Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
Every day now as the Australian federal election day approaches (August 21) the calls for fiscal austerity increase and the justifications become further removed from reality. I note The Greens, who are held out as our only hope are still running their neo-liberal line that budgets should be balanced over the cycle (see Neo-liberals invade The Greens! for more discussion on that). But the US political scene is even more moribund than ours if that is possible. Even the progressives are claiming there is a fiscal crisis. The facts speak otherwise.
Always start with facts
The US Bureau of Labor Statistics released the latest payroll data (August 6, 2010) which showed that:
Total nonfarm payroll employment declined by 131,000 in July, and the unemployment rate was unchanged at 9.5 percent …
There were 14.6 million Americans unemployed (6.6 million long-term) in July. The teenage unemployment rate was 26.1 per cent. Labour participation rates have been declining since April 2010 signalling a failing labour market. Full-time employment fell overall.
The alternative BLS measures of labour underutilisation, which broaden the narrow official unemployment to take into account underemployment and marginal attachment (including hidden or discouraged unemployment) show that the broadest U-6 measure (total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force) remains at 16.5 per cent and still higher than a year ago.
Conclusion: there is not enough activity in the economy to maintain employment and labour force growth.
Reason: Lack of aggregate spending. Please read my blog – What causes mass unemployment? – for more discussion on this point.
Solution: while private demand is weak the only solution is to increase public demand via increased net spending (deficits).
Is there any other solution? Answer: not if you desire stronger employment growth and declining unemployment.
After the facts you can start to appreciate the fiction
The New York Times editorial on Sunday (July 31, 2010) carried an alarmist piece – What They’re Not Telling You – which said:
There is a lot of heated talk in Washington these days about the deficit, unfortunately little of it serious. Playing on Americans’ deep anxiety about the economy, Republican politicians have seized the deficit issue as their own – eagerly blaming the stimulus and even an extension of unemployment insurance for the problem – while denying their own culpability for helping dig this deep hole with years of irresponsible tax cuts.
This is one of those regular narratives that have been creeping into the discussion as politicians and their defenders try to disown the situation – the goal? Spread the blame for “the problem”. Which problem? That hideous deficit that Americans should be fearful of.
My understanding of the US economy pre-crisis was that the deficit wasn’t excessive prior to the crisis. Excessive here in terms of Modern Monetary Theory (MMT) refers to a point where labour underutilisation rates are at full employment. The U-6 measure was still hovering around 8 per cent from September 2006 for some months after recovering somewhat from the recession in the early 2000s.
Inflation was also not out of control and largely being driven by energy prices (that is, not a deficit-nominal demand issue).
My conclusion that the US budget deficit was hardly excessive does not mean I supported the fiscal policy position at the time. The tax cuts for the rich were unnecessary and more spending should have been directed towards job creation.
Further, one could hardly suggest that the increase in the US budget deficit since the crisis was unnecessary. To say it was the result of lax policy is not the same as saying that the budget deficit did not have to rise to combat the falling private spending.
Both statements can be true. I didn’t like the composition of the stimulus packages and while Wall Street has rebounded and now making money again, it remains clear that the benefits of the stimulus packages were biased towards those experiencing the least disadvantage.
And, the fact that U-6 doubled since the crisis began and is stuck on 16.5 per cent at present, tells me that the stimulus was not large enough. The US federal government should be increasing its deficit right now.
So the only “deep hole” I can see in the US is the gaping real GDP gap and the resulting and shocking labour underutilisation data. Which sophisticated nation thinks it is acceptable to have 16.5 per cent of your willing labour force idle in some way or another? Answer: None. Only a nation operating under the destrictive spell of neoliberalism would envisage making such a situation worse by cutting back the very thing that is maintaining growth at present.
Please read my blog – We are in trouble – squirrels are falling down holes – for more discussion on this point.
The NYT editorial continued:
The deficit’s size is alarming. In the 2010 fiscal year, the government is projected to collect $2.2 trillion in taxes and spend $3.6 trillion, leaving a gap of $1.4 trillion.
