The G-20 Votes for Global Depression

By Rob Parenteau and Marshall Auerback on how global ‘fiscal austerity’ benefits bankers and wealthy, well-connected political insiders, while screwing the rest of us.

Marshall Auerback is a market analyst and commentator. Rob Parenteau, CFA, is sole proprietor of MacroStrategy Edge, editor of The Richebacher Letter, and research associate at the Levy Economics Institute.

The Communiqué of the past weekend’s G20 meeting illustrates that deficit hawks have gained ascendancy in global policy making circles. Great Depression II, here we come.

“Those countries with serious fiscal challenges need to accelerate the pace of consolidation,” the Communiqué noted. “We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions.”

The Great DepressionEuropean Central Bank President Jean-Claude Trichet said fiscal tightening in “old industrialized economies” would aid the global economic “expansion” by shoring up investor confidence. German Chancellor Angela Merkel said Germany was poised for a “decisive” round of budget cuts that would shape government policy for years to come.

Although, the global economy has revived somewhat from its post Lehman collapse, it hardly merits Trichet’s characterization of “expansion”, given prevailing double-digit unemployment across the globe. And global recovery will be severely hampered if active fiscal policy support — the kind of government stimulus required to sustain higher levels of growth and employment — is completely abandoned, as the G20 discussions suggest. The new remedy for collapsing demand is “budget consolidation” — a weasel term designed to mask more spending cuts in vital social services.

Notwithstanding the US Treasury’s attempts to mitigate the rise of hair shirt economics, the Obama Administration has contributed to this rising type of deficit reduction fanaticism through its own policy incoherence. The President and his main economic advisors — Timothy Geithner and Lawrence Summers — continue to accept the deficit hawk paradigm: they agree deficits are ‘bad’ in the long term. But they argue for the necessity of tax cuts and higher government spending increases in the short term, and deficit reduction later. They also embrace the principle of “sound finance” — the type you read about every day in the papers: balancing the budget over the course of the business cycle and only increasing the money supply in line with the real rate of output growth. They ignore the more crucial consideration: namely, that the government should maintain a reasonable level of demand at all times and that principles of “sound finance” should not be divorced from economic context.

It’s even worse in Europe. In Great Britain, the new Conservative-Liberal Democrat coalition is under pressure to eliminate the UK government’s deficits in spite of the fact that the previous Labour Government’s aggressive deployment of fiscal policy arrested the prospect of an Iceland-style economic calamity. Yet with no unintended irony, British PM David Cameron had this particular gem of an insight:

“Nothing illustrates better the total irresponsibility of the last government’s approach than the fact that they kept ratcheting up unaffordable government spending even when the economy was shrinking.” (Our emphasis)

So we’re supposed to ratchet up government spending when the economy is growing? When it can present genuine inflationary dangers? If this is the type of policy incoherence we have in store, then God help the United Kingdom. This statement would be funny if not so unintentionally destructive. The government will most certainly uphold the promise of “decades of austerity” with economic thinking of this quality.

Meanwhile, within the rest of Europe, the so-called “PIIGS crisis” has merely further reinforced the now prevailing view that deficits are bad and destabilizing in the long term, thereby necessitating strong doses of fiscal austerity, even at the cost of more short term pain.

They are all tragically mistaken.

To get back to first principles, there is no meaning in the term “large deficit”. As Bill Mitchell argues:

“The budget deficit is the difference between what the government spends and what it receives in revenue (mostly from taxation collections). We call the extra spending above taxation revenue – net public spending. It is an accounting statement only (that is, records information about the flows of spending and revenue collections) but movements in the deficit do provide information about the state of the economy… the budget balance will move toward or into deficit when the economy is weak because tax revenue is falling and welfare payments are rising.” (Our emphasis)

In this circumstance, the government must increase spending (either directly or via tax cuts) to arrest the downward spiral of private spending. In basic accounting terms, government deficit spending is merely the counterpart of private sector saving. It is not some sort of financial vacuum that draws in government revenues into one big financial black hole over time. What government deficit spending does is to permit the private sector to achieve its level of desired saving. When the latter changes, government spending ought to be adjusting in the opposite direction to offset it (unless the current account balance also changes).

