If the government parties now, will it be hungover in the morning?
Central Asia is relying increasingly on presidents and legislators, not on the central banks, to guide the economy. In 2009, the governments of Kazakhstan and Kyrgyzstan stimulated their languishing economies by spending more than they collected in taxes. The resulting deficits amounted to 2% of the size of the economy (gross domestic product) in Kazakhstan and 1.4% in Kyrgyzstan, according to the World Bank. (Data were not available for Tajikistan, Turkmenistan and Uzbekistan.) Is this trend healthy?
Keynesians may sympathize. As an antidote to recession, they tend to favor fiscal policy to monetary. Tax cuts and government spending may create jobs when the economy is operating below capacity. On the other hand, printing money might not work. When people are scared, they might simply hide the new money rather than spend it. That other tool of monetary policy -– the interest rate -– might also fail. In principle, lower interest rates enable firms to borrow more money in order to expand. But in a depression, the interest rate is already low; the central bank can't push it much lower. If it is zero, then banks will see no point in loaning out more money, even if the central bank does provide it for a song. Welcome to the liquidity trap.
Even in normal times, firms don't pay much attention to the interest rate when contemplating their investment projects, according to Keynesians. True, they would profit by giving the green light to a project with a rate of return exceeding the interest rate. But firms don't always know what rate of return to expect. Executives base their investment decisions partly on "animal spirits" -- on their gut sense of where the economy is headed. They might pay high interest rates if they think that the economy is headed for a boom. And they might pass up a chance to build a factory at bargain-basement interest rates if they think that the economy is headed for a fall.
Even Keynesians would concede that monetary policy is not always impotent. Printing money doesn't always revive the economy, but destroying money seems a sure-fire way to cool it off for a while. We can't be sure that increasing the money supply will encourage investment, since the central bank can't force firms to borrow money. But reducing the money supply will discourage investment. Firms can't build factories if they can't borrow money to pay the builders. Loans are especially important to firms in Central Asia, which have not been operating long enough to build up war chests of cash (“retained earnings”). In the West, the Federal Reserve and the European Central Bank must worry that their attempts to ward off inflation may succeed all too well.
To Keynesians, government spending in a recession will raise output, not prices, because firms will not mark up their prices when demand is anemic. In the United States, prices were indeed stable during the 1950s -– but not in the 1960s. Economists then took more interest in inflation, noted a macroeconomist at the U.S. central bank, Marco Espinosa-Vega. Nobel laureate Milton Friedman argued that a temporary increase in the money supply can affect output in only the short run, by tricking workers into producing more; eventually, they will realize what has happened and will act accordingly. By spending more, the government just confiscates more of the economic pie for itself.
Economists worry when the government borrows in order to spend. The competition with firms for loans forces up the interest rate, crowding out private investment. For example, the U.S. government mainly paid for the Civil War by borrowing money. The new federal debt claimed nearly one-sixth of the gross national product of the North –- large enough to crowd out all new investment during the war, wrote economic historians Jeremy Atack and Peter Passell.
Until recently, however, the bond markets didn’t worry about the deficit, perhaps because it does not claim as large a share of gross domestic product as it did in the Civil War -– or, for that matter, in the 1980s. You could argue that the U.S. deficit was not quite Brobdingnagian – not until recently, anyway.
But Americans really have foreign investors to thank, reported The New York Times. Asian central banks tried to weaken their currencies by selling them for dollars. (They want weaker currencies in order to boost exports.) To put their dollars to work, the central banks reinvested them in U.S. Treasury bonds, even when their rate of return was minuscule, according to The Wall Street Journal. (In May, net foreign assets for Kazakhstan were worth 10.7 trillion tenge, up by more than a third from the previous May, according to the National Bank of Kazakhstan.) Should the central banks stop buying dollars, the U. S. government would have trouble selling bonds. Bond prices would drop, and interest rates would rise. That would compound the difficulty of paying off Washington’s debt. And it would tend to raise interest rates paid by borrowers in Kazakhstan.
For an extreme example of what could happen in developing countries, let’s go to Argentina. A decade ago, the country’s mounting deficit convinced investors that they would never see their money again. They demanded higher interest rates before they would buy the country’s bonds. Over 2001, the interest rate on a 10-year bond rose by 20 percentage points to 35 percent, although the country had tried to reduce its deficit by raising income taxes, wrote Mark Spiegel. Argentina did not earn enough foreign currency from its exports to cover its interest payments, so the government eventually defaulted on its loans. Although Argentina became the second fastest-growing economy in the Western Hemisphere -– second only to oil-rich Venezuela –- it remained virtually the last place in the world in which investors would park their dollars, concluded a Federal Reserve economist, Ramon Moreno, in 2002.
