Deficits Do Matter, But Not the Way You Think
Dan here…a reminder about our federal deficit.
Deficits Do Matter, But Not the Way You Think
07.20.10 Roosevelt institute L. Randall Wray
In recent months, a form of mass hysteria has swept the country as fear of “unsustainable” budget deficits replaced the earlier concern about the financial crisis, job loss, and collapsing home prices. What is most troubling is that this shift in focus comes even as the government’s stimulus package winds down and as its temporary hires for the census are let go. Worse, the economy is still — likely — years away from a full recovery. To be sure, at least some of the hysteria has been manufactured by Pete Peterson’s well-funded public relations campaign, fronted by President Obama’s National Commission on Fiscal Responsibility and Reform — a group that supposedly draws members from across the political spectrum, yet are all committed to the belief that the current fiscal stance puts the nation on a path to ruinous indebtedness. But even deficit doves like Paul Krugman, who favor more stimulus now, are fretting about “structural deficits” in the future. They insist that even if we do not need to balance the budget today, we will have to get the “fiscal house” in order when the economy recovers.
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In fact, MMT-ers NEVER have said any such thing. Our claim is that a sovereign government cannot be forced into involuntary default. We have never claimed that sovereign currencies are free from inflation. We have never claimed that currencies on a floating exchange rate regime are free from exchange rate fluctuations. Indeed, we have always said that if government tries to increase its spending beyond full employment, this can be inflationary; we have also discussed ways in which government can cause inflation even before full employment. We have always advocated floating exchange rates — in which exchange rates will, well, “float”. While we have rejected any simple relation between budget deficits and exchange rate depreciation, we have admitted that currency depreciation is a possible outcome of using government policy to stimulate the economy.
A favorite scenario used by the critics is the ever-rising budget deficit that causes the government debt-to-GDP ratio to rise continuously. As interest payments on the debt increase, government faces a vicious cycle of rising deficits, more debt, more interest paid, higher interest rates, and even higher deficits.
Our response is two pronged.
First, OK, let us accept your premise. Will the government be able to make all payments (including interest paid on debt) as they come due? The answer is, of course, “yes — by crediting bank accounts”. Insolvency is not possible when one spends by a simple keystroke. The critic then quickly changes the subject: Weimar! Zimbabwe! You are a destroyer of the currency! Yes, but it was your scenario, not mine. And even in your worst case scenario, the government cannot be forced to default. Instead, Krugman argues “the government would decide that default was a better option than hyperinflation”. In other words, Krugman veers off into politics — government “decides” to default — because the economics does not give him the result he wants.
Second. Your scenario is highly implausible. As budget deficits rise, this increases income (government spending exceeds tax revenue, thus adds net income to the nongovernment sector) and wealth (nongovernment savings accumulated in the form of government debt) of the nongovernment sector. Eventually, this causes private spending and production to grow. As the economy heats up, tax revenue begins to grow faster than government spending or GDP. (In the US over the past two cycles, in the expansion phase federal tax revenue grew two to three times faster than GDP and government spending.) This reduces the government deficit (remember the Clinton boom and budget surpluses?). Even if the government spending is on interest (in Krugman’s model, the deficit is due to interest payments) that generates nongovernment income and spending. In other words, the cyclical upswing will automatically reduce the budget deficit. The scenario ignores the “automatic stabilizers” that cause the budget deficit to swing counter-cyclically.
How Republicans can explain how we cannot afford it
Republicans have this permanent game on: they can’t explain why the most productive country in the world cannot afford what everybody else can afford today …
… so they project the “cost” 40 years out and pretend that your grandchildren wont be able to afford it. How many people can realistically forecast in their minds 40 years out? So they fall for it — the far distant mirage.
Assuming the debt does pile up — thanks to Republican tax cuts for the rich and our unwillingness to pork the poor over them — our grandchildren and great grandchildren will have more money than we have to pay it off thanks to decades of productivity growth — but they wont pay; they will leave it for their great grands — who won’t pay for … . Nothing that would get me up early in the morning to work on it.