The level of employment is the most obvious factor which affects the private sector’s tendency to save. Higher unemployment induces a bigger desire (need) for more precautionary private sector saving. The fact that there is nearly 10 per cent official unemployment in the US at present and even higher unemployment in Europe means that the governments have not helped enough to offset this higher tendency to save by generating higher levels of employment.

If the government ran budget surpluses for several years, then the private sector would have to run deficits for just as many years — going into debt that totals trillions of dollars in order to allow the government to retire its debt. It is hard to see why households would be better off if they owed more debt, just so that the government would owe them less.

We should think of the fiscal policy as a balancing wheel where spending financed by borrowing must offset the propensity to save (and the propensity to import) out a full employment level — as long as private sector going into debt is not sufficient. Our position is, in effect, a 21st century version of the great post-Keynesian economist, Abba Lerner’s “functional finance” as opposed to the misleading and destructive “sound finance” theory. Lerner explained the way we ought to decide on fiscal policy like this: “The central idea is that government fiscal policy…shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound.” ) Lerner’s objective was to advance economic policy debate beyond what he called “sound finance” (which is the precursor to today’s destructive neo-liberal thinking).

Thinking along Lerner’s lines, we suggest that the primary objective of fiscal policy must be to spend on productive job creation packages. It should not be driven by crony capitalism, which directs massive financial subsidies to a few wealthy, well-connected political insiders. This has been a crucial flaw in virtually all global fiscal packages. Bond holders continue to get paid back at par, whilst the sheer magnitude of these payments is being used as an excuse to slash vital public services, pensions and other government spending.

As private spending recovers over time, the budget deficit starts to shrink automatically (via the automatic stabilisers). At some point, the government may have to cut back its discretionary net spending to avoid overall aggregate demand (the total spending in the economy) becoming excessive in relation to the capacity of the output side of the economy to produce. If demand outstrips that capacity, then we get inflation. Of course, when inflation happens, governments may choose to increase taxes to choke off some private spending. It all depends on the economic context in which these decisions are taken.

With Lerner’s ideas in mind, here’s what we would consider an ideal statement from the G20:

“A prosperous and sound economy is indeed one of the foundations of national security, if not the central pillar (or even the ground, for that matter) of any such foundation. Therefore, we demand that all G20 nations launch a new comprehensive employment security measure which entails a minimum or living wage job guarantee for all takers.

In Europe, we urge suspension of the self-imposed fiscal rules embodied in the Treaty of Maastricht. Furthermore, we recommend the expansion of the European Investment Bank to become the funding mechanism through which the current account surplus nations, such as Germany, can recycle their surpluses in demand deficient deficit countries within the EU, so as to generate additional employment and thereby better facilitate debt service across the euro zone.

In the US, pilot projects will be immediately authorized and put into action in Detroit and along the Gulf, preferably before a long hot summer gets too far underway. Gulf hiring will be devoted primarily to environmental restoration, including the largest scale roll out of Army Core engineers ever contemplated in civilian history to mitigate the emerging ecological disaster approaching our shores. Troop recalls and a significant slimming of the public trough upon which defense contractors have been engorging themselves since even before Eisenhower’s famous “military industrial complex” confession will be completed to ensure budget “neutrality”, which is an arbitrary and utterly useless thing, since the only sustainable fiscal balance is the one that ensures full employment with product price stability. The time for a new national security directive has indeed arrived, and we urge all national governments to reconsider what the true basis of national security really is – a sustainable and thriving economy, and not one picked over by global speculative capital or its sock puppets politicians within the Predator State.”

The more the bankers’ interest is served, the worse and more debt-burdened the economy will become. Their gains have been bought at the price of domestic austerity. The G20 Communique irresponsibly and immorally ratifies this disgraceful state of affairs and we will all pay a severe price going forward.

The G20 policy makers, and their allies in finanzkapital, are like vultures picking over a dying carcass. And the rest of us are helpless because the institutions designed to serve broader public purpose have become subverted. We are making bond holders and big bankers whole at the expense of impoverishing the entire society.

It is hard to avoid drawing very dark conclusions. Our policy making elites have discovered that the underclass doesn’t matter politically anymore, so why respond to it? That indifference is extending to the middle class. Ordinary, struggling folks are all becoming so demoralized that they present:

1. No voting threat, because none of the major political parties in Europe or the US genuinely represent their interests (and haven’t for years). There have been, as a result, no political price to pay for such shameless predatory capitalism.
2. They present no power threat, because they have been systematically destroyed over the last 30 years and what is happening now in Europe represents the final assault on the residue of the 20th century welfare state (the US social safety net eviscerated well before this).

