More thoughts on out of control deficit spending
About a year ago I wrote a post called "Out of control US deficit spending". The purpose of the post was to begin a series of posts presenting the modern monetary theory (MMT) framework from a deficit hawk’s perspective, what I later dubbed MMT for Autrians.
I just want to reiterate a few themes from that post and some other MMT-themed posts in light of Stephanie Kelton’s guest post where she asked Can The US. Afford Its Present Deficit Spending?. While I am not an MMT-er, I do use the MMT framework for discussing a lot of economic issues because it is a more accurate depiction of the mechanics of our fiat money monetary system. Bookmark this page if you want a post to review and come back to which highlights the major economic themes addressed by MMT.
- Like it or not, we live in a fiat money world. No major currency now traded on foreign-exchange markets is linked to gold or other precious metals. Wikipedia says, "Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree." This fiat money system is quite different from a gold standard. Many economic pundits are trapped in a gold-standard mentality and make arguments that are irrelevant in a fiat money world. (See Misunderstanding Modern Monetary Theory for an example).
- Most importantly, fiat money makes sovereign default less relevant but currency depreciation and inflation more relevant. And, no, a weaker currency and inflation do not equal default even if it feels like theft. Government can default on a fiat currency obligation. Doing so is a political decision not an economic one. The government can always make good on a claim in the money it has created if it chooses to do so. (See Russia, sovereign debt defaults, and fiat currency).
- From the government’s perspective, there is no functional difference between any of its obligations like bank notes, electronic credits, or treasury bills and bonds. As a ten pound note says, “I promise to pay the bearer on demand the sum of [fill in the blank sum][fill in the blank fiat currency].” The fact that the U.S. issues bonds to cover its deficit is an artificial constraint that is a legacy of the gold standard. I assume we still have this policy as a political decision to prevent government from just printing money to cover spending. (See If the U.S. stopped issuing treasuries, would it go broke?)
- The question then is about political choices, resource allocation, currency depreciation and inflation. For example, in the U.S. there has been a lot of discussion about ‘starving the beast’ by shutting down the government until spending is brought to heel. This is an entirely political debate based on choices about the size of government and resource allocation in the economy. It has nothing to do with affordability. I think this kind of brinkmanship is reckless and deeply irresponsible. This is not the way you would see these issues debated in Switzerland or Germany for example. For bondholders, the political risk of potential default in the U.S. is real in a way they are not in those other two countries. There is a real possibility the U.S. could default. For that reason alone, the U.S. doesn’t deserve a AAA bond rating. (See Bill Gross: Deficit Hawk, Bond Vigilante).
- In regards to resource allocation, we must always keep in mind the accounting identity which shows that government deficits are exactly equal to non-government sector surpluses. That is to say, in an open economy like the U.S., the private sector balance plus the current account balance is exactly offset by the government sector’s balance. Any movement in one balance necessarily moves the others. As I indicated in my post labelled "Out of control deficit spending", we need to separate the accounting from the ideology. The economics and accounting of budget deficits is clear. It is the policy prescriptions where ideology and political choice are key. (See Economics 101 on government budget deficits).
- MMT demonstrates that budget deficits are the result of an ex-post accounting identity. In plain English that means the policy prescriptions are the economic input and the deficit is the output. Focus on the policy and policy goals, not deficits. Stephanie Kelton correctly stated, "debates about "affordability" become inapplicable. As this becomes more widely understood, we can begin to have a completely different — and vastly more important — debate about the size and role of government." This is where MMT’ers and I differ. We both recognize that the policy prescription debate is about resource allocation and the size of government. However, MMT’ers are principally concerned with full employment and using government to help achieve that goal. I am also concerned with full employment but have a more negative view of government’s ability to achieve full employment without cronyism or resource misallocation. It is important to remember that one doesn’t have to agree with MMT’er policy prescriptions to use the MMT framework (See Does focusing on deficit reduction reduce deficits?)
