Felix Salmon

Ezra Klein has a good summary of the latest CBO budget projections, which show that the national debt really isn’t going to be a problem at any point in the foreseeable future. The deficit isn’t going away, of course: the smallest it’s likely to get, according to the CBO, is $378 billion, or 2.1% of GDP, in 2015. But that’s entirely manageable, and puts the national debt-to-GDP ratio on a pretty flat trajectory over the medium term.

Of course, in the real world, none of this is actually going to happen as forecast. It’s hard enough to forecast what’s going to happen in 2013, let alone what’s going to happen in 2023: the CBO projection for this year’s deficit has fallen from $845 billion to $642 billion just in the past three months, so it’s worth taking all future forecasts with a large pinch of salt — especially since the one thing that’s certain is that there will be substantial changes to US fiscal policy between now and 2023.

This chart contrasts quite dramatically with the bipartisan consensus that America’s national debt — and especially the way that it is built up by the entitlement programs of Medicare, Medicaid, and Social Security — are serious problems. As Paul Krugman explains wonderfully in his latest essay for the NYRB, America’s social safety net was actually a key channel through which countercyclical government stimulus entered the economy in the wake of the financial crisis. And given how difficult it is to legislate expansionary fiscal policy on the fly, there’s a strong purely economic case for keeping such programs.

With any luck, then, this chart will help us to stop bellyaching about the debt, and create a bit of space where we can try to work out how to really get the debt-to-GDP ratio down over the long term, by concentrating on increasing the denominator rather than decreasing the numerator. But don’t hold your breath. Even the CBO takes pains to warn of debt problems in the future, saying that a debt-to-GDP ratio around 75% “would have serious negative consequences” in terms of interest expenses, lower wages, and worse:

A large debt increases the risk of a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.

In the USA, this risk is de minimis, barely even worth mentioning: not only do we print our own currency, but in general US government bonds are universally considered the safest assets on the planet. So what’s the CBO playing at, here?

Krugman has a fascinating explanation for what might be going on:

Pre-Keynesian business cycle theorists loved to dwell on the lurid excesses that take place in good times, while having relatively little to say about exactly why these give rise to bad times or what you should do when they do. Keynes reversed this priority; almost all his focus was on how economies stay depressed, and what can be done to make them less depressed.

I’d argue that Keynes was overwhelmingly right in his approach, but there’s no question that it’s an approach many people find deeply unsatisfying as an emotional matter. And so we shouldn’t find it surprising that many popular interpretations of our current troubles return, whether the authors know it or not, to the instinctive, pre-Keynesian style of dwelling on the excesses of the boom rather than on the failures of the slump.

My opinion is that it’s even simpler than that. Krugman naturally sees macroeconomic problems in terms of cycles: there are booms and busts, and there are emotional reasons why economists prefer to concentrate on the problems with booms, and apply the solutions to those problems (spend less money) even during busts where they are contraindicated.

But I think the general view of the public, and of our mainstream elected representatives, is even simpler. These people aren’t economists, and don’t think in terms of cycles; they certainly can’t clearly articulate the difference between a financial crisis and a fiscal crisis. Everything just reduces to “we spent too much, we should spend less”, which makes intuitive sense: the biggest problem with Keynes is that, just like Ricardo, a lot of what he discovered is deeply counterintuitive.

In which case, Krugman’s cyclical arguments are not going to carry the day politically: it’s hard to explain that the right thing to do changes according to various measures of resource utilization. Instead, it might be best, on a tactical political level, just to point at the CBO’s debt-to-GDP chart and say look, we’ve solved this problem now. Even if the CBO wouldn’t really agree with that interpretation.

Today’s jobs report was a solid one, and shows that the recovery, while not exactly strong, is at least not slowing down: Neil Irwin calls it “amazingly consistent”. Whether you look at the past 1 month, 12 months, 24 months, or 36 months, you’ll see the same thing: average payrolls growth of roughly 170,000 jobs per month. That’s not enough to bring unemployment down very quickly, given the natural growth in the workforce. But unemployment is coming down slowly. And at the rate we’re going, at some point in the second half of 2014 we should see total payrolls reach their pre-crisis levels, and the headline unemployment rate hit the key 6.5% level.

There’s a real human cost to the fact that unemployment is coming down so slowly, but there are lots of reasons why it’s very hard to bring it down more quickly. First and foremost, of course, is the fact that US GDP growth is mediocre, coming in at less than 2% per year over the past few years. That’s not the kind of V-shaped recovery which creates jobs. Calculated Risk’s justly-famous jobs chart shows just how bad the recession was for employment, and just how painfully slowly we’re scratching our way back: we’re more than five years into this jobs recession, and we’re still at the worst levels seen in the wake of the dot-com bust.

One of the reasons is the undisputed conclusion of Reinhart and Rogoff: that recoveries from financial crises are much slower than recoveries from other crises. But there’s something bigger going on, too, which Joe Stiglitz writes about today in a very wonky blog post for the IMF.

This is more than just a balance sheet crisis. There is a deeper cause: The United States and Europe are going through a structural transformation. There is a structural transformation associated with the move from manufacturing to a service sector economy. Additionally, changing comparative advantages requires massive adjustments in the structure of the North Atlantic countries.

To put it another way: what looks like a broad economic recovery is actually a combination of many trends, including the end of what turned out to be a very short and weak recovery in manufacturing employment. Here’s Irwin:

The fact that the overall job growth numbers have been extraordinarily stable does not mean there isn’t some real churn going on in the U.S. workforce. In the earliest phase of the recovery, manufacturing jobs was a major driver of job creation, but that turned out to be not a longer-term trend but a partial reversal of the steep declines of the recession. Now, job creation is entirely confined to the services sector: Manufacturing had no net change in employment, construction lost 6,000 jobs, and even mining and logging was a net negative.

