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Diplomacy in Action

Debt Debate and its Financial Implications

David K. Backus, NYU Stern School of Business, Heinz Riehl Professorship in Finance and Economics
New York, NY
June 8, 2011

Date: 06/08/2011 Location: New York, NY Description: David K. Backus, NYU Stern School of Business, Heinz Riehl Professorship in Finance and Economics briefs on the Debt Debate and its Financial Implications at the New York Foreign Press Center. - State Dept Image
11:00 A.M., EDT

MODERATOR: Good morning. Thanks for coming. Today we have with us David Backus of the NYU Stern School of Business. He will be briefing on this debt – ongoing debt debate, whether we raise the debt ceiling or not. The U.S. hit its 14.3 trillion debt limit on May 16th, and Secretary Geithner has given an August 2nd deadline before he says the U.S. will run out of funding for current obligations. Democrats and Republicans now seek a solution to the debt ceiling limit.

So we have Mr. Backus, who will brief, and then we’ll do some questions. For transcription purposes, please state your name and news organization before your question. Thanks.

MR. BACKUS: Good. Well, thank you, Neda. I’m an old teacher, so I’d like to get a sense of who’s in the room. I noticed there was some people from China on the list. So I’m going to Shanghai in two weeks; maybe you can give me some – where are you from?

QUESTION: (Off-mike.)

MR. BACKUS: Okay. So you know Shanghai. You can give me some --

QUESTION: I’m from (inaudible).

MR. BACKUS: Okay. There we go. Okay. We got competition. And Norway? Some – yeah. So I have lots of friends from Norway, including coauthors, so – it’s a small country. I have one issue. So one of my good friends and coauthors works for the Norwegian Petroleum Fund, and they have $500 billion, and I can’t get him to give me any. I don’t know, it seems kind of unfriendly of them.

QUESTION: (Off-mike.)

MR. BACKUS: Right. Okay. We’re in the same boat. And Spain, is there somebody from Spain? Where are you from?

QUESTION: I’m Catalano, from Barcelona.

MR. BACKUS: Okay. Good. If you’d been a Real Madrid fan, we could have had trouble. But --


MR. BACKUS: Yeah. Barcelona will be okay. So thanks for coming. I guess my job is to be of use to you; you can best tell me how to do that. I thought I’d make some brief comments, but then ask whatever questions you want and I’ll do my best to answer them. I’m – I find that the academic world maybe is a little more open than others. You Google my name, you can find me. So if you want to – if you have a question at some point, shoot me an email. If you can’t find that, try to Google me and I’ll do my best to answer it or pass you on to somebody who could answer it.

NYU – I need to do a little bragging. NYU actually is an extremely good university in economics and finance. So I feel fortunate to be there. I’m one of many people who do macroeconomics and finance. A lot of us, myself particularly, have a strong international focus. So talking about the U.S. in some ways is a rare treat. In many ways, other countries are more interesting in a lot of different dimensions.

You might want to – I don’t know – if you think about this, do I have an ax to grind? Well, I think I’m not a – trying to think. Like most professional economists, we basically throw stones at whoever’s in office, and it’s fairly easy to do. My view of politics in the United States, probably elsewhere, is that it’s a source of late entertainment, sometimes worse. The Daily Show is probably the best example of that in the United States. If you want to get a sense of kind of U.S. political humor, that’s a good place to start.

The U.S. – a quick summary. So the debt limit has gotten a lot of attention to an issue, and you get the sense that it’s a crisis. It’s not a crisis. The U.S. is not in the kind of situation that Greece is in, that Argentina was in 10 years ago. Lots of countries have run up more debt than they can pay for. What is helpful, though, is that it’s a rare case in which politicians have focused on something that’s a really important long-term issue. So over the next 10, 20, 30 years, there are some spending plans built into U.S. law, but if we don’t reverse them we’re basically going to chew up larger and larger chunks of the U.S. economy. And the question is how to manage that. Like most problems, it’s really helpful to address them early rather than you wait for them to become a crisis. So even though it isn’t a crisis, it’s kind of helpful that people are looking at it.

The current situation, it’s a little bit odd. So we have this long-term issue, which is spending plans, particularly on health care, are going to bankrupt us probably. So we either have to cut down spending or increase revenue somehow, and by a lot. But the current issue is low revenue, and that’s primarily a cyclical thing. We’ve gone through this major recession, and like in most recessions, what you find is government revenue drops. So in this case government revenue dropped a lot, so most of the deficit you see right now is a drop in revenue.

Nothing I’m saying, by the way, is a surprise. This is just kind of mainstream evidence. But that’s likely to turn around. As the economy recovers, that’s going to reverse itself. What won’t reverse itself is this 10, 20, 30-year issue with spending plans. And like a lot of countries, we have spending plans that are kind of locked in and hard to reverse and that are exacerbated by an aging population. So the worst issue here is health care. Second-worst probably is Social Security. Together they add up to a fair amount of money. And as the population ages, it’s going to cost more and more money.

