In the words of Viktor Chernomyrdin, second longest serving Prime Minister of Russia and first Chairman of Gazprom:
"We wanted better, but it turned out as always."
From Wharton's Penn Wharton Budget Model:
Summary: PWBM estimates that---even under myopic expectations---financial markets cannot sustain more than the next 20 years of accumulated deficits projected under current U.S. fiscal policy. Forward-looking financial markets are, therefore, effectively betting that future fiscal policy will provide substantial corrective measures ahead of time. If financial markets started to believe otherwise, debt dynamics would “unravel” and become unsustainable much sooner.Key Points
The U.S. “public debt outstanding” of $33.2 trillion often cited by media is largely misleading, as it includes $6.8 trillion that the federal government “owes itself” due to trust fund and other accounting. The economics profession has long focused on “debt held by the public”, currently equal to about 98 percent of GDP at $26.3 trillion, for assessing its effects on the economy.
We estimate that the U.S. debt held by the public cannot exceed about 200 percent of GDP even under today’s generally favorable market conditions. Larger ratios in countries like Japan, for example, are not relevant for the United States, because Japan has a much larger household saving rate, which more-than absorbs the larger government debt.
Under current policy, the United States has about 20 years for corrective action after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt whether explicitly or implicitly (i.e., debt monetization producing significant inflation). Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the U.S. and world economies.
This time frame is the “best case” scenario for the United States, under markets conditions where participants believe that corrective fiscal actions will happen ahead of time. If, instead, they started to believe otherwise, debt dynamics would make the time window for corrective action even shorter.
When Does Federal Debt Reach Unsustainable Levels?
Introduction
This introduction to this brief is, by necessity, a bit more technical than found in most PWBM briefs. We provide a small “primer” for policymakers and other readers to understand how PWBM analyzes the impact of debt on the U.S. economy. These insights generally apply to the workings of other dynamic models used by government scoring agencies.
As we have discussed elsewhere, government debt reduces economic activity by crowding out private capital formation and by requiring future tax increases or spending cuts to accommodate future interest payments. The dynamic “overlapping-generations (OLG) model”, originally based on the seminal work by Diamond (1965) and Auerbach and Kotlikoff (1987), is the workhorse framework for analyzing the impact of government debt on the economy through both, tax and spending channels. The Penn Wharton Budget Model (PWBM) and the Congressional Budget Office use versions of the OLG model largely based on the papers by Nishiyama and Smetters (2005, 2007, 2014), subsequently modified in various ways over time. The Joint Committee on Taxation also has access to its own OLG model for assessing dynamics.
It is generally not well understood outside tight academic and DC modeling circles that these models effectively crash when trying to project future macroeconomic variables under current fiscal policy. The reason is that current fiscal policy is not sustainable and forward-looking financial markets know it, leading to the economy “unraveling” through “backward induction”....
August 21 and September 21: There It Is: The Yield On The 10-Year Treasury Index Futures Just Surpassed the October 2022 High Of 4.3330% (TNX)
4.3340% +0.0830% as of 10:13AM EDT
The CBOE 10-year T-note futures traded up to a 4.9750% yield an hour ago.
Back to Viktor. On the future:
"We will live so well that our children and grandchildren will envy us!"
