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Deficits are our saving

Even the most simple understandings are lost in the public debate about budget deficits and public debt. The Flat Earth Theorists who whip up deficit hysteria each day like to stun people with large numbers. They produce debt clocks that relentlessly tick over and try to get us to believe that impending doom is upon us. But if we just take a deep breath and think the situation through we would see that the ticking debt clock is really just a measure of the portion of non-government wealth embodied in public debt. We would then learn that budget deficits are just the mirror image of non-government savings. Saving is usually considered to be something we should aim for. Increased wealth is also something we usually aspire to. So the increasing deficits and increased debt outstanding is, in fact, beneficial to the private sector (overall). Once we understand that then the deficit hysteria becomes transparently ideological. These characters just hate government and want to get their greedy hands on more of the real pie.

I thought this article – The national debt is money the government owes us – which appeared in the UK Guardian (June 17, 2010) was interesting. If more people understood the argument that the journalist (Paul Segal) is making then the Flat Earth Theorists would starve for oxygen.

Segal says:

Politicians on the right love to scare us. George Osborne, in his Mansion House speech cited “fears” over government solvency and sovereign debt crises. David Cameron has declared the fiscal deficit a “threat” to “our whole way of life,” and “a clear and present danger to the British economy”. This is nonsense. The threat we face is ideologically driven cuts that risk causing a double-dip recession.

The fiscal deficit seems scary because it is debt. Cameron argues that within five years the national debt will rise to “some £22,000 for every man, woman and child in the country”. This may be true, but what he doesn’t tell us is that it is money the government owes to us – not money that we owe to anyone else. That’s right: 80% of our government debt is owed to the British people. What is called “national debt” is our own savings, looked at from the other side of the balance sheet.

People get very confused about the concept of national saving. They assume that saving is spending less than you earn and then apply that to budget surpluses and conclude that the surpluses add to national saving. But this view is erroneous. A sovereign government does not save. What sense does it make to say that the government is saving in the currency that it issues? Households save to increase their capacity to spend in the future. How can this apply to the issuer of the currency who can spend at any time it chooses?

As a matter of national accounting, a government budget deficit adds net financial assets (adding to non government savings) available to the private sector and a budget surplus has the opposite effect. The last point requires further explanation as it is crucial to understanding the basis of modern money macroeconomics.

While typically obfuscated in standard textbook treatments, at the heart of national income accounting is an identity – the government deficit (surplus) equals the non-government surplus (deficit). The only entity that can provide the non-government sector with net financial assets (net savings denominated in the currency of issue) and thereby simultaneously accommodate any net desire to save (financial assets) and thus eliminate unemployment is the currency monopolist – the government.

It does this by net spending – that is, running deficits. Additionally, and contrary to mainstream rhetoric, yet ironically, necessarily consistent with national income accounting, the systematic pursuit of government budget surpluses is dollar-for-dollar manifested as declines in non-government savings.

A simple example helps reinforce these points. Suppose the economy is populated by two people, one being government and the other deemed to be the private (non-government) sector. We abstract from the distinction between the external and private domestic sectors here – which mostly only involved distributional considerations anyway.

If the government runs a balanced budget (spends 100 dollars and taxes 100 dollars) then private accumulation of fiat currency (savings) is zero in that period and the private budget is also balanced.

Say the government spends 120 and taxes remain at 100, then private saving is 20 dollars which can accumulate as financial assets. In the first instance, they would be sitting as a 20 dollar bank deposit have been created by the government to cover its additional expenses. The government deficit of 20 is exactly the private savings of 20.

If the government continued in this vein, accumulated private savings would equal the cumulative budget deficits. The government may decide to issue an interest-bearing bond to encourage saving but operationally it does not have to do this to finance its deficit. If the savers transfer their deposits into bonds their overall saving is not altered and it has no implications for the government’s capacity to spend. It has the advantage for savers that they now also enjoy an income flow from their saving.

However, should government decide to run a surplus (say spend 80 and tax 100) then the private sector would owe the government a net tax payment of 20 dollars and would need to sell something back to the government to get the needed funds. The result is the government generally buys back some bonds it had previously sold. The net funding needs of the non-government sector automatically elicit this correct response from government via interest rate signals. Either way accumulated private saving is reduced dollar-for-dollar when there is a government surplus.

So it is clear that the government surplus has two negative effects for the private sector: (a) the stock of financial assets (money or bonds) held by the private sector, which represents its wealth, falls; and (b) private disposable income also falls in line with the net taxation impost.

Some may retort that government bond purchases provide the private wealth-holder with cash. That is true but the liquidation of wealth is driven by the shortage of cash in the private sector arising from tax demands exceeding income. The cash from the bond sales pays the Government’s net tax bill. The result is exactly the same when expanding this example by allowing for private income generation and a banking sector.

From the example above, and further recognising that currency plus reserves (the monetary base) plus outstanding government securities constitutes net financial assets of the non-government sector, the fact that the non-government sector is dependent on the government to provide funds for both its desired net savings and payment of taxes to the government becomes a matter of accounting.

This understanding reinforces why the pursuit of government budget surpluses will be contractionary. Pursuing budget surpluses is necessarily equivalent to the pursuit of non-government sector deficits. They are two sides of the same coin.

The decreasing levels of net savings financing the government surplus increasingly leverage the private sector and the deteriorating debt to income ratios will eventually see the system succumb to ongoing demand-draining fiscal drag through a slow-down in real activity.