PS. Just who would we owe all this money to — ourselves mostly? To the Chinese can only loan us money left over when we buy stuff but neglect to sell them anything back. Cumulative GDP over next two generations something over 1,000 trillion — that would be a lot of stuff. To the great grandchildren of the rich who loaned the government money rather than pay taxes? Once unions return rule to the average person we can just confiscatory tax most of that back.
I am certainly not a deficit hawk, but this:
“Will the government be able to make all payments (including interest paid on debt) as they come due? The answer is, of course, “yes — by crediting bank accounts”. Insolvency is not possible when one spends by a simple keystroke. ”
is just silly. The payments are not made with a “simple keystroke”, they are made by a contract. there is an obligation. And ignoring that simple fact is bewildering to me. And I get the fact that money could just be printed, but the controls on this printing is cumbersome unless you make raising taxes act like another “automatic stabilizer.”
Let me know when you find a party, let alone a government, who is going to be able to pass into law automatic tax increases that are set off when an inflation figure is issued.
Not in this lifetime.
“Second. Your scenario is highly implausible. As budget deficits rise, this increases income (government spending exceeds tax revenue, thus adds net income to the nongovernment sector) and wealth (nongovernment savings accumulated in the form of government debt) of the nongovernment sector. Eventually, this causes private spending and production to grow.“
First if the economy had continued as it had after 1945, then the assumptions in this scenario would be true. The booms and busts of the US domestic economy were controlled by the FED and tariffs regulated the externality of foreign trade.
But by about 1980, tariffs could no longer control Japan’s influence in the US economy. There were howls when Japan began buying US assets with their profits. The answer came in the form of voluntary quotas and Japan’s moving some of their production into the US.
In about 1985 the FED began a long trend of lowering interest rates and at about the same time the personal savings rate was falling. (Income minus spending is either savings or debt.) Something was wrong.
See EFFECTIVE FED FUNDS RATE: https://fred.stlouisfed.org/graph/?g=eXz2
See PERSONAL SAVINGS RATE: https://fred.stlouisfed.org/graph/?g=eXyS
Then came NAFTA in 1994 and the free trade treaties that followed, all of which lowered tariffs.
By about 1996 American workers/consumers were borrowing more and more money by removing equity from their homes. And that continued until about 2007 when the banks finally woke up to their impending peril. Why were the baby boomers running up debt just as retirement was bearing down on them? They were simply trying to maintain their standard of living, in the face of almost stagnant income.
See: https://www.federalreserve.gov/pubs/feds/2005/200541/200541pap.pdf
What we have seen from 1985 to the present is that the foreign trade externality has gotten completely out of control.
The economic health of our domestic economy has leaked out thru the mechanism of relentless annual trade deficits with China, Germany, Japan, South Korea, Taiwan…
And that damage is continuing.
Given our annual trade deficits, some part of all the federal government borrowing is just sent to our trade partners. And real private spending will not increase until consumers have more real income to spend!
Eventually the accumulated deficits will exact a toll.
The mainstream economists and our elected representatives have been in denial for at least a decade. Just as I predicted 9 years ago!
“when the banks finally woke up ”
Hard to believe anyone could be so wrong about anything.
wow
Well,
I can’t claim to understand MMT or any other theory of the economy for that matter.
But the “deficit hawks” (Peter G Peterson and co.) don’t give a damn about the deficit. they use hysteria about the deficit to kill Social Security which has nothing to do with the deficit (it pays for itself.. that is, the workers who will get the benefits pay for them, or can pay for them if they understand it is their own benefits they are paying for).
However, none of this turns out to be new. Apparently it has been going on since about 1865. The people with most of the money create a theory which explains why it is necessary to keep wages low, unemployment high, taxes nil, social spending zero… so that the “laws of economics” will be allowed to work themselves out” workers will be taught discipline, and the rich will get richer, not that they need the money, but they do need the power in order to keep the money.