- The U.S. dollar’s role as a reserve currency creates pressure on the capital account, causing a capital account surplus and a current account deficit. Combined with the private sector’s desire to net save, this entrenches federal government deficits (See How To Reduce Government Budget Deficits)
There are a few other points I want to highlight related to deficits and debt.
- The national debt is a government liability. The national debt is the debt holder’s asset. See Money the government owes us
- The BIS, the central banks’ central bank, has issued a report warning that malinvestment is likely to continue in a world of excess monetary stimulus. How do you deal with that problem? See Why Stimulus Is No Panacea
- The Europeans are in a fundamentally different situation to the U.S. or Britain because of the currency issue. Spain does not have a sovereign currency. Ireland does not have a sovereign currency. This makes them users of currency and beholden to market liquidity. See On Creators of Currency and the Sovereign Debt Crisis.
- QE2 is not good economic policy because it is just an asset swap and has no direct effect on the real economy except via private portfolio preferences. As a result, it encourages leverage and speculation and opens the Fed up to charges of recklessness. See QE2 Is Equivalent to Issuing Treasury Bills and Does Ben Bernanke Believe The Stuff He Writes?
I think I will leave it there. What should be clear is that if you can’t even agree about the mechanics of the issue, you’re not going to have a good debate about the substance. Some of the points I have outlined above are incontrovertible. The accounting identity of government deficits and non-government surpluses is one. You should view people arguing for cuts in deficit spending who do not also point to this identity in a dubious light. Assume they don’t even realize the identity exists. How are they going to be able to have an enlightened view about deficits if they don’t understand that government deficits are the mirror image of non-government surpluses?
Nice overview of MMT. From observing the MMT blogs and reading the books, I’m afraid I can’t conclude that MMTers are less inclined to believe in “government’s ability to achieve full employment without cronyism or resource misallocation.” If you read Galbraith’s book Predator State he fills the pages of examples of the government being used as a tool for just those things. All the MMTers are aware of how intellectually bankrupt economic ideology was and is being used to justify government policies which contributed to the current financial crisis which have generated record profits for the banks. I could go on, but I think I’ve conveyed the idea. Where there MIGHT be some disagreement between you and most MMTers is that they are less likely to use the possibility, even likelihood that full employment policies by the government will contain some degree of cronyism and “resource misallocation” (a highly subjective term) as a justification for policies which impoverish ourselves.
They are hugely doubtful of the private sector’s ability to generate full employment alone. Mosler proposed a full FICA tax holiday which was warmly received from every MMTer I know. The main problem facing mature capitalist economies is that productivity increases make it possible for fewer and fewer people to produce all that is demanded. So what if tax cuts just lead to more saving and not sufficient demand to generate full employment? What are the unemployed to do? What if tax cuts lead to an influx of money in financial markets seeking short-term returns. It may do little to improve employment- instead it probably will further worsen corporate productivity and wreak havoc on commodity prices.
All MMTers I’ve observed thinks government should be closely monitored and limited. They feel it should supplement demand when the profit motive alone is not enough to generate full employment. This isn’t the same as being nieve about corruption or pretentiously termed “moral hazard.” I see it about providing solutions to social problems that are never politically feasible if the public is convinced by an endless stream of mis-information the government has never done any good.
Thanks for the reply, Jeff. I was having this conversation with Scott Fullwiler and Randall Wray and, yes, they both indicated they were concerned about cronyism and the Predator State. So you are right that this is something that concerns them. Perhaps I shouldn’t say I am more negative than they are on that level. Perhaps I should say that they are more convinced that full employment is the primary goal of government.
Where I think Scott, Randy and I agreed as that the cronyism and resource misallocation is less important than the output gap from underemployment in a massive recession like the one we have had. If you had to err on any side, it would be on the side of increasing demand in order to close the output gap, even if that meant some level of government waste and/or cronyism and resource misallocation. The alternative is to allow labor to sit idle and thus mis out on tens of billions in potential production.
