Friday, January 27, 2006

Consequences of the fiscal gap

Anyone who takes a serious look at the U.S. government's current budgetary course knows that what we are doing is unsustainable. And we all know "Stein's Law," coined by the late economist Herbert Stein, which holds that anything that cannot happen indeed will not happen. But how will things shake out when the crunch comes?

The scenario that has gotten the most attention, and that I tend to believe, is that the U.S. government can't sell its bonds because its solvency is no longer credible, starts printing money triggering inflation, etcetera. But a second view is that we will avoid all these problems, and keep the bondholders happy, by enacting huge Social Security and Medicare cuts that involve means-testing, and that essentially convert these programs into mere safety nets for the elderly poor.

This might be a better outcome if it heads off larger economic dislocations - at least if you aren't one of the people whose benefits are substantially cut. But why would we expect it? The main argument I hear is that the Federal Reserve Board is independent and would refuse to start printing money (and also importantly, investors in the bond markets would know and rely on this). Thus, politically powerful though seniors are, taking the fiscal gap out of their hide, along with tax increases and the like, would at some point become the political path of least resistance.

Obviously, this depends on just how strongly rooted the Fed's independence actually is. Congress can bring the Fed to heel whenever it likes by changing the enabling legislation. So the question is whether the political commitment to the Fed's independence is (or rather at the key moment will be) stronger or weaker politically than the aversion to cutting benefits. This will depend in part on the political actors in place at the time, including the Fed Chairman, who would have to decide how forcefully to play his hand.

29 comments:

Anonymous said...

I favor the first scenario -- the fed printing money -- for the following reasons -- 1) the Bush administration has shown that they care far more about rich people than poor people, and I don't expect this to change; they are not interested in a safety net for the poor because they don't care about them. 2) they have also shown that they don't think that scientific laws, i. e. global warming, apply to them, and some think tank of neo-cons deep in the Administration has decided that they can print as much money as they want without having to worry about inflation, credit quality, etc.

-- Jon Beiler, JBeiler@aol.com

Anonymous said...

our impotent congress willnot and cannot control the fed. The days of reigning them in is past as they are now part of the international banking community and do not have to answer to any one but them.

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