Once we understand the accounting relationships it is easy to reject the argument that budget surpluses represents “public saving”, which can be used to fund future public expenditure. Public surpluses do not create a cache of money that can be spent later. National governments spend by crediting a reserve account in the banking system. The credits do not “come from anywhere”, as, for example, gold coins would have had to come from somewhere. It is accounted for but that is a different issue. Likewise, payments to government reduce reserve balances. Those payments do not “go anywhere” but are merely accounted for.

There is an elaborate institutional structure in place to obsfucate the true nature of these transactions. But in an accounting sense, when there is a budget surplus, then base money and/or private wealth is destroyed. The opposite is the case for budget deficits.

Please read my blogs – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3Please read my blog – for more background discussion on this point.

Segal continued:

Given that most of us do not knowingly buy government debt, how do our savings end up as the fiscal deficit? We put our savings in banks and pensions funds. But they are just intermediaries: they invest our savings by buying bonds and other securities that pay interest. Some of these bonds will be from private sector companies that want to borrow for investment. But when private companies do not want to invest as much as we, the people, want to save in a given year, then the only alternative is to invest the money in government bonds, ie public debt. The fiscal deficit is just the lending that we make to the government. The fiscal deficit is so high because we are demanding more bonds – that is, we want to save more – than the private sector is willing to invest.

Incidentally, this is not Keynesianism: it’s just accounting, familiar to any macroeconomist.

So after a promising start, Segal gets things a little backwards here.

First, the relationship between the government and non-government balances is just a matter of accounting. But the accounting is just a measure of the underlying behaviour of the various economic sectors.

Further, there multi-directional causality operating between the two sectors. Decisions taken in one sector can generate outcomes in the other sector, and vice versa. So it is not as simple as saying the government supplies debt up to the gap between what the private sector wants to save above the same sector’s willingness to invest.

In an accounting sense, that would be true for a closed economy. The sectoral balances are much simpler in that case.

So total expenditure would be:

GDP = C + I + G

which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), and total government spending (G).

National income (GDP) can be used for:

GDP = C + S + T

which says that GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.

Equating these two perspectives we get:

C + S + T = GDP = C + I + G

So after simplification (but obeying the equation) we get the sectoral balances view of the national accounts:

(I – S) + (G – T) = 0

That is, the two balances have to sum to zero.


(G – T) = (S – I)

The sectoral balances in this case are:

  • The Budget Deficit (G – T) – positive if in deficit, negative if in surplus.
  • The private domestic balance (S – I) – positive if in surplus, negative if in deficit.

It is clear that for any income (GDP) level, the deficit has to be equal to the excess of saving over investment in the private sector.

The current institutional arrangements imposed on governments by the dominant neo-liberal ideology adopts the so-called government budget constraint (GBC) as the model for handling deficits. The GBC says that the budget deficit in year t is equal to the change in government debt over year t plus the change in high powered money over year t. So in mathematical terms it is written as:


which you can read in English as saying that Budget deficit = Government spending + Government interest payments – Tax receipts must equal (be “financed” by) a change in Bonds (B) and/or a change in high powered money (H). The triangle sign (delta) is just shorthand for the change in a variable.

However, this is merely an accounting statement. In a stock-flow consistent macroeconomics, this statement will always hold. That is, it has to be true if all the transactions between the government and non-government sector have been corrected added and subtracted.

So in terms of Modern Monetary Theory, the previous equation is just an ex post accounting identity that has to be true by definition and has not real economic importance.

The money base changes every time the government spends because bank reserves rise. But the dominant paradigm argues that this will be inflationary and thus demands that institutional arrangements be set in place so that the governments match the deficits $-for-$ with bond sales. They even go so far in some countries as forcing the government to issue the debt first and then spend out of the account the debt sales accumulate.

All of this is a total smokescreen. But the point is that the change in high powered money (H) will be zero and the change in Bonds (B) will equal (G-T) in any period.

So that is Segal’s contention.

Of-course it leaves out the fact that there is an external sector. In that case the following sectoral balance identity applies:

So after simplification (but obeying the equation) we get the sectoral balances view of the national accounts.

(G – T) = (S – I) – (X – M)

where X is total exports and M is total imports and (X – M) is net exports. Please read my blog – Saturday Quiz – June 19, 2010 – answers and discussion – for more discussion on this derivation.

The point is that the deficit now reflects the excess saving of the private domestic sector less net exports. The latter injects aggregate demand into the economy (if positive) while the former (S – I) drains aggregate demand.

If a nation is running an external surplus, then some of its “saving” will be going abroad.

The other point to note relates to causality. The budget balance is the difference between total federal revenue and total federal outlays. So if total revenue is greater than outlays, the budget is in surplus and vice versa. It is a simple matter of accounting with no theory involved.


Budget Balance = Revenue – Spending = (Tax Revenue + Other Revenue) + (Welfare Payments + Other Spending)

We know that Tax Revenue and Welfare Payments move inversely with respect to each other, with the latter rising when GDP growth falls and the former rises with GDP growth. These components of the budget balance are the so-called automatic stabilisers.

In other words, without any discretionary policy changes, the budget balance will vary over the course of the business cycle. When the economy is weak – tax revenue falls and welfare payments rise and so the budget balance moves towards deficit (or an increasing deficit). When the economy is stronger – tax revenue rises and welfare payments fall and the budget balance becomes increasingly positive. Automatic stabilisers attenuate the amplitude in the business cycle by expanding the budget in a recession and contracting it in a boom.

Decisions by the non-government sector to increase its saving will reduce aggregate demand and the multiplier effects will reduce GDP. If nothing else happens to offset that development, then the automatic stabilisers will increase the budget deficit (or reduce the budget surplus).

So in that sense, the causality runs from the non-government sector to the government sector.

