Deficit Hawk Hypocrisy

HawkMarshall Auerback presents us with a perspective on how deficit hawks want to cut social programs but leave defense spending untouched while completely overlooking the fiscal cost of bailouts (originally published at New Deal 2.0).

Harold Meyerson is spot on: “Of all the gaps between elite and mass opinion in America today, perhaps the greatest is this: The elites don’t really believe we’re still in recession. Or maybe, they just don’t care.” What is even more galling is that, having been the greatest beneficiaries of the government’s largesse over the past 2 years, these very same people now decry the government’s “irresponsible” and “unsustainable” fiscal policy.

The collective amnesia and moral turpitude of these elites is truly mind-boggling.

Why do we have a deficit of about 10% of GDP right now when it was less than 2% about 3 years ago? The reasons are: the Obama stimulus, the TARP, and the slower economy (which arose in response to a major financial crisis, not because the government began an irrational and irresponsible spending binge). A slower economy leads to lower revenues (less income=less taxes paid since most tax revenue is based on income, and lower tax brackets) and higher spending on the social safety net.

Conveniently lost in all of this furor about the deficit are the beneficiaries of this recent government largesse. It’s certainly not the unemployed or the vast majority of people who do not work in the financial services industry.

And let’s stop with the now prevailing meme (regurgitated most recently in John Heilemann’s New Yorker Magazine piece, “Obama is from Mars, Wall Street is from Venus”) that the costs of the financial bailout are minimal thanks to the “successful” measures taken to “save” our financial system (as if it is worth saving in its current incarnation). With the conspicuous exception of Simon Johnson, virtually all analysts fail to factor in the fact that our public debt to GDP ratio has moved from 40% of GDP to 90% in the space of 2 years, directly as a consequence of the crisis of 2008.

Naturally, the deficit terrorists are now out in force about this fact, conveniently forgetting the underlying cause of this increase. So are the journalists who cover it, Meyerson being a conspicuous exception. In a market economy, where most of us have to work to make a material living, the threats posed by the likes of Pete Peterson and the deficit hawk brigade represent a true impingement on our right to work. As my friend Bill Mitchell notes, “the neo-liberals deliberately undermine the right to work of millions and force them into a state of welfare dependence and then start hacking into the welfare system to deny them the pittance that the system delivers.”

The elites who decry this government spending (especially the ones from Wall Street) are akin to a person providing someone with 5 packs of cigarettes a day and then bemoaning the fact that the recipient irresponsibly contracted lung cancer.

What will happen to the deficit as and when the economy finally improves? The Obama stimulus and TARP go away in a few years regardless. Tax revenues increase and safety net spending falls. We’re back to “normal” with deficits around 2-4% depending on the state of the economy, which is where we’ve been for the past 30 years aside from 1998-2001. Even CBO agrees, though what happens to the Bush tax cuts will have an effect of about + or – 2% of GDP (depending on whether they are extended or ended, respectively).

In fact, full employment is also the best “financial stability” reform we could implement, because with jobs growth comes higher income growth and a corresponding ability to service debt. That means less write-offs for banks and a correspondingly smaller need to provide government bailouts.

Fiscal austerity, by contrast, won’t cut it. Our elites seem think that you can cut “wasteful government spending” (that is, reduce private demand further) and cut wages and hence private incomes and not expect major multiplier effects to make things significantly worse. Of course, that “wasteful”, “unsustainable” spending never seems to apply to the Department of Defense, where we always seem to be able to appropriate a few billion, whenever necessary. “Affordability” principles never extend to the Pentagon, it appears.

Our policy-making elites also seem to have bought the IMF line that the fiscal multipliers are relatively low and that the automatic stabilizers (working to increase deficits as GDP falls) will not drown out the discretionary cuts in net spending arising from the austerity packages. The overwhelming evidence is that this viewpoint is wrong and implementation of policies based on it cause generational damages in lost output, lost incomes, bankruptcy and lost employment (especially denying new entrants from the schooling system a robust start to their working life).

The real issue is that those who are better off don’t want to have government intervention in economic affairs unless it benefits them. With typical ingratitude, Wall Street is now threatening to cut campaign donations for Obama and the Democrats because of their proposals to impose more regulation on the financial sector. However, when the government intervenes with bailouts, Wall Street stands first in the queue, cap in hand. No one wants to bear the actual discipline of markets if that means losses. Those at the high end of income distribution aren’t against every kind of government intervention, but are frequently against certain types of government intervention that might make the workers stronger, or create competition for private businesses (in the case of a public option in health care reform, for example).