If current tax and spending policies continue, deficits are estimated to remain near $1 trillion a year for the next decade. After that they will explode – to twice the size of today’s deficit as a share of the economy by 2050 – as health costs rise and the population ages, and outlays for Medicare, Medicaid and, to a lesser extent, Social Security continue to grow faster than revenues.
We agree the situation is unsustainable. But cutting spending right now on relief and recovery efforts would worsen the economic slowdown and the suffering of millions of Americans, while making only a tiny dent in future deficits.
What exactly is unsustainable about it? The commentators regularly repeat that a certain number on paper is unsustainable but they never credibly relate their concern to anything economic or financial. It becomes a matter of – if you repeat something enough times it becomes truth.
The deficits in the US might be politically unsustainable but that just means the politicians have to work harder to explain what the deficits are doing to underpin jobs and private saving and allow the public to see through the misinformation. The problem is that the politicians spread the misinformation themselves.
The so-called “gap of $1.4 trillion” is just a reflection of the private spending gap. Budget outcomes are driven in large part by the spending decisions of the non-government sector. If there is a high rate of labour underutilisation then you can be sure that the private spending gap is considerably larger than the actual budget deficit.
In other words, the deficit has to expand if the US government is to act responsibly and increase economic growth and reduce the terrible (and costly) waste embodied in the persistently high rates of labour underutilisation.
If I was to re-write that last paragraph it would go something like this:
The U-6 measure provided by the BLS is alarming. In the 2010 fiscal year, the government is projecting that the decline in U-6 will be modest, leaving a gaping loss of income to the American people.
If current tax and spending policies continue, then there will be a very slow recovery in the US economy perhaps even a return to recession which will ensure long-term unemployment in the US reaches record levels and persists for the next decade …
We agree the situation is unsustainable. Spending should be increased and targetted towards direct public sector job creation. This is the only way the US economy will return to robust rates of growth.
There is quite a difference between the two statements.
After claiming that “the biggest items in the budget (Medicare, Medicaid and Social Security make up about 40 percent)” have to be cut to restore fiscal sustainability, the NYT editorial said:
When it comes to controlling the near – term problem – trillion – dollar deficits every year for the next 10 years – the biggest help will be a return to solid economic growth and, with that, increasing tax revenues.
Growth will not be enough. There is no chance to put the budget on a sustainable path without significant tax increases, and not just on the wealthy. Few politicians, of either party, are willing to tell that truth.
Americans are right to worry about the deficit. They must also demand that their elected representatives do more than rail about the problem and begin a serious debate about the policy choices ahead.
So you can see that they are trying to be “progressive” here by arguing that growth will help bring the deficit down but fail badly in their attempt because they do not grasp the meaning and role of the deficits.
First, the health care issue is not a problem of fiscal solvency. If too many real resources are being expended on health care to the point of waste then cost control is necessary. But that has nothing to do with the claim that the government cannot afford to maintain health expenditures.
The US government can always fund health care and buy what health care products that are available. In doing so it might be party to an incredible waste of resources – unnecessary treatments; excessive use of expensive diagnostics etc – all driven by the greed of the big health providers and insurers. But that is a separate matter altogether and will not be solved by focusing on some “deficit number”.
Second, taxes only need to increase if the government wishes to maintain its current share of spending in GDP (its claim on real resources) and the growth in nominal aggregate demand is starting to outstrip the real capacity of the US economy to respond to it with real output increases.
At present and for the foreseeable future there is massive excess capacity in the US economy – capital and labour. There is no need to regulate aggregate demand via tax increases (which reduce the purchasing power of the private sector) at present and I suspect there will be no need for some years to come.
Of-course, the NYT is thinking neo-liberal and suggesting that the taxes are used to “fund” spending and so with some rigidity in program budgets (health etc) the deficit will only be reduced by more tax funding. The reality is that taxes do not fund anything.
A sovereign government is never revenue constrained because it is the monopoly issuer of the currency and so taxes are not required to “fund” the spending.
The NYT editorial then considers some specific issues all of which miss the point completely. They ask the question “Does the budget have to be balanced?” and say:
An economically powerful country can prudently run some deficits. A reasonable budget goal would be to reduce annual deficits to the point where the debt – the sum total of annual deficits, now $9 trillion – is no longer growing faster than the economy. Once the debt is stable, the nation would most likely avoid the worst effects of persistent deficits, including sharply higher interest rates and slower growth.
