Peter R. Orszag as director of the Office of Management and Budget. After running the Congressional Budget Office for nearly two years, as well as handling economic policy in the Clinton and Bush administrations, Mr. Orszag “doesn’t need a map to tell him where the bodies are buried in the federal budget,” Mr. Obama said."

He's a good appointment.

"Together with a two-year economic recovery package of hundreds of billions of dollars in spending and tax cuts, Mr. Obama hopes to win early approval in Congress next year for separate language committing the government to actions that would bring deficits under control once the economy recovers."

This is important to reassure investors that we will not default or print money, but will raise taxes or cut spending in the future. We need to say it and mean it, whether or not anyone believes us.

"Advisers to Mr. Obama and to Congressional leaders say they have hardly begun to figure out what kind of process they could devise to enforce fiscal discipline. But Obama advisers, in particular, consider it essential to signal that Democrats are not using the economic crisis to go on a spending binge without concerns for future deficits.

“In these challenging times, when we are facing both rising deficits and a sinking economy, budget reform is not an option,” Mr. Obama said. “It’s a necessity.”

Totally agree.

"Budget controls are also considered important to securing the votes of conservative Democrats in the House and the Senate, who might otherwise balk at an economic stimulus package that could exceed $500 billion. One of those at the center of the effort to draw up proposals is Rahm Emanuel, who was the fourth-ranking House Democratic leader until Mr. Obama tapped him to be the White House chief of staff."

This is good news.

"Mr. Obama cited, as an example of the possible cuts he expects Mr. Orszag and the rest of his budget team to find, the findings of a recent government report indicating that farmers whose incomes exceeded $2.5 million had most likely been mistakenly paid about $49 million in government subsidies from 2003 to 2006.

He did not offer any other specific targets, and by itself, correcting the problem with the farm program would make an undetectable dent in the government’s soaring deficits. After the financial recovery is under way, Mr. Obama said, the chase after wasteful spending will begin in earnest.

“Just because a program, a special interest tax break or corporate subsidy is hidden in this year’s budget does not mean that it will survive the next,” he said. “The old ways of Washington simply can’t meet the challenges of today and tomorrow.”

Time will tell.