IMG INVESTMENT INSIGHTS U.S. DEBT & DEFICITS
IMG INVESTMENT INSIGHTS U.S. DEBT & DEFICITS Nikhil Mehra, Bill O’Neill and Chris Wolfe
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JULY 2011
U.S. debt and deficits are so large as to be both a financial problem and a political problem. Persistently higher debt and deficits will put upward pressure on long-term interest rates with potential adverse effects on consumption, business investment and economic growth. Outcomes of higher debt and deficits include: poor or negative performance from U.S. Treasuries and Corporate bonds, a weak U.S. dollar and rising market instability.
Recent Perspectives on the U.S. Debt & Deficits Since the Financial Crisis of 2008, the U.S. government has adopted numerous fiscal policies to support the domestic economy and prevent the onset of a second Great Depression. However, these policies have led to historic deficits and levels of debt. In fact, U.S. debt and deficits are approaching levels where they cease to be just a “political problem,” but also a financial one that cannot be solved simply through strong economic growth. Under a number of scenarios, a significant deterioration in the U.S. government’s fiscal position would have a negative impact on interest rates, the economy and asset markets. At the most extreme levels of sustained high deficits (120% of Gross Domestic Product (GDP) or more) over the long term, the U.S. government could experience some of the problems currently faced by Greece, Ireland and Portugal. In this paper, we examine the background of the current U.S. deficit and debt situation, and consider the potential impact of sustained high deficits on long-term interest rates, monetary policy and asset class performance. We conclude: n
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U.S. sovereign bond markets would suffer as bond yields and volatility rise; the U.S. dollar would weaken further, potentially eliciting an additional set of reactions from policy makers; U.S. Corporates would potentially face a higher cost of capital and as such, corporate bond yields would be higher and equity valuations lower; Broadly, higher financial asset volatility would weigh on asset prices globally.
While the deficit’s relationship with the economy and the markets is complicated (with pages and pages of academic literature on the subject), we believe this is one of the most important financial topics for investors today because of its relevance to portfolios and its potential impact on long-term investment plans.
Macro Economic Background The GDP of the United States is the world’s largest by a wide margin. U.S. Government bonds are sought by investors around the globe and are considered virtually risk-free, and the nation’s consumers continue to have a strong appetite for the world’s goods and services. In addition, the U.S. has the ability to print its own money to satisfy its debts. These fundamental strengths make the U.S. different from Greece, Ireland and Portugal—three developed countries whose financial woes have been in the headlines and which are unable to issue currency to satisfy their debts. Still, the U.S. and these nations share unusually high budget deficits. In the U.S., that deficit is currently running at around 10% of GDP—the highest since World War II and a danger zone into which Greece, Ireland and Portugal have all entered. As a result of the combination of high deficits and high debt relative to GDP, Greece, Ireland and Portugal have had to accept European Union bailouts and strict austerity measures that may suppress economic growth for years. While we doubt the U.S. will face that level of financial distress, we expect the debt burdens of the U.S. federal government and of most U.S. states will have a significant and lasting impact on financial markets.
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On the political front, the perils of allowing the deficit to grow ever larger and thus contribute to the total debt have become an important topic for both Republicans and Democrats, both of whom are seeking to reduce the national debt significantly over the next decade. For example, to bring the deficit back to 2% of GDP—a historically “normal” level—will mean making difficult and unpopular choices, such as raising taxes and paring back outlays for Medicare, Medicaid and Social Security—giant programs that together account for more than 45% of primary spending.
Primary Deficit
In our view, we are now at a tipping point where avoiding these decisions in the short term will create a larger problem in the future (see Exhibit 1). Most critically, demographic trends have the potential to make the future problem unmanageable. As the U.S. population ages, healthcare and Social Security spending, if current law is unchanged, is projected to increase from 10% of GDP to 16% of GDP by 20351, while overall debt as a percentage of GDP rises to 84%2.
Exhibit 2: Primary Deficit as a Percentage of U.S. GDP
According to the Congressional Budget Office (CBO), the primary deficit is forecast to be 7.9% of GDP this year and is only forecast to return to surplus in 2021 under the CBO’s baseline scenario (See Exhibit 2). The baseline scenario is calculated based on current law and includes the impact of the recent healthcare legislation as well as the expiration of the tax cuts enacted in 2001 and 2003.
90 80 70 60 50 40 30 20 10 0
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Exhibit 1: Debt as a Percentage of U.S. GDP
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Total Deficit (-) or Surplus as a % of GDP Primary Deficit (-) or Surplus as a % of GDP Debt Held by the Public / GDP (RHS)
200 200 160 160
Source: Congressional Budget Office, Federal Reserve
120 120 80 40
80 40 2011 2015 2015 2015 2019 2019 2019 2023 2023 2023 2027 2027 2027 2031 2031 2031 20352035 2035 2011 2011 Extended Scenario Extended BaseliBaseline ne Scenario
Alternative Scenario Alternative Fiscal Fiscal Scenario
Source: Congressional Budget Office, Federal Reserve
Debt Dynamics To put the current U.S. fiscal position in perspective, we examine three key ratios: the primary deficit, total deficit and total debt. The total debt is the amount of money owed by the government overall, while the total deficit is the government fiscal shortfall over a specific period of time. Most commonly, total deficit and total debt are used in the analysis of fiscal sustainability, but we believe the primary deficit should also be considered. The primary deficit is the difference between government spending and tax revenues, but unlike the total deficit, it does not take into consideration the interest payments for servicing the stock of debt. In practical terms, this means the government spends no more than it earns in each period with the only additional cost being the interest payments on the debt. The first goal for the U.S. government is to return to a primary budget balance, which is also the principal aim for Greece, Ireland and Portugal, as well as all other indebted European countries.
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However, the CBO also provides an alternate scenario, which “incorporates several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period.” Should these changes occur (e.g., higher payment rates for physicians under Medicare and extensions of the 2001 and 2003 tax cuts), the primary balance is projected to remain in deficit beyond 2021 and is forecast to be 6.6% of GDP by 2035, only marginally better than the current level. These forecasting models are very sensitive to changes to inputs. They are best used to describe scenarios for the future and should not be considered definitive.