Full employment is the real value that should guide economic policy, not the bogus emphasis on financial ratios that just play into the hands of the financial sector. Somehow, I doubt that this is the underlying principle guiding our “counsel of wise men” who are deliberating the future of Social Security and Medicare behind closed doors as the rest of us debate this issue in the open.

  1. Jack says

    What would you expect people in power to do? Act generously?

  2. Matt Stiles says

    A lot of blanket statements again here, Marshall.

    Myself and most other libertarians who would consider themselves “deficit hawks” have lamented the US’ imperialism as both costly and unconstitutional.

    We all know that neo-cons are hypocrites. We know that corporatism is just as far away from free-markets as is socialism. So why do you continually group all deficit hawks together?

    I don’t believe in government deficits because I don’t believe the pursuit of any certain “equilibrium” is attainable by doing so, primarily because of malinvestment that is heightened by government central planning. But also because I don’t believe in equilibrium based models at all.

    A lower level of output, employment, wages and prices is likely NECESSARY to stimulate investment in goods of a higher order. And it is those goods of higher order (things that make things) that will improve the overall welfare of a nation.

    A depression is necessary and desirable. Your attack on all deficit hawks starts from the assumption that some indiscriminate notion of equilibrium must be maintained. That is where you are wrong.

    1. Marshall Auerback says

      You might not feel that way, Stiles, if you join the ranks of the
      I never speak in terms of “equilibrium” because I don’t think it exists in
      markets. They are not self-correcting. That’s your phrase, not mine.
      Yes, I attack deficit hawks because I believe they display a complete
      ignorance or lack of understanding of basic accounting identities. As a pure
      factual matter, the annual govt deficit equals, to the penny, the change in the
      total of Tsy secs (time deposits in Fed accounts), reserves (clearing
      balances at the fed), and cash in circulation.
      And the cumulative govt deficit- the total debt- is equal to tsy secs,
      reserves, and cash in circulation. to the penny.
      And, also as a point of fact, the total debt is equal to the total net
      savings of dollar denominated financial assets of the non govt sectors, to the
      In other words, you could change the name on the national debt clock in
      NYC to the world net dollar savings clock and leave the numbers alone.
      And govt (on a consolidated basis) does spend simply by changing numbers
      up on its own computer and taxes by changing numbers down on its own
      The govt never has nor doesn’t have dollars, any more than the bowling
      alley has or doesn’t have the points they post as your score. If you don’t at
      least start with the operational realities you’re just spewing empty

      The Great Depression taught us that, without government intervention,
      capitalist economies are prone to lengthy periods of unemployment. The emphasis
      of macroeconomic policy in the period immediately following the Second
      World War was to promote full employment. Inflation control was not considered
      a major issue even though it was one of the stated policy targets of most

      In a message dated 5/28/2010 10:25:00 Mountain Daylight Time,

  3. DavidLazarusUK says

    Bizarrely deficit hawks did not criticise Bush when he ran up the deficit. So this all looks either racist or partisan. While I would accept that it does need to be dealt with the fact that as Americans have already had 30 years of stagnant wages the economy will collapse if wages were to fall any further. Making a few CEO’s rich does not constitute a healthy economy.

    1. Marshall Auerback says

      And cutting the deficit in the manner proposed by the likes of Pete
      Peterson will actually exacerbate those very income strains that you rightly
      decry. For several decades after WWII, “finance capital” played an uncommonly
      small role. Memories of the Great Depression generated reluctance to
      borrow. Unions pressed for, and obtained, rising compensation—allowing rising
      living standards financed mostly out of income. In any case, government
      guaranteed mortgages and student loans (both at relatively low interest rates)—
      so most of the household debt was safe, anyway. Jimmy Stewart’s small
      thrifts and banks (burned during the depression) adopted prudent lending
      practices. The Glass Steagall Act separated investment banks from commercial banks,
      and various New Deal reforms protected market share for the heavily
      regulated portions of the financial sector. Military Keynesianism provided demand
      for the output of industry, often at guaranteed marked-up pricing. Low
      debt, high wages, high consumption, and big government promoted stability.
      The 1970s through to the present saw the development of an array of
      financial institution liabilities circumventing New Deal constraints as finance
      responded to profit opportunities. After the disastrous Volcker experiment
      in monetarism (1979-82), many new financial practices were adopted to
      protect institutions from interest rate risk. These included securitization of
      mortgages, derivatives, and other “off balance sheet” operations. Favorable
      tax treatment of interest encouraged leveraged buy-outs to substitute debt
      for equity. Another major transformation occurred in the 1990s with
      innovations that increased access to credit and changed attitudes of firms and
      households about prudent levels of debt. Now consumption led the way as the
      economy finally returned to 1960s-like performance. Robust growth returned,
      now fueled by private deficit spending, not by growth of government spending
      and private income. All of this led to what Minsky called “money manager
      capitalism” : “Capitalism in the United States is now in a new stage, money
      manager capitalism, in which the proximate owners of a vast proportion of
      financial instruments are mutual and pension funds. The total return on the
      portfolio is the only criteria used for judging the performance of the
      managers of these funds, which translates into an emphasis upon the bottom
      line in the management of business organizations.” He wrote this in 1996, and
      it’s only got worse since then. Of course, Minsky has been completely
      ignored until recently, so we get frauds like Bernanke perpetuating a radically
      different narrative.