Any sovereign country can “prudently” run some deficits if the conditions are requiring them. It has nothing to do with whether the nation is “economically powerful” – whatever that means. The US is currently not “an economically powerful country” given how much labour it is wasting and the atrophying of its capital stock.
Besides, it is dependent on China for financing! (I just had to write that – it was a joke! Please note that: a joke).
I would have written that paragraph as follows:
Any sovereign country can “prudently” run deficits if there is an external deficit and the private sector is desiring to save overall. A reasonable budget goal would be to maintain annual deficits to the point where nominal aggregate demand absorbs all the available real productive capacity including all willing labour resources. A responsible government will only examine real factors and ignore financial ratios (such as the public debt to GDP ratio).
Again, there is quite a difference between the two statements.
Of-course, the NYT editorial was influenced by the latest report from the US Congressional Budget Office (CBO) which was released on July 27, 2010. This major statement – Federal Debt and the Risk of a Fiscal Crisis – has given new impetus to the deficit terrorists. The full document is HERE.
It reads like an undergraduate essay on steroids where the primary source material was Mankiw’s Principles of Economics. It is totally mainstream in its macroeconomics and delivers an almost juvenile representation of what is going on. It is as flawed as the paradigm it is working within and delivers very little insight about what the real issues are.
In the full report, the CBO says that “Compared with the size of the economy, federal debt held by the public is high by historical standards but is not
without precedent”. There was an extraordinary footnote attached to that statement (thanks Gary!):
The size of a country’s economy provides a measure of its ability to pay interest on government debt, in the same way that a family’s income helps to determine the amount of mortgage interest that it can afford. Federal debt has two main components: debt held by the public, and debt held by government trust funds and other government accounts. This issue brief focuses on the former as the most meaningful measure for assessing the relationship between federal debt and the economy. Debt held by the public represents the amount that the government has borrowed in financial markets to pay for its operations and activities; in pursuing such borrowing, the government competes with other participants in credit markets for financial resources. In contrast, debt held by government trust funds and other government accounts represents internal transactions of the government.
You can see where the NYT editorial got the “economically powerful country can prudently run some deficits” thought from.
The statement that the “size of a country’s economy provides a measure of its ability to pay interest on government debt” is without foundation. That is, it is nonsensical, meaningless and vacuous statement (where tautology prevails).
A sovereign government of any size economy can always pay interest on government debt. They simply credit a bank account with the required income flow as they would do for any spending operation. The only issue is the sovereignty which requires the government has the monopoly over the currency issuance.
But the CBO’s ignorance (or culpability) is clear when they try to invoke the household-government budget analogy. I almost laughed when I read this. If this was given to me by a macroeconomics student (of any undergraduate or postgraduate level) as part of their assessment I would advise them to leave the course immediately after giving them 0/100.
For a government agency to be pumping out this absolute rubbish – it beggars belief. It shows how far the erroneous neo-liberal ideas drawn from error-prone and inapplicable macroeconomics textbooks have penetrated.
To repeat what I said yesterday (operating under the principle if something is said enough times it becomes ingrained) – there is no possible parallel that can be drawn between a household budget and the budget of a sovereign government. Mainstream macroeconomics starts with this flawed analogy between the household and the sovereign government as a means to justify the imposition of fiscal discipline on the government.
They argue that any excess in government spending over taxation receipts has to be “financed” in two ways: (a) by borrowing from the public; and/or (b) by “printing money”. They claim the second option is always inflationary so deficits have to be funded via debt-issuance.
Neither characterisation is remotely representative of what happens in the real world in terms of the essential nature of the operations that define transactions between the government and non-government sector.
Further, the basic analogy is flawed at its most elemental level. The household must work out the financing before it can spend. The household cannot spend first. The government can spend first and ultimately does not have to worry about financing such expenditure.
The CBO want us to construct public debt as the “the amount that the government has borrowed in financial markets to pay for its operations and activities” whereas in fact the opposite is true.
