The response to the S&P downgrade of the US credit rating has been quite interesting thus far. Those who for several weeks spoke in apocalyptic terms about what would happen if the US defaulted on its debt are now filled with shock: “A credit rating should reflect the probability of default, and the probability of the US defaulting on its debt is zero.” Hmmm….
Beyond this 180 degree pivot, another response has been to shoot the messenger. As Austin Goolsbee, outgoing CEA Chair, stated:
“They made a $2 trillion math error, and they didn’t check their work.”
This line has been repeated like a mantra by members and supporters of the administration (is anyone noting a pattern in White House rhetoric? A few weeks ago, the President comparing Congress to his children and their homework and later making comments about “eating our peas?”)
Economist John Taylor has an interesting piece that clarifies things a bit. Two key points:
First: the dispute did not arise from a simple arithmetic problem (e.g., “S&P failing to check their work”) but in a dispute over basic assumptions. As Professor Taylor explains:
“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.”
It should be noted that the Treasury concedes this point in its release on the “S&P’s $2 Trillion Mistake.”
“The error came about because S&P took the amount of deficit reduction CBO calculated from the Budget Control Act and applied it to the wrong starting point, or ‘baseline.’ Specifically, CBO calculated that the Budget Control Act, including its discretionary caps, would save $2.1 trillion relative to a “baseline” in which current discretionary funding levels grow with inflation.”
Second, as Taylor notes and the Treasury concedes in the above quote, the disagreement over assumptions revolved on whether to adopt the CBO’s alternative fiscal scenario, the scenario that the CBO and many others view as being far more credible than the “extended baseline scenario.”
Ultimately, the math error seems to have come down to a difference in opinion regarding long-range scenarios. Elected officials—insert gasp of surprise here—tend toward Rosie Scenario. Those who are not nearly as interested in spinning and framing tend toward more realistic scenarios.
For our elected officials who combine the “math error” with statements about S&P’s past errors in assessing the risk of the mortgage backed securities in the years leading up to the financial collapse, one quick reminder: S&P was never indicted for being too pessimistic—quite the opposite. If anything, it seemed to understate the magnitude of the risks.
Given the $54 trillion+ in unfunded liabilities currently on our books, it might be difficult to overstate risk. If you have any doubts, take a few minutes and read the most recent CBO Long-Term Budget