Government employment, meanwhile, continued its long swoon… That leaves one sector to drive the train of job creation: private sector services. This particular month, there were strong gains in leisure and hospitality, retail jobs, and professional and business services, and health care has been a mainstay of the expansion.

Stiglitz makes the case that in a recovery with so many moving parts, the single blunt instrument of setting short-term interest rates at the Fed will never be enough, and that “there needs to be close coordination between monetary and fiscal policy.”

What’s more, as Mohamed El-Erian says, policymakers should ideally be able to use job growth not just as a goal, but also as a tool for achieving other ends.

Robust employment growth would – and, let us hope, will – play a critical role in helping the US pivot to a better place… It would do this by maintaining consumption and allowing for a more sustainable savings rate; by countering an excessive upfront fall in public spending that increases the risk of a recession; by enabling the Fed to slowly and gradually normalise monetary policy before it breaks too many things; and by reducing the risk of financial bubbles.

The US economy is a highly complex machine, with many moving parts which ought to be working with each other rather than against each other. Stiglitz makes a strong case that the financial sector broadly is right now part of the problem rather than part of the solution: it’s not directing funding to help the economy grow and create jobs, even as it continues to represent a serious systemic risk. It should go without saying at this point that fiscal policy broadly is part of the problem as well: you don’t create jobs by firing people, and the government should be borrowing if and when the private sector won’t. And as for monetary policy — well, it’s probably too early to tell. It’s done a great job of making people with money richer, but it has had a much less obvious effect on creating jobs for those who want them and don’t have them.

And yet there’s real room for optimism in today’s jobs report. Look at the revised numbers for February: an incredibly heartening 332,000 jobs created, in one short month. Look at the number of people unemployed for 27 weeks or more: that unhappy cohort shrank by 5.6% in April alone, to 4.3 million people. It’s still far too high, but this time last year it was over 5 million, so we’re making a significant dent in what has been the toughest nut to crack.

We can — and should, and could, and must — do better than this. But doing so will require a thaw in the Washington gridlock. When Jack Lew became Treasury secretary, it was understood that the most crucial thing he could deliver would be greater cooperation between the White House, Treasury, and Capitol Hill. That hasn’t happened yet. I hope and trust that he’s been working very hard behind the scenes to make it happen — partly because he doesn’t seem to have achieved anything else, but mainly because it’s by far the most important thing that he could be doing right now. Behind the jobs numbers there are some powerful forces driving real recovery in large parts of the US economy. It’s Lew’s job to work with Congress to identify those forces, and to give them all the support the government can muster.

This chart comes from Arindrajit Dube, who has a fantastic post chez Rortybomb on whether high debt causes lower growth or whether it’s the other way around. What you’re looking at is the famous Reinhart-Rogoff dataset, as made available by their critics (and Dube’s colleagues), Herndon, Ash and Pollin. Reinhart and Rogoff are the poster children for the statement that high debt loads cause lower growth, especially once those debt loads exceed 90%. But do they?

There does seem to be an inverse correlation between debt and growth, but Dube shows that the correlation is strongest at low levels of debt, below 30% of GDP, rather than at high levels of debt. Countries with debt of 30% of GDP have a significantly lower growth rate, on average, than countries with debt of 10% of GDP, while the numbers at debt ratios above 90% have much wider error bars and are much less useful.

But let’s grand the correlation, for the sake of argument: the next question is whether the correlation implies causation, and if so, which way the causation flows. Here’s Dube:

Here is a simple question: does a high debt-to-GDP ratio better predict future growth rates, or past ones? If the former is true, it would be consistent with the argument that higher debt levels cause growth to fall. On the other hand, if higher debt “predicts” past growth, that is a signature of reverse causality.

That’s what you’re seeing in the charts. Both of them have the same axes: GDP growth on the y-axis, and debt/GDP on the x-axis. Both of them plot the correlations in the dataset, with the dark line being the signal and the dotted lines showing the 95% confidence interval. And just as in the main dataset, the correlations are much clearer at low levels of debt/GDP than they are at higher levels.

But the two charts are different, all the same, especially at levels of debt/GDP above that 90% level. If you look at the left-hand chart, it shows that it really doesn’t matter how much debt you have: you’re likely to average about 3% GDP growth a year over the next three years. On the other hand, if you look at the right-hand chart, it shows that the more debt you have, you’re significantly more likely to have experienced low growth in the past three years.

In other words, the causation here seems about as clear as causal analysis can ever be: low growth causes high debt, rather than high debt causing low growth. Indeed, once you get past 90% of GDP, your debt load doesn’t seem to have any significant effect on future growth at all!

Never mind Sachs vs Krugman: by far the most interesting and important fiscal-policy debate right now is Cameron vs Wolf.

David Cameron, of course, is the prime minister of the UK, and last week he gave a rambling 4,000-word speech on the national economy which is almost impossible to read. For some reason the speech appears online in what you might call teleprompter format, with a single sentence sometimes spanning three separate paragraphs. It’s a clear indication that Cameron is more interested in rhetoric than he is in substance.

Meanwhile, Martin Wolf, who for many years has been the most respected and important economic commentator in Europe, has in recent weeks become much more accessible. Check out his column on bankers’ bonuses, for instance: it’s a smart and rollicking read, arguing persuasively that the UK government is being idiotic in its opposition to European bonus caps.