Total Deficit Including interest servicing costs, the total deficit is expected to be only 3.1% by 2021 under the baseline scenario, a level that would still be considered manageable. The total deficit under the alternate scenario, however, is expected to be considerably worse, at 7.5% in 2021 and an alarming 15.5% by 2035, over one and a half times the current level. The reason being that with a slower rate of improvement in the primary deficit (i.e., the primary deficit remaining larger for longer), the level of total debt will rise each year, driving up total interest costs (more total debt = more total interest to pay, assuming no change in the interest rate). In addition, this analysis does not even consider the impact of higher interest rates, which we consider later in the paper. Government
After ensuring the primary deficit returns to balance, a necessary condition for medium- and long-term sustainability is to stabilize the debt-to-GDP ratio. Public debt as a percentage of GDP will be constant if the primary budget is equal to the difference between the real interest rate paid to service the existing debt and the real GDP growth rate, times the existing debt as a percentage of GDP3. The higher the gap between the real interest rate and the real growth rate of the economy, or the higher the initial size of the debt as a percentage of GDP, the higher the necessary medium-term primary budget surplus. Thus, if a country can grow at a higher real rate of GDP, assuming all else remains constant, the lower the required primary surplus. Beyond this, the speed of adjustment is a political choice. Under the baseline scenario, the CBO expects debt held by the public as a percentage of GDP will reach 76% in 10 years and will rise to 84% by 2035. However, should the expected changes to law occur, the alternate scenario projects debt as a percentage of GDP to reach 101% in 10 years and almost 200% by 20354. To ensure the public debt is not increasing as a proportion of GDP under the alternate scenario, it will require a higher primary surplus in future years, a higher real rate of growth or a lower real interest rate. To maintain a sustainable fiscal situation, it is therefore vital that the U.S. government stabilizes total debt as a percentage of GDP in the near future and at as low a level as possible. If the total debt as a percentage of GDP increases further, there would be considerable negative impacts to the economy. Two researchers, in reviewing over 200 years of analysis covering over 44 countries, found that government debt-to-GDP above 90% historically resulted in median growth rates falling by one percent and average growth rates falling by more5. The CBO has found that if debt as a percentage of GDP were to reach their projected levels under the adverse alternative scenario in 2035, real GDP could be 10% lower than under stable economic conditions of steady growth rates of output.
Impact on Interest Rates The view that higher debt and deficits lead to higher interest rates is not straightforward, but from our perspective, is clear. A great deal of academic research has sought to determine whether higher debt as a percentage of GDP and a higher deficit as a percentage of GDP will have a material impact on long-term interest rates. The challenge to answering this
A widely recognized model run by Thomas Laubach, formerly of the Federal Reserve, found that a one percentage point increase in the deficit as a percentage of GDP increases the forward longterm interest rates (five and more years into the future) by roughly 25 basis points6. Likewise, a one percentage point increase in the outstanding debt as a percentage of GDP increases long-term interest rates by roughly 3 to 4 basis points. His conclusions are especially powerful because they account for business cycle and monetary policy changes and his studies are consistent with prior empirical work7 as well as with the CBO itself, which finds that “if debt was 76% of GDP instead of its 40-year average of 37%, the interest rate in the long run, all else being equal, would be roughly 1 percentage point higher.”
The Debt Forecasts The chart below shows the CBO’s baseline scenario for debt held by the public as a percentage of GDP (see Exhibit 3). The CBO provides long-term interest rate projections, forecasting that 10-year bond yields will steadily rise from the current 3.2% to 5.4% in 2017 and remain at this level until 2021. The longterm interest rate forecasts by the CBO are used for calculating interest costs for the Federal budget in future years and do not include a risk premium from higher government debt. Under this scenario, debt as a percentage of GDP is expected to reach 76% by 2021. The chart also forecasts the projected rate for 10-year bond yields, but also incorporates a very moderate upward impact based on Laubach’s results. Exhibit 3: CBO Projected Debt a Percentage of GDP and Interest Rates* 90 90
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85 85
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80 80
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75 75 70 70
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65 65 60 60
2011 2013 2011 2013 *Baseline Scenario
2015 2015
2017 2017
2019 2019
2021 2021
1010-YEAR YEARBOND BONDYIELD YIELD
Total Debt*
question comes from the fact that the driving factor for interest rates over the long term is that usually inflation—for example, 80 years of U.S. history show a mixed relationship between the fiscal budget position and long-term interest rates. Nonetheless, economists continue to point to higher deficits as being intuitively problematic and seek to develop models to describe the relationship between investor behavior and government action.
DEBT DEBTAS AS%%OF OFGDP GDP
spending on interest payments would increase from currently 6% to over 25% of total government spending by 2035 under the alternate scenario. It is clear from these numbers that the first goal of policymakers is to move the primary balance out of deficit as soon as possible.
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Debt as as % % of of GDP GDP (Baseline (Baseline Scenario, Scenario, LHS) LHS) Debt 10-year Bond Bond Yield Yield (CBO (CBO Projection, Projection, % % RHS) RHS) 10-year 10-year Bond Bond Yield Yield (under (under Baseline Baseline Scenario, Scenario, % % RHS) RHS) 10-year
Source: Congressional Budget Office, Federal Reserve
*Total debt in the CBO example does not include “Intergovernmental transfers”. As of July 20, 2011, debt held by the public (the number used by the CBO, was $9.7 trillion or approximately 66% of U.S. GDP. Including the $4.6 trillion in intergovernmental transfers like Social Security/Medicare would raise the debt-to-GDP ratio to 98%. Most economic analyses exclude intergovernmental transfers (although the debt is still owed!) as it represents debt the government owes itself and can at any time, change the terms of the debt. 3 | G WM I N V E S T M E NT M A NAGEMENT & GUI DA NCE
Now consider the forecast under the alternate scenario, where debt as a percentage of GDP is expected to reach 101% by 2021. The chart below shows debt as a percentage of GDP forecasts and the subsequent impact on long-term interest rates (see Exhibit 4). Again, as modeled using Laubach’s analysis, the trend for interest rates under this scenario is significantly higher. Exhibit 4: CBO Projected Debt a Percentage of GDP and Interest Rates*
DEBT ASAS % OF GDP DEBT % OF GDP
100 100
6 6
90 90
5 5
80 80
4 4
70 70 60 60
2011 2013 2011 2013 *Alternate Scenario
2015 2015
2017 2017
2019 2019
2021 2021
10-10YEAR BOND YIELD YEAR BOND YIELD
7 7
110 110
3 3
Debt as % of GDP (Alternate Scenario, LHS) Debt as % of GDP Scenario, 10-year Bond Yield(Alternate (CBO Projection, %LHS) RHS) 10-year % RHS) % RHS) 10-year Bond Bond Yield Yield (CBO (underProjection, Alternate Scenario, 10-year Bond Yield (under Alternate Scenario, % RHS)
Source: Congressional Budget Office, Federal Reserve
Calculating the impact of the alternate scenario on longterm interest rates Based on Laubach’s findings and the CBO’s estimates, we calculate yields on 10-year bonds in the alternate scenario would be 96-128 basis points higher than they otherwise would be in 2021 (using the expected increase in debt as a percentage of GDP from this year to future years multiplied by 3-4 basis points per percentage point increase). Under the baseline scenario, the increase in yields due to higher debt is less severe—roughly 25 basis points by 2021. To put these numbers in perspective, the CBO forecasts 10-year yields to be 5.3% in 2016 and 5.4% in 2021. Under the baseline scenario where the debt-to-GDP ratio grows to 76%, the additional interest rate premium causes 10-year U.S. Treasury bond yields to rise to 5.7% in 2021. Under the alternate scenario, where the debt-to-GDP ratio grows to 101%, 10-year bond yields would be even higher, above 6.5% in 2021. This increase of roughly 1 percentage point in long-term yields is due to the more than 30 percentage point increase in the debt-to-GDP ratio under the alternate scenario. At that level of interest rates, all things being equal, the additional risk premium from higher U.S. government debt would clearly drag on economic growth. In addition, that level of debt-to-GDP
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(200%) would be more than twice the 90% threshold that Reinhart and Rogoff have identified as a primary driver of lower GDP growth. In their paper, GDP is on average 1% lower per year for countries with debt-to-GDP of greater than 90%8.