However, the government may decide to expand its discretionary spending and/or cut taxes. This will add to aggregate demand and increase GDP. The deficit will increase by some amount less than the discretionary policy expansion because the automatic stabilisers will offset that increase to some extent. But the non-government sector will also enjoy the increased income and this allows them to increase total saving.

So the causality in this situation runs from the government sector to the non-government sector (and feeds back again as the automatic stabilisers go to work).

In general, if the private sector desires to increase its saving, the role of the government is to match that to ensure that the income adjustment will not occur – with the concomitant employment losses etc. In that sense, fiscal policy has to be reacting to private spending and saving decisions (once a private-public mix is politically determined).

Segal continued:

The fiscal deficit adds to the stock of government debt owed to us, and it is true that we do not want that debt to grow as a proportion of GDP forever. But relative to GDP, the stock of national debt in the UK remains below that of the US, France and Germany. And when the economy starts to recover, the deficit will decline in any case, as investment and tax receipts rise. Household saving will also decline with time from its current high rate: saving rose because we became so indebted during the boom years, running down our savings and buying goods on credit. Having built up so much debt we now want to pay some of it off. But once we have paid off enough of that debt, our saving rate can decline and private spending pick up, further helping reduce the deficit.

This is not the statement a person who really grasped the situation would make. The public debt to GDP levels in France and Germany have no relevance to those in the US and the UK. The monetary systems are different and the capacity of the respective governments to service the debt is fundamentally different.

Further, it makes no sense to even focus on the public debt to GDP ratio. What exactly does it tell us? Answer: Not much. It is the history of the public deficits scaled by the size of the economy. That is all it signals. The more complete understanding comes from analysing what was going on in the real economy to generate those deficits over time.

Were they the manifestation of a government intent on expanding its share in total production and squeezing private spending out as a political strategy?

Were they a sign that private spending was weak and the automatic stabilisers were operating to provide some support for aggregate demand?

Were they are sign of added discretionary fiscal support to failing private demand?

What was happening to employment growth and unemployment?

These are the questions that need to be focused on.

Paul Krugman’s story in the UK Guardian last Friday (June 18, 2010) – The price of economic posturing – captures this point well, although I doubt that Krugman would support my logic to its conclusion if pushed.

He said:

German hawk: “We must cut deficits immediately, because we have to deal with the fiscal burden of an ageing population.”

Ugly American: “But that doesn’t make sense. Even if you manage to save 80 billion euros – which you won’t, because the budget cuts will hurt your economy and reduce revenues – the interest payments on that much debt would be less than a tenth of a per cent of your GDP. So the austerity you’re pursuing will threaten economic recovery while doing next to nothing to improve your long-run budget position.”

German hawk: “I won’t try to argue the arithmetic. You have to take into account the market reaction.”

Ugly American: “But how do you know how the market will react? And anyway, why should the market be moved by policies that have almost no impact on the long-run fiscal position?”

German hawk: “You just don’t understand our situation.”

Segal’s other points about how growth is the way forward rather than austerity are well-taken. They are so obvious that you cannot understand why the general populace would tolerate politicians who want to cut government support for their economies at a time when they most need it.

Segal also argued that the austerity programs will drive down aggregate demand and as a consequence “companies … [will] … go bankrupt and workers … [will] … get fired”. He said:

With unemployment already at 8% and GDP well below capacity, this would spell double-dip recession. Ironically, this would lower tax receipts and could make the deficit even worse.

And then the calls for austerity will be even greater. The problem is that these programs are relying if anything on an increase in external competitiveness by internal deflation. It is a grinding way to get any relief and the damage done in the meantime will be very significant and span generations. It is a mindless way of managing the economy.

Segal then tried to make sense of the motivation:

This reveals the underlying reason why politicians on the right really want to reduce the deficit: expenditure cuts today imply tax cuts and smaller government in the long run. And once we see that the fiscal deficit is our saving with the government, it becomes obvious that Cameron and Osborne’s claim that the deficit has us “living beyond our means” is nonsense. Any politician who cares more about public services than tax cuts should be relaxed about a few years of fiscal deficits.

Exactly. The unemployed are not “living beyond their means”. No economy (whichever one you want to choose) is living beyond its means – how could they be when there is such a large output gap present across the world. That output gap manifests as unused machines, idle labour and a huge capacity to increase real output.

The austerity programs will worsen that situation not improve it.

I also thought the article by Jeremy Seabrook in the UK Guardian (June 20, 2010) – – was apposite in this context.

Seabrook said that:

The coming cuts aren’t just austerity measures. They are the Tories’ way of proclaiming the ultimate victory for the free market

when … [David Cameron] … said the effects of his policies would be felt for decades to come, he meant something more than a mere diminution of the structural deficit. He admitted as much – it is a question of seeing what competences can be removed from government and outsourced to private interests.

So the austerity drive is really about reducing the size of government and restoring the “primacy of the market” as the neo-liberals see it.

Seabrook said:

Today’s detestation of “big government” stems from this same source, and the affection of Cameron and his colleagues for the “big society” is a euphemism for the reduction of public funds in assisting the poor: rolling back the state, leaving the market to distribute its rewards in accordance with the natural order of things … the market mechanism is as flawless a creation as the earth, and should remain untouched by the hand of meddlers, whose only effect is to upset its power to enrich us all … Once more, the state shrinkers, the advocates of vanishing government, the cutters of red tape and regulation, the liberators of a humanity constricted by statist straitjackets, believe they have a mandate for freedom. But it is freedom under the law of an imagined jungle; by a savage irony, at a time when the smoke from the stumps of felled trees in the real jungle darken the horizon of a used-up future.