The message from the G20 seems to be this: We’re through with domestic spending to employ the underclass.

There are decent jobs for about 20% of the working-age population in the west. And for the rest? Poverty a la South America. It is extraordinary that voters around the globe continue to tolerate this corrupt state of affairs, but it’s getting increasingly hard to see a way out.

This post first appeared at New Deal 2.0.

  1. Jbecker says

    Thank you Mr. Parenteau, for your very well written and easy to understand post. It is fascinating how the orthodoxies that rule the public discourse on budgets and defecits always come out with the same conclusion – the poor and middle class must bear the brunt of any financial pain, while the investor and upper class will continue to sip the bubbly, thank you very much. They cry “Markets must be free” and then when the —— hits the fan, it’s “save us, and pass the pain down the line.” Your comment on Mr. Cameron’s statement is amusing, but scary. How is it that politicians the world over understand so little of how the economy really work? In California right now we have a candidate for governer (who might win) promising to end the last major welfare program left to keep the jobless and poor off the streets! All in the name of balancing the budget and running the state “right size.” Where will it end? Thank you Credit Writedowns for offering a place to fine sane discourse on this rough time we are going through.

    J. becker

    1. Macrostrategy Edge says

      Jbecker: Glad you get it. You would be surprised at how many people don’t – or rather, won’t. I have personally handed my papers on these matters to Paul Krugman, and even though he devised a diagram that puts him in the same analytical framework almost a year ago, he still writes as if he cannot get this elementary accounting straight in his head. And this is a Nobel Prize winning economist?

      Now as to where it will end, the depends upon what you are willing to do now that you armed with the proper framework, one that is at least coherent and consistent in dealing with macrofinancial matters. Marshall and I, among others, have chosen to stick our necks way out to get the truth out. It is not easy. We face many closed doors and outright harassment because we are willing to speak truth to power.

      So J. Becker, what are you willing to do to rip the Vampire Squid off your face, and off the faces of those you care about? Reading a blog is one thing. Thinking it through is admirable. Now forward it to ten of your friends at least. And figure out how you can spread the word and take action informed by this analysis to mitigate the unnecessary human suffering that is being imposed in the name of “sound finance”.



      1. J. Becker says


        Thanks for the challenge! To be honest, and as was probably obvious from my post, I am a layperson when it comes to economics and I have to work really hard to understand some of the concepts and terms thrown around on these pages. My awakening was this last crash when I saw my 401K (what a waste – hostage money!) lose half its value for the second time in a decade (2000 was the last) and then the company I work for almost went under. I decided I better find out what the hell was going on so that I could take some actions to mitigate the effects on my family. In the realm of “ripping the vampire squid off…” I have brought up the subject with freinds and famiy, and the reception has not been the warmest. But, as you said, speaking truth to family and friends (much less to power) is not easy. I will start forwarding the blog, maybe that will have more impact then my unclear ramblings.


        J. Becker

  2. Chad S says


    Question: What happens when both the private and public sectors are over indebted? Is there not a limit to the aggregate borrowing of the economy?

    This is not a trap question, but a legitimate one i’ve been pondering. As you say, when the private sector deleverages and increases its savings, the government is simply taking these savings and spending/investing them. However, what if the economic growth that occured to get us to this point was based on overexpansionary credit growth?

    It just seems that someone that under this scheme there is never a method of debt reduction because someone is always a net borrower. thus, the only way to reduce is to become a net exporter, in which case an entire currency/global trade balance adjustment would be needed.

    Incidentally, the WWII debt was reduced because massive private savings were available. Now, we don’t have that.