Impact on Policy Options Higher debt and deficits would have a considerable impact on future fiscal and monetary policy. Extended fiscal burdens would reduce the government’s ability to use fiscal policy should the economy experience a severe downturn. Between 2007 and 2010, U.S. debt as a percentage of GDP increased by 50% as the government used fiscal policy to mitigate the recession. At current debt and deficit levels, it is unlikely the government could afford to increase the debt-to-GDP by another 50% without increasing its interest payments significantly. As a result, monetary policy under a high government indebtedness scenario needs to be considered when analyzing the implications and effects on asset markets. As discussed above, it is very likely that the persistence of higher debt and deficits will lead to higher long-term interest rates. This logic would suggest that investors avoid an allocation to long-duration government bonds. In the last year, bond portfolios that did not allocate to Greek, Irish or Portuguese sovereign bonds performed substantially better than portfolios with exposure to these regions. The Federal Reserve has a mandate to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”9 Higher debt and deficits will have significant consequences for these economic targets, as well as complicate the ability of the central bank to achieve its mandate (e.g., deteriorating fiscal balances increase long-term interest rates but could reduce employment). Looking at monetary policy ramifications that would result from higher levels of debt, it is most effective to split the central bank decision framework into two broad options. In the first, the Federal Reserve supports the government by maintaining accommodative monetary policy to account for worsening fiscal balances, with less stringent targeting of inflation. Historically, the U.S. experienced similar conditions in the 1970s during the tenure of Federal Reserve Chairman Arthur Burns, after public debt escalated primarily due to the Vietnam War. Under the second option, the Federal Reserve increases interest rates to reduce the risk of long-term price instability. By historical comparison, this would be similar to Paul Volcker’s tenure as the Federal Reserve Chairman in the 1980s. The policy options and likely economic and financial market implications are best shown in the diagram on the next page (see Exhibit 5).
Exhibit 5: Policy Options of the Fed U.S. Dollar Status as Reserve Currency Maintained Non-U.S. inflation rates accelerate Gradual breaks of fixed/flexible U.S. dollar pegs
Federal Reserve Remains Accommodative
Rising Debt as a Percentage of GDP Federal Reserve Responds by Tightening
U.S. Dollar Loses Status as Reserve Currency U.S. dollar in secular decline Domestic U.S. prices increase—higher domestic inflation U.S. yield curve steepens to new levels Long-term cost of finance for Corporates high Higher Real Bond Yields Higher real private sector interest rates—higher cost of capital Lower private investment and greater “crowding out” U.S. yield curve flattens considerably, potentially inverting
Lower GDP and Higher Long Term Interest Rates
U.S. Dollar Status as Reserve Currency Maintained Higher real U.S. dollar Higher private savings but lower national saving Greater foreign capital inflows but low long-term gains as profits likely to be repatriated
Option 1: The Fed accommodates the deteriorating fiscal position
Option 2: The Fed tightens policy in the face of the deteriorating fiscal position
The top half of the diagram considers the likely outcome should the Federal Reserve maintain an accommodative stance and keep monetary policy conditions favorable. The key question here is whether the Federal Reserve can maintain credibility, which would make it less likely that the U.S. dollar collapses. However, this response would result in persistent inflation across the global economy, with inflation rates in Emerging Markets higher than in the U.S. and forcing greater currency appreciation by the emerging bloc. Alternatively, if the Federal Reserve loses credibility, there would be greater potential for the U.S. dollar to lose its status as the reserve currency. In this case, the U.S. would also likely experience either higher domestic inflation (due to higher import costs, as in the UK currently), or the expectation of higher inflation in the years ahead.
The bottom half of the diagram considers the economic and market implications should the Federal Reserve choose to tighten monetary policy, either by reducing the size of their balance sheet or by increasing interest rates. Again, U.S. Treasury bonds would perform poorly under this scenario. In addition, Corporate bonds would experience an increase in real funding costs from a higher real cost of capital, reducing profitability and economic growth as well as bond returns. The U.S. dollar would likely be supported under a tightening in policy as higher domestic interest rates would drive a larger inflow of foreign capital savings, and more of the growing debt would be financed internationally.
If the Federal Reserve continues to pursue ongoing monetization of the debt through further quantitative easing, this could in fact slightly dampen the increase in long-term interest rates. This approach would likely have adverse effects on the U.S. dollar, which would compound the risk of increased inflation and lead to much greater volatility in bond markets, especially among longer-maturity Treasuries. Higher long-term Treasury yields would also likely result in higher long-term credit yields, increasing the financing costs for companies to fund Corporate bonds, thereby resulting in lower business investment, lower profitability and lower economic growth.
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Regardless of what monetary policy the Federal Reserve pursues, it is unlikely to reverse the negative long-term impact on growth arising from higher debt and deficits, nor the upward pressure on interest rates. The primary reason for this is that higher interest rates “crowd out” the private sector, which is a reduction in private sector investment due to increased expenditure by the government. Higher long-term government bond yields put upward pressure on long-term Corporate funding rates, which in turn increases the cost of investing for businesses. The CBO estimates that under the alternate scenario, real GDP per person could be up to 3% lower in 2025 and up to 10% lower in 2035 than under the baseline scenario, as private activity would be affected.