People in China, so you have a very different system there. In fact I don’t even know how it works. But if you look at the demographics, the demographics in China are, if anything, more extreme than you see in the United States. I mean, you see a very rapidly aging population. Japan is more extreme than the United States; Germany is more extreme than the United States. So lots of countries are facing these demographic issues, but they hit countries a little bit differently depending on how they manage pensions and healthcare. And both of those things differ a lot around the world.

You might get the idea that this is news. So all of a sudden people have gotten – we’re looking at the debt limit. There’s a crisis of the – something out snuck up on us. What’s interesting is, not the politicians but their staff, in particular the head of the Congressional Budget Office, which has switched parties every time Congress switches parties, they’ve been pointing to this issue since at least the mid ’90s. And it’s kind of ironic. You say this about 20 times and finally somebody goes, oh yeah, that’s right. So there’s a sense in which the people who have been paying attention don’t find this news. So it’s helpful that the politicians now have paid some attention to it, but it’s not particularly a new issue.

The thing that is an issue and has gotten a lot of attention is the – this federal debt limit. So we have this process in the United States that – it’s one of these historical accidents that’s a little bit odd. The Congress will establish a budget that is spending and tax policies, and that’ll determine what the deficit is and how the debt accumulates. But they have this kind of funny procedure in which they vote separately on the deficit – that’s part of the budget – and on the debt limit, which is a consequence of the deficit policies.

So that tends to get a lot of attention because it’s immediate, there’s a deadline, and it kind of gets people thinking about, hopefully, long-term issues. Now, what’s unfortunate about it is, I think, that it’s led to a lot of jockeying, political jockeying with the next election in mind. And a lot of the things they’ve talked about changing – cutting spending – have been little things that are not tied to this long-term problem. So it’s a typical political thing which we’re dancing around, trying to get attention for the next election and not necessarily focusing on the long-term issue. My hope is that, as in past such cases, eventually people start to spend some attention – pay some attention to the long-term issues and will come up with some way of addressing it.

A couple more things. First, the numbers are big, so I can show you something – so the best way – the best place to go for data here is the Congressional Budget Office. They’re not always right but they have a reputation of being pretty competent and non-political, which is kind of a wonderful thing in a political world. And every June they come out with a report they call the Long-Term Budget Outlook, and they will show you some nice graphs and say this is how we anticipate spending plans to go. And what they’re projecting now is that over the next 20 years you’re going to see the spending on particularly healthcare and Social Security increase by maybe 10 percent of GDP. Now, if you’re in an economy where the federal government spends roughly 20 percent of GDP on average, adding 10 percent of GDP, that’s a huge increase.

So there’s a fundamental debate going on – and should be going on – which is, how big do we want the government to be in the economy? So how we’ll resolve that, I don’t know. Healthcare is an ungodly complicated issue, and it’s kind of hard to know how you’re going to come up with an easy fix to it.

So let me turn it over to you. If you have any questions, fire away.


QUESTION: Morten Aanestad, Norwegian Business Daily. There has been a discussion – President Obama said that not raising the debt limit would be a catastrophe, but (inaudible) today you see that Republican politicians saying that it will not be a catastrophe. For example, with the default of the U.S. debt and so on. What’s your opinion?

MR. BACKUS: (Laughter.) Well, a fair answer is I don’t know. So the – there are two issues here. So the first is, are there ways you can kind of diddle the budget, the spending numbers, just to kind of keep paying debtors? The second is, so right now we’re issuing a lot debt. U.S. Government debt is a very attractive asset for lots of people. At least I infer that because the interest rates we pay are pretty low. So the question is: If somebody’s invested a large amount of money in our debt and then we stop paying coupons for a while, at what point do they panic? So I can imagine some of them will say, well, that’s okay, we can hold on; or others will – but it’s not the kind of thing I’d want to play with. So that’s a tricky thing. It’s really a question of what’s the psychology of the investors. Are they willing to put up with a delay in payments? Personally, I wouldn’t want to try it.

The history of the United States, if you go back to the beginning, Alexander Hamilton arranged to pay off the original debt, which was the Revolutionary War debt the United States had that was carried over from before the United States was set up as a country. And Hamilton argued that paying off that debt would establish such a good reputation for being a good borrower that it would lower our interest rates. And that’s true at the time. So in 1792, the United States was an emerging market. They were issuing debt partly in the London markets. And what happened was the spread over UK guilds went from about 600 basis points to 2- or 300 basis points in four or five years, having paid off the debt. So given that history, I kind of – I prefer not to play the alternative experiment, which is what happens if you stop paying off your debt, at least even temporarily.

QUESTION: Yes. Neeme Raud, Estonian TV. I got the microphone. We hear a lot about –

MR. BACKUS: So you’re next – (laughter) – okay, good.

QUESTION: -- this W-shaped economic crisis and the recession that we are like going down again. What’s your view about it? Is it justified, all this talk about it?

MR. BACKUS: Well, there are two things that seem to be true about news. So one is bad news just spreads really well. So you guys are in this business. So you say is it a headline to say things are fine? I know that’s not it. You say the world’s going to hell; oh yeah, that’s a headline. So not to pick on them because I like them a lot, but my colleague, Nouriel Roubini, has made a career. We’re in trouble, so every year or so there’s a new reason we’re in trouble. We’re always in trouble that always makes a headline.