The third-largest economy in the world, Japan’s, was in a similar predicament. Japan’s national debt amounts to 150 percent of its gross domestic product -– the highest ratio among leading industrial nations. In 2005, Moody’s ranked Japan’s bonds below those of Botswana. The fear was that Japan, having run deficits for 15 years, would simply keep issuing bonds, increasing the supply and forcing down the price, reported The New York Times. There was no point in speculating on the bond. The nuclear-power disaster at Fukushima this year has revived this economic problem.
The “in” crowd
Fortunately, the government can “crowd in” investment by paying off its debt. This enables savers to put their money instead into private investment. When the United States government paid off the Civil War debt, interest rates dropped, encouraging private investment and industrialization, concluded Atack and Passell.
The deficit might actually mean something if we could express the net cost of government to you over your lifetime. That’s the idea behind generational accounting. Due partly to the growing burdens of Medicare and Social Security, a 25-year-old male American could expect to pay nearly $200,000 more to government than he would receive in benefits, reported economists Roy Ruffin and Paul Gregory at the turn of the 21st century. On the other hand, the grandparents made out like bandits. Seventy-year-olds received over $50,000 more than they paid in taxes. And Uncle Sam was kinder to the 25-year-old female than to her male Significant Other; she could expect to pay only $90,000 more than she would receive. Women live longer than men, so they can expect to receive benefits for longer. They may also receive benefits as survivors of their husbands.
Kazakhstan is on a similar trajectory. For nearly 30 more years, the pension program will continue its transition from a pay-as-you-go system, in which current workers finance payments to current retirees, to fully-funded liabilities, in which each worker provides for her own eventual retirement. Future generations of workers will have to shift for themselves, unlike workers of 15 years ago.
Sustaining the unsustainable
If we can shift the burden of taxes to future generations, then we may spend too much today. That may help explain why the young bear a larger net burden than the old. It remains to be seen whether the young will pass on their spending to their progeny, too.
If the young perceive that they must pay higher taxes, then they may invest less in education and training, since they would take home a smaller share of the paycheck. The lack of education would strip our economy of growth. And that’s not the end of the story. Higher taxes might also discourage skilled immigrants from moving to the United States; and they might dissuade foreign investors from staking their wealth here, speculated The Financial Times.
Because the government must pay interest on the debt, we can expect it to grow at the rate of interest, unless we run up a surplus that diminishes it. The government cannot run deficits forever if the interest rate exceeds the rate of economic growth. Eventually, we would have to devote the entire economy to paying the interest. Even before interest payments overwhelm, foreigners may refuse to lend us money, for fear that we won’t pay it back. Adjusting for inflation, the annual interest rate at which the National Bank of Kazakhstan lends money, a benchmark for the economy, is roughly zero -- well below the national rate of economic growth, 7% or 8%. The government’s securities amount to 1.8 trillion tenge, according to the National Bank of Kazakhstan. Is cheap money addictive? – Leon Taylor, tayloralmaty@gmail.com
Good reading
Jeremy Atack and Peter Passell. A new economic view of American history. New York: W.W. Norton. Second edition. 1994.
Marco A. Espinosa-Vega. How powerful is monetary policy in the long run? Economic Review. Third quarter 1998.
Milton Friedman. The role of monetary policy. American Economic Review. March 1968. Pages 1-17.
Jagadeesh Gokhale. Tomorrow’s generation will foot the bill. The Financial Times. February 13, 2004. Page 13.
David Leonhardt. That big fat budget deficit. Yawn. The New York Times. February 8, 2004.
Ramon Moreno. Learning from Argentina’s crisis. Economic Letter. October 18, 2002.
Roy J. Ruffin and Paul R. Gregory. Principles of macroeconomics. Seventh edition. Addison-Wesley. 2000.
Michael R. Sesit. The hazard of currency reserves. The Wall Street Journal. February 11, 2004. Page C4.
Mark M. Spiegel. Argentina’s currency crisis: Lessons for Asia. Economic Letter. August 23, 2002.
Todd Zaun. After 100 years, Japanese will go abroad to sell bonds. The New York Times. January 15, 2005. Page B3.
References
World Bank. World Development Indicators. Online at http://data.worldbank.org/indicator
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