That seems to be a suitably depressing note to finish on.


The point is that whatever the mainstream economists say the policy agendas they advocate cannot be justified in terms of the financial issues they hide behind – crowding out, inflation, sovereign insolvency etc.

Once you understand the way the monetary system operates their agendas become transparently ideological and intent on redistributing real output to the rich and way from the poor.

They might be clothed in the sophistry of the market and supported by mathematical models but when you distil the arguments down to their essentials you realise they just represent a crude and unsophisticated grab for wealth.

This Post Has 37 Comments

  1. I think the deficit terrorists are on to something!

    The ratio of the UK public sector deficit, to my telephone number, is much bigger than I had previously realised.

  2. Dear anon

    Because he concludes: “So America has a long-run budget problem”.

    No it hasn’t. It has a long-run political problem where a particular cohort in the population will require more real resources (possibly) and that will have to be mediated by: (a) productivity growth; (b) others having less.

    There is no financial problem for the US government in any of that. It is a real resource availability problem which becomes a political problem.

    Of-course, they can start converting primary schools into aged care units as they become obsolete.

    best wishes

  3. Yes, Bill. I understand that.

    But does that mean this math is wrong:

    “Unfortunately, that’s not enough. Even if the government’s annual borrowing were to stabilize at 4 percent of G.D.P., its total debt would continue to grow faster than its revenues. Furthermore, the budget office predicts that after bottoming out in 2014, the deficit will start rising again, largely because of rising health care costs.”

    Would MMT reject that math as wrong, or merely consider it irrelevant?

  4. Dear anon

    The maths might be right or wrong – given it is based on so many assumptions that are forecast out 30 odd years or more. None of this is exact. I am sure based on those assumptions the maths are “correct”.

    But MMT would just consider it to be irrelevant and advise the US government to get as many people working again as soon as possible and start investing in R&D and public education through to higher education.

    best wishes

  5. Thanks, Bill.

    It seems to me its implicit in MMT that any “unsustainable” (in conventional terms) deficit math will eventually be overcome by correct application of MMT deficit and (future as necessary) tax approaches.

    Perhaps this should be an MMT theorem.

  6. I think what Bill is saying anon is that given the future that is presented the math is correct however we are not confined to the future which is presented. We can make our own future.

  7. The point is that whatever the mainstream economists say the policy agendas they advocate cannot be justified in terms of the financial issues they hide behind – crowding out, inflation, sovereign insolvency etc.”

    More and more mainstream economics becomes a curiosum to me. Mainstream economists should be in the meantime a worthwhile subject for studies of sociologists, anthropologists and psychologists? Only yesterday I read a reference to the book “Debt, Crisis and Recovery” from an American Albert G. Hart in a German blog. The quote:

    For understanding financial instability, it is important to start from the fact that bank lending creates money … However, new credit typically is at least partially funded by an expansion of money because money is typically the low-cost source of funds. (It is this fact that explains the dynamic in our financial system toward the creation of new forms of money and money substitutes.) The reason is that wealthholders are typically willing to forgo some interest in order to enjoy the liquidity services that money provides. The key point is that, by funding loans with money, bankers in effect bridge contradictory views about the future. Bank assets reflect borrower optimism about the future, while bank liabilities reflect wealthholder conservatism. The institution of banking allows optimists to act on their optimism while providing for pessimists the comforting illusion of liquidity.

    So long as expectations about the future are sufficiently divergent, it is possible for bankers to balance the hopes of borrowers against the fear of lenders, and in so doing to regulate the pattern and pace of economic activity. The balancing act fails, however, in general of optimism or pessimism, and this is the source of the inherent instability of credit. In a general wave of optimism, borrowers find they can attract funds from wealthholders directly without the mediation of banks, so the ability of banks to control the flow of credit is limited by competition with the capital market as a source of funds. It is not that bankers necessarily get swept up in a general euphoria, but rather that their efforts to act as ‘pessimists of last resort’ are of little force when eager funds seek an outlet. Contrariwise, in a wave of general pessimism, banks find themselves with funds for which no lending outlet can be found because borrowers are unwilling to expand. The efforts of bankers to act as ‘optimists of last resort’ are if little force when borrowers see no future.

    So much for the creation of money and credit through commercial banks and the effectiveness of monetary policy in a wave of general pessimism. This was written in 1938! The mainstream attitude in economics as a “science” seems to be: let’s burn all the old stuff, so we can invent some new stuff and sell our own story?

  8. Krugman and MMT are schizophrenically aligned and misaligned.

    They are aligned in the sense of sensible deficit timing.

    Krugman is obviously very different than the “austerians” in this regard.

    They are misaligned in the reasoning for deficit timing.

    Krugman’s reasoning has to do with achievable deficit mathematics in the long run, while aggressively pursuing somewhat MMT sympathetic re-employment objectives in the short run (although short of full employment).

    MMT’s reasoning has to do with not responding to anything other than real constraints and visible inflation in the short and long run. It is assumed that future taxation potential can overcome, not only any future inflation threat, but any threat due to what may appear to be unsustainable deficit mathematics.

    Maybe MMT should identify a refined subspecies of the deficit terrorist – the deficit math terrorist.

  9. Anon, I think Professor Mitchell already has a term for the subspecies you refer to. He calls them “deficit doves,” and in many ways I believe he thinks they are worse than the hawks. See, for example, the “Enemies from Within,” suite of blog posts.