      In a message dated 5/30/2010 04:25:19 Mountain Daylight Time,

  4. Sam Costanzo says

    Deficit hawks on Presidential Fiscal Reform Commission have latched on to a theory that the level of debt determines potential GDP. Never mind the composition of expenditures or the tax structure, just attack the deficit aggressively and that will increase economic growth. Some are saying we should target surpluses because that is the only way to bend the debt curve downward. A further increase in gross debt, they say, will kill growth and end the American dream.

    Anyone know where this theory comes from? Seems dubious to me, but very effective politically.

  5. Edward Harrison says

    I think the general thinking is that the government crowds out the private sector by redirecting investment capital away from the private sector to government. The higher debt is an ex-post indication that this has occurred.

    And, of course, the theory is that because the government is a poor steward of investment capital (no profit motive), this necessarily means lower growth. The Rogoff-Reinhart book is the research underpinnings used to support this.

    I have fewer problems with this than some more Keynesian types. However, its pretty obvious that 17% underemployment is an enormous burden to the economy. We are losing more in output through this lost employment than any misallocation of capital could possibly create. This should be obvious. Think 15 million people times $40,000 (unemployed) plus another 9 million times $20,000 (underemployed) That equals that’s $600 plus $180 billion annually. Or three-quarters of a trillion in lost output.

  6. Tschäff Reisberg says

    You’re right Edward. Add to that a “rational” public that increases their savings rate in expectation of higher taxes equal to the deficit+interest in the near future negating economic benefit.

  7. Tschäff Reisberg says

    In the current environment, government spending crowds in private investment, by adding to aggregate demand. The $800B stimulus package’s spending multiplier is estimated to be between 1 and 1.5. Indicating that consumption of private goods increased as a result.

  8. Edward Harrison says

    Bill Mitchell has a good post demonstrating that stimulus was/is the only thing standing between us and Depression:

    I would point out that the jobs bill going through congress is filled with non-jobs oriented stuff. If we really wanted to get stimulus bang for the buck, we would be getting people jobs.

  9. Scott Fullwiler says

    And while govt spending can most obviously be inefficient and/or poorly directed, regardless of the size of aggregate demand, a deficit doesn’t crowd out any available funds for non-govt sector–loans create deposits, after all. Deficits can crowd out private sector use of real productive capacity (and thereby create inflation), but they can’t crowd out available nominal “funds,” as the latter is not limited operationally.

  10. Sam Costanzo says

    Edward, public debt is rising very rapidly at present but I see no evidence of crowding out. At full employment it becomes a valid consideration, but one cannot make the arbitrary assessment that government is a poorer steward of capital than the private sector.

    A little crowding out from 2002-2007 would have been a good thing if it resulted in fewer houses being built and more smart grid, or more investment in basic research which is largely funded by government.

    Carmen Reinhart was a hit with some members of the Commission when she declared that gross debt is the best metric, and when it crosses the red line of 90% of GDP horrible things happen.. like the economy stops growing. This seems dubious to me and I was wondering if she had anything more than simplistic historical correlations to back it up… i.e. is there any convincing trail of causality?

  11. Edward Harrison says

    Government is a poor steward of capital. Deficit spending does not crowd out the private sector. That is my stance on those issues. The bubble was a result of lax regulation and low interest rates and has nothing to do with the private sector’s allocation of capital.

    Even so, bubbles have formed and will form even in the absence of those phenomena. But I would take the private sector over the public any day. Why not just go to complete public sector control then? That’s the logical extension of your argument, Sam.