Wolf’s immediate response to Cameron was solid, but his second go-round is just devastating: we’re now officially in a world where the wonkiest columnist in the driest newspaper in Britain is stating his case far more simply and clearly than the populist PR man turned prime minister:

Mr Cameron argues that those who think the government can borrow more “think there’s some magic money tree. Well, let me tell you a plain truth: there isn’t.” This is quite wrong. First, there is a money tree, called the Bank of England, which has created £375bn to finance its asset purchases. Second, like other solvent institutions, governments can borrow.

Wolf’s main point is simple: in an economy which might already be in a triple-dip recession, deficits are caused by economic sluggishness. That’s what forces up government spending while reducing government revenues. Everything comes back to growth: the UK credit rating, the size of the deficit, and, most simply, nominal GDP, which is now 13.6% lower than the government officially forecast it would be back in 2008.

What’s more, government spending comprises a much larger share of GDP in the UK than it does in the US, which means that spending cuts can easily directly cause recessions. And deficits always go up, rather than down, in recessions:

The prime minister also stated: “[Labour] think that by borrowing more they would miraculously end up borrowing less … Yes, it really is as incredible as that.” What truly is incredible is that Mr Cameron cannot understand that, if an entity that spends close to half of gross domestic product retrenches as the private sector is also retrenching, the decline in overall output may be so large that its finances end up worse than when it started. Bradford DeLong of Berkeley and Larry Summers, the former US Treasury secretary, have shown that, in a depressed economy, what Mr Cameron deems incredible is likely to be true.

Cameron’s speech is basically the horrible personal-finance metaphor writ large: he’s trying to persuade people that solutions which make sense on a household-budgeting level can scale up to the national-accounts level. He’s obviously never heard of the paradox of thrift.

In fact, the speech is even more confused than that. At the beginning of the speech, Cameron attacks the policies of politicians who thought “that we had ended boom and bust”. Obviously, we haven’t. But then he makes no attempt at all to explain what government policy should be during boom years, and how that policy should differ during recessions. And finally he gets into the thicket of monetary policy, explaining that he essentially needs to abolish boom and bust himself, else none of his policies are going to work.

Cameron boasts in the speech that “it is now possible to buy a new home anywhere in the country with only a 5% deposit, and at very low interest rates,” and worries that “even just a 1 per cent rise in mortgage interest rates would cost the average family £1,000 in extra debt service payments”. He then says (the ellipses are his, not mine):

It is hard to overstate the fundamental importance of low interest rates for an economy as indebted as ours…

…and the unthinkable damage that a sharp rise in interest rates would do.

When you’ve got a mountain of private sector debt, built up during the boom…

…low interest rates mean indebted businesses and families don’t have to spend every spare pound just paying their interest bills.

In this way, low interest rates mean more money to spare to invest for the future.

A sharp rise in interest rates – as has happened in other countries which lost the world’s confidence – would put all this at risk…

…with more businesses going bust and more families losing their homes.

In other words, Cameron is placing all his chips on permanently low interest rates, which are the one thing he can’t control. And at the same time, he’s pursuing a contractionary fiscal policy, which is the main thing he can control. Here’s Wolf, explaining elegantly just how confused the prime minister’s thinking is:

As the prime minister himself notes, “we had over-indebted households borrowing from over-indebted banks”. So why does he expect monetary policy to achieve much? He evidently thinks people should borrow less…

Today, even more aggressive monetary policy is quite likely to be ineffective, even counterproductive, to the extent that it slows desirable deleveraging. It is likely that direct monetary financing of even larger fiscal deficits would be more effective and less damaging than using even looser monetary policy to prod the private sector into life.

This is the political mess that Mark Carney is inheriting as he takes over the Bank of England. The prime minister is betting everything on low interest rates and on loose monetary policy, while using fiscal policy to make Carney’s job as difficult as possible.

The UK is in a very tough economic spot right now, and it needs coordinated fiscal and monetary policy to get itself growing again. But the leader of the Conservatives seems to relish the idea of doing nothing at all on the fiscal side, while the leader of the Bank of England only took the job after deciding that he wouldn’t run for leader of the left-wing Liberal party in Canada. The chances of these two working effectively together seem slim indeed — and as a result, the future’s looking pretty bleak for Britain.

Update: Wolf’s colleague Chris Giles pushes back.

The main lesson I’ve learned from the sequester fustercluck, and from the failure of austerity programs in Europe, is that you can steer yourself very, very wrong indeed if you try to find fiscal solutions to fiscal problems.

The two phenomena are different: the stated aim of the sequester was to focus attention on long-term fiscal problems, while European austerity is generally targeted much more at the short term. But both resulted in the same thing: governments cutting their spending and hurting growth, when growth is the only real solution to the problem at hand.

In Europe, the key short-term problem is unemployment; in the US, the long-term problem is America’s ability to pay its scarily-rising healthcare costs. In neither case do government budget cuts do anything whatsoever to address the problem; instead, they exacerbate it.

Unemployment is the more obvious case: if the government lays off thousands of workers, and stops injecting money into the economy through other channels, that’s never going to help people find work in the short term. But the case against a fiscal solution to the healthcare-cost problem is also a pretty simple one. Here’s John Carney:

The main challenge we face on entitlements is not financial — it’s demographic. It’s not really even a question of “entitlements” at all. The challenge is just whether the economy in the future will be productive enough to produce all the medical care, food, and shelter required by the elderly when there are fewer people actually working. How we pay for this is secondary matter.