Greater levels of crowding out will lead to higher levels of public debt as taxation revenues fall. With regard to consumption, the CBO estimates that a 10-year delay in stabilizing the debt would “reduce the well-being of future generations by the equivalent of a cut of roughly 1%-2% of their [potential] lifetime consumption.”10 The overall size of the private sector in the economy would decrease as the size of the public sector increased. Clearly, failure to make the difficult decisions necessary to bring the U.S. fiscal position— and especially the primary balance—back to a sustainable path would have considerable effects on the economy through higher real interest rates. In turn, a deteriorating economy worsens the fiscal position, thus creating a vicious cycle. The U.S. economy would lose competitiveness and growth potential to the international economy, but the impact on prices and domestic inflation will depend on whether the Fed accommodates higher fiscal debt and deficits, or tightens policy by increasing interest rates.
Impact of Higher Interest Rates and Monetary Policy on Equity Markets The path for equity markets in a period of higher debt and deficits is less clear than for most other assets. As discussed above, a greater amount of government debt has the potential to “crowd out” other investments. For example, companies may be forced to issue debt at higher interest rates to attract buyers. Higher corporate debt costs mean a higher cost of equity capital as well. In order to make equities “cheap” in valuation relative to corporate bonds that now carry higher interest rates, equity prices would need to be lower. However, for a corporation, equity is expensive to issue to the public when it has a cheap valuation. One way to consider the cost of higher government interest rates is to compare the cost of debt and the cost of equity. For example, if 10-year U.S. Treasury yields are 5.7% in 2021 under the baseline scenario and an investor needs to earn a return above long-term U.S. Treasuries in line with a historical average of 2.5%, then equities would need an earnings yield of 8.2% to compensate investors. However, an earnings yield of 8.2% corresponds to a price/earnings multiple of 12x, a number below the much-quoted historical multiple of 15x. Under the alternate scenario, the earnings yield would go to 9.0% (6.5% bond yield + 2.5% equity risk premium), and this equates to a price/earnings ratio of 11x. The current prospective price/earnings multiple is 13.5x. If the market were to trade at 11x tomorrow, all things being equal, the S&P 500 would be almost 20% lower. Over the long term, this valuation headwind brought about by higher debt and interest rates would lower prospective equity market returns. However, we note the potential positive consequence of a more uncertain environment of higher debt and deficits—higher savings. Investors are currently saving more than 6% of their
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disposable income in the U.S., and as this pool of savings grows, it amounts to a potential source of support for attractively priced assets, including in some measure, stocks.
Conclusions To prevent the U.S. economy from sinking into a second Great Depression, the U.S. government adopted numerous fiscal policies that supported the fragile domestic economy. However, this did not come without cost. The deteriorating fiscal position of the U.S. government could have considerable impacts on interest rates, the economy and on asset markets, all of which are likely to be negative. According to academic research, the higher debt and deficit levels are forecast to increase long-term interest rates by as much as 1 percentage point above what is currently predicted by the CBO, depending on the speed of the U.S. government to return to fiscal budget (especially primary) surplus. By 2035, with a projected debt of 187% of GDP (over double the current level), the U.S. government could potentially experience the problems currently faced by many of the peripheral Euro zone governments. The impact of higher debt and interest rates is clear: “countries that continually spend beyond their means suffer slower growth in incomes and living standards and are prone to greater economic and financial instability.”11 The principal reason is that higher interest rates crowd out private sector activity and increase household savings. The U.S. would also see its economy give up economic leadership to its international partners. Private capital would be incentivized to shift overseas as the U.S. dollar weakens. The specific impact on asset markets depends on the policy options adopted by the Federal Reserve, but a few generalizations can be made: 1) U.S. Treasuries will likely suffer as bond yields and volatility rise; 2) the U.S. dollar will likely weaken over the medium term though whether the greenback will lose its reserve currency status is unclear; 3) Corporate bonds would face a higher cost of capital and, as such, for the majority of Corporate bonds, yields would be higher; and 4) financial instability and financial market volatility would likely increase. Portfolio allocations would benefit by reducing exposures to U.S. government bonds, the U.S. dollar and unsecure, unfunded Corporate bonds. Broadly, financial assets will likely suffer as real assets such as commodities and inflationprotected securities outperform in an inflationary environment. An allocation with greater exposure to assets that benefit from inflation sponsored by a weaker U.S. dollar, including Emerging Markets fixed income, currency and equity would also likely benefit.
References: 1.
Pakko, Michael. 2009. “Deficits, Debt and Looming Disaster.” The Regional Economist, Federal Reserve Bank of St. Louis, January, Vol 17. (1): 4-9.
2.
Congressional Budget Office. 2011. “The Long Term Budget Outlook.” (Washington: CBO, June ). Available at http://www.cbo.gov/doc.cfm?index=12212
3.
Buiter, Willem, H. 2003. “Fiscal Sustainability.” Paper presented at the Egyptian Center for Economic Studies in Cairo on 19 October 2003. Available at http://www.nber.org/~wbuiter/egypt.pdf
4.
Michael Pakko, op cit., p. 4-9.
5.
Reinhart, Carmen, M., and Kenneth S. Rogoff. 2010. “Growth in a time of debt.” National Bureau of Economic Research Working Paper 15639. Cambridge, MA.
6.
Laubach, Thomas. 2003. “New Evidence on the Interest Rate Effects of Budget Deficits and Debt.” Finance and Economics Discussion Paper #2003-12, Board of Governors of the Federal Reserve System.
7.
Gale, William, G., and Peter R. Orszag. 2004. “Budget deficits, national saving, and interest rates.” Brookings Papers on Economic Activity, Issue no 2: 101210.
8.
Carmen Reinhart and Kenneth Rogoff, op cit.
9.
Federal Reserve. 2005. “The Federal Reserve System Purposes & Functions.” Chapter 2, Monetary Policy and the Economy, page 15. Available at http:// www.federalreserve.gov/pf/pf.htm
10. Congressional Budget Office. 2010. “The Long Term Budget Outlook.” (Washington: CBO, June (revised August)). Available at http://www.cbo.gov/doc. cfm?index=11579 11. Bernanke, Ben, S. 2010. “Fiscal Sustainability and Fiscal Rules.” Speech at the Annual Meeting of the Rhode Island Public Expenditure Council, Rhode Island, United States. Available at http://www.federalreserve.gov/newsevents/speech/bernanke20101004a.htm
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U.S. debt and deficits are so large as to be both a financial problem and a political problem. Persistently higher debt and deficits will put upward pressure on long-term interest rates with potential adverse effects on consumption, business investment and economic growth. Outcomes of higher debt and deficits include: poor or negative performance from U.S. Treasuries and Corporate bonds, a weak U.S. dollar and rising market instability.