    1. Marshall Auerback says

      In a message dated 6/7/2010 1:56:12 P.M. Mountain Daylight Time,

    2. Marshall Auerback says

      There is a limit on public sector spending, but the limit is an
      INFLATIONARY constraint, not some self-imposed notion of “national solvency” which is
      predicated on a gold standard system. Those rules and the restrictive
      accounting procedures that they lead too are just voluntary constraints that
      have been inherited from the gold standard days where exchange rates were
      fixed and governments were financially contrained.
      In the era of fiat currency systems, the rules have been perpetuated by the
      mainstream economics ideology to constrain government to give more
      latitiude for “market activity”. The lunacy of that stance is that the private
      sector actually does better when there is a strong fiscal involvement.
      Anyway, the public debt limit is one such voluntary constraint that could
      be easily legislated out of existence if the public truly understood how the
      monetary system operated and that time has moved on since 1971 when the
      convertible currency system collapsed.
      Further, the idea that “taxpayers’ funds” will be squeezed to repay debt
      or service the health needs of the future society is also nonsensical. MMT
      tells us that taxpayers do not fund “anything”. Taxes are paid by debiting
      accounts of the member commercial banks accounts whereas spending occurs by
      crediting the same.
      The notion that these “debited funds” have some further use is not
      applicable to anything. When taxes are levied the revenue does not go anywhere.
      The flow of funds is accounted for, but accounting for a surplus that is
      merely a discretionary net contraction of private liquidity by government does
      not change the capacity of government to inject future liquidity at any
      time it chooses.
      The standard mainstream intertemporal Government Budget Constraint analysis
      that deficits lead to future tax burdens is also problematic. The problem
      is that the GBC is not a “bridge” that spans the generations in some
      restrictive manner.
      Each generation is free to select the tax burden it endures through the
      political system. Taxing and spending transfers real resources from the
      private to the public domain. Each generation is free to select how much they
      want to transfer via political decisions mediated through political processes.
      When I say that there is no intrinsic financial constraint on federal
      government spending in a modern monetary system, I am not, as if often
      erroneously claimed, saying that government should therefore not be concerned with
      the size of its deficit.
      I have never advocated unlimited deficits. Rather, the size of the deficit
      (surplus) will be market determined by the desired net saving of the
      non-government sector. This may not coincide with full employment and so it is
      the responsibility of the government to ensure that its taxation/spending are
      at the right level to ensure that this equality occurs at full employment.
      Accordingly, if the goals of the economy are full employment with price
      level stability then the task is to make sure that net public spending is just
      enough to ensure that is it not inflationary (adding to much nominal
      demand in relation to the real capacity of the economy to absorb it) nor
      deflationary (not filling the spending gap left by non-government saving).
      This insight puts the idea of sustainability of government finances into a
      different light. If the federal government (anywhere) tries to run budget
      surpluses to keep public debt low then it will ensure that further
      deterioration in non-government savings will occur until aggregate demand decreases
      sufficiently to slow the economy down and raise the output gap.
      The goal should always be to maintain efficient and effective public
      services and full employment. Clearly the real public command on resources
      matters by which I mean the resources that are employed to deliver the public
      services. So real infrastructure and real know how etc define the essence of
      an effective provision of public goods.
      The actual deficit figure is irrelevant in making this assessment, EXCEPT
      AN EXTERNAL CONSTRAINT (likewise in regard to a currency board set-up).

      In a message dated 6/7/2010 1:56:12 P.M. Mountain Daylight Time,

      1. Thenoblerot says

        what a bunch of bolox

        1. Marshall Auerback says

          “Thenoblerot” – is that your name, or a description of your brain?

          In a message dated 6/7/2010 4:30:14 P.M. Mountain Daylight Time,

          Thenoblerot (unregistered) wrote, in response to Marshall Auerback:

          what a bunch of bolox

          Link to comment:

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      2. David Saunders says

        Mr Auerback,
        I’m a big fan of MMT and view the events of 2008-2010 as irrefutable evidence that mainstream economists don’t know what they are talking about–the Fed was run over by a train it never saw coming …
        You write, “the private sector actually does better when there is a strong fiscal involvement.” Can you provide a link or other pointer to a source which describes in detail why this is true? Just would like to dot the i’s in my own understanding … the impression I have is that neo-classical economic theory has been essentially fine-tuned to maximize the profit of the finaicial sector, and other busines sectors in the economy would actually benefit reigning the banks in. Cheers.

        1. Marshall Auerback says

          It’s pretty basic, David. Any private business does better when the
          economy is growing more rapidly and employment is higher. Clearly, we are not
          advocating a government takeover of the private sector, but
          because a more or less free market system does not (and, perhaps, cannot)
          continuously generate true full employment, the government can facilitate
          higher employment levels and, therefore, a more optimal use of human
          resources. No civilized nation should allow a large portion of its population to
          go without adequate food, clothing and shelter. This is why most advocates
          of Modern Monetary Theory advocate the creation of a stock of EMPLOYED
          people, rather than a buffered stock of unemployed, where social capital
          depletes rapidly, and several long-term social pathologies develop. The current
          policies clearly are not working; it’s time to try something that can put
          as many people as possible into productive employment.

