Treasury Versus S&P on the Downgrade: It’s Not a Math Error

The White House and the Treasury are accusing Standard and Poor’s of making an elementary arithmetic mistake in the recent downgrade decision.  Treasury’s John Bellows writes about what he calls a “$2 trillion mistake” saying that “After Treasury pointed out this error – a basic math error of significant consequence – S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one.”  White House adviser Gene Sperling adds that “The magnitude of their error combined with their willingness to simply change on the spot their lead rationale in their press release once the error was pointed out was breathtaking.”

But if you examine the details of the S&P–Treasury–White House dispute, rather than a “math error” you will find what is better described as a “difference of opinion” about a forecast for future government spending.  In other words, the issue is about the appropriate “baseline” for government spending in the absence of more actions. Since when did different views or assumptions about the future become a math error?

In their original draft report, S&P evidently assumed that discretionary government spending would grow by about 5 percent per year over the next 10 years if no further action were taken (beyond the Budget Control Act of 2011). In the final draft, at the urging of the Treasury, they assumed that discretionary spending would grow at about 2.5 percent per year if no further actions were taken.  The first assumption leads to a higher level of debt than the second.  Over 10 years the difference is about $2 trillion.

So this is a matter of different assumptions rather than a math mistake.  In fact, the alternative assumption of faster spending growth is not so unreasonable, and whether or not S&P put it in their final report it is something they or anyone else should worry about.  In fact this assumption is used by CBO in their “alternative fiscal scenario,” which I and others have used to project debt into the future as in the exploding debt chart below.  CBO devoted part of its January 2011 Budget Outlook to considering such alternatives. See in particular Table 1-7 of that CBO report where they show that increasing discretionary appropriations at the rate of nominal GDP growth (assumed to be about 5%) increased the debt by $1.8 trillion, or about $2 trillion over ten years, compared with the 2.5% assumption.

There are of course reasons to dispute the downgrade decision of S&P, but a math error is not one of them. It would be more productive for government officials to move on and to use their time to find ways to reform taxes or entitlements, fix the exploding debt problem, and thereby prevent the likelihood of the outcome in this chart, which shows CBO forecasts (during the past three years) under their alternative fiscal scenario explained in more detail here.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

Visit: John Taylor's Page, Blog

2 Comments on Treasury Versus S&P on the Downgrade: It’s Not a Math Error

  1. The national government acts as though this comes as a surprise or that it should not happen. As has become the fashion of our political state our representatives have chosen to complain (waste time) about the problem rather than solve it.

    If the federal government were a person they would not so much as be able to get a pay day loan due to their spending habits yet they feel as though they should be given a blank check to continue spending as always.

  2. Thanks for posting the first reasonable explanation. Every other channel covered the white house criticism without explaining the underlying problem, leaving most TV and radio viewers to assume that S&P had made some major gaffe and was now trying to save face. It’s shameful what passes for journalism.

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