Recent Perspectives on the U.S. Debt & Deficits Since the Financial Crisis of 2008, the U.S. government has adopted numerous fiscal policies to support the domestic economy and prevent the onset of a second Great Depression. However, these policies have led to historic deficits and levels of debt. In fact, U.S. debt and deficits are approaching levels where they cease to be just a “political problem,” but also a financial one that cannot be solved simply through strong economic growth. Under a number of scenarios, a significant deterioration in the U.S. government’s fiscal position would have a negative impact on interest rates, the economy and asset markets. At the most extreme levels of sustained high deficits (120% of Gross Domestic Product (GDP) or more) over the long term, the U.S. government could experience some of the problems currently faced by Greece, Ireland and Portugal. In this paper, we examine the background of the current U.S. deficit and debt situation, and consider the potential impact of sustained high deficits on long-term interest rates, monetary policy and asset class performance. We conclude: n
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U.S. sovereign bond markets would suffer as bond yields and volatility rise; the U.S. dollar would weaken further, potentially eliciting an additional set of reactions from policy makers; U.S. Corporates would potentially face a higher cost of capital and as such, corporate bond yields would be higher and equity valuations lower; Broadly, higher financial asset volatility would weigh on asset prices globally.
While the deficit’s relationship with the economy and the markets is complicated (with pages and pages of academic literature on the subject), we believe this is one of the most important financial topics for investors today because of its relevance to portfolios and its potential impact on long-term investment plans.
Macro Economic Background The GDP of the United States is the world’s largest by a wide margin. U.S. Government bonds are sought by investors around the globe and are considered virtually risk-free, and the nation’s consumers continue to have a strong appetite for the world’s goods and services. In addition, the U.S. has the ability to print its own money to satisfy its debts. These fundamental strengths make the U.S. different from Greece, Ireland and Portugal—three developed countries whose financial woes have been in the headlines and which are unable to issue currency to satisfy their debts. Still, the U.S. and these nations share unusually high budget deficits. In the U.S., that deficit is currently running at around 10% of GDP—the highest since World War II and a danger zone into which Greece, Ireland and Portugal have all entered. As a result of the combination of high deficits and high debt relative to GDP, Greece, Ireland and Portugal have had to accept European Union bailouts and strict austerity measures that may suppress economic growth for years. While we doubt the U.S. will face that level of financial distress, we expect the debt burdens of the U.S. federal government and of most U.S. states will have a significant and lasting impact on financial markets.
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On the political front, the perils of allowing the deficit to grow ever larger and thus contribute to the total debt have become an important topic for both Republicans and Democrats, both of whom are seeking to reduce the national debt significantly over the next decade. For example, to bring the deficit back to 2% of GDP—a historically “normal” level—will mean making difficult and unpopular choices, such as raising taxes and paring back outlays for Medicare, Medicaid and Social Security—giant programs that together account for more than 45% of primary spending.
Primary Deficit
In our view, we are now at a tipping point where avoiding these decisions in the short term will create a larger problem in the future (see Exhibit 1). Most critically, demographic trends have the potential to make the future problem unmanageable. As the U.S. population ages, healthcare and Social Security spending, if current law is unchanged, is projected to increase from 10% of GDP to 16% of GDP by 20351, while overall debt as a percentage of GDP rises to 84%2.
Exhibit 2: Primary Deficit as a Percentage of U.S. GDP
According to the Congressional Budget Office (CBO), the primary deficit is forecast to be 7.9% of GDP this year and is only forecast to return to surplus in 2021 under the CBO’s baseline scenario (See Exhibit 2). The baseline scenario is calculated based on current law and includes the impact of the recent healthcare legislation as well as the expiration of the tax cuts enacted in 2001 and 2003.
90 80 70 60 50 40 30 20 10 0
2 0 -2 -4 -6 -8 -10 -12
Exhibit 1: Debt as a Percentage of U.S. GDP
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Total Deficit (-) or Surplus as a % of GDP Primary Deficit (-) or Surplus as a % of GDP Debt Held by the Public / GDP (RHS)
200 200 160 160
Source: Congressional Budget Office, Federal Reserve
120 120 80 40
80 40 2011 2015 2015 2015 2019 2019 2019 2023 2023 2023 2027 2027 2027 2031 2031 2031 20352035 2035 2011 2011 Extended Scenario Extended BaseliBaseline ne Scenario
Alternative Scenario Alternative Fiscal Fiscal Scenario
Source: Congressional Budget Office, Federal Reserve
Debt Dynamics To put the current U.S. fiscal position in perspective, we examine three key ratios: the primary deficit, total deficit and total debt. The total debt is the amount of money owed by the government overall, while the total deficit is the government fiscal shortfall over a specific period of time. Most commonly, total deficit and total debt are used in the analysis of fiscal sustainability, but we believe the primary deficit should also be considered. The primary deficit is the difference between government spending and tax revenues, but unlike the total deficit, it does not take into consideration the interest payments for servicing the stock of debt. In practical terms, this means the government spends no more than it earns in each period with the only additional cost being the interest payments on the debt. The first goal for the U.S. government is to return to a primary budget balance, which is also the principal aim for Greece, Ireland and Portugal, as well as all other indebted European countries.
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However, the CBO also provides an alternate scenario, which “incorporates several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period.” Should these changes occur (e.g., higher payment rates for physicians under Medicare and extensions of the 2001 and 2003 tax cuts), the primary balance is projected to remain in deficit beyond 2021 and is forecast to be 6.6% of GDP by 2035, only marginally better than the current level. These forecasting models are very sensitive to changes to inputs. They are best used to describe scenarios for the future and should not be considered definitive.