    Also, in regard to the potential of taxation policy to overcome “…any future inflation threat,” Professor Mitchell does tend to emphasize the use of fiscal policy (higher taxes/less spending) to counteract possible future rises in inflation expectations, but that doesn’t mean other policy options aren’t on the table as well. For example, Professor Mitchell’s Job Guarantee proposal has an anti-inflation component built into it. See this website for an explanation, and the reference on the bottom of the website for an even more detailed explanation:

    An even more explicit anti-inflation policy initiative consistent with MMT principals is Aba Lerner’s 1980 “Market Anti-Inflation Plan (MAP).” See this website toward the bottom for a description:

    I don’t think you meant to imply this Anon, but I wouldn’t say that MMT-consistent policy responses to inflation are limited to fiscal policy initiatives. Professor Mitchell does tend to focus on fiscal policy though so I can understand the confusion.

    If possible Professor Mitchell I’d love to see some more blog posts on innovative ways to deal with the possibility of inflation. Aba Lerner’s MAP proposal would be a great place to start. From what I’ve read it seems very promising.

  10. For Anon and NKlein1553 re control of inflation:
    I believe Prof. Mitchell also recommends the use of restrictions on the availability of credit for mortgages to control house price inflation rather than increases in interest rates. You may be interested to know that Mark Carney, Governor of the Bank of Canada, said the same thing in testimony to the Canadian Senate late last year.

  11. Of course Krugman’s math is wrong. Krugman is assuming that the interest raid paid on debt is greater than the growth rate of revenue (e.g. of GDP). This is an assumption necessary when using certain economic models to get certain time series to converge. I.e. assume the facts are such that easy models can be applied. This assumption underlies the crowding out hypothesis, too.

    But the data is such that only for the longest maturities is the rate charged equal to the growth rate of revenue, and, over long time periods, it does not exceed this growth rate. Moreover, maturities on government debts tend to be in the 5-7 year range, not at the long end of the curve. So you would expect the interest rate on government debt to be less than the growth rate of revenue, which changes the dynamics of the Debt/Revenue ratio.

    We can test this theory — information about government interest payments, weighted average maturity of debt outstanding, and interest rates are widely available. This is easy. In the U.S., real rates paid on government debt were 1.7%, and real GDP grew at a rate of about 3% — r < g. In Canada, it's the same story: 1.7% interest rates and growth rates of 3%. In Britain, the spread between interest rates and growth rates was about 1%. That is how all governments bring the debt/revenue ratio down — by stabilizing deficits and letting time take its course.

    So the math is simple: as long as the growth rate of revenue exceeds the interest charged on debt, there is always a sufficiently high debt level so that it's slower growth rate is such that debt to revenue is constant — for any level of deficit spending that is bounded from above in terms of % of GDP. For each deficit rate, whether that is 4% or 2%, there is an associated constant Debt/GDP ratio. Lowering the deficit rate from 4% to 2% will rapidly bring the Debt/GDP ratio down to the lower level corresponding to 2%, but there is *never* any requirement to monetize debt or only issue currency in an attempt to prevent Debt/GDP ratios from spiraling out of control.

    The one exception to this is a situation such as Japan — since 1997 their NGDP remains stuck at 500 Trillion Yen and they have had an official ZIRP policy — with no prospects for improvement on either front. Because of the zero bound, JGBs have paid a nominal rate in excess of the (zero) growth rate of revenue. But apart from this zero bound, risk-free medium maturity interest rates are going to be less than the long run growth rate of revenue, regardless of the deficit.

  12. Prof Mitchell:
    I think there is some problem with the comments posting to this blogpost. I actually sent my comments after NKlein1553 at 23:34. I think (not sure) that RSJ’s comment came later than mine as well.

  13. Dear Keith

    Yes, I had to reboot a server this morning and the date and time reset and I forgot for a while to update it.

    Fixed now.

    best wishes

  14. The larger issue with U.S. debt is medicare, and out of control health-care costs.

    This is actually a perfectly good example.

    Bill advises to spend whatever the providers decide to charge while simultaneously investing in universities and research because the government is not revenue constrained. Instead the government is real resource constrained. That is true, but there is a third constraint on the economy — that of relative prices being in line with the contribution of factor shares to real growth. The healthcare system has been seizing more and more income from the rest of the economy and is now charging households more than they can pay. This is only because of the wierd government system that we now have. The providers charge whatever they want, and government subsidizes them via making the employer insurance tax deductible and simultaneously funding the majority of health care expenditures via government programs. It does this without imposing price controls. At the same time, it forces doctors to carry expensive liability insurance and pays medical schools to not admit doctors in order to reduce the supply.

    The proper solution to this problem is not to spend “whatever the private sector wants” and invest in universities. We have more than enough research in universities, and we are already spending too much on healthcare. Under no circumstance should we spend more.

    The problem is that relative prices are out of control, and this wont be helped by deficit spending unlimited amounts. Doing this will hurt the economy and will solidify the labor and economic rents in this industry. I think here the austrians are onto something about their “stages of production”. As soon as one industry obtains strong market power, additional investment is funneled into that industry. More gizmos, more expensive medical devices, more sub-industries and suppliers, all attach themselves like barnacles to the ship, and the industry bloats up so that individual actors are not seizing obvious economic rents, even though in aggregate, the industry is. Everyone’s cost rises to absorb part of the economic surplus. Then the process of shrinking that industry and moving the real resources out of it becomes difficult.

    These problems are exacerbated by a “government checks will never bounce” approach to economic management.

