I suppose I had to respond to this atrocious piece of deception pedalled by the New York Times (March 5, 2011) as an “Economic View”. The article – It’s Time to Face the Fiscal Illusion – is not economics. It is a religious diatribe with strays into lies and deception. The reality is that mainstream economics has learned nothing from the crisis that has left their key intellectual propositions being exposed as vacuous nonsense. The inability of my profession to move on and embrace the challenge that an alternative theoretical structure is more relevant is sad. Instead the same old mantra based on theories that have no empirical basis are being wheeled out – the same theories that pressured policy makers to create the conditions which ended in the crisis. In relation to today’s blog we should understand that government deficits are the norm and they generally never pay back their debt (overall).

I have been travelling today and so haven’t had much time outside of my commitments. But I did read some truly astounding articles today. As the conservatives take control of the political processes in the advanced nations they are revising history faster than we can read about it. Meanwhile they use the TINA claim to implement policies that damage the well-being of the average citizen and set up dynamics that will manifest as the next crisis. And we say we like it – because we have been bluffed into the TINA lie. The fact that the public believe all the conservative dogma and go along with it astounds me. Economics is not that hard. If no one is spending then output will fall and unemployment will rise. But somehow the public believes the opposite. They have been conditioned to believe that a rising (large!) budget deficit is bad and a falling (small!) deficit is good. The reality is that there are no better or worse deficits.

I have been working on the macroeconomics textbook today that Randy Wray and I are hoping to publish sometime next year. We have a publisher and now just have to complete the text which is progressing well. Also today I have been wondering why UK business firms are not horrified at the latest damaging policy announcement by the new conservative British government. My thoughts generalise to any government at present in terms of the obvious need to expand fiscal policy. I brought those two things together today – the practical need for continued fiscal support for private sector activity and the development of our textbook – by considering the macroeconomic origins of profits. It is an interesting story that very few people really understand because they think micro all the time when it comes to the understanding the profits of business firms whereas you have to start thinking from a macroeconomics perspective to really understand this. It also helps you understand the relationship between the government and non-government sector more fully – a relationship which is at the heart of Modern Monetary Theory (MMT). So read on and see if you have thought about this before.

I have always been antagonistic to the mainstream economic theory. I came into economics from mathematics and the mainstream neoclassical lectures were so mindless (using very simple mathematical models poorly) that I had plenty of time to read other literature which took me far and wide into all sorts of interesting areas (anthropology, sociology, philosophy, history, politics, radical political economy etc). I also realised that the development of very high level skills in empirical research (econometrics and statistics) was essential for a young radical economist. Most radicals fail in this regard and hide their inability to engage in technical debates with the mainstream by claiming that formalism is flawed. It might be but to successfully take on the mainstream you have to be able to cut through all their technical nonsense that they use as authority to support their ridiculous policy conclusions. That is why I studied econometrics and use it in my own work. It was strange being a graduate student. The left called be a technocrat (a put-down in their circles) while the right called me a pop-sociologist (a put down in their circles). I just knew I was on the right track when I had all the defenders of unsupportable positions off-side. But an appreciation of the empirical side of debates is very important if a credible challenge to the dominant paradigm is to be made. That has motivated me in my career.

The headline news for today was that the actor Kevin McCarthy died at the age of 96. He was the star of the legendary 1956 science fiction movie the Invasion of the Body Snatchers which was about a doctor who tried to tell the world that it was being invaded by the emotionless alien Pod People. The movie was in the “so bad that it was good” category. Given the ending was open, perhaps we can persuade some of the Pods to return and subsume a few neo-liberals and also some progressives who have neo-liberal tendencies. There has been a lot of noise lately about why Modern Monetary Theory (MMT) is essentially misguided because it ignores the dangers of the external sector. The claim goes that while there is no financial constraint on government spending, expansionary policy leads to an expanding current account deficit and rising foreign debt levels which are unsustainable over any period longer than a few years. Okay, we have heard this all before. Here are some thoughts.

Last year it was Reinhart and Rogoff being rammed down our throats as the deficit terrorists were claiming that governments in the advanced nations were on the cusp of defaulting on their sovereign debt. Their book was relentlessly misused by commentators and academics (like Niall Ferguson and others) and even the authors themselves left things ambiguous in interviews. The fact is that their research (if we dare call it that) is applicable to only a narrow set of situations none of them relevant in the contemporary setting. More recently, the deficit terrorists have been holding up a new effigy – a new hero. Another Harvard economist – Alberto Alesina. What is it about that place? Alesina has allegedly provided a solid theoretical case to support the absurd claims by the austerity proponents that cutting the very thing that is supporting growth at present will not damage that growth. He is now the new hero. Well it is another scam job! He chooses to use flawed orthodox textbook models to assert his case without mind to the situational context and other realities. He is no hero but just another mainstream economist seeking celebrity with zero substance to offer and very little else to sell other than a headline.