The debt is in fact an expression of the specific way in which we choose to hold the financial wealth that has been permitted by the deficits. Government spending is not constrained by debt issuance. The government never needs to issue this debt. It does every one a favour by offering us a risk-free annuity. Please read my blog – Market participants need public debt – for more discussion on this point.
Further, the government provides the financial resoruces that it borrows back. There are no finite savings available that government and private agents compete for. The CBO choose to perpetuate the mainstream textbook myth of crowding out. They should have done the quiz last week. Please read my blog – Saturday Quiz – August 7, 2010 – answers and discussion – for more discussion on this point.
In the CBO Director’s blog which summarises the Report you read:
In fiscal crises in a number of countries around the world, investors have lost confidence in governments’ abilities to manage their budgets, and those governments have lost their ability to borrow at affordable rates. With U.S. government debt already at a level that is high by historical standards, and the prospect that, under current policies, federal debt would continue to grow, it is possible that interest rates might rise gradually as investors’ confidence in the U.S. government’s finances declined, giving legislators sufficient time to make policy choices that could avert a crisis. It is also possible, however, that investors would lose confidence abruptly and interest rates on government debt would rise sharply, as evidenced by the experiences of other countries.
Unfortunately, there is no way to predict with any confidence whether and when such a crisis might occur in the United States.
The number of countries around the world is a very small number and they are all economies where the government is not sovereign. Pity they didn’t mention that. In all the advanced nations where the governments have not ceded their currency authority bond yield are low and stable if not falling. There has been no auction dramas and all of those that I see data for are oversubscribed each time a tranche of public debt is issued.
This CBO statement is thus a lie! The officer who wrote it should be dismissed.
There is also the possibility that interest rates will rise and that this will reduce aggregate demand via the balance between expectations of future returns on investments and the cost of implementing the projects being changed by the rising interest rates.
MMT proposes that the demand impact of interest rate rises are unclear and may not even be negative depending on rather complex distributional factors. Remember that rising interest rates represent both a cost and a benefit depending on which side of the equation you are on. Interest rate changes also influence aggregate demand – if at all – in an indirect fashion whereas government spending injects spending immediately into the economy.
But the crowding out story is not remotely correct. The interest rate rises may reflect the fact that central banks push up interest rates up because they believe they should be fighting inflation and interest rate rises stifle aggregate demand.
Then you see the CBO fuelling the fire a little with the “It is also possible … that investors would lose confidence abruptly” and that “there is no way to predict with any confidence whether and when such a crisis might occur in the United States”.
Has a crisis like this occurred in the past in the US? Answer: No! So why even hint that it “might happen”?
Will there be a fiscal crisis in the US? Answer: No!
And finally today there was this story – Republicans see balanced budget amendment as potent campaign weapon – published by The Hill, which is owned by some multi-millionaires (the Finkelstein family).
The report says that:
Senate Republicans are planning a new push for a balanced budget amendment to the Constitution when lawmakers return to Washington after the August recess … The amendment would bar the federal government from spending more than it collects in revenues each year. It would also require a two-thirds majority vote in each chamber to raise taxes.
You can imagine that if this becomes law then the US unemployment rate would be more than double what it is now. If that much spending (the deficit) had not have entered the economy then the US would look much grimmer than it already does.
A significant portion of the US deficit is being driven by the automatic stabilisers. So a balanced budget rule would force the discretionary component of the budget to become highly contractionary at the same time as private spending was collapsing.
Just look at the plight faced by American states at present because of their balanced budget limitations. It is clear that the cut-backs that the States have been making have undermined the federal stimulus – Please read my blog – The old line back to free market ideology still intact – for more discussion on this point.
But if the federal government had have been forced to follow suit the US economy would have entered a depression of the same scale as they endured in the 1930s.
Imposing any sort of rule on fiscal policy reflects a lack of understanding of how the monetary system operates and the role that budget deficits play in the expenditure stream. It also represents a failure to comprehend the link between spending and jobs and prosperity.
Please read my blog – Fiscal rules going mad … – for more discussion on this point.
Some serious educational failures are apparent in the public debate.
That is enough for today!