QUESTION: Roubini says we are not in trouble.

MR. BACKUS: Yeah. Then you start to –

QUESTION: (Inaudible.)

MR. BACKUS: Yeah. Okay, so – yeah. I told him if he picked the turn, he’d be a hero, but he hasn’t – there’s always more trouble down the road. So the other thing is we don’t know the future. So a fair statement is we don’t know what the U.S. economy is going to look like in a year. We have a guess, but the guess is – I mean, in statistical terms, you’re – the R-squared on that guess is about 25 percent, which is most of it is unpredictable. Now, what do we know? There’s a fair amount of weakening in the economy, and that is we’re not growing as fast as we could, but we’re a long way from a recession. So I’m tempted to say my bet is actually faster growth. I don’t know whether that’s a scientific statement or just one that I have a more positive outlook on life than my friend Nouriel.

So – but I think people tend – right now, I think the psychology is people are a little bit spooked because we went through this incredibly traumatic experience. So people, I think, are putting a little bit too much emphasis on the bad news. I’d say the United States still is a strong economy. Nothing about that has changed. Every time – over my lifetime, every 10 years people say the U.S. economy is falling apart, blah, blah, blah. I grew up in Pittsburgh, the Rust Belt, and obviously the steel mills are no longer there, but Pittsburgh is doing fine. So every time people have said the U.S. economy has fallen apart, they’ve been wrong, and I think – I would bet on history. So yeah. But I’m sure the politicians are worried about this. This is going to be a major issue in the election, how well the economy does. I don’t know, does that address your question? No. Sorry, it wasn’t your – your question, sorry.

QUESTION: Thank you, Mr. Backus. I’m Fei with Shanghai newspaper called Jiefang Daily. I have two questions. The first one: The United States met its debt limit on May the 16th, and then the Treasury Department extended to August 2nd by taking extraordinary measures. I’m wondering what are – these extraordinary measures are.

The second question is: What are the problems of raising debt limit? Why the United States can always pay the debt by printing dollars. Yeah. That’s two questions.

MR. BACKUS: Yeah. So what are the extraordinary measures? I have no idea. It’s just – it’s a technical detail; it’s not my thing.

On the U.S. can always cover the debt by – cover its deficit by printing money, there’s a long history that suggests that that’s a bad idea. So the extreme case is Zimbabwe. But basically we have 400 years of evidence of when countries do that, they get lots of inflation, which is a good way to kind of devalue the debt, but long term doesn’t create an environment in which people want to buy your debt in the future. So if you – Brazil, for example, had very high inflation in the early ’90s, and they’re still paying what look like extraordinary interest rates on their debt. What are they, like 8 or 10 percent. So – and most people would attribute that to this hyperinflationary experience. So I think the United States printing money is probably not what they want to do. What they need to do is continue to make it clear to people that buy their debt that they’ll be repaid.

And what you see – there are lots of examples when that’s failed, and what will happen is it flips very quickly. So Argentina was issuing debt, and then all of the sudden people just said okay, no more. Mexico was issuing debt – all of the sudden – so I think we want to avoid getting into that situation. Now, I would think we’re a long way from it. I mean, we’ve seen this in emerging markets. You don’t see it a lot with developed countries, but that’s the fear. So what you want to do is – what Alexander Hamilton said is when you’re issuing debt, you want to have accompanying that a plan for paying off the debt, which is a long-term budget plan in which it’s clear that a moderate amount of tax revenue will cover whatever debt we issue. I don’t know if I answered your question, but I remember talking to Bob Lucas one time, a well known economist. He was – I asked him a question, and he said – he tried to give me an answer, and he said, “Well that wasn’t a very good answer, but I didn’t like the question either.” So – (laughter) – I don’t know. I gave him credit for honesty. So I mean that in the nicest possible way.

QUESTION: Yes. De Gasquet from the French newspaper, Les Echos. Sorry to be late.

MR. BACKUS: Oh, you missed some great stuff. No.

QUESTION: Yes, I’m sure. What is your best bet on the schedule of the summer? I mean, are we in a shutdown-like scenario with the negotiations going on until the last minute, until the beginning of August? Or do you think it will be solved before – much before?

MR. BACKUS: I don’t know. We’re betting on politicians. So who knows?

QUESTION: (Off-mike.)

MR. BACKUS: Yeah. We should look up – what is it – Don’t they have contracts on this? You could find out what the August contract looks like? I think it would be helpful to resolve it earlier, but going into an election year there’s just a tremendous amount of value to individual politicians posturing about things that are largely irrelevant but generate a fair amount of attention. So this debt limit seems to have generated a fair amount of attention.

QUESTION: So you think it could go until the last minute –

MR. BACKUS: Well, that’s my fear. I don’t know if I would bet on that.

MODERATOR: We have a question in Washington.

QUESTION: Hello. Can you hear me?

