The Impoverished, and Impoverishing, Debate about Fiscal Deficits
by Peter Dorman
The Impoverished, and Impoverishing, Debate about Fiscal Deficits
originally posted at Econospeak
It is like living in a dream—a very bad dream. Everything seems at once real and imaginary, serious and deliriously impossible. The language is familiar and incomprehensible. And it seems there is no waking up, ever.
I’m talking about the “debate” over America’s fiscal deficits, which is what I stumbled into after a night of much happier visions. Now, according to this morning’s New York Times, the left has weighed in with its own plans to achieve deficit stability. Of course, it is more reasonable than the pronunciamenti of the Simpson-Bowles cabal, with a wiser assortment of cuts and more progressive tax adjustments. Still, it is part of the same bizarre trance, disconnected from the basic laws of income accounting.
All you need to know is the fundamental identity. In its financial balance form, it appears as:
Private Deficits + Public Deficits ≡ Current Account Balance
If the US runs, say, a 4% CA deficit, the sum of its net public and private deficits must equal 4%. You can’t alter this no matter how you juggle budgets.
Add to this one more piece of wisdom, which we should have learned from the past three years, even if we were blind to everything else: private debts matter as much as public ones. The indebtedness of households, corporations and financial entities can bring down the economy as readily as the profligacy of the public sector. In fact, in the grip of a crisis (which we have not yet escaped), private deficits are far harder to finance because of their greater default risk. That’s why governments slathered themselves with red ink: they borrowed to assume the debts that private parties could no longer bear.
So what does this mean for US fiscal deficits? Isn’t it obvious? Public deficits can be brought down only to the extent that the private willingness and capacity to borrow increases and current account (mostly trade) deficits shrink. There is still an important discussion to be had over the size and composition of revenues and expenditures, of course, but this is only about how, not how much. To put it differently, if private deficits and the external position of the US economy remain as they are, planned deficit reduction by the government cannot be realized. Revenues will fall along with spending, the economy will take a dive, and actual fiscal deficits will be unmoved. This is guaranteed by the laws of arithmetic, and you can see such a process happening in real time in the peripheral Eurozone countries.
What can break this fall? The current account constraint can be relaxed as falling incomes drive falling imports, but this entails an economic catastrophe unless devaluation can do the job instead. Or the borrowing capacity of the private sector can rise, but this is inconceivable in a collapsing economy. Or, facing the abyss, those who run the show can dispense with all the nonsense about fiscal prudence in isolation from surrounding economic conditions, and open the spigots once again.
My prediction: if there is deficit-cutting in the US of any sort before the private sector is prepared to take on more debt and, especially, approximate trade balance is restored, we will see exactly this third scenario. The economy will take a dive, political leaders (whether of the latté or tea persuasion) will spend like crazy, and fiscal deficits will be larger than ever. The deficit-cutting debate is delusional.
Just as it’s meant to be?
Thanks for all you do to clear up the what can only be termed as “purposive” fog.
Suzan
The deficit-cutting debate is delusional.
Okay, you are really pushing me now because I studied international economics about just about 40 years ago and really have had little reason to think about it in detail since, but that dim recollection did not have current account as equaling private and public deficits, but rather was made up of the trade deficit/surplus plus monetary trandfers which could be deficits but I thought could include some other things like dividends paid to U.S. owners or the purchase of assets in this country–stock, real estate etc. Be that as it may, i certainly agree with the other conclusions and believe that allowing the U.S. dollar to devalue is the only alternative to a trade war to close the trade deficit. Paul Ryan–only the latest in Wisconsin’s string of embarrasments to hit the national political stage asked the rhetorical question about a week ago, about naming any country whose economic condition improved through devaluing its currency. Today in a letter to the editor his question was answered–China.
Likely the other way around. Current account deficits never improve when government is too far into debt.
Still adding apples & oranges.
I always have problems with this formula. Possibly you can help me. In 2009 the US CA was-378b. US Federal Debt rose from 10.6T to 12.3T. an increase of 1.7T.
Does this mean that the other components of this formula produced a surplus of 1.322 Trillion? I would think not. There was not that much debt deflation in 09. States and other Munis increased debt.
Is it correct to conclude that households and corporations had surpluses of at least 1.3T in 09?
Perhaps it would help to think of this in the context of Keynes’s beauty contest analogy. The deficit-cutting delusion is a kind of third derivative product of group think. As such, persuasion is futile because it’s not really about what people themselves believe but about what they think other people’s ideas are about what is the general consensus. It’s all shadow boxing.
So, how does one think outside of the shadox box? I like the “Private Deficits + Public Deficits = Current Account Balance” accounting identity. But I would take that a step further. Why are we talking about “accounting identities” at all? What is the historical significance of this discourse?
Actuall the hydraulic math is
Private Deficits(p,w) + Public Deficits(p,w) ≡ Current Account Balance(p,w)
Where the p is phase and the w is one over the inventory cycle. both continuous variables. We neve see the j, phase shift as it is handled inside the firm. We see positive w, approximately; and negative w appears during that short period of mass banklruptcy. If we avergae long enough the phase shift balances out and w is mainly positive; andf then the static version of the equation might be true. This is the true hydraulic model. The Finite precision model is, theoretically, the hydraulicmodeld with distinct spctral lines corresponding to finite dimensionality of economies of scale.