To put it differently, no matter what budget reforms we enact, we have a long-term care problem — not a long-term deficit problem. Even if we dramatically cut down on the long-term deficit by slashing entitlement spending, so that any care in excess of that has to be funded privately, we’ll still face the same challenge.

That challenge cannot really be solved through budgets. No matter how much we tax now, no matter how much we save now, in the future the economy will be limited to what it is able to produce. The challenge is to set that limit as high as possible, so there is as much as possible for the young and the old to divide it among themselves.

Put aside, for one minute, the question of whether marginal discretionary government spending is good or bad for economic growth; the point here is that the problem of healthcare costs isn’t fiscal. Indeed, it’s easy to go even further than that, and to say that the more money the government spends on healthcare, the smaller that the problem of healthcare costs becomes. After all, everywhere in the world, including in the US, the government gets by far the best price in the market when it spends money on healthcare. If you switch healthcare expenditures from the public sector to the private sector, all you do is make them more expensive.

And as Joe Weisenthal points out, quoting Richard Koo, the more that a government worries about long-term fiscal balance, the less effective it becomes in attempting to stimulate the economy to provide the kind of growth that everybody wants to maximize. Just look across the Pacific, says Koo: Japan has never once met its fiscal targets in the past 20 years, precisely because it has been consistently far too worried about meeting its medium-term fiscal targets.

The solution to all these problems has to be to maximize the number of people with jobs; to maximize the amount of money those jobs pay; and to maximize the number of years that people are earning money in those jobs. Eduardo Porter, today, makes the case for raising the retirement age, which of course would reduce the increase in Social Security costs. But he also makes the point that if people stay in well-paying jobs for longer, that benefits the entire economy — which in turn will improve our ability to provide America’s seniors with the healthcare they deserve.

Meanwhile, the rhetoric of the sequester is making everybody look in exactly the wrong place for solutions to America’s long-term fiscal problems. The amount that the government spends on national parks, or on FBI salaries, or even on mine-resistant, ambush-protected Army vehicles, is of course irrelevant to the question of how to create an economy which can afford medical care for all over the long term. But it also creates a framing problem — making it seem as though government expenditures are the nail, and that therefore budget cuts are the necessary hammer. Even as, all the while, the deep and real problems become that much more structural, embedded, and intractable.

Japan’s economy has been far too stagnant for far too long: everybody can agree on that. The aging population, now used to deflation, prefers saving to spending — an entirely reasonable stance if prices will be lower tomorrow than they are today. So the government has long been facing a very tough task: to change the psychology of a nation, basically. You can’t do that — as Japan learned the hard way — with old-fashioned public-works spending. Instead, you have to target expectations.

The Bank of Japan started on this road last month, formally adopting a 2% inflation target. That was the BoJ’s way of saying “start spending now, because your yen won’t be worth as much tomorrow as they are today”. And now the finance minister is doing his part to get the party started as well, in a highly unorthodox manner. In a speech on Saturday, he said that he wants to see the Japanese stock market rise 17% to 13,000 by the end of March.

It was a national holiday in Japan today, so the stock market was closed, but we’ll see tomorrow what effect Amari-san’s words will have: my guess is that they’ll give the market a pretty impressive boost. That’s certainly the intention. The Japanese stock market has been on fire of late, rising more than 30% since mid-November. The clear risk is that the rally will lose steam, and that people will start taking profits; the finance minister, with his speech, is basically trying to extend the rally as much as possible.

There’s no particular reason why the Nikkei shouldn’t continue to rise through the end of March, even reaching 13,000. Momentum is a powerful force, in the stock market, which is why central banks know that FX intervention is much more likely to work if you’re acting broadly with the market rather than broadly against it. Amari’s announcement is a canny way of anchoring expectations: the Nikkei might reach 13,000, or it might not, but for the next few weeks at least the perennial stock-market question is going to be reframed. Rather than “how far are we from where we closed yesterday”, it’s going to be “how far are we from 13,000″. The idea is that with stocks, just like with cars, you generally drive in the direction you’re looking.

I like this move: it shows imagination, and the upside is much bigger than the downside. The worst that can happen is that it doesn’t work, and the stock market ends up doing what the stock market would have done anyway; the best that can happen is that it helps accelerate the broad recovery that everybody in Japan is hoping for this year.

What’s more, Amari is not the first policymaker to talk about targeting asset prices. Minneapolis Fed president Narayana Kocherlakota, for instance, said quite clearly in 2011 that stock prices “are really going to be a central ingredient in the recovery process”, adding:

In this kind of post financial crisis, post net worth driven recession, it makes sense to be thinking about asset value as a way to try to generate more stimulus than you do in a typical recession.

In other words, don’t look to government spending for stimulus: Japan, of course, has learned that lesson the hard way. Instead, simply goose the stock market instead.

There are risks to this approach: if it works too well, you create a bubble — and when a bubble bursts, that can hurt confidence much more than a rising stock market helped it. But for the time being, the Japanese stock market still looks cheap, both on an absolute basis and in terms of its p/e ratio. Now’s no time to worry about overheating. Instead, Japan’s fiscal and monetary policymakers are working together to try to make the country as bullish and successful as possible. I’d do the same thing, if I were them.

(h/t BI)

As Cardiff Garcia says, when it comes to #mintthecoin, “it’s important for advocates to define carefully what they’re actually calling for”. The basic matrix, as I see it, looks a bit like this:

I’m in the bottom-left corner: Negotiate. That’s the job of the President of the United States: to negotiate with Congress, rather than to do tricksy, Constitutionally-dubious end-runs around it. Joe Weisenthal, to his credit, is also clear where he stands — he’s in the bottom-right corner. He doesn’t advocate using the threat of minting the coin as a negotiating tool; rather, he’s advocating that negotiations should happen as normal, and only in the very last resort, if all negotiations fail, should the coin be deposited at the Federal Reserve so as to avoid a catastrophic default.