MR. BACKUS: Yes. I was just going to comment. The weather here is horrible, but my experience is it’s usually worse in Washington. So yes, please go ahead.

QUESTION: Hi. This is (inaudible) from China’s (inaudible) Media. I have one question. In terms of the U.S. Treasury bond, your idea – what – I mean, what should be the catastrophic factors to the performance of these bonds and in the near-term and in the midterm? Thank you.

MR. BACKUS: I don’t think there are any catastrophic factors. This is just an incredibly attractive market, and it would take a lot to kill it. So I’d like to think of the political process, as much as it’s prone to posturing about little things, eventually when something becomes serious, they’ll whip themselves into shape. I hope that’s the case.

QUESTION: Nikolaus Piper, Sueddeutsche Zeitung, German daily newspaper. Nikolaus Piper, Sueddeutsche Zeitung, German daily newspaper. I have a question about the solutions. As I understand, there are a couple of concepts out there how to solve the long-term problem – the bipartisan commission introduced by Obama, the Gang of Six, Paul Ryan. Could you elaborate a little bit about your opinion on these different solutions? Is there any – are there solutions or is it just – I don’t know.

MR. BACKUS: Well, you think it’s hopeless. Well, it’s like a lot of things. I’m told – I don’t want to talk about this, but I’m told that in the Middle East, sensible people can look and see what a solution looks like; it’s just that it’s hard to get there. So I don’t think this is as intractable as that. But we know what the issue is. So if you look at the CBO report, we have this very sharply increasing set of what we call entitlements, a lot of them healthcare related. And we need to reduce those somehow. So there are a lot of ways of doing it, and there’s going to be a lot of debate over who loses.

So on Social Security, I think there’s kind of an obvious answer. So Social Security isn’t the biggest number. But the obvious answer is when we put – is to raise the retirement age. So the question is: Well, when do you start raising it? So is it raised at me? Or I think it should be raise on the people right behind me. Right? So – but that’s true in every country in the world. We know that that’s the obvious answer, and it’s just a question of getting that in place. But we’ve gotten ourselves into this situation. I think the 65-year retirement age was put in place in the ’30s and people now live, what, 15, 18 years longer than that. So it’s become a lot more expensive. Well, you need a system that automatically ratchets that up rather than having – politicians don’t like to blamed for taking the cookies away from the party. So you need a system that would automate that. So lots of countries do that. I mean, Sweden has a system that will automatically ratchet down benefits in some way if the revenue isn’t enough to cover it. So the question is exactly how to do that.

On healthcare, that’s just an ungodly complicated thing. So one of the issues is we’ve seen pretty sharp increase in the price of healthcare, and the question is: Is there a way to get around that? So on the, what was it, the 2,000-page Obama healthcare bill, I mean, there might be things that will help in there. I just don’t know. I mean, it’s – and there may be other things we could do. The Ryan plan, as I understand it, is to take the government out of it and just give people a fixed amount of money, so that would do it. So rather than say we’re going to cover whatever your healthcare costs are, it would say okay, we’re going to give you $1,000 a year and then if it’s more than that, you take care of it. So a lot of different things, but it’s clear we have to address these healthcare costs.

The current system is just ungodly complicated, too. I mean, if you’re from another countries, you’ve probably experienced other – so everybody has a different view. So I lived in Canada. So this was 25 years ago, I lived in Canada. It was extremely easy from the point of view of a user. What I’m told is that – and if you look at the Canadian budget, Canada is one of the few countries in the world to actually bring down the size of government relative to GDP while running a hundred percent government-run healthcare system. So – but there are a lot things that are different about Canada.

So one thing about Canada is you go to medical school and it’s more or less free. So here you come out of medical school and you’re $200,000 in debt. So that’s one of the things that’s different. Another thing that’s different is, so Canada has this system where there’s no private sector. It’s illegal to get private healthcare, right, because they didn’t want that to whittle away the system. And the result is there are a lot of people – I have friends whose families have gone through this – you go the hospital and you just sit in there for a day and a half waiting for a bed. So rationing is a way to handle that.

So there are no simple solutions, I don’t think, to healthcare. But it’s clear that we’ve got to do something to keep the payments from just exploding on us.

So you and then – is that --

QUESTION: Tomasz Deptula, NewsWeek Polska, Polish edition of a news magazine. I would like to hear something about in Europe in that problem. Why, and if you can compare, American debt structure to European – to problems of countries like Greece, Portugal, Ireland – why we are dead serious about their debt over there and why you’re saying it’s not reason to panic here.

MR. BACKUS: Sorry, what’s different about Europe?

QUESTION: (Off mike.)

MR. BACKUS: Well, the first this is suppose we look at Greece, they just have a lot more debt relative to the size of the economy. So that’s just a question of spending and tax plans made in the past that just generated a whole lot more debt than was warranted, then you can support on that tax base. Now I would argue in a sense the Eurozone was a facilitator, an enabler of that because they were able to issue debt at really attractive rates, even though there was an enormous amount of it. So the ballpark numbers – what are we – debt is a ratio to GDP, the United States is, what, 75 or so and heading up. And Greece is like 110, 115 and heading up even faster. So the numbers are a bit different. Also, I think Greece is in – according to many of the development indicators, it’s just not a developed country. It has institutions that look like, say, Eastern Europe or some countries that are at a lot lower stage of development, and I think the institutions make it hard to do.