  15. “So the math is simple: as long as the growth rate of revenue exceeds the interest charged on debt, there is always a sufficiently high debt level so that it’s slower growth rate is such that debt to revenue is constant – for any level of deficit spending that is bounded from above in terms of % of GDP. For each deficit rate, whether that is 4% or 2%, there is an associated constant Debt/GDP ratio. Lowering the deficit rate from 4% to 2% will rapidly bring the Debt/GDP ratio down to the lower level corresponding to 2%, but there is *never* any requirement to monetize debt or only issue currency in an attempt to prevent Debt/GDP ratios from spiraling out of control.”

    Leaving Krugman aside, that’s what I’m talking about.

    What you’ve described is a constraint of sorts.

    Why does MMT (apparently) ignore it as an issue or not deal with it directly?

  16. As long as Anon brought up Professor Krugman’s recent editorial, here are two really nice responses to his arguments made in the comments section of Mark Thoma’s website:

    and just below it:

    I’m continually impressed by how intelligent and articulate many commentators are on various econo blog sites.

  17. proposition:

    all deficit terrorists are deficit math terrorists whether they realize it or not


  18. Dea Tom,

    Sometime ago you had a thoughtful comment about relativity and its implications and I commented that soon I will post here, a summary of a framework on relativity, bifurcation and optimization of behavior derived from my recent work. In this comment I SHARE this effort with you and other fellow blog participants.

    Behavior is composed of decision and praxis and consists of a response to a bounded occurrence due to imperfection, friction and the resulting complexity. Decision is a planning exerscize and it involves selecting alternative prospects. Praxis is an activity application and it involves collecting contest outcomes. It is usually assumed that all increments/segments of parts of a unit occurrence are independent and identical to each other and consist of a stationary and linear process (i.i.d.). However, as I argue here, ther is a concept of relativity that affects optimal behavior and has implications that can lead to multiple equilibria and instability.
    We can use as an example, spending decisions as preferences over/across alternative possibilities and plans and spending practices as propensities over/across actual outcomes of response to occurrence. We can show that spending preferences over/across their sequence are related to each other and the spending decision can be stated in terms of the rpspect hypothesis (PH) (Tversky,Kahneman 1979,1992). On the other hand, we can show that spending propensities over/across their sequence are related to each other and the spending praxis can be stated in terms of the Contest Hypothesis (CH) (Keynes 1936, Nagel 1986 and others).
    In my theoretical framework, I examined the expressions of spending preference of decisions and the propensity of practices, endogeneously determined, but mathematically specified to include a vertical generation mechanism and a horizontal allocation mechanism. The preference/propensity structure of decisions/practices involves a constant intercept, a slope term, a curvature term and an adjustment path of the curvature term. The last responds to the burden of danger/scarcity by exhibiting a transition tropy of generation and an articulation tropy of allocation terms of a Langrange approximation of the remainder term of the completion process of occurrence. (However, this is not the purpose of this comment. Relieved?)
    The adjustment path is perceived as income transitions/articulations. or relative loss or gain ranked by danger for preference and scarcity for propensity. Loss value for preference is presented as the “leakage” of reserves (liquidity) held during spending plans as liquidity against income.Loss for propensity is presented as the “leakage” of savings held as a residual of income after spending activity. Gain value for preference is presented, given income expectations, as the spending plan and gain value for propensity is presented as the spending outcome, given income.

  19. Dear RSJ (at 2010/06/22 at 7:55)

    Last time I visited the US (a month ago) I saw massive underutilised capacity – lots of idle people and urban blight. I will see it again next week when I am in Boston. That is a massive untapped potential that can ensure more real resources will be available in the future if properly tapped. Investment in innovative public educational programs in the slums of Baltimore would only deliver benefits. Investing in R&D in renewables will deliver benefits. Reducing expenditure on the military and redirecting it into urban renewal projects will be beneficial.

    But if you think having 17 odd percent of your country’s available labour resources idle then we are operating on a different values plane. That is the true waste.

    I also have never advocated “spending whatever the private sector wants”. I would not give any public monies to the private sector. I have a zero subsidy approach. And I would tax economic rents were they arise.

    Further, in this discussion and previous discussions (about no bonds and the implications for private capital yields) I note you adopt a view that indicates the government should protect private yields etc. I have exactly the opposite view. The government should protect society. If the change of current policies reduces or alters private yields then so be it. It just means that the present structure of returns is being cosseted by corporate welfare at the expense of the poor. For example, if there were no bonds, the private sector would have to come up with a low risk asset to price their other higher risk assets off. The “market” will take care of that and the public would no longer be providing a guaranteed annuity to bond holders.

    best wishes

  20. “all deficit terrorists are deficit math terrorists whether they realize it or not”

    Hmm, I would say that they are terrorists — using emotions to triumph over both logic and math. The circular firing squad is as follows:

    Assume interest rates in excess of the growth rate of revenue
    –> all debts must be repaid with future surpluses (e.g. tax increases)
    –> therefore balance sheet expansion cannot occur (i.e. borrowing transfers wealth from creditor to debtor, but aggregate wealth is constant)
    –> therefore crowding out occurs
    –> therefore interest rates rise when debts rise
    –> therefore certain debt levels are unsustainable.
    –> therefore certain deficits are unsustainable

    I wouldn’t attribute the problem to math. With better math, they could generate more realistic models in which debt was viewed as the flip side of assets, rather than something that is eliminated in the future.

    Then we could have a serious discussion about what multiples and asset levels are optimal for the private sector to have, rather than what asset levels are possible.

    A question I have been asking here for some time.

    But the conversation is stuck. Mainstream folks argue about what deficits are “sustainable” and MMT says that all deficits are sustainable unless they cause an unacceptable price inflation/unemployment trade-off.

    As if we were in a one good economy populated by representative households.

    We have had plenty medical price inflation, driven in large parts by government deficit spending.