I have noticed a few commentators expressing concern about the dangers that might arise if a nation runs a persistent current account deficit. There have been suggestions that this area of analysis is the Achilles heel of Modern Monetary Theory (MMT). I beg to differ. A foundation principle of MMT is that to be able to freely focus on the domestic economy, the national government has to be freed from targetting any external goals – such as a particular exchange rate parity. The only effective way for this to happen is if the exchange rate floats freely. In this sense, the exchange rate is the adjustment mechanism for external imbalances.

Australia is becoming caught up again by the rhetoric flowing from the minerals lobby that we are about to enter the “mother of all mining booms”. Almost every day now, the politicians, business spokespersons and the media are beating up this story. The minerals lobby has achieved spectucular success over the years in inflating its importance such that people genuinely believe our prosperity comes from this sector. Somehow we believe that this sector is our vehicle to Shangri La. Corresponding to all this hype is a growing push for significant cuts in public spending to “make room” for the mining boom. The debate is interesting because, like the intergenerational (ageing population) debate, it demonstrates how erroneous understandings about the monetary system and the role of the government within it lead to spurious conclusions. And all the while – labour underutilisation rates remain high.

Today I am writing about the sectoral balances which are derived from the national accounts. A recent article in the Financial Times uses these balances to demonstrate that attempts to reduce the UK public deficit can only be successfully achieved by engineering growth in non-government spending. That is an insight that is core to Modern Monetary Theory (MMT) but typically escapes the understanding of most commentators. The article is interesting because it shows how the sectoral balances – which are accounting statements and thus true by definition – can be interpreted in different ways and influence different policy strategies. But the fundamental understanding you gain from knowledge of these balances is that at present public deficits are here to stay … and if you don’t like them … you better get used to it!

The latest economic news from the UK and the US is hardly inspiring. Further, detailed examination of the sectoral balances in the OECD nations reveals a massive drop in private demand since 2007. The mirror image of that spending collapse has been the increase in public deficits via the automatic stabilisers (discretionary stimulus packages aside). These swings are just signs that economies are adjusting back to more normal relations (private saving, public deficits). The sharpness of the swings reflects the atypical period that preceded the crisis where growth was fuelled by private debt in the face of fiscal contraction. It will take some years for the adjustment to be completed and the danger is that ideological attacks on the fiscal deficits will derail the process. But when the sectoral balances return to more normal levels in relation to GDP then guess what? We will still have budget deficits and we all better get used to it.

Today I have been reading all the documentation surrounding the proposals issued by the Bank of International Settlements to reform the regulatory system for international banking. These considerations then took me to an interesting paper from Deutsche Bank where they refute (albeit unintentionally) much of the media hysteria about exploding government bond yields and bond markets “closing governments down” because their deficits are “ballooning out of control”. In fact, the DB Report shows categorically that within the new regulatory framework that the BIS (and hence the Australian Prudential Regulation Authority will introduce), there is scope for larger budget deficits. In terms of the state of the Australian labour market and the very slow growth that the world economy will experience in the coming years, a further stimulus package is necessary. The DB Report implies that the bond markets would welcome it. Curious?

Person the life-boats! Get the hard hats out! Strife and pestilence is coming! I am wondering what all these loons – the deficit terrorists – who are now elevating a simple endogenous fiscal balance into a national emergency – will say in a few years when growth returns, unemployment falls, people start rebuilding their savings and most importantly their children do not go into slave camps making widgets to send back to the previous generation to pay for the fiscal balances and … the sky stays firmly above our heads although it does rain occasionally down on us to help farmers grow vegetables. What will these hysterical idiots say then? Today, the budget deficit has become the latest WMD. A seek and destroy mission is required. Bring out the military and attack treasury offices everywhere. Rally patriots the hour of calling is nigh?

Several readers have written to me asking about the Ricardian equivalence theorem, which is increasingly getting mentioned in the media and public policy reports. As I will explain, the theorem is used by anti-government proponents to argue that fiscal deficits are counterproductive and that cutting deficits in the middle of a recession will actually be good for the economy. They never really give up, do they? The theorem is a good example of the general mainstream approach where stark policy conclusions are derived which capture the popular debate but the underlying assumptions that are required to generate those conclusions are rarely widely known or mentioned in the popular press. Of-course, if the public understood these underlying assumptions then they would not take the conclusions seriously.

In the coming period and probably years you should expect to hear, read and be submerged with mainstream economists coming out and assessing the structural budget deficit. Across most economies, these so-called “experts” will be arguing that the structural deficit in the nation is too high and deep cuts are needed to bring it into surplus. The importance of this debate is that they use the structural deficit estimates as an indicator of the fiscal stance being taken by the government and thus separate out the effect of the automatic stabilisers. The problem is that it is an inexact science. The mainstream approach is highly dependent on the NAIRU concept (see below) and thus will err on the side of concluding that the deficit is “too big” and “likely to cause inflation”, whereas it is probable that the deficit will be too small to underpin private savings and high levels of employment.