Ireland’s a completely different issue. So Ireland currently has a serious debt problem, but their problem was – and they claim because they were encouraged by the European Central Bank – their problem was they guaranteed their banks and their banks basically bankrupted the country. So the United States guaranteed the banks, but it wasn’t quite as big a number relative to the size of the economy.

So in both cases, the question is: How do you get out of it? Default – countries can always default. Countries can always do what they want. But the question is in the European Union and in the Eurozone, what will the other people do to fight back? So that will be kind of an interesting negotiation, probably much of it behind closed doors, in which they effectively default and then somehow other people take care of the problems.

I don’t know, does that address your question? I mean, they’re much more serious immediate issues than you’re facing in the U.S. So that is – that’s the bad scenario for the United States 10, 20, 30 years down the road. In some ways, maybe it’s a nice thing – well, I don’t know how to word this. It’s useful to the United States to see those examples. Right, just say you can’t do this forever.

Portugal is another one. Italy. One of the great things about being an academic economist is I have colleagues from most of these countries and they kind of give me a sense of how it works. I don’t know. You’re from Europe. You probably have a better sense than I do about how this works.

QUESTION: Has the discussion about the debt limit and the impact on the economy now – I mean, consumers may be worrying about the debt limit and don’t spend so much. Has this any influence on the recovery?

MR. BACKUS: I don’t think so. I think what does have – so anything related to healthcare and taxes could have a big effect. So again, it’s very complicated, so I don’t know how it adds up. But one of the costs of hiring people in this country is providing healthcare. And the more that becomes really expensive, the more you’re either trying to avoid providing healthcare or you hire fewer people because you’ve just made hiring people more expensive. So now the new healthcare system is changing how that works, so that’s going to be a major thing when you’re trying to hire people. So I would say those things, long-term tax plans, those are probably a bigger issue.

QUESTION: Follow up?

MR. BACKUS: Please.

QUESTION: The recovery is weak. We saw it in the last few numbers which came out last week. How is this recovery different from other recoveries in the past, and what are the reasons for that?

MR. BACKUS: Well, the difficulty is that the past will give you almost any pattern you care to look at. So one pattern you see is a sharp down was followed by a sharp up, and we didn’t really see that. Another pattern you see is in lots of sharp recessions where you – that were triggered by a financial crisis, those take a lot longer.

Now, what seems a little bit odd right now is that the financial markets seem to have calmed down, so maybe that’s misleading, but it looks as if the financial trigger has kind of passed. If you look at Ireland, I mean, one of the things Ireland is facing is the banks can’t make any loans. They’ve – so – but I don’t think that’s true in the United States. So the question is: What’s keeping the recovery from happening? Is that bad luck? Is it there’s still a hangover from – is it that people are worried about the future? It’s hard to know. I mean, that’s one of the unfortunate things about my field; you never know for sure. It doesn’t make a good sound bite, but you don’t know. I don’t know, does that – you’d rather I say, “Oh, yeah. This is it.”

QUESTION: (Inaudible) because you have such (inaudible) financial crisis here, is that the reason – because it’s --

MR. BACKUS: I don’t think so. Living in New York, you know lots of people working in financial services. There’s a lot of activity going on in the financial services business, so it doesn’t look like there’s a lack of money. I mean, maybe people are a little bit more gun-shy than they were, but it doesn’t look like that. But what’s happening is output’s going up, employment’s going up very slowly, and that’s unusual. It’s not wildly unusual. So going back to the ’90 recession – the ’90 recession, the 2002 recession, there were a series of headlines over the next two or three years saying: Where are the jobs? And what happened was the jobs took a while to get going. And that’s true here, only a little more so. So if we follow the pattern of those two previous recessions, we should see the jobs picking up at some point. It’s just – it’s not – economies just do not continue to grow without hiring people. So --

QUESTION: Do you --

MR. BACKUS: So – I think you had a question, and then --

QUESTION: It’s been answered.

MR. BACKUS: Oh, answered. Okay. Georget (ph).

QUESTION: Yes. Just a follow-up on the political side. Do you think there is a good number of Republicans thinking a technical default could be a good – a useful step?

MR. BACKUS: I haven’t heard that, no. It could be true.

QUESTION: Some of them, probably.

MR. BACKUS: What, who?

QUESTION: Don’t know. John Boehner, no? Then you think there is no probability of a technical --

MR. BACKUS: Well, you can always find somebody that’ll say anything. But I just don’t see any mainstream politician saying that that’s a good idea.


MR. BACKUS: I mean, you could try that experiment. We haven’t – never done it before. Maybe it’d be right. But --

QUESTION: And what could be the best scenario for the Obama Administration then, before the 2nd of August, in terms of --

MR. BACKUS: What would be the best scenario? I --

QUESTION: For the debt ceiling, yeah.