One problem is that it’s very hard to keep the existence of the coin secret, especially if the executive-branch negotiators, who are going to be spending a lot of time with the representatives of House Republicans, know that they have it in their metaphorical back pocket. Basically, the existence of  a secret plan to mint a coin is functionally equivalent to a public threat to mint the coin, if the House Republicans find out about the secret plan. In that event, the Negotiate strategy becomes the Bluff strategy. And as Cardiff says, the Bluff strategy is really stupid:

For the Republicans, having Obama threaten to use the coin might be wonderful news because then they could force him to actually use it. By this reasoning, not only will the worst-case scenario of default be avoided, but they could then look forward to screaming “Dictator!” while accusing him of having used a legally questionable tactic (or at least of going against the intent of the law) and of running an end-around on the balance of powers (and actually they’d be right about this).

This argument would be ludicrously hypocritical, but unfortunately it would also play better publicly than the hypothetical White House defence. Which would probably sound something like this: “The Republicans backed me into a corner again, and despite my being the president who said that we should all put aside childish things, I ordered a shiny coin and called it a trillion dollars, which I’m allowed to do because of a poorly written amendment to a law that was undeniably meant for something else.” Not exactly a winning case.

The Open Defiance strategy — let’s just print the coin anyway, and thereby stop the House Republicans from using the threat of default as a negotiating tactic — looks pretty silly too, because you’re basically using a sledgehammer to crack what might ultimately be a pretty thin nut. At this point, it’s worth moving out of the econowonkosphere and into the even weirder world of Republican politics. Once we get there, we learn from the likes of Greg Sargent and Kim Strassel that the Republicans aren’t nearly as coherent on this issue as they were in 2011, and that, in Strassel’s words, there’s a good chance that “Round Two is already Mr. Obama’s”.

The grown-up Negotiate strategy, it turns out, actually has an incredibly high chance of success, while any other strategy risks creating massive political chaos. (I can easily, for example, see the Republican party refusing to support any nominee at all for key positions like Defense and Treasury and State, if Obama goes all scorched-earth with a Coin strategy.)

The Negotiate strategy is far from ideal, of course. Since the debt ceiling has been and will be reached many, many times, even something with a very high chance of success is statistically certain to fail eventually. So the obvious best-case scenario is to abolish the debt ceiling entirely, or, failing that, to raise it to, say, a few quadrillion dollars. But right now, when we’ve already reached the debt ceiling, is probably not the best time to try to negotiate such a thing. (In fact, any time there’s a Democrat in the White House is probably not the best time to try to negotiate such a thing.) For the time being, the executive branch should do what the executive branch has always done when the debt ceiling looms, which is to persuade Congress to raise it.

It’s worth adding a meta-media note here, too. The #mintthecoin meme has successfully migrated from the outer reaches of the econoblogosphere into a fair amount of mainstream media coverage, and as a result it has actually started to be taken seriously outside the Beltway. And even, in a few cases, inside the Beltway too. But be clear, this is absolutely a media-driven meme: people talking about it are not talking about an actual political proposal which an important number of serious DC politicians genuinely want to implement. As I say, it’s a Flying Spaghetti Monster thing — it’s a ticklish thought experiment, nothing more. Many media organizations are having a lot of fun with it, and that’s their right. But, especially in this case, it’s important not to mistake media coverage for reality.

Happy fiscal cliff day! The fiscal prognosis is, amazingly, probably fuzzier today than it has been in weeks: the only thing that seems certain is that no one has a clue what’s going to happen, especially in the House. But amidst the chaos of the intraday news chase, I think two broader stories have failed to get the attention they deserve.

The first is that we have now officially reached the debt ceiling. Naively, I had assumed that any fiscal-cliff deal would automatically include raising the debt ceiling — after all, after going through the present legislative nightmare, who’s going to have any appetite for another one immediately afterwards? And yet, astonishingly, it seems as though even if the fiscal cliff does manage to get averted, the debt ceiling will remain in place, and raising it will require its own separate legislation.

The second broad narrative is the slow death of the Grand Bargain. If and when we do get some kind of fiscal cliff deal, it will be a patched-together hodgepodge of policies designed with exactly one goal in mind: finding a piece of legislation which is capable of getting, somehow, through Congress. It will not be a shiny new tax code which radically rethinks US fiscal policy to put us on a healthy long-term footing: instead we’ll just get something better than the fiscal-cliff alternative of doing nothing at all.

So if you were hoping that the cliff might finally give us the opportunity for a deep rethink of something like the mortgage-interest tax deduction, or even tax expenditures more generally, think again. And other reforms are similarly not going to happen. For instance, Bob Pozen and Lucas Goodman have a sensible idea: pay for a reduction in the corporate income tax rate by allowing corporations to deduct only 65% of their interest expenses.

It’s fun to look at Pozen’s idea side-by-side with that of Cromwell Coulson: Coulson proposes that we tax dividends at the same rate that we tax income, but that we also allow all dividends to be tax-deductible to corporations.

The point in both cases is that both dividends and interest payments are ways of returning capital to people who funded the company, but debt is more systemically dangerous than equity is. So why structure the tax code to make debt more attractive than equity?

