Koo Calls For Stimulus as Private Sector Deleverages

Richard Koo was on Bloomberg yesterday making a lot of good points about what public sector retrenchment will mean, namely a decrease in private sector savings. With households already highly indebted in many countries, this cannot be a good thing.

Nevertheless, from my perspective, he has the politics of this all wrong. Koo says:

I think the Greek situation should be separated from what I call the balance sheet generally. I’m against a pre-mature cut in fiscal deficits for those countries where the private sector is deleveraging.

But, here’s the problem. Greece is on the verge of default. And it most certainly would default as would Portugal, Spain and Ireland if they did not attempt to cut fiscal deficits. The big bad wolf pack is at the four little pigs’ door and they want to blow their house down. Do you think for a second that Greece would have any access to debt markets if it tried to maintain a large fiscal deficit?  Not on your life. I’m sorry, but this talk of high fiscal deficits in the Eurozone crisis countries is a complete non-starter.

But, then there are the other less imperilled Eurozone countries like Germany, the Netherlands and so on. Legitimately they could try to run high fiscal deficits.  But, consumers there are not deleveraging.

That leaves us then with the UK and the US, the only other countries where consumers are deleveraging.  Here, we know that government policy is aimed at keeping consumer spending high and, therefore, at actually preventing deleveraging. Moreover, as I have been saying for over half a year:

Deficit spending on this scale is politically unacceptable and will come to an end as soon as the economy shows any signs of life (say 2 to 3% growth for one year).

The recession is over but the depression has just begun, Oct 2009

Koo even talks about the political pressure in Japan that caused the government in 1997 and 2001 to reduce deficit spending. So, he knows full well that America and Britain cannot resist this. Perhaps Koo is making a rhetorical point like:

In a perfect world in which political leaders actually understood the financial sector balances, we would have the government sector deficit spend and stop propping up bankrupt companies who are poor stewards of capital. Then households could rebuild their balance sheets as we re-allocated investment to new enterprises and better stewards of capital.

But, you know and I know the predator state is alive and well; just look at so-called health care reform and the giveaway to healthcare insurers worked out in back rooms with no real cost adjustments. Clearly we need to be moving away from stimulus happy talk to focus on malinvestment. As long as the overleveraged and outsized financial sectors are being propped up in the UK and the U.S., I don’t see the point of talking about large deficit spending.

Now, I know my MMT friends would stress the points I made about the sectoral financial balances where government deficits exactly equal non-government surpluses.  Fair enough. That means, then, that the efforts to reduce government deficits will likely fail because of the efforts of the private sector to net save. And in a scenario in which the government is reducing aggregate demand that means recession. The only other scenario is one in which households maintain excess consumption and high leverage, making them sitting ducks in the next downturn. Take your poison.

But, I am going to take a different tack here. In a world in which stimulus is going to be used as an excuse to maintain excess consumption, prop up zombie companies and forestall an inevitable deleveraging, all while increasing public sector debt, I say no thanks.

Call me when we are no longer living in a predator state. Then, you can talk about stimulus.

The Koo video is below.

  1. Matt Stiles says

    “Call me when we are no longer living in a predator state.”
    The state is inherently predatory.

    1. Marshall Auerback says

      As opposed to the private sector, which of course, always acts in the
      public interest.

      In a message dated 5/19/2010 09:36:02 Mountain Daylight Time,

  2. Chad S says

    Yes, Edward. I think you have succintly summarized the “no free lunch” option of deficit spending. Theoretically this could work in the sectoral balances model, if we could assume that government expenditures and investment would be allocated at their highest and best economic uses, or, at a minimum, with the same payoff as the private sector would use those funds. However, this is very far from reality, .e.g. allocating public funds to bail out bank bondholers and union welfare benefit plans. Therefore, government deficit spending + unresolved bad debt = a net negative for economic growth.

    It’s becoming more difficult to see how this will not result in another global recession within the next 2-3 years, as we continue to prop up the zombie animal.

    Simply stated, the only medicine that will cure this is a massive and orderly debt for equity conversion at nearly every level, combined with a very necessary recession to deflate away mailinvestment. Of course, some currency devaluation could help ease the transition in the developed world, but it is hard to for everyone to do this at the same time.

    My thoughts anyway. No good options but taking the medicine.

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