MR. BACKUS: Well, you’d like to see some agreement. My guess – so if I were Obama, what would I be doing? So I would be doing two things in parallel. I’m not saying this is what he’s doing, but when we study game theory – did you ever study game theory? What you do is you want to look at all the scenarios. So I would be doing two things that are, in a sense, inconsistent. So the first thing I’d be doing is I would be figuring out ways to get around this. So, like, maybe you tell people, “I’m going to only pay you half pay for three months and then you’ll get it later,” or – I don’t know. I’m sure there are experts at how to – what did you call them, these extreme measures?

So there are – so that’s the first thing you’re I’d do. The second thing you would do is you would say there are no extreme measures; this is a real deadline because you want them to come to agreement. And the question is: Which do you believe? It’s probably some of each. But I guess that they got a lot longer than August 2nd.


QUESTION: So if (inaudible) bank were in QE2 coming June, end of June, so could you evaluate the QE2 from the viewpoints of the cost and benefits?

MR. BACKUS: No. (Laughter.) I think it’s a good answer. No, the difficulty with macroeconomics is you would like to do the experiment and say, okay, I’m going to do QE2 and I’m going to go back in history and redo the economic performance without QE2, but you don’t get to do that. So you’re trying to figure out what would it have been like. I personally don’t think it was a huge deal. I think it might have had some psychological effect, but I don’t know that it’s a huge deal.

The biggest issue right now seems to be the mortgage market that the federal government owns just a huge fraction of the existing mortgages, and at some point they’re going to have to unload those. And the question is how quickly can that unwind itself. So in the mortgage market that may be an issue, but in general, I’m not sure it’s that big a deal. So I don’t think Bernanke would ever say this, but he said things like monetary policy can’t do everything; we’ve got to do something on the fiscal side. And I think he’s admitting you can’t solve all problems.

I think what he was trying to do is you want to avoid risk on the downside. So I think they’ve certainly accomplished that. They’ve done all they can. I mean it’s hard to imagine there could be more, although there could be more QE, so 3 is being debated. But my view is it’s mostly window dressing, but who knows. People have strong opinions about that both ways.

MODERATOR: Over here.

QUESTION: Hi. First of all, sorry to be late. I had assignment earlier. Anyway, I’m a reporter with China Daily. I want to follow up on a question about the Treasury bonds. So back in China some economists have been arguing that with the current situation that China should be stop paying – buying the treasuries and stops lending money. So what do you make of this point and do you think it’s too much cautious to do this?

And also second question, if you don’t mind. Even if the debt ceiling is increased, people are still wondering – mostly the buyers of the loans, how do you make it possible to pay back the money? So do you necessarily link spending cuts to solving this problem?

MR. BACKUS: Okay. So my memory’s not as good as yours. So should China stop buying these? People were saying that years ago. It depends what the alternative is. So China’s invested in lots of assets that did a lot worse than U.S. treasuries. So the standard investment advice, so China has a large portfolio, so you can think of the Central Bank as basically a huge portfolio manager, and the best advice is to diversify generally banks by debts. So you could diversify internationally. But over the last few years, U.S. debt has looked a lot better than say European debt. So I don’t buy that we should stop now.

To give you some perspective on this, one of my colleagues in the field, Jeff Frankel, is an economist at Harvard. And he was quoted in the newspaper a few years ago saying, “U.S. is issuing too much debt. Eventually there will be a problem.” And then he said – and I think this is a sign of Jeff’s sense of humor, he says, “I’ve been saying this for 25 years and it’s yet to happen.” So the same thing was said about the U.S. debt in the ‘80s, but then it was will the Japanese Central Bank stop buying U.S. treasuries? And now it’s the Chinese Central Bank. So it’s the same story. Maybe you like that in the media business – they’ve got the same story, you just change a couple of things – (laughter) – and then you’re ready to go. But I would infer from that that disaster could always be around the corner, but it hasn’t been around the corner yet. So I don’t – I see no reason to stop buying these things.

Now the question is can we pay them back? This is not – the amount of money we have now is not something that’s impossible to pay back. What’s important, though, is that the U.S. economy keep growing. That if the U.S. economy stops growing that that absolutely swamps the effect of the current debt. All right, so the difference between – suppose over the next 25 years you say we are going to grow at 2.5 percent or 3 percent. That’s a lot of money, right? But that’s potentially more important than not of the long-term fiscal issues but of the current debt issue.

So the key thing is you’ve got to keep the economy growing. The measure we use is usually debt relative to the size of the economy. If the size of the economy keeps growing then those kinds of things will take care of themselves.

QUESTION: So you said to keep the economy growing, how crucial it is to focus on spending cuts. Because we know – I don’t know if you have seen I.O.U.S.A. It’s a documentary focusing on telling people how serious spending is and then how important it is to focus on spending cuts. What do you make of this?

