The dollar faucet
Stocks vs. flows in the debt ceiling debate
Before the debt ceiling debate gets stale, I wanted to clarify one last thought on the subject. I have already begun to spell out what I call a liquidity view of the debt ceiling. Here I begin to put that view into conversation with other perspectives.
Debt ceiling in terms of stock variables
A question that comes up when trying to think about government debt is what exactly to write on the balance sheet. At first it seems like a small question about how to record the transaction, but I think it turns out to be a big question. Outstanding government debt is surely a liability to the government. But the balance sheet should balance, so what corresponds to it on the asset side?
One possibility is to write nothing on the asset side, and instead to allow government debt to be a one-sided transaction. The government borrows, and in this view its promise to repay is credible based on its say-so or fiat, without making reference to any asset position. In this sense the government's counterparty, owners of government debt, are holding something like gold, which also appears to have a one-sided character to it, as it is an asset that is not anyone's liability.
But this is not entirely satisfying: in fact the US Treasury does pay its debts when due. Governments raise money differently than do businesses, but are they really more like gold? One answer is to put some kind of reasonable placeholder on the asset side. I have sometimes chosen to think of this as something like a residual or equity claim on the US public. This reflects two important facts: first, that the Treasury's ability to repay does in the end derive from US incomes; and second, that the government has the power to tax those incomes, but that power is not unlimited, so it is a equity claim.
Viewed in this way, the debt ceiling (if we choose to take it seriously rather than purely as political theater) codifies a concern about the amount of outstanding debt relative to the value of the Treasury's equity claim on the US public. More generally, such concerns are framed around stock concepts: variables with an instantaneous value, like the Treasury's debt outstanding relative to the ceiling, or like a contingent equity claim. The balance sheet, at a particular moment in time, is the place for such variables.
Debt ceiling in terms of flow variables
The liquidity view, by contrast, is framed around flow concepts: variables whose value is measured over an interval, like the Treasury's payment commitments over the next six weeks, or the flow of tax receipts over the course of a year. Expressed in flows rather than stocks, the debt ceiling is a more precise problem: to keep its cash commitments, the Treasury needs to raise funds. Having exhausted all other sources, it needs to borrow. If it cannot borrow, the Treasury cannot keep its cash commitments and so some people will not get paid.
In the stocks view, there is a question about what balances the issuance of new Treasury debt: maybe an abstract equity claim, collectible through taxation, maybe taxing authority itself, maybe nothing at all. In the flows view, there is no such ambiguity. Issuing debt is a source of funds, and the Treasury's cash payments (transfer payments, salaries of government employees, debt service) are the use of funds.
As this cash-flow statement shows, stocks and flows are related to one another. Here, an increase in liabilities is the source of funds for the Treasury's normal payment obligations. This issue of stock–flow consistency is frequently raised as an argument against the debt ceiling. Plans for the flow of spending and for the flow of taxation have already been made, the argument goes, and the difference between them, the budget deficit, will therefore have to be financed. If Congress approves the spending but not the borrowing, then Congress is being logically inconsistent.
I cannot really disagree. But the fact remains that the debt ceiling is a law that appears to bind the Treasury Secretary. Congress is required first to choose the flows, then to approve the stocks. Yes, the changes in stocks are a mechanical consequence of the flows. But the approval must be given separately, and is not guaranteed. Maybe in December it will not be forthcoming.
Why the flow view is more helpful
We might summarize the two views like this:
Debates about the debt ceiling can be understood as a contest between the solvency and liquidity views. But why should we prefer the liquidity view to the solvency view? Thinking about stock variables here leads, I think, to bottomless questions about inside money and outside money, about how the debt ceiling is nonsensical, about procedural gimmicks to circumvent the limit.
It is only the liquidity view that has any purchase on the unfolding of events. Yellen's plea to Congress, for example, is based on flow concerns. With a binding debt ceiling, the Treasury Secretary argued, the US government would reach a point where it was unable to pay its obligations. Those were the considerations that created the October 18 deadline and which prompted the actions that led to the current reprieve.
In the end, perhaps the question has been given the wrong name. It is not really about how much borrowing is too much, but rather about whether payments will be made as promised. It's not a ceiling that contains a rise, but a faucet that regulates a flow.