This morning I took part in a forum on budget reform organised by the Peterson-Pew Commission. Background reading for the event was the Commission’s excellent report, Red Ink Rising, which I wrote about in December in National Journal. (List of speakers at the event. C-Span video.)
Everybody agreed that US fiscal policy is unsustainable. The question is whether the government will bring long-term deficits back under control before another crisis intervenes, and forces it to. In other words, is the country scared enough yet? Despite all the talk about deficits, not to mention Peterson-Pew’s efforts to raise awareness, I said the answer is no.
Many Americans object to continued heavy borrowing–but not as much as they object to spending cuts or tax increases. Politically, it still makes sense for the Senate to vote down a statutory fiscal commission; it makes sense for Republicans to pledge no cuts to Medicare; it makes sense for Democrats to extend the larger part of the Bush tax cuts, and for Obama to renew his promise not to raise taxes except for the rich. I put in another word for a VAT, which is still regarded as an outlandish idea. You could make this the litmus test: as long as a VAT is regarded as political suicide, the country isn’t ready to be serious.
The Atlantic’s Derek Thompson came along. He has some observations on the right way to be scared of the debt.
Norman Ornstein was on my panel and made a good point to qualify what I’d said about Obama. The president was asked whether the budget commission he proposes to set up by executive order would be told that tax increases are off the table. He said no, all options must be considered. I’m not sure he could have said anything else, but still, as Ornstein observes, that is something. The best case for a commission is that it might give politicians on both sides a way to go back on promises they should not have made in the first place. If you excluded that possibility at the outset, what would be the point?
Thomas Hoenig, head of the Kansas City Fed, spoke about his concerns that fiscal mismanagement would complicate the Fed’s exit strategy and compromise its independence. Hoenig is an inflation hawk, and was the sole dissenter at last month’s FOMC, opposing language promising that interest rates would stay near zero “for an extended period”. Olivier Blanchard’s new paper on macro policy, which tentatively suggests a more dovish attitude to inflation, had already come up during the discussion. Blanchard is interested in using a slightly higher inflation target–say 4%–to make room for counter-cyclical monetary policy in the next cycle, rather than to inflate away the current debt problem, though one could always make the case for doing both. Hoenig would be opposed to any such relaxation, stressing the difficulty (ie, the cost) of getting inflation back down once it has been allowed to rise.
The scope for using inflation to ease the US public debt burden is limited, in fact, because public debt maturities are quite short. (There would be a bigger effect on private debts, especially mortgages.) The Economist’s Free Exchange has a discussion of the Blanchard paper which is worth reading–though I veered away at the end.
Perhaps the important thing to take away from this discussion is that to central bankers, inflation is a bogeyman. But to good economists, inflation is merely a variable, an economic indicator over which governments have some control and which they can manipulate to good or ill effect.
What does this view–the suggested distinction between central bankers and good economists–imply for central-bank independence? (By the way, aren’t Ben Bernanke and Mervyn King good economists?) Second, does a good economist really think of inflation as merely one more variable to manipulate? Anti-inflation zeal, like most kinds of zeal, can be taken too far, but this seems too relaxed. There might be a case for a slightly higher inflation target, as Blanchard says. There might be a case for a price-level target, which would call for catch-up inflation after recessions. There might be a case for nominal GDP targets, my own preference, which also fail to nail down a particular inflation rate. But all of these approaches require pre-commitment to a regime, and a record that establishes credibility. I don’t see how you square the “just another variable” approach with that.
I thought the most important thing in Blanchard’s paper was what he said about the need for better automatic fiscal stabilisers–which is where we came in. (A VAT plus “regulator”, anyone?) This has attracted far less attention than what he said about inflation. Raising inflation to deal with the long-term fiscal problem is a more respectable topic for discussion than tax reform. A sign of the times–and, as I say, we aren’t scared enough yet.