MR. BACKUS: Well, the – this again, is mainstream economics. So if government spending becomes a much larger share of the economy, of the GDP we would say, then you’re going to have to raise tax revenues somehow to pay for it. And I think most people believe that the higher the tax rates are the worse that is for the economy. So it’s not – it depends partly on the form of the tax system, but raising taxes certainly discourages some types of activity. And the two types of activity we’d be most concerned with were – would be employment and investment, that if you make investment a lot less attractive through the tax system, then conceivably people will do less of it.

So again, it’s a very complicated thing, but I think those are the concerns people would have, that if you raise tax rates enough you’re going to discourage some activity that’s actually very helpful to the economy as a whole. Or in general, if you raise a tax on something you tend to shrink the tax base. The whole argument for putting taxes on cigarettes is to shrink the number of cigarettes that people smoke. So if you tax other things, I think you tend to shrink those too. So in a dynamic economy, that’s a very complicate thing, but that’s the concern. So there are – there’s actually a technical debate on exactly how to take into account that kind of feedback in judging the effectiveness of any tax change.

QUESTION: Thank you, Professor Backus. Wang Yu from Caijing Magazine, which is business economics magazine from China. So I have two questions. First is about the Treasury things because just like after the financial crisis we have bail out towards the financial institutions, the bail out towards automobile industry. But right now we just jump to the issue we are going to face 10 years later or 20 years later. Is there are just like some say now we’re in the middle, that the government still could stimulate the economy’s growth better with some sense of consolidation of the budget. So this is the first question.

And the second one is --

MR. BACKUS: Could we ask them one at a time? My memory is not that good.

QUESTION: Oh, I’m sorry.

MR. BACKUS: So what is --

QUESTION: Yeah. Just like after the crisis we have just like very short-term bail out towards financial institutions, the automobile. But right now, towards the budget issues we are facing the problem which we are going to face 10 years later or 20 years later. If there is some plan in the middle which the government could still stimulate the economy but with some sense of the consolidation of the budget?

MR. BACKUS: So I take the question to be: Is expansion or a fiscal policy more difficult given the budget situation?


MR. BACKUS: And I would say there are a couple issues there. So, yeah, the simple answer is yes. Right? You’ve given yourself a lot less room for maneuver, but there’s a bigger debate about whether expansion or a fiscal policy really has much effect. I mean, there’s no question it had some effect, but the multiplier numbers – does that make sense? So the question is if the government spends a billion dollars how much does the size of the economy go up? So if it goes up $2 billion we would say the multiplier is two. And I think most people – it’s hard to argue for a multiplier that it’s a lot bigger than one.

I think Christy Romer was arguing when they pushed through one of the stimulus packages that it was a little over one and a half. And I think people felt that that was overly optimistic just because it was a sales pitch. But a lot of people actually think the multiplier could be significantly less than one. So I think there’s an open question whether that’s – whether that tool – even if you were able to use that tool, whether that tool is that useful.

Even Paul Krugman – I think Krugman buys this. I was in a room with him. He said that the multiplier is 1.1. Now his – what he takes from that is you just need to do a bigger stimulus because the multiplier is small. But at some point it sounds a little bit like the argument of I tried something it didn’t work, therefore I have to do it twice as hard, right? So – whereas I would say well, the alternative hypothesis is well maybe that’s just not what you want to do.

I know – if you follow sports, I think the – in all walks of life, including sports, focusing entirely on the short term tends to give you bad long-term performance. So I think the more that – the United States is not in a recession right now, so the more we focus on things that are good for long-term economic performance, I think the better off we’ll be.

QUESTION: I do have one towards the monetary policies. Just like you also quoted about the Bernanke measures, the monetary policy cannot solve all of the problem. But how could we make them be more effective than now? Because you also mentioned about the mortgage-backed securities, these kind of things. So how could the Fed really put the gasoline into the economy? Thanks.

MR. BACKUS: There’s – if I could argue with this, I think there’s a sense in which the government – that the politicians sell to us which the government is driving the economy. So if the economy does well, you go, oh, it’s me, I was the president or I was the senator. And I think most of the evidence is that the political system has at best a secondary impact on how the economy behaves. We see business cycles. The economy grows fast sometimes, slow other times. That’s been true for as long as we’ve had economic data. It was probably true in Roman times.

So I think most of us feel that – most professional economists feel that the government is not the primary engine for the economy. I don’t mean that in a negative sense. I think the government is a facilitator and is very important as a facilitator. It’s very important to set up some institutions that will allow the economy to grow, but that’s very different from actually doing it. It’s like when you have kids: You can’t do your kids’ homework; what you have to do is provide an environment where they can do it. And trust me, it’s not easy. But creating an environment is a subtle thing. It’s not driving the outcome. It’s providing an environment that can – where success can happen.

So my students all think, “What happened? Why is the U.S. economy successful?” They think, oh, good government policy or Bernanke or Obama or whoever you want, or the other one would be Steve Jobs. But I think it’s really in the middle. What’s critical is for the government to set up a set of institutions so that people like Steve Jobs can be successful.

Is that too – I think the evidence is overwhelming that that’s the way it works. Now, in China, you’ll have to explain to me how it works. Nobody from the outside quite is sure. It’s a bit mysterious. It’s kind of very fascinating and mysterious.

