Fed vs White House

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Fed economist Thomas Laubach estimates in a recent paper that every
additional $100 nillion increase in projected annual budget deficit adds
one quarter percentage point to the yield on 10-year Treasury bonds.
The Fed's traditional position is that budget deficits raise longterm
interest rates, over which Fed monetary policy as currently constituted
has little control.

White House economists and tax cut advocates contends that the link
between deficits and interest rates is loose and is negligent when
compared with other economic forces.  Further, they contend that tax
cuts by themselves do not necessarily produce deficits because tax cuts
stimulate the economy and in turn increase tax revenue even with a lower
tax rate.

The Laubach estimate is 16 times that estimated by Bush's Council of
Economic Advisors, as it was headed by Glenn Hubbard of Columbia, which
came to 0.015 percentage point for each addition $100 billion.

Based on the Laubach estimate, the Bush budget if passed as is ($300
billion) would increase 10 year Tresuries by 0.5 to 0.6% in 2004.  The
bond market has reacted accordingly.

Laubach is a recognized inflation targeter, part of the Princton gang
that includes Taylor of the Taylor Rule, Bernanke, the money printer of
late.

(Inflation Targeting: Lessons from the International Experience
by Ben S. Bernanke, Thomas Laubach, Frederic S. Mishkin, Adam S. Posen)

According to the Financial Times, the administration’s estimate of a
cumulative deficit for $1,048 billion for the five-year period 2004-2008
was only achieved through a “sleight of hand” carried out by offsetting
surpluses set aside for Social Security payments against the “massive
future liabilities of the federal government.” If these surpluses are
stripped out, the cumulative deficit in the next five years rises to
$2,140 billion.

That's $400 billion additional deficit a year, which will push 10 year
Treasuries 1% higher each year for the next five years from its current
4%.  Ten year rate could reach 9% in 2008.  Goodbye recovery.

Henry C.K. Liu