The problematic basis for deficit phobias

With the natural disaster in the US now in its clean up stage the discussions have turned, in a predictable way, to “how will the US pay for this especially when it has huge deficits and debts and has to fall off a fiscal cliff anyway to stop the sky from falling in” – and narratives like that. Remember when Hurricane Irene struck in 2011? The resurgent Republicans tried to push through bills, which would have required matching cuts in other federal spending. The other Sandy reminder is that when the chips are down who do we all turn to? Government. What do you think would have been the current state, if the Republican contender was President and followed through on his promise to scrap FEMA and put emergency relief in the hands of the private sector, which apparently does things better? Chaos at best is the answer. The fact is that the federal government will be able to provide whatever financial assistance is required beyond private insurance payments. The only constraint that might hamper the recovery is the availability of real resources, which can be brought to bear. Further, it seems that the whole fiscal crisis beat up, even with the terms of the mainstream paradigm, is a beat-up, courtesy of some spurious work done by the Congressional Budget Office, that much-quoted, but seemingly, errant organisation.

First, lets quickly deal with Sandy.

America is in the vice-like grip of leaders and lobby groups who have constructed a parallel world for themselves, one which denies the uniqueness of a currency issuing government and then pretends that the same government is constrained by the same financial limitations as you and I.

The incumbent President said in his – State of the Union Speech 2011 – that the US was choking from the “legacy of deficit spending that began almost a decade ago” and that things could not continue if the nation was “buried under a mountain debt”.

He said that he was worried about “the fact that our government spends more than it takes in” and that this was “not sustainable”.

Then a major crisis like Sandy hits and immediately government resources are mobilised and grand statements about being their for the duration and making sure infrastructure is restored and the like are made.

Sandy has clearly wiped out massive amounts of productive capacity nd left whole communities without essential public infrastructure.

The US government is totally sovereign in its own currency and has no revenue constraint. That means – and there is no ambiguity or “if” factor about it – that the US federal government can muster any idle resources which are for sale in US dollars and put them to productive use whenever it has the desire to do so.

In fact, given how governments invade our freedom with a range of laws and regulations, the only reason we put up with them is because we expect them to do exactly that – ensure all productive resources are contributing and that all citizens have access to a stable income which they can use to advance their own well-being.

I am sure no-one on Staten Island is at present refusing any public spending support or busily planning to save more to pay for the implied higher deficits.

We expect government to provide productive public infrastructure – productive in a broad sense – that it not only enhances the ability of private enterprises to make gains but it also makes our lives as citizens more fulfilling. We should never appraise public infrastructure just in terms of its subsidy to private profit.

There should be no talk of levies or tax increases or spending offsets. It is definitely time to be increasing the deficit, which will also push the US economy into a higher growth path and bring unemployment down more quickly.

Blind adherence to confected fiscal rules – as if they are hard constraints – is very dumb indeed at the best of times but worse now that growth is continuing but still relatively anemic.

The storm has been very damaging. But when we assess “costs” to government of the clean-up, we should only consider the real resources that it will need to deploy in the delivery of that program.

Costs are never meaningfully represented by the numbers that appear in the budget allocations. They are just $ representations of the current market value of the real resources being mustered. If there are real resources available for sale in the currency of issue then any sovereign national government can “afford” to purchase them and to utilise them to advance public purpose.

Any other representation of the “costs” is erroneous.

The relevant questions that the government should be asking include: Are there enough workers available to implement the programs without causing inflationary bottlenecks in the labour market? Are there enough raw materials – timber, concrete etc available for use in the reconstruction?

The Government can find any financial sum necessary to muster those real resources from the private sector by simply typing some numbers into a computer terminal at the Federal Reserve. It issues the currency. It can “find” its own currency whenever it wants to.

It would also seem to be the case that there is ample idle labour that could be brought in to help in the rebuilding – although I eschew the use of volunteer labour. Public sector jobs should be created to do the reconstruction work.