This was exactly the kind of debate that the fiscal cliff was supposed to engender: after many years of a “permanent temporary tax code”, we’d finally be forced to implement the kind of profound fiscal revamp that all politicians agree is needed.

And yet, we have failed. The solution to the fiscal cliff will be just as tenuous and temporary as anything which went before it, and will include nothing radically new. The legislative process in the US makes all fiscal policy extremely path-dependent, and the degree of dysfunction in Congress makes any path at all extremely rocky and tenuous. No matter how attractive the final destination, the further away it is, the more likely it is that you simply can’t get there from here.

The result is complete idiocy like running up against the debt ceiling, or raising taxes on pretty much every income-earning American, despite the fact that nobody wants either thing to happen.

If you look at legislatures around the world over the past five years or so, they have all — consistently — proved either reluctant or incapable of making big fiscal decisions when necessary: this is one reason why central bankers have become so incredibly important to the world economy. I don’t know if this is some kind of bug which is found in mature democracies, but the problem is real, and it’s global. And I suspect that even if it doesn’t cause another recession in the US, it’s ultimately going to shave many trillions of dollars off global GDP in the years to come.

James Stewart has a long attack this weekend on the one idea from the presidential campaign which managed to receive genuine bipartisan support: the cap on deductions. He’s a first-rate reporter and columnist, so it’s worth going into some detail about all the different places he’s wrong.

Stewart starts off his column by summing up his two main arguments against a cap on deductions:

Without addressing larger tax preferences, like a lower rate on capital gains, it does almost nothing to cure the so-called Buffett problem, in which Warren Buffett’s secretary pays a higher effective rate than her billionaire boss. It doesn’t even raise much revenue.

Saying that a cap on deductions doesn’t cure the Buffett problem is a bit like saying that some random bit of Dodd-Frank doesn’t solve too-big-to-fail, or wouldn’t have prevented the 2008 financial crisis. It’s true, but it’s irrelevant. You can’t approach the current fiscal negotiations with the idea that solving the Buffett problem is a necessary precondition for any fiscal-policy tweak: you’d never get anywhere if you did. The task right now is to come to an agreement on a set of policies which will raise revenues and cut expenditures; a cap on deductions does exactly that. And what’s more, while it won’t mean Warren Buffett paying a higher tax rate than his secretary, it will at least reduce the distance between them.

As for the idea that a cap on deductions “doesn’t even raise much revenue” — well, that’s in the eye of the beholder. The dog not barking here is that Stewart never actually comes out and say how much money a cap on deductions would raise. Here are the numbers, from the Tax Policy Center: a cap at $50,000 would raise more than $700 billion over ten years, while a cap at $25,000 would raise some $1.2 trillion. That’s real money. Even if you exempt charitable donations from the cap, you’re still raising almost $500 billion at the $50,000 level, and more than $800 billion with a $25,000 cap.

Stewart is at least honest about the main reason he opposes this cap:

It would hit people like me: taxpayers in higher brackets who rely on earned income as opposed to investment income or an inheritance, who give to charity and live in a high-tax state. Assuming a $35,000 limit on itemized deductions, my federal tax last year would have risen to 27 percent of my adjusted gross income, from 22 percent.

Stewart talks about his own personal tax rate a lot in his column; he must think it’s of great interest to the rest of us. Interestingly, he always talks about his tax rate as a percentage of his adjusted gross income, which is surely a lot higher than his tax rate as a percentage of the total amount of money he makes every year. (As a self-employed professional, Stewart can take a large number of expenses, including housing expenses, and deduct them from his income before calculating any tax at all.)

Stewart’s point is absolutely correct, as far as it goes. The three major deductions are state and local taxes; mortgage interest payments; and charitable contributions. So people who spend a lot of money on those three things every year — people like Stewart — are going to be precisely the people who are most hit by a cap on deductions.

At the same time, however, Stewart is rich, and everybody knows that the rich are going to have to pay more in taxes, one way or another. Indeed, Stewart says he’s OK with that: he claims that he “wouldn’t mind paying more” in taxes, just so long as the top 400 taxpayers in the country all paid more in taxes as well.

But here’s the thing — they would! According to Stewart’s own calculations, the taxable income of the top 400 taxpayers would rise by $32 million, on average, while their overall tax rate could go up to 25% from 20%. Seems like a big hike to me. But because that 25% is lower than Stewart’s own 27%, he’s decided that we’d be better off not capping deductions at all.

This is profoundly myopic. I can see how on a philosophical level it makes sense to ask the top 400 taxpayers in the country to pay a higher tax rate than James Stewart. But the top 400 taxpayers are, by definition, a highly exceptional bunch, who spend millions of dollars a year on tax-avoidance strategies. It might or might not be possible to construct a tax regime which makes the top 0.0001% pay a higher tax rate than James Stewart, but I really don’t think that failure to do is reason to do nothing at all.

Maybe realizing that he’s on to a losing argument here, Stewart shifts course at this point, describing the deduction cap as “a stake aimed at the heart of the charitable deduction”. And once again, the dog doesn’t bark: he quotes lots of people who work in the non-profit sector, saying that this move would reduce the amount of money that people give to charity. But not once does he hazard a guess at the amount by which charitable giving might decline; indeed, he quotes Patrick Rooney, of the Center on Philanthropy at Indiana University, as saying that he hasn’t studied that question.

Rooney has studied similar questions, however. For instance, his institute looked at the effect of capping the deduction at 28%, even for taxpayers with a higher marginal tax rate. That tweak would reduce charitable giving by some $2 billion per year, they found — but it would raise ten times that amount in new tax revenues.

