Wednesday, January 25, 2023

The Debt Limit: A Note on the G Fund and the Exchange Stabilization Fund

The G Fund is one of the funds offered to federal employees as part of the Thrift Savings Plan, the federal employee equivalent to a 401(k) plan.  This fund is invested in one-day non-marketable Treasury securities with an interest rate determined monthly. There is a special provision in the law creating the Thrift Savings Plan that makes the G Fund whole if the Secretary of the Treasury decides to disinvest it entirely or partially due to a debt limit problem once the debt limit issue is resolved. The nonmarketable Treasury securities in the G Fund count against the debt limit, thus, disinvesting the G Fund makes room under the debt limit for the Treasury to issue marketable Treasury securities in order to raise needed cash.

The G Fund is included in intragovernmental accounts. As of the end of December 2022, its assets were $210.9 billion.

The Exchange Stabilization Fund (ESF) is a fund managed by the Secretary of the Treasury. It is primarily used for foreign exchange operations. Here is the Treasury’s brief description of the ESF.

As of November 30, 2022, the ESF had $210.3 billion in assets, of which $17.6 billion were in non-marketable Treasury securities. When the ESF is disinvested because of a debt limit problem, the Treasury does not have the authority to make it whole once the debt limit impasse is resolved.

The Bipartisan Policy Center (BPC) has a description here of what it calls “the big three” extraordinary measures. These are the G Fund, the ESF, and federal employee retirement funds.

Interestingly, Jerome Powell, before he was nominated by President Obama and confirmed to be a governor of the Federal Reserve, worked at BPC. He took a particular interest in debt limit issues, which he knew first hand as an Under Secretary of Treasury for Domestic Finance in the George H. W. Bush Administration. (He was for a time my boss at Treasury.) Probably his efforts at lobbying Republicans in Congress on the debt limit while at BPC during the Obama Administration was a factor in his nomination to the Fed Board.

Tuesday, January 24, 2023

Debt Limit and Treasury Securities Held by the “Public”

The debt limit reporting in the media is fairly good on the political aspects of the issue, but less good on other relevant aspects.

One issue has to do with the size of the debt. The debt limit is $31.4 trillion and the debt subject to that limit is bumping up against that number. However, reporting I have seen fails to mention that of that $31.4 trillion, about $6.9 trillion is held by intragovernmental accounts, including the Social Security trust funds. The Treasury consequently reports that about $24. 6 trillion is held by “the public.”

However, included in “the public” is the Federal Reserve System. Federal Reserve outright holdings of Treasury securities currently stand at about $5.5 trillion. (The system also reports owning $2.6 trillion of mortgage-backed securities, which they state are “fully collateralized” by Treasury securities.)

Subtracting the $5.5 trillion from $24.6 trillion leaves about $19.1 trillion of “privately-held” debt of the type subject to the limit. This includes foreign holdings, including foreign governments and central banks.

While the Federal Reserve Banks are technically private corporations owned by the member banks, for most analytical purposes they should be considered part of the government. The Fed remits “excess earnings” to the Treasury. Its major expenses are for its operations, interest paid on bank reserves, and interest paid in connection with its open market operations. A major source of income is interest received on Treasury and other securities. (For more on this, see this Fed press release.)

While $19.1 trillion is still a large number, the current reporting misses that close to 40 percent of  the debt subject to limit is debt that the government essentially owes itself or to the Federal Reserve.

Wednesday, January 11, 2023

A Comment on "A Monetary and Fiscal History of the United States, 1961–2021" by Alan S. Blinder

Prominent economist and former vice chair of the Federal Reserve Board has written an interesting and accessible book on macroeconomic policy from 1961 to 2021. The title is deliberately similar to the tome written by Milton Friedman and Anna Schwartz, A Monetary History of the United States, 1867–1960. Blinder clearly wants to emphasize that fiscal policy matters.

Blinder’s perspective of this history is mostly persuasive, and he effectively argues against Milton Friedman’s simplistic and often quoted statement: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” One of the weaknesses of monetarism as a policy guide is its assumption that velocity is more or less constant in the famous identity, MV=PQ. Monetarism holds much less sway among economists than it did in the 70s and 80s.

While I recommend the book for those interested in the subject from historical, political, or economic perspective, I will focus here on Blinder’s comments about economic policy in the first few years of the Reagan Presidency. I did not find Blinder’s analysis here convincing.

When Reagan entered office, the Federal Reserve under Paul Volcker was pursuing a very tight monetary policy and the economy was suffering from a recession. In the summer of 1981, the Congress passed and Reagan signed The Economic Recovery Tax Act of 1981, which provided large tax cuts. Also, there was a large increase in defense spending, and the federal budget deficit increased dramatically.

In other words, monetary policy was contractionary and fiscal policy was expansionary. As we know, this policy mix eventually worked. Inflation came down and the economy recovered. However, in discussing this episode, Blinder attacks economist Robert Mundell.

Blinder states that “according to the mainstream view, contractionary monetary policy (à la Volcker) raises real interest rates, though perhaps only transitorily, and slows the growth of aggregate demand...[E]xpansionary fiscal policy (à la Reagan) raises real interest rates and speeds up the growth of aggregate demand. Put them both together at the same time, as Reagan and Volcker did, and you should expect real interest rates to rise sharply while the net effect on real output depends on how the tug-of-war just sketched works out.” (p. 143). 

He contrasts this conventional view with what Mundell wrote in a 1971 paper: “Monetary acceleration is not the appropriate starting point from which to initiate the expansion [in 1971], because the risk of igniting inflationary expectations. Tax reduction is the appropriate method. It increases the demand for consumer goods, which reverberates on supply...Because of the idle capacity and unemployment, in many industries increased supply can generated without causing economy-wide increases in costs. Tax reduction is not, therefore, inflationary from the standpoint of the economy as a whole.” (p.144). 

There does not seem to be a huge difference between the two views, but Blinder asserts without much discussion that there is. He views the “Reagan-Volcker policy mix” as “a bold experiment” and asks: “Which side of the policy mix debate came out looking better?” He answer that it is “the conventional side, by a country mile.” To prove that, he discusses an increase in real interest rates (defined as the Treasury ten-year rate minus CPI inflation over the past 12 months) and an increase in the dollar exchange rate. However, he has not provided any information about what Mundell may have said about the effect on real interest rates or exchange rates. 

While one can criticize both the size and the details of Reagan’s enormous tax cuts, the size and details of the increase in defense spending, and the effect on the lives of many people suffering from unemployment at least partly due to monetary policy, it is nonetheless true that the economy recovered and inflation came down. Blinder does not like the argument that Mundell essentially made: the government had two policy goals (ending the recession and reducing inflation) which should be addressed with two different policy instruments (fiscal and monetary policy). Blinder may have good reasons to disagree with using fiscal and monetary policy differently when faced with stagflation, but he does not effectively argue why. 

It is not clear whether Reagan or his economic advisers had developed their economic policy with any formal analysis of the combined effect of a contractionary monetary policy and an expansionary fiscal policy. They may have stumbled into it for polical or ideological reasons. Blinder is surely right that Republicans have since then seemed to think that tax cuts are always the answer to whatever the current economic problem is and are effectively more relaxed about budget deficits after the Reagan experience (no matter their rhetoric arguing for balanced budgets).  

It is disapointing though that Blinder does not have a better analysis of the policy mix in the early Reagan years and whether he thinks that there could have been better policies at the time. A better thought out and explained argument against what Mundell was advocating would have been interesting.