Total Deficit Including interest servicing costs, the total deficit is expected to be only 3.1% by 2021 under the baseline scenario, a level that would still be considered manageable. The total deficit under the alternate scenario, however, is expected to be considerably worse, at 7.5% in 2021 and an alarming 15.5% by 2035, over one and a half times the current level. The reason being that with a slower rate of improvement in the primary deficit (i.e., the primary deficit remaining larger for longer), the level of total debt will rise each year, driving up total interest costs (more total debt = more total interest to pay, assuming no change in the interest rate). In addition, this analysis does not even consider the impact of higher interest rates, which we consider later in the paper. Government
After ensuring the primary deficit returns to balance, a necessary condition for medium- and long-term sustainability is to stabilize the debt-to-GDP ratio. Public debt as a percentage of GDP will be constant if the primary budget is equal to the difference between the real interest rate paid to service the existing debt and the real GDP growth rate, times the existing debt as a percentage of GDP3. The higher the gap between the real interest rate and the real growth rate of the economy, or the higher the initial size of the debt as a percentage of GDP, the higher the necessary medium-term primary budget surplus. Thus, if a country can grow at a higher real rate of GDP, assuming all else remains constant, the lower the required primary surplus. Beyond this, the speed of adjustment is a political choice. Under the baseline scenario, the CBO expects debt held by the public as a percentage of GDP will reach 76% in 10 years and will rise to 84% by 2035. However, should the expected changes to law occur, the alternate scenario projects debt as a percentage of GDP to reach 101% in 10 years and almost 200% by 20354. To ensure the public debt is not increasing as a proportion of GDP under the alternate scenario, it will require a higher primary surplus in future years, a higher real rate of growth or a lower real interest rate. To maintain a sustainable fiscal situation, it is therefore vital that the U.S. government stabilizes total debt as a percentage of GDP in the near future and at as low a level as possible. If the total debt as a percentage of GDP increases further, there would be considerable negative impacts to the economy. Two researchers, in reviewing over 200 years of analysis covering over 44 countries, found that government debt-to-GDP above 90% historically resulted in median growth rates falling by one percent and average growth rates falling by more5. The CBO has found that if debt as a percentage of GDP were to reach their projected levels under the adverse alternative scenario in 2035, real GDP could be 10% lower than under stable economic conditions of steady growth rates of output.
Impact on Interest Rates The view that higher debt and deficits lead to higher interest rates is not straightforward, but from our perspective, is clear. A great deal of academic research has sought to determine whether higher debt as a percentage of GDP and a higher deficit as a percentage of GDP will have a material impact on long-term interest rates. The challenge to answering this
A widely recognized model run by Thomas Laubach, formerly of the Federal Reserve, found that a one percentage point increase in the deficit as a percentage of GDP increases the forward longterm interest rates (five and more years into the future) by roughly 25 basis points6. Likewise, a one percentage point increase in the outstanding debt as a percentage of GDP increases long-term interest rates by roughly 3 to 4 basis points. His conclusions are especially powerful because they account for business cycle and monetary policy changes and his studies are consistent with prior empirical work7 as well as with the CBO itself, which finds that “if debt was 76% of GDP instead of its 40-year average of 37%, the interest rate in the long run, all else being equal, would be roughly 1 percentage point higher.”
The Debt Forecasts The chart below shows the CBO’s baseline scenario for debt held by the public as a percentage of GDP (see Exhibit 3). The CBO provides long-term interest rate projections, forecasting that 10-year bond yields will steadily rise from the current 3.2% to 5.4% in 2017 and remain at this level until 2021. The longterm interest rate forecasts by the CBO are used for calculating interest costs for the Federal budget in future years and do not include a risk premium from higher government debt. Under this scenario, debt as a percentage of GDP is expected to reach 76% by 2021. The chart also forecasts the projected rate for 10-year bond yields, but also incorporates a very moderate upward impact based on Laubach’s results. Exhibit 3: CBO Projected Debt a Percentage of GDP and Interest Rates* 90 90
77
85 85
66
80 80
55
75 75 70 70
44
65 65 60 60
2011 2013 2011 2013 *Baseline Scenario
2015 2015
2017 2017
2019 2019
2021 2021
1010-YEAR YEARBOND BONDYIELD YIELD
Total Debt*
question comes from the fact that the driving factor for interest rates over the long term is that usually inflation—for example, 80 years of U.S. history show a mixed relationship between the fiscal budget position and long-term interest rates. Nonetheless, economists continue to point to higher deficits as being intuitively problematic and seek to develop models to describe the relationship between investor behavior and government action.
DEBT DEBTAS AS%%OF OFGDP GDP
spending on interest payments would increase from currently 6% to over 25% of total government spending by 2035 under the alternate scenario. It is clear from these numbers that the first goal of policymakers is to move the primary balance out of deficit as soon as possible.
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Debt as as % % of of GDP GDP (Baseline (Baseline Scenario, Scenario, LHS) LHS) Debt 10-year Bond Bond Yield Yield (CBO (CBO Projection, Projection, % % RHS) RHS) 10-year 10-year Bond Bond Yield Yield (under (under Baseline Baseline Scenario, Scenario, % % RHS) RHS) 10-year
Source: Congressional Budget Office, Federal Reserve
*Total debt in the CBO example does not include “Intergovernmental transfers”. As of July 20, 2011, debt held by the public (the number used by the CBO, was $9.7 trillion or approximately 66% of U.S. GDP. Including the $4.6 trillion in intergovernmental transfers like Social Security/Medicare would raise the debt-to-GDP ratio to 98%. Most economic analyses exclude intergovernmental transfers (although the debt is still owed!) as it represents debt the government owes itself and can at any time, change the terms of the debt. 3 | G WM I N V E S T M E NT M A NAGEMENT & GUI DA NCE
Now consider the forecast under the alternate scenario, where debt as a percentage of GDP is expected to reach 101% by 2021. The chart below shows debt as a percentage of GDP forecasts and the subsequent impact on long-term interest rates (see Exhibit 4). Again, as modeled using Laubach’s analysis, the trend for interest rates under this scenario is significantly higher. Exhibit 4: CBO Projected Debt a Percentage of GDP and Interest Rates*
DEBT ASAS % OF GDP DEBT % OF GDP
100 100
6 6
90 90
5 5
80 80
4 4
70 70 60 60
2011 2013 2011 2013 *Alternate Scenario
2015 2015
2017 2017
2019 2019
2021 2021
10-10YEAR BOND YIELD YEAR BOND YIELD
7 7
110 110
3 3
Debt as % of GDP (Alternate Scenario, LHS) Debt as % of GDP Scenario, 10-year Bond Yield(Alternate (CBO Projection, %LHS) RHS) 10-year % RHS) % RHS) 10-year Bond Bond Yield Yield (CBO (underProjection, Alternate Scenario, 10-year Bond Yield (under Alternate Scenario, % RHS)
Source: Congressional Budget Office, Federal Reserve
Calculating the impact of the alternate scenario on longterm interest rates Based on Laubach’s findings and the CBO’s estimates, we calculate yields on 10-year bonds in the alternate scenario would be 96-128 basis points higher than they otherwise would be in 2021 (using the expected increase in debt as a percentage of GDP from this year to future years multiplied by 3-4 basis points per percentage point increase). Under the baseline scenario, the increase in yields due to higher debt is less severe—roughly 25 basis points by 2021. To put these numbers in perspective, the CBO forecasts 10-year yields to be 5.3% in 2016 and 5.4% in 2021. Under the baseline scenario where the debt-to-GDP ratio grows to 76%, the additional interest rate premium causes 10-year U.S. Treasury bond yields to rise to 5.7% in 2021. Under the alternate scenario, where the debt-to-GDP ratio grows to 101%, 10-year bond yields would be even higher, above 6.5% in 2021. This increase of roughly 1 percentage point in long-term yields is due to the more than 30 percentage point increase in the debt-to-GDP ratio under the alternate scenario. At that level of interest rates, all things being equal, the additional risk premium from higher U.S. government debt would clearly drag on economic growth. In addition, that level of debt-to-GDP
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(200%) would be more than twice the 90% threshold that Reinhart and Rogoff have identified as a primary driver of lower GDP growth. In their paper, GDP is on average 1% lower per year for countries with debt-to-GDP of greater than 90%8.