One more thing about the cronyism that has to do with the present political debates. I think this goes to my point more and is something I have discussed quite often with Marshall Auerback. The Obama Administration is seen as having used ‘Keynesian’ stimulus as a primary tool in dealing with the crisis. In my opinion, it is relatively certain the economy would be in worse shape if they hadn’t done so. The same goes for the liquidity provided in QE1.
The problem is the WAY it was done and why this invariably leads to a certain disgust in the electorate. In both cases, in terms of the Obama Administration and the Fed, you saw the Predator State at work, meaning policies favoured certain groups over others. Now I think the fiscal stimulus was too small and not targeted enough. But that’s neither here nor there when the bailouts are the major ‘stimulative’ activity that the electorate sees. That’s where the problem is. And while Tim Geithner says these ‘deeply unpopular, deeply hard to understand’ policies were necessary, doing things this way ensures that stimulus is discredited as a policy tool. I am thinking principally of the freebies for the too big to fail banks.
My point here about cronyism and resource misallocation has much to do with that. The point being that if you are destined to get cronyism in a deep downturn, you are also likely to get stimulus revulsion and that necessarily undermines the ability to provide any stimulus, whether it helps or not. What I am saying is that the move into deficit hawk territory and the (often false) arguments used to support this move are enabled greatly by cronyism. The cronyism makes these arguments persuasive and fatally undermines any attempts to use government as a tool to diminish the impact of underemployment.
So, while MMT’ers are hugely doubtful of the private sector’s ability to generate full employment alone, they will have to make do with the private sector’s lead while the government is in the thrall of corporatism – if only for political reasons.
I hope I explained that better this go round.
Ah, now we’re all on the same page. Sometimes I forget that a large segment of our population thinks that government should do nothing to fix the #1 problem Americans are dealing with- that of involuntary unemployment.
I actually think that the US and UK governments reliance on the private sector to reduce unemployment while refusing to run deficits to allow the economy to recover is foolish. While waste and misallocation is a risk, the lost output is far greater and that is the greater crime. High unemployment leads to a lost generation and even greater problems decades down the road.
Ultimately I can only see the situation getting worse, as government policy is misguided and the deficit cutting fails to help the economy. As you say the private sector will fail to create enough jobs to save them. There will be further suffering as millions in the US exhaust their benefits and are effectively written off permanently. These will also be permanently excluded consumers, that is a lost opportunity for businesses. It could take many years before the realisation of the mess that they have created.
In the UK they only have a couple of years before the coalition has to make a substantial U-turn to get re-elected. In the US with the constant political cycle they are only interested in getting re-elected than solving the deeper fundamental problem of their political system and the economy. Congress and the President have already abdicated their responsibility to the Fed. It looks like it will depend on a sustained global recovery to help the US.
Nice overview of MMT. From observing the MMT blogs and reading the books, I’m afraid I can’t conclude that MMTers are less inclined to believe in “government’s ability to achieve full employment without cronyism or resource misallocation.” If you read Galbraith’s book Predator State he fills the pages of examples of the government being used as a tool for just those things. All the MMTers are aware of how intellectually bankrupt economic ideology was and is being used to justify government policies which contributed to the current financial crisis which have generated record profits for the banks. I could go on, but I think I’ve conveyed the idea. Where there MIGHT be some disagreement between you and most MMTers is that they are less likely to use the possibility, even likelihood that full employment policies by the government will contain some degree of cronyism and “resource misallocation” (a highly subjective term) as a justification for policies which impoverish ourselves.
They are hugely doubtful of the private sector’s ability to generate full employment alone. Mosler proposed a full FICA tax holiday which was warmly received from every MMTer I know. The main problem facing mature capitalist economies is that productivity increases make it possible for fewer and fewer people to produce all that is demanded. So what if tax cuts just lead to more saving and not sufficient demand to generate full employment? What are the unemployed to do? What if tax cuts lead to an influx of money in financial markets seeking short-term returns. It may do little to improve employment- instead it probably will further worsen corporate productivity and wreak havoc on commodity prices.