          In a message dated 6/7/2010 10:44:20 P.M. Mountain Daylight Time,

          David Saunders (unregistered) wrote, in response to Marshall Auerback:

          Mr Auerback,
          I’m a big fan of MMT and view the events of 2008-2010 as irrefutable
          evidence that mainstream economists don’t know what they are talking about–the
          Fed was run over by a train it never saw coming …
          You write, “the private sector actually does better when there is a strong
          fiscal involvement.” Can you provide a link or other pointer to a source
          which describes in detail why this is true? Just would like to dot the i’s
          in my own understanding … the impression I have is that neo-classical
          economic theory has been essentially fine-tuned to maximize the profit of the
          finaicial sector, and other busines sectors in the economy would actually
          benefit reigning the banks in. Cheers.

          Link to comment:

          Options: Respond in the body to post a reply comment.

          To turn off notifications, go to:

          1. Vangel says

            There you go again, advocating more meddling to solve the problem created by meddling in the first place. For the record, we are nowhere near a free market system. The problem originated in the highly regulated financial sector and has yet to be corrected even after hundreds of billions in wasted taxpayer bailout funds. Having the government spend more money on schemes that will not permit the market to liquidate malinvestments will create even bigger problems down the road.

    3. Macrostrategy Edge says

      Massive domestic private sector net savings (that is saving out of income flows minus tangible investment spending) can only occur if:

      a) the government is running a fiscal deficit,
      b) the trade balance is in surplus, or
      c) the trade balance exceeds the fiscal balance

      That’s not high theory, that’s 500 years of double entry book keeping.

      If you want to slow, halt, or reverse the pace of national debt (government plus domestic private sector) then you need to run a massive trade surplus for some time – preferably against countries that previously had been running trade surpluses with your nation.

      Got it?

      1. Chad S says

        Thanks, Rob. Yes, that confirms the heart of my question. Therefore, the only pathway of reducing the domestic U.S. debt is to become a net exporter, which would then allow an orderly reduction in public and private debt.

        Now, how does one magically become a net exporter to formerly surplus nations? Because the U.S. is competing globally for goods and labor, and those factors are not price-competitive today, it seems that the only option is deflation, either through an internal deflation or currency devaluation.

        I’m still wondering how government and/or the private sector can indefinitely over borrow with impunity. The rest of the medicine seems to have a low view of private property, in so far as the government is constantly central planning through the transfer of wealth between parties to stabilize a nationalized view of the economy…but I admit to potentially being wrong about that (to not insert a view that isn’t held).

        a) what should the government have done over the past couple of decades to avert excess credit growth

        b) isn’t currency devaluation legalized plunder of savers by those with first access to capital and winner-picking

        Thinking aloud…

        1. Marshall Auerback says

          The problem with an “internal devaluation” is that it doesn’t work. The reasoning is a bit like what we saw in Vietnam: destroying a village to save it (presumably from the perils of communism, although there wasn’t much to “save” once the place was turned into an ash heap). You forget that rapidly cutting fiscal deficits, without considering the impact of such moves on private sector financial balances, is a shortsighted, if not dangerous, policy direction. Sector financial balances — the difference between saving and investment, or income and expenditures — are interconnected, and cannot be treated in isolation. The “exit” here appears to be the dumpster at the end of the trash shoot. The US economy is of such a huge magnitude that any resultant increase in exports would surely be insufficient to offset the destruction of the domestic economy. On the other issue, a sovereign government in effect “borrows from itself”, so it can “borrow with impunity”. A sovereign government spends by issuing its own currency and as it’s the monopoly issuer of that currency, there are no financial constraints on its ability to spend. It doesn’t need to tax or issue bonds to spend; it simply does so by crediting bank accounts, technically changing numbers on spreadsheets. On the other hand, countries that give up their monetary sovereignty either by pegging their currency to a metal or to another currency, or by adopting a foreign currency altogether (for example through “dollarization”) lose their ability to finance their spending by issuing currency. A non-sovereign country that pegs its currency to another currency can only issue domestic currency up to the point where its foreign currency reserves will allow it to maintain the peg. If it issues too much of the domestic currency, a speculative attack will force the country to go off the peg. Adoption of a peg forces a government to surrender at least some fiscal and monetary policy space—of course, constraints are loosened if the nation can run current account surpluses to accumulate foreign currency (or precious metal) reserves.

