 | The Lindsey Rebuttal |
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| Posted Under: Government • Inflation • Interest Rates |
On the editorial page of today's Wall Street Journal, Larry Lindsey – a former aide to President George H. W. Bush – wrote what could be viewed as a response to our most recent Monday Morning Outlook (link). The Op-Ed editor even gave it a title that sounded vaguely familiar "The Deficit is Worse Than We Think." Brian's 2009 book – "It's Not As Bad As You Think" – is still available at Amazon.
Our Monday Morning Outlook suggested that the budget gap could be closed more easily than many doomsayers suggest. We have said it before, and we will say it again, we are in "no man's land" when it comes to politics and economics. Our constituency is the investor, not either side of the political aisle. We make liberally-minded people mad because we think the increased size and scope of government is keeping the economy from its full potential. We think the size of government should be reduced sharply.
We make conservatives mad because we think the economy is so resilient and productive that it will grow despite the increased size of government. We also believe that the budget gap can be closed with some politically difficult, but very doable, actions. We vehemently disagree with those conservatives who try to paint a picture of a country near collapse. Yes, we have serious challenges. Yes, we could be doing much better. But, we are not the Weimar Republic (Germany after WWI), Greece, or even France - yet. This is America, and defeatism (even if it has swept up the elites) has never been its problem. Yes, we have headed down a wrong path, but we believe we will find our way back to the main trail well before we are lost in the wilderness for good.
Dr. Lindsey suggests that rising interest rates will make it nearly impossible to fix our budget problems as "normal" interest rates would raise debt-service costs by $4.9 trillion over 10 years, dwarfing the savings from any currently contemplated budget deal.
We think in his piece, Lindsey is making some aggressive assumptions on the impact on the budget of higher rates. First, he is assuming a 320 basis point increase in rates across the entire yield curve. That's possible, but pretty aggressive. Second, an environment in which we get such a large increase in interest rates is likely to be one in which revenue growth is even stronger than we assumed, hitting an even higher share of GDP than 18.5%. Third, we were cautious in our assumption we could only trim 1.5% of GDP from discretionary spending. The US trimmed 3% in the 1990s. Fourth, Lindsey apparently ignored that a significant portion of debt is held by the Fed, which sends almost all its interest earnings back to the Treasury. And fifth, Lindsey complains about the administration's supposedly optimistic assumption about 4 percent economic growth. We don't think this optimism is misplaced over the next few years. In addition, it is important to recognize that revenue forecasting does not depend on growth alone but arcane assumptions about employer provided health benefits, the distribution of income and assets values. All of these are likely to encourage revenue over the next few years.
That said, on health care spending, Lindsey is absolutely right. New health laws could raise healthcare spending sharply. But it remains to be seen whether these new laws will ever be implemented. Not only could the courts rule against President Obama, but the changing composition of the House and Senate, along with parliamentary rules, make it likely that Congress could repeal whatever is left.
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