Almost everyone seems to be debating the same issues. Spend less, tax more, or both?
Now perhaps Portugal has made some progress. Hoping to bring its budget deficit down to 4.6% of GDP in 2011, their VAT will ascend to 23%. But will they cut public sector pay 5%? They vote in several days. Last spring, Italy announced a civil servant wage freeze. Meanwhile Ireland, with the highest budget deficit in the EU (Luxembourg was the least indebted in the EU) announced that its spending cuts and refusal to pay into a pension reserve fund were achieving some success. Interestingly, Spain said it has made progress but, the areas it will not cut include pensions and unemployment benefits. Finally, Greece. Maybe some progress with spending cuts but tax revenue is a challenge.
What does all of this mean? Markets are not optimistic. The price of insurance, a credit default swap, on PIIG’s debt has risen.
The Economic Lesson
A credit default swap is like an insurance policy. Instead of diminishing the impact of a house fire or a jewelry loss, this kind of insurance lowers the risk of a financial investment. Yes, credit default swaps were central to AIG’s financial debacle because AIG sold much more “insurance” than they could possibly cover. Managed appropriately, as described in this econtalk discussion, credit default swaps perform a valid financial role.
On Amazon (“gift wrap available”), you can purchase the 1995 “Final Report to the President” of the “Bipartisan Commission on Entitlement and Tax Reform”. During February, President Obama announced the creation of the National Commission on Fiscal Responsibility and Reform. The old and new commissions have a lot in common.
I actually have a copy of the 1995 report on my bookshelf and just read its 269 pages. My conclusion? Nothing has substantially changed. In 1995, they said that Social Security expenditures would exceed Social Security tax revenue in 2013. The current projection is 2014. They said the system would have no trust fund money left in 2029. The current projection is 2037. Even one of the names is the same. Senator Alan Simpson was on the original commission and now is a co-chair of the current one.
Because many of the facts have not changed, their solutions remain viable. Reflecting timeless political realities, the 32 members of the commission could not agree. Consequently, the report included general conclusions, policy suggestions, and reports from committee members. In addition, the staff presented 3 policy packages ((pp. 169-175). 1) “No Tax Changes” so benefits would decrease. 2) “Minimize Benefit Reductions” so taxes would rise. 3) A “Blended Approach” which combines benefit cuts and tax increases.
As was true 15 years ago, because discretionary items like education, space, and justice represent a small proportion of all federal spending, the 2010 commission will have to focus on mandatory spending which takes us to Social Security, Medicare, and Medicaid. Will the Congress and the President respond now as they did 15 years ago?
The Economic Lesson
Specifically defined, federal fiscal policy refers to taxing, spending, and borrowing. It involves the federal deficit which is the shortfall between annual spending and revenue. The federal debt is the total amount that the U.S. government owes.
11.84 is the current level of our “misery index” if we use what Arthur Okun (economic advisor to Lyndon Johnson) created. November unemployment + inflation rates = 11.84.
However, according to Floyd Norris, a new index might be more appropriate. Suggested by Pierre Chilleteau, it combines a nation’s budget deficit as a percent of GDP with its unemployment rate.
The Economic Lesson
A misery index reflects an economic dilemma. Each has a different opportunity cost for less unemployment. Each requires a tradeoff. For Okun, if we solve unemployment, we get more inflation (or the opposite). For Chilleteau, a Keynesian solution to unemployment means an even higher budget deficit or less spending means (Keynes again) more unemployment.