Amol Amol and Erzo Luttmer, both associated with the University of Minnesota and the Federal Reserve Bank of Minneapolis, published a working paper on October 17 titled “Unique Implementation of Permanent Primary Deficits?“
A permanent primary deficit refers to a fiscal situation where a government consistently spends more than it earns from its regular income (like taxes) without including the interest it has to pay on its existing debt. Essentially, the government’s expenditures are higher than its revenues, creating a gap that needs to be financed. Unlike occasional deficits caused by one-off events, a permanent primary deficit implies that this shortfall continues year after year. Governments typically finance this deficit by borrowing, issuing more debt to cover the gap between income and spending. The “primary” part means it only looks at the core operations of the government, excluding the cost of servicing its debt (interest payments).
Economists generally view a permanent primary deficit as sustainable only if the government can keep borrowing at affordable rates or if its economy grows fast enough to keep debt manageable. However, if left unchecked, it could lead to rising debt levels, inflation, or a loss of confidence in the government’s ability to repay its obligations.
In the paper, the researchers argue that governments can maintain permanent primary deficits under specific conditions in an economy where markets are incomplete and consumers are highly risk-averse. According to Amol and Luttmer, the government can achieve this by issuing nominal debt and employing continuous Markov strategies, which rely on current economic conditions and prices.
Amol and Luttmer explain that these strategies allow the government to finance a deficit while keeping the price of government debt stable. They assert that, through careful management of the relationship between government spending and debt issuance, the government can avoid being forced into a balanced budget. The paper emphasizes that such fiscal policies are designed to maintain an equilibrium where the price of government debt remains positive, allowing the government to continue financing its deficit without facing financial constraints.
However, Amol and Luttmer highlight that the presence of Bitcoin, which they refer to as a “useless piece of paper” with no intrinsic value, complicates this strategy. The authors state that despite being unrelated to real economic resources, Bitcoin can still trade at a positive price, which introduces multiple possible economic equilibria. Amol and Luttmer argue that this leads to what they describe as a “balanced budget trap,” where the government is forced to balance its budget despite its goal of running a permanent primary deficit.
The paper suggests that governments could counter this disruption by taxing Bitcoin or outright prohibiting its use, as Amol and Luttmer argue. They propose that imposing a tax on Bitcoin equal to its market value could prevent alternative equilibria from forming. They say such measures would restore the government’s ability to implement continuous fiscal deficits without the interference caused by Bitcoin.
The authors further stress the broader implications of this issue, noting that the existence of assets like Bitcoin complicates government efforts to control fiscal outcomes. They explain that Bitcoin allows for an alternative method of wealth storage that operates independently of government fiscal policies. They argue that this independence undermines the government’s ability to ensure fiscal stability when attempting to maintain permanent deficits.
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