    It hasn’t lowered unemployment, either. And when we deficit spent less (on a secular basis), secular unemployment was much lower.

  21. Dear RSJ

    Poorly designed deficit spending which buffers economic rents and rewards waste is not an indictment of properly targetted deficit spending.

    best wishes


    We can, now examine the concept of relativity by introducing the marginal propensity for expenditure (MPE) out of income and the marginal liquidity preference (MLP) out of expected income to be received at each stage of the process. As mentioned in (part I), without relativity, their terms are assumed to be at their optimal equilibrium values, where they are (i.i.d.) and the geometric sequence of the terms (including the curvature term) they display is stationary. However, (MPE, MLP) parts at each stage of the series are relative to each other and they display non-linear properties. Assuming imperfection, friction and complexity (discussed elsewhere), relativity can affect these processes in the presence of the contest concept (CH) for relative spending propensities and in the presence of the prospect concept (PH) for relative spending preferences. Remember, that preference segments and propensity increments are valued to offer utility as relative value payoffs in transition generation and articulation allocation between loss and gain.
    Selection of preferences of potential spending alternatives is based on a heuristic method, a trial and error process of what selections are more likely to produce acceptable solutions and at each stage of the process they are edited by elimination of these possibilities that do not conform to the current logic criteria of consencus. The eliminated options are “leakages” held as liquid reserves. Similarly, collection of propensities of actual spending outcomes is based on a heuristic method (trial and error process) of what collections are more successful solutions of praxis and at each stage of the process they are edited by elimination of these actions that do not conform to the current rule criteria of consencus. The eliminated actions are “leakages” held as savings, a residual of what is not spent. Notice that the heuristic for preferences is imposed by the danger burden upon decision and the heuristic for propensity is imposed by the scarcity burden upon praxis. Explaining further the heuristic concept, in ancient Greek Philosophy, as in Plato, it was used as a reference “leverage” tool to indirectly, via dialectics, reveal categories that can help identify the ‘IDEA” of occurrence behind reality.
    The heuristic in the contest/prospect hypothesis is modified by a subjective judgement factor per contest/prospect stage of the consencus held by the participants of the contest/prospect, regarding the knowledge of the revealed propensities/preferences of these participants. For example, Keynes assumed for contests that this factor is equal to unity and it leads to multiple equilibria. Otherwise, if the factor is less than unity, it can converge to a Nash equilibrium at zero. Furthermore, as for the contest/prospect process is concerned, each stage contest propensity/stage prospect preference is modified by the elimination factor (savings propensity/liquidity preference) dispalayed cumulatively at prior stages of the process.
    The weighting function that attaches weight decisions of the cumulative probabilities/frequencies of the value plans of the spending pattern process is higher for a loss (liquidity) transition/articulation than for a gain (spending plan) from the heuristic value (loss aversion) for preference. Similarly, for a loss (savings) transition/articulation than for a gain (spending activity) from the heuristic value for propensity. These weighting factors decrease with the cumulative probability/frequency of alternative plans and activities but at a decreasing rate (asymptotic hyperbolic function). As the value function rises for the prospect segment and the contest increment, the value change decreases if the distance from the heuristic value rises. They both lead to a non-linear function for the processes of spending preference and propensity.

  23. Bill,


    But how do you know when it buffers economic rents and rewards waste, and when it doesn’t?

    The macro-economy — ignoring the foreign sector for the moment — is a closed system. In theory, it never needs more money. The only reason it always needs more money is to prevent deflation in the face of rising productivity.

    But apart from that, the wages paid to workers and the income from capital provide enough money to purchase output at all times. There is never a shortage of income.

    There is only a situation of those who want to accumulate receiving excess income in relation to those who want to spend — this is a class-issue.

    In that case, deficit spending to increase demand buffers economic rents, no?

    Suppose 35% of national income is diverted to the top 10%, who only consume 20% of output.

    In that case, should the government deficit spend enough to fill the 10% gap? A permanent deficit of 10%?

    If tax policy is used to suppress the income of the top 10% to, say, 23% of national income, then the government will only need to deficit spend 2%, not 30%. And as savings does not fund investment, this would not reduce overall output. There is a reason why, when we had 90% top marginal rates, the U.S. was primarily supply constrained, and the main concern problem was inflation in an environment of robust growth.

    So I would argue that deficit spending, in the face of demand failures, directly buffers economic rents in almost all cases.

    If you disagree, then what level of deficit spending do you think is appropriate, and what economic management approach you would take in the case of demand failures.


    Finally, the transition value of loss or gain relative to the modified heuristic has a steeper slope for the loss transition/articlulation, and its curvature of the spending pattern is convex while for the gain transition/articulation is concave.
    The interplay of the curvature shape and the overweight of small probabilities/frequencies allow for a switch of spending pattern and attitude of spending behavior (bifurcation effect). As the overweight factor of small probabilities/frequencies of large plans/outcomes can switch the convexity of spending patterns and the potential for loss outcome is overweighted. The attitude becomes of a negative frame adopting a risk-taking position. Depending on the specification, critical shocks beyond or below a bifurcation point, leads to reversals of preference or propensity, inducing a transition/articulation of likelihood of plans or actuality of spending from gains to losses and vice versa. The attitude towards danger and scarcity can change. For example, when they exhibit a positive frame, agents have a danger/scarcity averse atttitude, having a preference/propensity for certain but small gains and large liquid reserves/savings.
    Assuming that the spending propensity/preference process is non-linear due to relativity, there is a bifurcation effect to be considered. This takes place when small and smooth shocks are made upon the spending propensity/preference response parameters of the sytem, if they cross positively or negatively a critical threshold which is a bifurcation point. In this case there are sudden and qualitative changes in the behavior of the corresponding spending/income and money/income velocity multipliers. The local stability properties of system equilibria are switched and any equilibrium, if it exists. is non-hyperbolic at the bifurcation point but beyond and below this point there are multiple equilibria, some stable and some not.
    Lately, I have been working on a framework to incorporate these insights of relativity, bifurcation and their impact upon optimization, offering a mathematical specification and proofs for various levels of the bifurcation point, analysing the effects upon equilibria and their stability conditions. One implication, not shown here, is that the vertical generation of the spending propensity/preference process, if expressed seperately, can be specified as a “saddle-node” bifurcation function that can be associated with hysteresis loops. Furthermore, the horizontal allocation of the spending propensity/preference process, if expressed seperately, can be specified as a transcritical bifurcation function that can be associated with fluctuation periods.