  12. Sam Costanzo says

    By the way, SC Representative Spratt impressed me as the most intelligent and thoughtful member of the Commission. He had to remind the others that the composition of government spending and the tax structure was also a relevant consideration in assessing the impact of fiscal policy on growth.

  13. Sam Costanzo says

    No, public sector control is not the logical extension of my argument, Edward. The government has a role to play in our economy wether we like it or not. I take it there is no middle ground where you are concerned. It’s either all private sector or all government. Would be interesting to know, however, how you propose to remove the government from all stewardship of capital. Is there no such thing as a public good? Roads maybe?

    Also, I think the recent financial and economic debacle was much more that a bubble. We have a dysfunctional financial system more interested in playing at the casino than being good stewards of capital.

  14. Edward Harrison says

    Sam, “no middle ground”? what are you talking about? I proposed a jobs program and have said that deficit spending is what is needed over the short-term. I find that comment offensive frankly. I’m actually trying to have a real discussion.

    The question for me is what is the appropriate level of spending for government in society. That depends on the conditions at the time. For example, with a huge output gap and the private sector unable or unwilling to provide jobs, government needs to step in. That’s also what Randy Wray and Scott Fullwiler say as well by the way.

    But the concept that government is as good a steward of capital ceteris paribus over the course of the business cycle is not something I buy into. Debating that is a meaningless exercise in the context of what we are discussing here which is getting jobs right now and I think most everyone on this thread believes that the government needs to provide them directly, political commitment willing.

  15. Edward Harrison says

    how you propose to remove the government from all stewardship of capital. Is there no such thing as a public good? Roads maybe?

    I wouldn’t:

    Here’s the story, Sam. You seem to be having a phantom discussion with someone you consider a Libertarian ideologue. Instead I would prefer a conversation based on a mutual understanding of what government CAN do.

    And I think we would both agree that government can and SHOULD do more than it is at present (provided it doesn’t DO for the FIRE economy but for the rest of the economy). While I have less faith in government than you, it isn’t useful to have a discussion in which we entrench ourselves along ideological batt;lelines. That’s what I perceived you doing in the last comment. Am I wrong? If so, I understand.

    Read the link above. That gives you a better gist of my commentary.

  16. Sam Costanzo says

    Krugman has picked up on the spell that Reinhart’s “Law” has cast over the Presidential Fiscal Commission. According to Krugman, it is just a crude correlation without sound theoretical underpinnings.

  17. Sam Costanzo says

    Edward, sorry if my remarks were offensive. I agree with what you say about the output gap and near term need for deficits. I also agree that government stewardship of capital leaves much to be desired. My point is that we can’t escape it. There is a necessary role for government, and one that it has not filled well.

    Let’s find a way for the government to do a better job, like having a separate capital budget with different rules than other appropriations, and maybe something like the National Infrastructure Bank that Felix Rohatyn is promoting. Perhaps the World Bank could serve as a model with up or down Congressional votes as for base closings.

  18. Sam Costanzo says

    Scott, would you agree that deficit induced higher long term interest rates could crowd out private investment by making an increasing number of investment projects uneconomic?

  19. Scott Fullwiler says

    Sam . . . you’re making many good points here. Ed is, too. I find myself agreeing with both of you (I don’t think you’re that far apart). I completely agree with Sam on the 90% debt ratio. Regarding crowding out and interest rates, Sam, I would reject the premise that deficits would raise long-term interest rates for a currency issuing govt under flexible fx unless the cb raises its target or is expected to. I think that’s also the key problem with Reinhart/Rogoff, beyond correlation/causation, is the failure to distinguish b/n currency issuers and non-currency issuers, flexible and fixed fx, borrowing in currency of issue vs. borrowing in foreign currency, etc. In some cases R/R do make such distinctions, but the vast majority of applications of their results in the financial press never do.

  20. Scott Fullwiler says

    Ed . . .I think public vs. private is contextual, and that’s why MMT doesn’t take a big stance there. In the US, majority opinion will almost always be for a smaller public sector than, say, Sweden. I can live with that, whether or not I agree with it. The problem is pushing for a smaller public sector via reasons related to “affordability” or “the debt ratio is too high” or “interest rates will rise.” Those are invalid arguments (not that you’re making them . . .most everyone else is, though, unfortunately).

  21. Edward Harrison says

    Scott, I agree with those statements 100%. The size of government is a political or ideological issue and those who present it as an affordability issue do so to push an agenda on those who don’t understand the economics.