All MMTers I’ve observed thinks government should be closely monitored and limited. They feel it should supplement demand when the profit motive alone is not enough to generate full employment. This isn’t the same as being nieve about corruption or pretentiously termed “moral hazard.” I see it about providing solutions to social problems that are never politically feasible if the public is convinced by an endless stream of mis-information the government has never done any good.
Thanks for the reply, Jeff. I was having this conversation with Scott Fullwiler and Randall Wray and, yes, they both indicated they were concerned about cronyism and the Predator State. So you are right that this is something that concerns them. Perhaps I shouldn’t say I am more negative than they are on that level. Perhaps I should say that they are more convinced that full employment is the primary goal of government.
Where I think Scott, Randy and I agreed as that the cronyism and resource misallocation is less important than the output gap from underemployment in a massive recession like the one we have had. If you had to err on any side, it would be on the side of increasing demand in order to close the output gap, even if that meant some level of government waste and/or cronyism and resource misallocation. The alternative is to allow labor to sit idle and thus mis out on tens of billions in potential production.
One more thing about the cronyism that has to do with the present political debates. I think this goes to my point more and is something I have discussed quite often with Marshall Auerback. The Obama Administration is seen as having used ‘Keynesian’ stimulus as a primary tool in dealing with the crisis. In my opinion, it is relatively certain the economy would be in worse shape if they hadn’t done so. The same goes for the liquidity provided in QE1.
The problem is the WAY it was done and why this invariably leads to a certain disgust in the electorate. In both cases, in terms of the Obama Administration and the Fed, you saw the Predator State at work, meaning policies favoured certain groups over others. Now I think the fiscal stimulus was too small and not targeted enough. But that’s neither here nor there when the bailouts are the major ‘stimulative’ activity that the electorate sees. That’s where the problem is. And while Tim Geithner says these ‘deeply unpopular, deeply hard to understand’ policies were necessary, doing things this way ensures that stimulus is discredited as a policy tool. I am thinking principally of the freebies for the too big to fail banks.
My point here about cronyism and resource misallocation has much to do with that. The point being that if you are destined to get cronyism in a deep downturn, you are also likely to get stimulus revulsion and that necessarily undermines the ability to provide any stimulus, whether it helps or not. What I am saying is that the move into deficit hawk territory and the (often false) arguments used to support this move are enabled greatly by cronyism. The cronyism makes these arguments persuasive and fatally undermines any attempts to use government as a tool to diminish the impact of underemployment.
So, while MMT’ers are hugely doubtful of the private sector’s ability to generate full employment alone, they will have to make do with the private sector’s lead while the government is in the thrall of corporatism – if only for political reasons.
I hope I explained that better this go round.
Ah, now we’re all on the same page. Sometimes I forget that a large segment of our population thinks that government should do nothing to fix the #1 problem Americans are dealing with- that of involuntary unemployment.
I actually think that the US and UK governments reliance on the private sector to reduce unemployment while refusing to run deficits to allow the economy to recover is foolish. While waste and misallocation is a risk, the lost output is far greater and that is the greater crime. High unemployment leads to a lost generation and even greater problems decades down the road.
Ultimately I can only see the situation getting worse, as government policy is misguided and the deficit cutting fails to help the economy. As you say the private sector will fail to create enough jobs to save them. There will be further suffering as millions in the US exhaust their benefits and are effectively written off permanently. These will also be permanently excluded consumers, that is a lost opportunity for businesses. It could take many years before the realisation of the mess that they have created.
In the UK they only have a couple of years before the coalition has to make a substantial U-turn to get re-elected. In the US with the constant political cycle they are only interested in getting re-elected than solving the deeper fundamental problem of their political system and the economy. Congress and the President have already abdicated their responsibility to the Fed. It looks like it will depend on a sustained global recovery to help the US.