Thomas Sargent on Government Default
By David Henderson
Tom Sargent’s Nobel prize lecture is quite clear and informative. True to form, Sargent shows some equations at first. This reflects his view that the way to be a “real economist” is to use equations. Yet he does pretty well with words and one can understand virtually everything he says without even looking at the equations. Indeed, as Sargent tells his narrative, he scarcely refers to the equations.
Sargent starts with Alexander Hamilton pushing for the U.S. Constitution so that the United States could have a strong federal government with taxing power. Result: the bonds that the U.S. government and state governments issued when they were fighting the British, which had been selling at a deep discount, now sold at par. Sargent recognizes, without judging, that the beneficiaries and the lobbyists for a strong U.S. central government were the bondholders and those beholden to them.
Fast forward to the 1830s when state governments were building canals and other infrastructure and issuing bonds to pay for them.
25:50: The depression in the late 1830s caused state bonds to go “belly up.” Bondholders and state governments went to the federal government and said, “Our country was born with a big bailout. Let’s do it again.” The federal government said no, that was different; the stakes then were huge–we were fighting the British.
27:30: One result of the feds saying no to a bailout was that federal credit suffered and U.S. bonds started selling at a discount because foreign creditors were not sophisticated enough to distinguish between the United States and Ohio.
27:54: Another result, though, was a fiscal revolution at the state level. Most states did not have balanced-budget requirements before that. Now they amended their constitutions to require balanced budgets.
28:30: How should you judge this decision not to bail out? If the feds had bailed them out, would you have had these balanced-budget amendments? Also, wouldn’t you have set up incentives for future profligacy at the state government level and, therefore, future bailouts? Also, wouldn’t the feds, because they were bailing out, have exercised stronger control of the states?
29:30: Statement out of nowhere. (That is, I don’t know why he said it. Does anyone else know the connection with the rest of his talk?) “Read the 11th amendment. It’s really sleazy.”
In the last 2 or 3 minutes of the lecture, Sargent provocatively teases the audience by highlighting some of the ways in which the situation in Europe today resembles (and some of the ways it doesn’t resemble) the situation in early America.
HT to Jeff Hummel.