    The real problem is that right now we need MORE government but that government is captured both by crony capitalists and by deficit hawks. I am not optimistic.

  22. Scott Fullwiler says

    Agreed, Ed. Here’s a twist, though, since you’re the one saying we need more govt . . . MMT would argue that you need more govt OR less taxes OR some combo of those, not necessarily more govt. I think a payroll tax holiday, for instance, would have done far more for the economy than everything that’s been tried to this point put together. Further, the job guarantee isn’t necessarily about more govt . . . govt spending overall could fall under some circumstances.

  23. Edward Harrison says

    Exactly. Mark Thoma has come around to this way of thinking and that is more politically viable. I will probably write something on this tomorrow AM. The key, however, is deleveraging because Thoma says his concern is boosting aggregate demand by having people spend and they will save some of the taxes. Why is that a bad thing? The private sector needs to net save, especially households. We WANT them to save. If they spend, the saving will be done in the corporate sector or will simply go to increasing the trade imbalance.


  24. Scott Fullwiler says

    Exactly (back at you!). From the sector balances model, trying to do this via the non-govt sector reducing saving just reduces the non govt sector line. That could work, but, like you, I don’t think the non-govt sector has done enough deleveraging–households in particular, as firms aren’t nearly as bad off, having used the 2001 recession to fix their balance sheets when households didn’t. The end result if you try to get the non-govt sector to drive an expansion right now is just pushing off the day of reckoning and making the required fiscal adjustment that much larger . .. or, perhaps interest rates stay REALLY low for a long time to reduce debt service even as debt rises. That comes up against the problem that low rates can also be deflationary, as Warren keeps reminding.

  25. Sam Costanzo says

    Scott, understand your point about long term interest rates and generally agree with it, but have lingering concerns about the possible impact of “bond vigilantes” if deficits were perceived as spiraling out of control.

  26. Scott Fullwiler says

    Yes, I’ve heard that. My response to that is 4-fold. First, I doubt it will happen. Second, even if it does, it would have to be sustained for a few years or more to have a significant effect on the overall cost of debt service. Third, even if it does happen, the Tsy could issue short-term debt only. Fourth, the Fed could always target long-term Tsy rates either directly or via swaps. In short, even if it does happen and is sustained, it’s still a choice by Tsy and/or Fed to allow it to matter. (MMT adds a fifth, which is that the Congress could require the Fed to give the Tsy overdrafts at the target rate, or thereabouts, and then pay interest on the reserve balances created–net effect on the budget is the equivalent of debt service at the Fed’s target. Again, politically difficult, but it’s an option.)

  27. Scott Fullwiler says

    I could add a sixth, too, which is that the Marshall’s and Warren’s of the world would have a massive arbitrage opportunity if Tsy rates got significantly out of line with expected Fed target rates.

  28. Sam Costanzo says

    Edward, read your piece on government and found nothing that I would disagree with. Not sure what your point was regarding the Austrians. While they understood bubbles and the need for recessions, they were at a loss as to what to do in a depression other than follow Mellon’s advice to “Liquidate stocks, liquidate labor, liquidate farmers.”

    I am a great admirer of Keynes, who pointed out the shortcomings of Austrian theory, but like Keynes I do not believe that deficits are appropriate in all circumstances.

  29. Edward Harrison says

    Scott, the arbitrage question is one I took up recently:

    If the Fed controls short rates and the yield curve is a bootstrapped series of short rates, implicitly long-term yield changes imply some a future rate rise. And unless inflation comes-a-knocking, eventually that rise will not materialize. Investors who know this would arbitrage that situation via a relative value play.

  30. Edward Harrison says

    Sam, we’re fully on the same page then. The Austrians – especially those that believe in self-equilibrium – can be dangerous. Moreover, the Utopian view doesn’t consider the social and political climate of the purge they recommend. History shows that deep downturns incite social unrest and lead to military confrontation.

    I appreciate the framework regarding debt.

  31. Tschäff Reisberg says

    There are some things that markets do extraordinarily well when there are many sellers, low barriers to entry, undifferentiated products, buyers and sellers have perfect information. Practically nothing fits all these categories perfectly, maybe commodities are the closest thing I can think of to that. The farther you get away from those requirements the less likely you’ll get the benefits you seek from the market, yet for some reason people become blind to these problems or just accept them as a fact of life.

    But what I am wondering the most is how good is capitalism at creating large scale capital projects? My hunch is not very.

Comments are closed.

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More