In ensuring sufficient budget outlays are made to facilitate the reconstruction, the Government will also help boost the ailing private sector.

There is a massive reconstruction effort that can deploy tens of thousands of unemployed workers on a Job Guarantee – at the federal minimum wage. The work will be local and in the most populace states.

Given that we have been seeing volunteers with no specific skills already working on the task, it is obvious that the Federal government could hire these workers and put them to work close to their homes with minimal training. So even if these are low-skilled workers there is no excuse at all not to hire them for the reconstruction effort.

The problematic basis for deficit phobias

Modern Monetary Theory (MMT) demonstrates the unfounded nature of the deficit phobias, which have crippled the capacity of currency-issuing governments around the world to respond effectively to the crisis. After nearly 5 years, some countries are mired in recession or low growth purely because their governments have refused to expand net government spending to match the collapse in non-government spending.

There is simply no intrinsic financial constraint on a currency-issuing government. As I have noted previously, ideological issues relating to government involvement in the economy may lead to the introduction of a raft of voluntary constraints and elaborate accounting conventions, which place constraints on government spending.

But these voluntary hurdles do not alter the essential fact relating to the intrinsic capacities of the government. How quickly did the US government respond when Lehmans crashed? Answer: very quickly – keystrokes on computers delivered billions of $US in moments.

The same logic applies in the case of the response to Sandy as explained above.

But I was sent an interesting paper over the weekend that demonstrates that even within the logic of the mainstream economists, the fears of a deficit explosion in the US, which has been promoted, initially, by various Congressional Budget Office reports and then propagated by an uncritical and unthinking media, have no evidential foundation.

That is the fears are irrational and are largely driven by spurious extrapolations produced by the CBO.

April 3-5, 2008, the periodic workshop on public finance staged by the Banca Italia was devoted to the topic – Fiscal Sustainability: Analytical Developments and Emerging Policy Issues.

One of the papers presented at that conference – An Examination of Health-Spending Growth in the United States: Past Trends and Future Prospects – was written by two US Federal Reserve Board economists, Glenn Follette and Louise Sheiner.

The summary of the paper is as follows.

The authors say that:

Long-run projections of the U.S. federal budget have played a prominent role in discussions about fiscal policy and the design of major transfer programs for several decades. The projections typically show large fiscal imbalances owing to ramping up of retirement and health care costs relative to GDP. Health care costs are the key factor in these projections for two reasons. First, in current projections they are the prime source of growth of spending as a share of GDP. Second, they are the most uncertain part of the forecast.

The authors acknowledge that the “state of the art in health care projections is still very rudimentary” and that “long run analysis … typically focuses on the age-composition of the population and an assumed excess growth rate of per capita spending above per capita income.”

The CBO deploy “assumptions about excess growth” that “are based on historical growth rates for health care relative to income”, although this “standard approach of extrapolating historical excess growth is problematic for constructing a useful benchmark that facilitates policy analysis”.

The paper examines a number of aspects relating to these extrapolations from historical data concerning the “rate of excess health-spending”. The major findings are:

1. While “(h)ealth-spending growth has exceeded income growth by 2.5 percentage points, on average since 1960” in the US – the so-called “excess growth” – detailed study reveals that it “falls over time”. This is also consistent with international evidence.

2. Microeconomic studies of health spending find that:

… aging and real income growth account for a relatively small fraction of the increase in real spending over the 1940 to 1990 period, while increased insurance coverage, changes in relative prices, and increased administrative costs have been important contributors to growth. The reminder, about 50 to 60 per cent, is assigned to technology-related changes in medical practice.

3. Projections of health spending and income movements to 2090 based on plausible assumptions show that:

1 per cent excess growth looks to be an upper bound for seventy-five year projections … Balanced projections that leave room for errors on both sides should probably assume rates of excess growth lower than 1 per cent.

These projections were based on detailed analysis of consumption trends – health and non-health.