Impact on Policy Options Higher debt and deficits would have a considerable impact on future fiscal and monetary policy. Extended fiscal burdens would reduce the government’s ability to use fiscal policy should the economy experience a severe downturn. Between 2007 and 2010, U.S. debt as a percentage of GDP increased by 50% as the government used fiscal policy to mitigate the recession. At current debt and deficit levels, it is unlikely the government could afford to increase the debt-to-GDP by another 50% without increasing its interest payments significantly. As a result, monetary policy under a high government indebtedness scenario needs to be considered when analyzing the implications and effects on asset markets. As discussed above, it is very likely that the persistence of higher debt and deficits will lead to higher long-term interest rates. This logic would suggest that investors avoid an allocation to long-duration government bonds. In the last year, bond portfolios that did not allocate to Greek, Irish or Portuguese sovereign bonds performed substantially better than portfolios with exposure to these regions. The Federal Reserve has a mandate to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”9 Higher debt and deficits will have significant consequences for these economic targets, as well as complicate the ability of the central bank to achieve its mandate (e.g., deteriorating fiscal balances increase long-term interest rates but could reduce employment). Looking at monetary policy ramifications that would result from higher levels of debt, it is most effective to split the central bank decision framework into two broad options. In the first, the Federal Reserve supports the government by maintaining accommodative monetary policy to account for worsening fiscal balances, with less stringent targeting of inflation. Historically, the U.S. experienced similar conditions in the 1970s during the tenure of Federal Reserve Chairman Arthur Burns, after public debt escalated primarily due to the Vietnam War. Under the second option, the Federal Reserve increases interest rates to reduce the risk of long-term price instability. By historical comparison, this would be similar to Paul Volcker’s tenure as the Federal Reserve Chairman in the 1980s. The policy options and likely economic and financial market implications are best shown in the diagram on the next page (see Exhibit 5).
Exhibit 5: Policy Options of the Fed U.S. Dollar Status as Reserve Currency Maintained Non-U.S. inflation rates accelerate Gradual breaks of fixed/flexible U.S. dollar pegs
Federal Reserve Remains Accommodative
Rising Debt as a Percentage of GDP Federal Reserve Responds by Tightening
U.S. Dollar Loses Status as Reserve Currency U.S. dollar in secular decline Domestic U.S. prices increase—higher domestic inflation U.S. yield curve steepens to new levels Long-term cost of finance for Corporates high Higher Real Bond Yields Higher real private sector interest rates—higher cost of capital Lower private investment and greater “crowding out” U.S. yield curve flattens considerably, potentially inverting
Lower GDP and Higher Long Term Interest Rates
U.S. Dollar Status as Reserve Currency Maintained Higher real U.S. dollar Higher private savings but lower national saving Greater foreign capital inflows but low long-term gains as profits likely to be repatriated
Option 1: The Fed accommodates the deteriorating fiscal position
Option 2: The Fed tightens policy in the face of the deteriorating fiscal position
The top half of the diagram considers the likely outcome should the Federal Reserve maintain an accommodative stance and keep monetary policy conditions favorable. The key question here is whether the Federal Reserve can maintain credibility, which would make it less likely that the U.S. dollar collapses. However, this response would result in persistent inflation across the global economy, with inflation rates in Emerging Markets higher than in the U.S. and forcing greater currency appreciation by the emerging bloc. Alternatively, if the Federal Reserve loses credibility, there would be greater potential for the U.S. dollar to lose its status as the reserve currency. In this case, the U.S. would also likely experience either higher domestic inflation (due to higher import costs, as in the UK currently), or the expectation of higher inflation in the years ahead.
The bottom half of the diagram considers the economic and market implications should the Federal Reserve choose to tighten monetary policy, either by reducing the size of their balance sheet or by increasing interest rates. Again, U.S. Treasury bonds would perform poorly under this scenario. In addition, Corporate bonds would experience an increase in real funding costs from a higher real cost of capital, reducing profitability and economic growth as well as bond returns. The U.S. dollar would likely be supported under a tightening in policy as higher domestic interest rates would drive a larger inflow of foreign capital savings, and more of the growing debt would be financed internationally.
If the Federal Reserve continues to pursue ongoing monetization of the debt through further quantitative easing, this could in fact slightly dampen the increase in long-term interest rates. This approach would likely have adverse effects on the U.S. dollar, which would compound the risk of increased inflation and lead to much greater volatility in bond markets, especially among longer-maturity Treasuries. Higher long-term Treasury yields would also likely result in higher long-term credit yields, increasing the financing costs for companies to fund Corporate bonds, thereby resulting in lower business investment, lower profitability and lower economic growth.
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Regardless of what monetary policy the Federal Reserve pursues, it is unlikely to reverse the negative long-term impact on growth arising from higher debt and deficits, nor the upward pressure on interest rates. The primary reason for this is that higher interest rates “crowd out” the private sector, which is a reduction in private sector investment due to increased expenditure by the government. Higher long-term government bond yields put upward pressure on long-term Corporate funding rates, which in turn increases the cost of investing for businesses. The CBO estimates that under the alternate scenario, real GDP per person could be up to 3% lower in 2025 and up to 10% lower in 2035 than under the baseline scenario, as private activity would be affected.
