Sobering Thoughts on Federal Debt from Marc Joffe
By David Henderson
Another worry about Moody’s position is that the firm is frequently represented in the media by economists from Moody’s Analytics, such as Mark Zandi. Moody’s Analytics is a distinct subsidiary within Moody’s Corporation from the rating issuing entity, Moody’s Investors Service. Consequently, Zandi and others at Moody’s Analytics are not involved in the sovereign ratings process, a fact often lost on interviewers. Further, Moody’s Analytics economists have previously been on record as supporting fiscal stimulus measures including the recent temporary reduction in the Social Security tax rate. While Keynesian policies may be justified on other grounds, they are not consistent with maximizing a sovereign issuer’s creditworthiness at least in the short run. It is thus unfortunate when the public gets the impression that Moody’s Analytics economists are somehow representing the views of the rating agency.
Finally, it has been disappointing to see the third rating agency joining the discussion so late. In a report dated June 8, 2011, Fitch stated that it would place the US on negative watch on August 2nd if the debt ceiling was not raised and suggested that outright downgrades would occur only in the event of an actual failure to pay scheduled interest or principal. The idea that a default would be needed to trigger a downgrade negates the value of credit ratings. If credit ratings are not supposed to hold predictive content, it is hard to see why investors would need them.
In short, the leading credit rating agencies are belatedly awakening to the fact that a dysfunctional political system and long term fiscal imbalances have created significant risks for Treasury investors. Now these agencies, led by S&P, are beginning to provide investors with insight into the unfolding situation, largely free of the biases that affected them during the 2007-2008 credit crisis. That said, investors would ultimately be better served by measures of advanced economy sovereign risk that react more quickly and are less burdened by potential conflicts.
This is from Marc Joffe, “US Debt Ceiling Crisis: Rating the Rating Agencies.” Marc is a former employee of Moody’s. Although, as his bio points out, he was not a ratings analyst at Moody’s, he is now a consultant in the credit assessment field. His whole piece is worth reading. He also discusses the advantages of Canada’s and Australia’s parliamentary system. I discussed the Canada case here and here (the latter with Jerrod Anderson). The upside of a parliamentary system is that it can be better than our system of checks and balances. The downside is that it can be way worse. Good reforms can be implemented more easily. Bad policies can also be implemented more easily.
You might think that Keynesians would take issue with Joffe’s above statement, “While Keynesian policies may be justified on other grounds, they are not consistent with maximizing a sovereign issuer’s creditworthiness at least in the short run.” The argument would be that Keynesian increased-deficit policies, through the multiplier, would cause a large increase in GDP so that the net effect is lower deficits. But even assuming a multiplier of 2, the net effect on tax revenues of an $x increase in government spending would be less than $x, for an overall increase in the deficit. That will be true as long the marginal federal tax rate on GDP is less than 50%.
Aside on math:
$x increase in G increases GDP by $2x. (Assuming a multiplier of 2.)
Tax revenues from increased GDP of $2x are MTR (marginal tax rate on GDP) * $2x.
If, therefore, MTR is less than 0.5, increased tax revenues are less than $x.
My guess is that, considering individual income taxes, corporate income taxes, payroll taxes, and excise taxes, it’s “only” about 40%.
HT to Jeff Hummel.