4. In terms of health spending across income quintiles, the authors find that:

… while private health care spending will rise to a very large share of income among the lower quintiles, real non-health consumption will not be crowded out – for the quintile on average – over the projection period. Low-income groups now only spend a small portion of their income on health because 40% a large share of health spending is financed by the public sector. In 2080, when health care costs are projected to be 124 per cent of income on average for the lowest non elderly quintile, only 38 per cent of income will be spent on private insurance and out-of-pocket health expenditures. Thus non-health consumption can continue to grow, on average, for this quintile.

On Page 459 you realise that these authors are operating totally within the mainstream way of thinking. They say that their analysis of the impacts across the quintiles “does not account for the taxes that will be needed to finance the increased transfers for Social Security and health care. If these increased taxes are broadly based, then some of the lower quintiles may also see declines in the resources available to finance non-health spending”. Enough said.

5. In terms of the CBO projections, the authors say:

CBO’s baseline projection for overall health care as a share of GDP is unbalanced as there is little reason to expect health care to crowd out other consumption and thus there may be little risk of higher overall health spending but a substantial risk of lower overall health spending … The relatively high share of health spending in the CBO projection owes to the high levels of excess growth assumed for various pieces of the health payment system. These in turn reflect their decision to base spending on average rates of growth over the past 35 years, without examining whether there has been a slowdown and without accounting for non-demographic factors …

Which leads to the overall conclusion that:

… there is evidence that excess growth has slowed over time and that some of the factors that have boosted it historically may not be factors going forward. This calls into question the use of long historical averages for baseline forecasts … If we assume 1 per cent excess growth, then past experience suggests that the resulting pattern of health spending across income groups will create pressures to increase government support of health care among lower income groups. However, reductions in government subsidies of health care are feasible for higher income groups.

The mainstream press ignored this work. While I don’t agree with all the analysis presented, nor its initial motivation, the general findings carry much more plausibility than those provided by the relatively crude CBO analysis.

Conclusion

There is much more in the paper – but the point is that the results are extremely damaging for the mainstream case that immediately invokes CBO projections when mounting attacks on US government deficits.

It would probably be too much to ask the deficit terrorist zealots to adopt an evidence-based approach. Blind ideology is, after all, blind.

But then from an MMT perspective it is all moot anyway!

Good News from Australia today

The Federal Court in Australia today rules against Standard and Poors and the company will have to share in the payments amounting to $A30 million to local councils for losses they made in 2008.

Here is the headline from the Sydney Morning Herald today (October 5, 2012), which says it all really – worthless:

ABC News story (October 5, 2012) – Councils to recoup GFC losses after court ruling – tells us that:

Tne ratings agency Standard and Poors says it will appeal against a landmark ruling which will allow 13 local councils to recoup losses they suffered during the 2008 financial crisis.

The New South Wales councils … brought a class action against Standard and Poor’s, investment bank ABN AMRO and Local Government Financial Services (LGFS).

The councils claimed they were misled into losing almost $16 million in the financial crisis, saying Standard and Poor’s led them to buy complex investments called Constant Proportion Debt Obligation Notes (CDPOs), which the agency had given a AAA rating.

Today’s ruling found that rating was misleading and deceptive.

The judge said the ABN Amro products were “grotesquely complicated” and that the AAA rating had been “simply bulldozed … through”.

The decision is seen as a “a major blow for ratings agencies” and one lawyer said:

No longer will rating agencies be able to hide behind disclaimers to absolve themselves from liability …

Another legal opinion was that the decision has global relevance:

It fundamentally arose by rating agencies and investment banks looking after their own interests and potentially being a material cause of the global financial crisis … Here we have Standard and Poor’s, which is a live breathing ratings agency that has a business that everybody in the financial markets relies upon. And we’re looking to sue Standard and Poor’s … [elsewhere] …

Now it is up to the rest of the world to follow the lead.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.