And when the CBO recently looked at various different ways of changing the charitable tax deduction, they came to much the same conclusion:

In each case that CBO examined, the reduction in the subsidy (and thus the increase in revenues) would exceed the reduction in charitable contributions, whether measured in dollars or as a percentage change.

If there’s one constant when it comes to the charitable deduction, it’s this: its opponents love to get quantitative, while its defenders generally refuse to talk numbers at all. For instance, check out Bob Shiller’s column this weekend: despite the fact that he’s a fine economist, he never once talks costs and benefits, instead relying on general principles such as the one saying that “income that is freely given away should not even be considered as taxable income”. And then compare Dick Thaler, or any of the many other critics of the charitable deduction: they ground their arguments in reality, rather than in the clouds.

So when Stewart starts saying that capping deductions will hurt the poor, on the grounds that the poor go to hospitals and museums, and those hospitals and museums are reliant on charitable donations — well, take it all with a pinch of salt. And move on to Stewart’s next argument, which revolves around the deductibility of state and local taxes:

According to the Census Bureau, state taxes per capita in 2011 ranged from $3,491 in New York to $1,674 in South Dakota. For many higher-income taxpayers in high-tax states, state and local taxes alone would exceed the cap limit, completely depriving them of the mortgage and charitable deductions.

This is an interesting use of the word “many”. If the cap was put at $25,000, that would be more than seven times the average state taxes in the state with the highest taxes in the union. If the cap was at $35,000, it would be more than ten times New York’s average state taxes. So yes, if you pay ten times the average amount of taxes in your state, and if you live in New York, then you might use up all of your cap with state taxes alone. You’ll excuse me if my heart doesn’t bleed.

Stewart concludes by reiterating that he would rather see other people pay more in taxes, rather than himself — especially people who rely less on income and more on capital gains. I’m inclined to agree with him, on a policy level: I too would like to see unearned income taxed at the same rate as earned income. But the fact is that all the big deductions — charitable, mortgage-interest, even state and local taxes — are bad public policy. We should cap them, at a high level if necessary, and then bring down the cap over time, until it reaches zero. That, in turn, will help income tax rates to converge on capital-gains tax rates, again over time. Few things in fiscal policy happen overnight. But capping deductions is a step in the right direction. And Stewart should embrace that, rather than fighting it.

This is the US unemployment rate, from Calculated Risk. Today’s jobs report was a very positive one: not only did job creation exceed all expectations, but unemployment fell too, to 7.7%. For the first time, the unemployment rate is lower than it was when Barack Obama took office, in January 2009.

The employment recovery is now 33 months old, and as strong as it’s ever been. We’re still a long way from achieving pre-recession levels of employment, but the fact is that it’s hard to maintain a sense of crisis and emergency for this much time: if you live with anything for more than a couple of years it becomes normal. (Which is one reason why Europe, which has a structurally much higher unemployment rate than the US, doesn’t consider itself to be in a permanent jobs crisis.)

The levels in the employment report are still scary. 7.7% is high in absolute terms, and both the employment-to-population ratio and the labor force participation rate are much lower than they should be. America should have millions more people at work than it does, and there’s a very strong case, looking at levels alone, for further economic stimulus to help us further in the right direction.

But there’s something oxymoronic about the concept of a permanent state of emergency. And in terms of how strong the recovery feels, first derivatives are just as important as levels: if unemployment has fallen from 8.7% to 7.7% in the past year, that feels better than an economy where unemployment has risen from, say, 6.1% to 7.1%. When the temporary payroll tax cut was passed, unemployment was higher than it is now, and it was rising; clearly we’re in a much better spot now than we were then.

The best-case outcome from the fiscal negotiations now taking place between Barack Obama and John Boehner is that they move us out of the “permanent temporary” tax code and into a world where everybody knows what tax rates are and what they will be. Putting expiry dates on tax cuts is a gimmick, and while there’s a case for doing that kind of thing in the middle of a major crisis, we’re really not in the middle of a major crisis any more. It took far too long for the unemployment rate to start falling, and it has been falling far too slowly. But “unemployment should be falling faster” is not a crisis.

With any luck, then, the resolution to the fiscal-cliff debate will be a set of tax policies that both sides agree on, along with a clear date when they will be fully in force. I’m thinking January 1, 2014. The key number to look at will be total federal taxes as a percentage of GDP: it needs to be high enough to be able to run a mature modern democracy. Then, once you have a clear and permanent tax code as your primed canvas, you can start having a sensible conversation about government expenditures: where they need to come down, and which areas of the economy need some stimulus. Even if spending-related stimulus is no more effective than tax-cut-related stimulus, it’s still a better option, because it allows you to leave the tax code alone.

If Obama’s first term was about doing whatever was necessary to get us out of the biggest crisis in living memory, his second term should be dedicated to building strong and permanent foundations for the economy going forward. America’s fiscal architecture is a key part of that — indeed, it’s the key part. So if the payroll cut disappears, along with all other temporary bells and whistles, that’s fine. What’s good for the economy now will also be good for the economy next year, and the year after, and the year after that. Let’s structure any a deal so that it can work forever. And then, if there are temporary political and economic issues which need addressing, let’s tackle them through means other than the tax code.

Today’s rapturously-received news that Mark Carney, a Canadian, will be the next governor of the Bank of England reminded me of this tweet from Charles Kenny:

One day we’ll see legal discrimination by *place* of birth as evil as discrim. by other features of birth –gender, orientation, color.