    Tom, I am tired!!!


    Mistake: The reference for contest theory apart from Keynes is R. Nagel (1995).

    In case you were wondering (many I assume!) I did not discuss the effects upon optimization and the alternative optimum concept of ariston! Suspense for another comment for those that cannot wait!

  26. RSJ:

    Suggest you look at a few financial statements of our so-called health care providers (say Anthem) and see how much debt they carry to cover acquisitions and capital investment. Think for a bit how health care costs can be rising at 7%-15% annually when pay rates for health care doctors, nurses and staff are not.

    Similar to the job guarantee, government spending on health care directed, as in one example, towards funding medical students in return for their work in community clinics would reduce the expensive emergency care the private sector provides, and would also reduce overall demand at private health care facilities, which I understand might lower prices.

    But since private health care wants a monopoly and since they are able to shift costs to premium holders – soon to be universalized by our health financialization bill – there is no interest the private sector has in having public options that would drive down prices.

    There is no question our government is captured by interests that direct a great deal of spending toward other than public purpose – but lets focus our criticisms on that misappropriation and not the completely valid method (fiscal policy) that is being misused.

  27. Dear RSJ

    I would start by employing all workers who currently have zero bid in the private market. There in an infinity of productive outlets for the valuable but unused labour. They are no earning rents now by definition. The advantage of fiscal policy is that you can target it and also reduce spending elsewhere.

    In the case of the US health system – that is not a macroeconomic problem. But I would eliminate private health insurance as a starting point.

    best wishes

  28. I have argued before that taxation is mainly distributional. There are price distortions, transfer pricing, bribes and rents collected and externalities imposed by those exploiting market power, excessive behavior and “capture” of state policy. These can be addressed by taxation policy which is discretionary. Yes, there is waste in government operations and can be addressed by automatic controls. Public policy must be coordinated if deficit spending is going to support public purpose. Is inflation possible in a service economy (supply dependent demand) and with firms that have market power? Yes it is possible. However, not Bill or anyone in MMT (I think) are saying that fiscal policy is a simple exercise. Imperfection and complexity applies to the state as well!

  29. bill: “The maths might be right or wrong – given it is based on so many assumptions that are forecast out 30 odd years or more. None of this is exact. I am sure based on those assumptions the maths are “correct”.

    “But MMT would just consider it to be irrelevant and advise the US government to get as many people working again as soon as possible and start investing in R&D and public education through to higher education.”

    anon: “It seems to me its implicit in MMT that any “unsustainable” (in conventional terms) deficit math will eventually be overcome by correct application of MMT deficit and (future as necessary) tax approaches.”

    I think that Bill’s point is simpler and mathematical. The projections are made far into the future, and are based upon many hidden assumptions. That makes them worth little, if anything. Do you ever hear of error estimates with such projections? No, because that would reveal how absurd they are. As the computer scientists say, “Garbage In, Garbage Out.”

    Near term projections how persistent high unemployment. One of the hidden assumptions of those projections is the lack of a Jobs Guarantee or other government hiring. That is probably an assumption of the other projections, as well. Bill’s suggestion that the U. S. gov’t “get as many people working again as soon as possible and start investing in R&D and public education through to higher education,” makes all such projections irrelevant.

  30. I can’t improve on what Bill Vickrey wrote 17 years ago–

    This then is the goal I lay before you. Real full employment, at levels higher than have been experienced in peace-time over at least the last century, is to be reached within two or three years and maintained thereafter, with magnificent results not only in increased output and income, but reduced poverty, iII-health, drug abuse, crime, and commitment to the maintenance of a useless military superfluity. But to do this we have to toss out our shibboleths of budget balancing, puritanical abstinence, maintaining the value of the almighty dollar and servicing a “favorable” balance of trade, and instead focus our attention on the real resources, human and material, that we have on hand and figure out how to use them effectively to produce real welfare…

    For too long we have unquestioningly allowed numbers on books of account to control our lives. Such accounts have their place, but when they are allowed to compel us to tolerate the wastage of human resources and all the concomitant social problems that unemployment provokes, we must look at the “real” side of the coin. William Jennings Bryan used to conclude his stock campaign oration with “you shall not crucify mankind upon a cross of gold.” today we might say “we must stop shooting ourselves in the foot with a blunderbuss of financial rectitude.”;col1

  31. For clarity (X-M) in the equations above reads as the terms of trade but in reality it represents the current account …right?

  32. Dear Max (at 2011/07/30 at 12:00)

    Yes the external balance is the current account – the sum of the trade balance and the invisibles.

    best wishes

  33. thanks Bill. In Australia’s case the terms of trade are supposedly positive yet the current account is negative so the “invisibles” must be substantial.

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