  3. Vangel says

    What deficit reduction? All we have seen from governments is growth in deficit spending and money printing. Given the problems facing us there is no way that we will see anything but easy money conditions and monetization of debt as far as the eye can see. Does anyone think that the US Treasury and Fed will allow the states to go under and see the Chinese see the purchasing power of their Treasury paper explode as US consumers are going bankrupt? If you do buy long bonds or possibly gold. But if you don’t see them having the guts to do that sell bonds and buy gold.

  4. purple says

    There is a fairly string link between financial instability and income inequality, which was noted in ‘The Great Crash’ . An economy built around selling stuff to rich people inevitably rests on their puffed up asset values. These can deflate at very unpredictable times.

    The imbalances of income are at least as great as the imbalances of trade – the later, which many believe were the cause of the 2008 financial crisis.

  5. dga says


    > If the government ran budget surpluses for several years, then the private sector would have to run deficits for just as many years — going into debt that totals trillions of dollars in order to allow the government to retire its
    debt. It is hard to see why households would be better off if they owed more debt, just so that the government would owe them less.

    The statement that a public sector surplus necessarily causes a private sector deficit, and vice versa, comes from the basic macroeconomic equation that has been posted before, which you are no doubt familiar with:

    Private Saving – Investment = (Government Spending – Taxation) + (Exports – Imports)

    So it is possible that the western government budget surpluses will be offset by changes in their balance of payments with other governments, and not by increased household indebtedness.

    However, even in the absence of any change in the balance of payments, I think that your inferences are at best too alarmist, and possibly wrong. By considering human nature and the actual mechanisms by which the government borrowings will be repaid, it seems to me that the increase in private sector indebtedness, that would indeed follow inevitably from the decreased public sector indebtedness (in the absence of a change in the balance of payments), would most likely be in the form of new business ventures created by corporations or entrepreneurs, and not in the form of increased indebtedness of normal households.

    People tend to fall into one of three categories regarding their saving and spending habits:

    1. Spending maximisers. The profligate, those having trouble making ends meet, and many of those living on state benefits, spend whatever money they have and save nothing. This group of people do not hold government bonds in any significant quantity, if at all.

    2. Fixed savers. Many people save a fixed amount, or a fixed proportion of their income, which generally goes into a pension vehicle or similar savings vehicle. Anything they earn above that is spent. Their portfolios, whether self-managed or managed by others, will often include government bonds.

    3. Savings maximisers. They take a view on what to spend each year, often based on a lifetime income strategy, and save everything else. The very prudent, the thrifty, and those keen to retire as soon as possible would fall into this category. Their portfolios, whether self-managed or managed by others, will often include government bonds.

    There are also non-individual investors such as insurance companies who invest their premiums and investment banks who trade speculatively on their own behalf.

    When a government runs a budget surplus and uses the surplus to pay back bonds this will happen mainly by them not rolling over a maturing government bond. So the money from the budget surplus will be spent on repaying bonds at maturity. They might also actively repurchase their own bonds on the secondary market. The money would flow to the people in groups 2 and 3 above, plus the non-individual investors, and would end up initially as cash in their portfolios. None of the people in group 1 would see any of the cash as they didn’t have any bonds to begin with. But the people in groups 2 and 3 would not want to spend the cash – it would stay within their savings/retirement portfolio and they would want it reinvested. Neither would the non-individual investors want to leave the cash as-is as the repayment wouldn’t alter their trading strategy. What would follow would be a cascading series of trading activity. A pension fund may buy some equities or different bonds with the money. A bond mutual fund may buy some different government bonds. For every buy there is a sell, so other funds, trading desks and other portfolios would end up with the cash instead, and would mostly be wanting to reinvest it in something else. The money would flow around and gradually the market prices would rise, and so the cost of funding for new projects would fall. Note that those in group 1 are still no better or worse off because they didn’t have any investments in the first place. New ventures by companies and entrepreneurs would however become viable under the decreased cost of funding. Entrepreneurs would set up new companies and borrow money from banks or venture capitalists. Companies would start new ventures and some would raise new money on the stock or corporate bond markets, or borrow from banks or entrepreneurs. An equilibrium would be reached only when all additional funds from the maturing government bonds had been used up by new business ventures. So this is where the money that originally came from the maturing government bonds would end up. The additional private sector debt from the above equation would be in the form of private companies and entrepreneurs that have borrowed money for new ventures. This is good for the ecomony. In effect, the government borrowing had been crowding out the borrowing of private sector companies and entrepreneurs, and by running a budget surplus this crowding out diminishes.