What the author misses is the unsustainability (unserviceability) of the debt load created by the long-running deficits.
A deflationary collapse is what is more probable, even if they do try to spend their way out.
And anyway, the problem is the distribution, not the level of aggregate demand. You can run a current account deficit without high unemployment. If we had balanced domestic demand (absent our pathological inequality) unemployment would not be as great, and we could work on balancing the current account in far less painful ways than are now talked about.
The most compassionate thing to do now would be to raise taxes on the rich and use the money to help the poor and unemployed, and boost the multiplier effect to AgD in the process.
Bruce, you math is correct. Take a look at the corporate savings and/or retained earnings data and you will see that it easily covers the numbers you came up with.
It’s interesting to read these responses. I get the impression that the use of accounting identities to structure macroeconomic thinking, as simple as it is, is unfamiliar even to people who may have had many courses in economics. Obviously there is much more to be said that requires higher-level analysis, but the starting point has to be the identities and how they are maintained under various conditions and assumptions. I’m writing the macro half of my principles textbook at the moment, and the identities are really foregrounded — also the fundamental asymmetry between surplus and deficit countries. I hope this way of approaching macro gets more traction.
As for where the identity comes from, think of it this way. At the level of the whole world, net deficits are zero, since every liability is someone else’s asset. If you divide that into public and private deficits, the sum of the two is zero. Drill down to the country level, and some countries are net creditors and others net borrowers; the sum of the deficits of their public and private sectors is greater than zero (net creditor) if the country in question has an external surplus, less than zero if it has an external deficit.
I should also clarify by saying I don’t assume that any particular component of this identity is fixed. I do ask, though, that if you want to engineer a significant change in one of them, you have a plausible story about how the others will adjust to make it possible. Remember that identity is not like equilibrium: you can be out of equilibrium but never, not for a moment, out of identity.
Without in any way disputing the accounting identity story, it is still possible to “drill down” conceptually deeper than the country level. Accounting, as it is currently practiced, views the underlying transactions exclusively as exchanges of money of account. But there are other exchanges going on “off the books” so to speak. Those are exchanges between “the economy” and nature, between capital and labor and social exchanges that superficially appear to be financially “irrelevant”.
I wouldn’t be so sure that the accounting identity tells the WHOLE story. It’s true by definition. But does the defining framework give sufficient information about what we must do? It only does so in terms of money of account. Is that the only consideration? Should it be?
Given the tautological nature of the policy prescription the accounting identity implies, might not the deficit-delusionists be doing the right thing for the wrong reasons? I’m not saying they ARE doing the right thing. I’m only suggesting that the accounting identity, though true, may not be a sufficient rebuttal.
Sandwichman: “Given the tautological nature of the policy prescription the accounting identity implies, might not the deficit-delusionists be doing the right thing for the wrong reasons?”
Well, of course, anybody can do the right thing for the wrong reasons. But those deficit delusionists who say that both the gov’t and the private sector should save or reduce their debt do not realize that the odds of our doing both are extremely low. In all likelihood attempting to balance the Federal budget will mean that more households will end up reducing their savings or increasing their debt. Is that what we want now?
Min: “Is that what we want now?
No. That is not what we want now. But by the same token I don’t see much discussion of policies that we not only want but need.
What we need are policies of transition to a different kind of economy. The kind of thing that the U.K. report Prosperity without Growth put forward or Peter Victor’s Managing without Growth. The “without growth” in both of those titles is a bit of a misnomer. What they’re talking about is abandoning the presumption that vigorous growth is indispensable for social well-being and progressive change.
Things are not going to go back to “the way they used to be” — even assuming one would want that. But I can assure you that if we pursue the same mix of policy prescriptions and assumptions as have prevailed over the last 60 years, things are going to get very, very much worse. It’s not just the economic ‘paradigm’ that’s busted. The system’s legitimation, rationality and motivation structures are simultaneously breaking down.
So I find it odd that rational people — albeit with exagerrated faith in technocratic solutions — would be surprised that delusion prevails. “I’m shocked, shocked to find that gambling is going on in here!”
Min said:
“In all likelihood attempting to balance the Federal budget will mean that more households will end up reducing their savings or increasing their debt. Is that what we want now?”
It also means more unemployment, more forclosures, more bankruptcies, both personal and business. Less tax revenue. Deflation. In short, more misery for the little guy. As Peter points out, however, one person’s debit is someone else’s asset, and the creditors will do very well. Indeed, they, the banks, have helped manufacture this situation by hoarding money. This makes it impossible for all debts to be paid off, forcing either increased borrowing or default. This has been going on for years, and this is how we have gotten into this situation. Just in the US there is over $50 Trillion debt of all kinds, far and away a record. This is all money owed by the many to the few. See: http://anamecon.blogspot.com/2010/11/banks-are-forcing-debt-on-rest-of-us.htmlSomething to make the bear angry. Also see:
http://www.youtube.com/v/vVkFb26u9g8” type=”application/x-shockwave-flash” width=”170″ height=”140
A primer on how banking rreally works: http://www.youtube.com/watch?v=vVkFb26u9g8
i can’t comment on the substance because i don’t know enough.
but it seems to me that an “identity” that says C = A + B implies only that IF C is constant then changing A requires an equal and opposite change in B.
But it doesn’t say anything about what happens when C is not constant.
China ….. and Sweden … and Argentina ….. and Iceland … and