— Charles Kenny (@charlesjkenny) June 25, 2011

As far as I can tell, absolutely everybody thinks that Carney is the best possible person for the Bank of England job, and that it’s an absolute triumph for UK chancellor George Osborne that he managed to persuade Carney to change his mind and accept it.

Much the same can be said of Stanley Fischer, who’s done a fantastic job running the Bank of Israel. Indeed, in general, high-profile public-sector jobs tend to be done better when they’re done by foreign nationals. The logic is simple: if you’re choosing from a global pool of candidates rather than simply a national pool of candidates, you’ll end up with a better person at the end.

Which raises the obvious question: why is such a move still unthinkable in the US? There are lots of big jobs coming up here: Treasury secretary, SEC chairman, Fed chairman — and all of them are going to go, automatically, to US nationals. Think about it this way: Mark Carney is the best central banker in the world, and he would be an amazing replacement for Ben Bernanke. What’s more, given the choice, he would surely plump for the Fed over the Bank of England. So it’s reasonable to assume that if the US wanted him, they could have had him.

In England, everybody has cheered the choice of Carney as inspired — but if the same announcement had happened in the US, there would be an immediate chorus of boos. Apparently US exceptionalism is so deeply ingrained in the national psyche that not only must everybody always believe that the US is the greatest nation on the planet, it is also necessary to believe that all the greatest people on the planet were born here too. (Except Jesus, maybe.)

It’s obvious that the leadership of the world’s most important international financial institutions — the World Bank and the IMF — should go to the best-qualified candidate, rather than whomever happens to have been chosen for the job by the US and Europe respectively. But the fact is that the same is true for the world’s most important national financial institutions as well. If England can have a Canadian central bank chief, why can’t the US pick a Brazilian? Arminio Fraga for the Fed! It would be inspired.

The fiscal debate which is just beginning in Washington is the political equivalent of trench warfare: the two sides have strongly-held positions, and the confrontations are going to be held on a thousand different fronts. In the end, there will be some tax-code changes here, some spending cuts there — but the baseline is the status quo, and the further that a plan deviates from the status quo, the less likely it is to get adopted.

Fiscal policy, in other words, is like healthcare policy: it’s path-dependent. There are lots of things that in an ideal world virtually everybody would like to see the end of; the mortgage-interest tax deduction is only the most obvious. But you can’t get there from here. What’s more, it’s incredibly difficult to get anything brand-new into the mix. I would love to see a carbon tax, and a financial-transactions tax, and a wealth tax — all of them are more attractive than an income tax, and some combination of them would be much better. But the point is that we’re not starting from scratch, which means that according to the rules of politics, we basically have to go to work only with the tools we have.

And yet, every time there’s a big problem, thinkers start coming out with big solutions. Bloomberg View, for instance, has a classic QTWTAIN headline: “Could 18th Century’s ‘Sinking Fund’ Solve Fiscal Cliff?” And at the NYT, Daniel Altman proposes this:

American household wealth totaled more than $58 trillion in 2010. A flat wealth tax of just 1.5 percent on financial assets and other wealth like housing, cars and business ownership would have been more than enough to replace all the revenue of the income, estate and gift taxes, which amounted to about $833 billion after refunds. Brackets of, say, zero percent up to $500,000 in wealth, 1 percent for wealth between $500,000 and $1 million, and 2 percent for wealth above $1 million would probably have done the trick as well.

In other words, don’t simply add a wealth tax into the mix, but abolish the heart of the tax code at the same time, and use only a wealth tax to try to replace all that lost revenue. He starts with those tax revenues, divides them into an estimate for household wealth, and presto — out the other side comes a solution to all our problems, which would slow the rise of inequality, deliver a tax cut to the majority of American families, and probably improve motherhood and apple pie at the same time.

As I say, I like the idea of a wealth tax. (My proposal: 1% of all wealth over $5 million, each year.) It would diversify the tax base, it would give the rich an incentive to take more risks with their investments, and by definition it would only be paid by people who can afford it. But administering such a thing would be a nightmare, and it’s always best to lower oneself into such waters gently. After all, the IRS has had decades to learn how people avoid income tax; it hasn’t even started to imagine all the different ways they could avoid a wealth tax.

Jill Lepore, in the latest issue of the New Yorker (although sadly not online), has an interesting history of the US tax code, explaining how the antitax tradition, which is rooted in slavery, has weirdly and yet consistently failed to really gain traction in practice. She concludes:

What’s surprising, given how much money and passion have been spent to defeat a broad-based, progressive income tax over the past century, and how poorly it has been defended, is that it has endured—testimony, perhaps, to Americans’ abiding sense of fairness.

The US tax code is already progressive. It could do with higher rates at the top end and lower marginal rates at the bottom end, but in terms of broad architecture it works pretty well — especially in the way that Americans have to pay tax on their global income. America’s fiscal problems come just from the fact that we raise too little money in taxes, rather from the fact that the taxes we do have are in any fundamental way ill-conceived.

Altman’s idea, much like Herman Cain’s 9-9-9 plan, is more than just unrealistic: it deliberately jettisons the one upside we have, which is a decades-long tradition whereby Americans pay income taxes in payment, as Oliver Wendell Holmes put it, “for civilized society”. Income taxes are easy to collect, and for most of us on payroll they’re collected automatically and largely invisibly — by the time we get our paychecks, the taxes have already been paid. We have a smoothly-functioning machine, with tax rates which can be adjusted quite easily. Adding new gears to the machine — a carbon tax, for instance — might make sense in theory, although it’s hard. But dismantling the machine entirely and rebuilding something brand new? That is a very bad idea indeed.