    Your article says that ‘households’ will necessarily become more indebted because of the government budget surplus. I would not describe the private sector debts arising from additional corporate and entrepreneurial ventures as ‘household’ debt. You imply in a way that the already-over-burdened people in group 1 will become still more in debt, but I do not see that this is likely or even possible.

    Nor do I think it follows that the fiscal austerity will lead to another great depression, as you claim. Per the above logic, the austerity will lead to a replacement of public sector indebtedness with private sector indebtedness from new business ventures. If the repayment of government debt ends up being spent by new business ventures, which I think it probably would as new ventures tend to only raise money that they need to spend, then private sector spending + public sector spending on aggregate should remain much the same, so GDP may not be affected that much.

    That’s not to say that a downward GDP spiral due to private sector deleveraging won’t happen, but that’s a separate issue. According to the above reasoning, any attempt by governments to boost demand by increasing their spending and borrowing more would just crowd out more private sector enterprise.

    1. Marshall Auerback says

      I don’t accept the crowding out thesis, the notion that when the government
      borrows to finance its budget deficit, it crowds out private borrowers who
      are trying to finance investment. Thus, the most basic lesson about budget
      deficits … When the government reduces national saving by running a budget
      deficit, the interest rate rises, and investment falls. Because investment
      is important for long-run economic growth, government budget deficits
      reduce the economy’s growth rate.

      In fact, it’s just the opposite:
      First, there is no finite supply of saving that are available for
      borrowing. Aggregate saving increases with income and the latter responds positively
      to spending. So aggregate spending, however sourced “brings forward its
      own saving” as the dynamic adjustments occur to ensure that the planned
      aggregates are brought into concert with each other as required.
      The upshot of this is that the notion that government borrowing competes
      for scarce savings which then drive interest rates up is nonsensical.
      Governments only borrow back their own spending. The issuance of debt is just an
      offer to provide an interest-bearing asset in place of non-interest bearing
      (or low bearing) bank reserves. Exactly the same outcome would occur if the
      government just paid a return on overnight (excess reserves). This would
      accomplish all the central bank operational requirements to stop competition
      in the interbank market from driving the overnight interest rate away from
      that targeted by the central bank.
      And this strategy would have absolutely no implications for the government
      spending which created the reserves in the first place. The government doesn
      ’t need to borrow remember. When you are meditating this might be a nice
      mantra to work with – the government is not revenue-constrained.
      A private business is externally constrained. Yes, it might be the case
      that the entrepreneur, as opposed to the indebted household takes on that
      debt. But there are still limits and it is still inherently more financially
      fragile than public debt.
      Second, you can readily understand that budget deficits (net spending) by
      adding net financial assets to the non-government sector actually finance
      saving by that sector. It does this by providing the aggregate demand that
      keeps output and employment from contracting when the non-government sector
      is increasing its desired saving. So far from undermining saving (as in the
      second graph above) budget deficits are essential for the non-government
      sector to save.

      In a message dated 6/8/2010 11:51:11 A.M. Mountain Daylight Time,

    2. Edward Harrison says

      I also see crowding out arguments as spurious. See one of my posts today.

      The key is Marshall’s comments here:

      “there is no finite supply of saving that are available for borrowing. Aggregate saving increases with income and the latter responds positively to spending. So aggregate spending, however sourced “brings forward its own saving” as the dynamic adjustments occur to ensure that the planned aggregates are brought into concert with each other as required.”

      This is right. If the government spends, it INCREASES the supply of savings by increasing incomes. The only real worry a poor allocation of the increased capital investment aka malinvestment, not the actual amount of investment.

      Legitimately, government policy can promote such an enormous skew that it diminishes from savings available for specific private sector investment. But that’s an industrial and monetary policy phenomenon and not fiscal.

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