Greater levels of crowding out will lead to higher levels of public debt as taxation revenues fall. With regard to consumption, the CBO estimates that a 10-year delay in stabilizing the debt would “reduce the well-being of future generations by the equivalent of a cut of roughly 1%-2% of their [potential] lifetime consumption.”10 The overall size of the private sector in the economy would decrease as the size of the public sector increased. Clearly, failure to make the difficult decisions necessary to bring the U.S. fiscal position— and especially the primary balance—back to a sustainable path would have considerable effects on the economy through higher real interest rates. In turn, a deteriorating economy worsens the fiscal position, thus creating a vicious cycle. The U.S. economy would lose competitiveness and growth potential to the international economy, but the impact on prices and domestic inflation will depend on whether the Fed accommodates higher fiscal debt and deficits, or tightens policy by increasing interest rates.
Impact of Higher Interest Rates and Monetary Policy on Equity Markets The path for equity markets in a period of higher debt and deficits is less clear than for most other assets. As discussed above, a greater amount of government debt has the potential to “crowd out” other investments. For example, companies may be forced to issue debt at higher interest rates to attract buyers. Higher corporate debt costs mean a higher cost of equity capital as well. In order to make equities “cheap” in valuation relative to corporate bonds that now carry higher interest rates, equity prices would need to be lower. However, for a corporation, equity is expensive to issue to the public when it has a cheap valuation. One way to consider the cost of higher government interest rates is to compare the cost of debt and the cost of equity. For example, if 10-year U.S. Treasury yields are 5.7% in 2021 under the baseline scenario and an investor needs to earn a return above long-term U.S. Treasuries in line with a historical average of 2.5%, then equities would need an earnings yield of 8.2% to compensate investors. However, an earnings yield of 8.2% corresponds to a price/earnings multiple of 12x, a number below the much-quoted historical multiple of 15x. Under the alternate scenario, the earnings yield would go to 9.0% (6.5% bond yield + 2.5% equity risk premium), and this equates to a price/earnings ratio of 11x. The current prospective price/earnings multiple is 13.5x. If the market were to trade at 11x tomorrow, all things being equal, the S&P 500 would be almost 20% lower. Over the long term, this valuation headwind brought about by higher debt and interest rates would lower prospective equity market returns. However, we note the potential positive consequence of a more uncertain environment of higher debt and deficits—higher savings. Investors are currently saving more than 6% of their
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disposable income in the U.S., and as this pool of savings grows, it amounts to a potential source of support for attractively priced assets, including in some measure, stocks.
Conclusions To prevent the U.S. economy from sinking into a second Great Depression, the U.S. government adopted numerous fiscal policies that supported the fragile domestic economy. However, this did not come without cost. The deteriorating fiscal position of the U.S. government could have considerable impacts on interest rates, the economy and on asset markets, all of which are likely to be negative. According to academic research, the higher debt and deficit levels are forecast to increase long-term interest rates by as much as 1 percentage point above what is currently predicted by the CBO, depending on the speed of the U.S. government to return to fiscal budget (especially primary) surplus. By 2035, with a projected debt of 187% of GDP (over double the current level), the U.S. government could potentially experience the problems currently faced by many of the peripheral Euro zone governments. The impact of higher debt and interest rates is clear: “countries that continually spend beyond their means suffer slower growth in incomes and living standards and are prone to greater economic and financial instability.”11 The principal reason is that higher interest rates crowd out private sector activity and increase household savings. The U.S. would also see its economy give up economic leadership to its international partners. Private capital would be incentivized to shift overseas as the U.S. dollar weakens. The specific impact on asset markets depends on the policy options adopted by the Federal Reserve, but a few generalizations can be made: 1) U.S. Treasuries will likely suffer as bond yields and volatility rise; 2) the U.S. dollar will likely weaken over the medium term though whether the greenback will lose its reserve currency status is unclear; 3) Corporate bonds would face a higher cost of capital and, as such, for the majority of Corporate bonds, yields would be higher; and 4) financial instability and financial market volatility would likely increase. Portfolio allocations would benefit by reducing exposures to U.S. government bonds, the U.S. dollar and unsecure, unfunded Corporate bonds. Broadly, financial assets will likely suffer as real assets such as commodities and inflationprotected securities outperform in an inflationary environment. An allocation with greater exposure to assets that benefit from inflation sponsored by a weaker U.S. dollar, including Emerging Markets fixed income, currency and equity would also likely benefit.
References: 1.
Pakko, Michael. 2009. “Deficits, Debt and Looming Disaster.” The Regional Economist, Federal Reserve Bank of St. Louis, January, Vol 17. (1): 4-9.
2.
Congressional Budget Office. 2011. “The Long Term Budget Outlook.” (Washington: CBO, June ). Available at http://www.cbo.gov/doc.cfm?index=12212
3.
Buiter, Willem, H. 2003. “Fiscal Sustainability.” Paper presented at the Egyptian Center for Economic Studies in Cairo on 19 October 2003. Available at http://www.nber.org/~wbuiter/egypt.pdf
4.
Michael Pakko, op cit., p. 4-9.
5.
Reinhart, Carmen, M., and Kenneth S. Rogoff. 2010. “Growth in a time of debt.” National Bureau of Economic Research Working Paper 15639. Cambridge, MA.
6.
Laubach, Thomas. 2003. “New Evidence on the Interest Rate Effects of Budget Deficits and Debt.” Finance and Economics Discussion Paper #2003-12, Board of Governors of the Federal Reserve System.
7.
Gale, William, G., and Peter R. Orszag. 2004. “Budget deficits, national saving, and interest rates.” Brookings Papers on Economic Activity, Issue no 2: 101210.
8.
Carmen Reinhart and Kenneth Rogoff, op cit.
9.
Federal Reserve. 2005. “The Federal Reserve System Purposes & Functions.” Chapter 2, Monetary Policy and the Economy, page 15. Available at http:// www.federalreserve.gov/pf/pf.htm
10. Congressional Budget Office. 2010. “The Long Term Budget Outlook.” (Washington: CBO, June (revised August)). Available at http://www.cbo.gov/doc. cfm?index=11579 11. Bernanke, Ben, S. 2010. “Fiscal Sustainability and Fiscal Rules.” Speech at the Annual Meeting of the Rhode Island Public Expenditure Council, Rhode Island, United States. Available at http://www.federalreserve.gov/newsevents/speech/bernanke20101004a.htm
The CIO Team
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