MODERATOR: We have time for one more question.

QUESTION: Zdenek Fucik, Czech News Agency. You talked a lot about health care and Social Security. Do you think that the defense spending is also a problem here?

MR. BACKUS: I think when you have a – when you – so there’s no question that the entitlements are the big issue. But when you attack this, there are going to be thousands of smaller issues that you attack. And I would say even in the top five or ten, you’re going to get to defense spending. So – but it’s – this is going to get – so the wars in the Middle East are going to be a hot-button issue. So for me, I don’t think it’s critical that we leave tomorrow or we leave next year. What’s critical is we not be there ten years from now, that it’s really the long term that’s critical. But there’s enough money there that that’ll make some difference at the margin. That alone will not solve the problem, if you know what I mean, but a bunch of things like that will certainly be helpful.

MODERATOR: Do you want to take this last one?


MODERATOR: We’ll do one more.

QUESTION: I have three questions that are very quick. I will repeat them.


QUESTION: One is basically –

MR. BACKUS: Well, since you’re a Barca fan, that’s okay.

QUESTION: This is basically the metrics. I’d like to know what are top three metrics that you follow. There are a hundred metrics in economics, but I’d like to see what are the metrics that you’re going to follow for the next 12 months.

I’d like to know what are the three top events that you are following closely.

And what’s your overarching thesis? I mean, Medicare, Medicaid – for instance, Medicaid is only 10 percent of the population in the U.S. is covered by Medicaid. It’s small peanuts compared to Spain or Sweden or any other government in the world that is 100 percent covered. In the U.S., the government covers a very tiny, small amount. So it’s a little bit questionable that Medicare is the number one problem on the spending.

So I’d like to basically hear: number one, what are the metrics, what are you following, what is the metrics, the numbers that you follow closely; second, what are the events; and third, what is your overarching thesis, what is your understanding of the economy and basically what is your forecast, what is your understanding of what’s going to happen.

MR. BACKUS: Well, let me start with one and then we could follow up.


MR. BACKUS: So what would I follow? I would follow employment. So the monthly jobs report. And if I were going to look at a specific component of that, I would look at the private sector. So right now, the budget crunch we’re talking about at the national level is happening probably at a worse – in a worse way at the – immediately at the state and local level. And one of the byproducts of that is state and local government employment is shrinking. So the question of what’s happening in the private sector.

What was the other one? So I have the answer. I can’t remember the second question.

QUESTION: What are the top three metrics? One is unemployment. What are the – what will be the next two?

MR. BACKUS: Let me do one for now and then we can continue later if you’d like.

So what am I following? I’m following FIFA. So if you follow this – so the International Soccer Federation, which is kind of an interesting example of governance with a complete lack of transparency. So we often talk about corporate governance, but there’s governance of lots of things. So FIFA – actually, they run the World Cup and they manage billions of dollars in ways that are a bit mysterious. So maybe when you go back to Zurich you could figure out what’s really going on there.

And then the third thing, what’s the overarching theme? I think you’ve got to keep your eye on the long term. When I came to – I’ve been an economist, a Ph.D. in what, ’81? I went to the Sterns School, NYU Sterns School, in 1990. And what you see is the flavor of the month, so I think you’ve got to focus on the long term.

So the flavor of the month – and it’s always the U.S. is in trouble – so in 1990 it was the U.S. is in trouble, we’re going to be bypassed by Japan shortly. I would say, well, fine, that would be great for Japan. Now, it turned out that it wasn’t the case. So the U.S. economy, I just think has been – traditionally has been extremely resilient. Lots of things have happened to change it. The composition is wildly different than it was 50 years ago or 150 years ago, but it still keeps moving. And I think the reason is we’ve provided – as crazy as politics is, by and large, we’ve provided an environment in which people can succeed – not all of them, and there’s a fair amount of risk. In some ways, I’m kind of astonished. In New York, you can be fired for any reason – at will, I guess they call it – so I could just say, okay, I don’t need you.

And the bad news is, it creates a fair amount of stress at the individual level, but it also creates a tremendous amount of efficiency for the economy as a whole. And what we find when we study that is that countries where it’s easy to lose your job like that are also countries where it’s very easy to find another one. So one of the issues that comes up in Spain, in Portugal, in a lot of other countries, is the labor market is simply not that flexible. And that means if you have to make a transition – so in Spain, you had a very large housing construction sector, so that’s unlikely to come back in that magnitude, so you’ve got to take a bunch of those people and somehow they have to be channeled into other businesses. And I think there’s a question whether the Spanish institutions are as flexible as they have to be to accomplish that. So that’s the overarching theme. It’s – I don’t think of it as free market, so there’s a lot of people who talk about free markets. The more you study markets, the more you realize you need a solid government infrastructure to facilitate these things. So that’s the trick, kind of getting the government infrastructure in place but then letting the rest of the economy go after that.

MODERATOR: Thank you.

MR. BACKUS: Thanks very much. By the way, if you have kids, friends who want to go to graduate school, undergraduate, NYU. Okay? Keep us in mind.

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