{"id":12003,"date":"2010-10-21T18:12:23","date_gmt":"2010-10-21T07:12:23","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=12003"},"modified":"2024-04-11T11:44:45","modified_gmt":"2024-04-11T01:44:45","slug":"why-budget-deficits-drive-private-profit","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=12003","title":{"rendered":"Why fiscal deficits drive private profit"},"content":{"rendered":"

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.
\n
\nIn this context, this article in the UK Guardian (October 20, 2010) – America can carry this deficit<\/a> – is worth considering. It provides good insight into why the US (and any sovereign government) should be seeking to expand their discretionary fiscal deficits rather than cut them back.<\/p>\n

The article says:<\/p>\n

\nThe federal fiscal policy debate is being overwhelmed by a growing sense that America must slash its deficit now, before it is too late. Actually, the United States is in no danger of a treasury debt crisis and can carry far more debt than people believe without dire consequences.<\/p>\n

Unfortunately, many who argue for rapid deficit reduction base their case on a slew of misunderstandings and fallacious generalisations about the consequences of high public debt\n<\/p><\/blockquote>\n

I continually try to reinforce the notion that there is no basis in economic theory or in the way the monetary system operates for advocating deficit reduction at this point in time. I try to highlight where the misunderstandings come from and expose the usual “theoretical authorities” that are used to justify this damaging policy advocacy as erroneous if not out-rightly fraudulent.<\/p>\n

There is no doubt in my mind that the case for fiscal austerity is based on the ideological hatred of government intervention rather than any sound economic case that the cutbacks will improve the aggregates we are usually concerned with – output and income growth, reduced unemployment, low inflation etc. It is clear to me that the fiscal austerity approach – for example, epitomised now in the announcement in the UK yesterday – will damage employment growth and undermine economic growth.<\/p>\n

Further, the UK Guardian article notes that:<\/p>\n

\nIn both the US and the UK (the two high-debt-capacity countries with the longest history of public debt), there is no visible relationship between the public debt ratio and inflation. For example, the peak US public debt ratio of 109% in 1946 was followed by a decade of low inflation.<\/p>\n

Similarly, both American and British histories fail to show that high public debt is a drag on growth; in fact, peaks in the public debt ratio have been precursors to unusually strong economic growth.\n<\/p><\/blockquote>\n

Most of the deficit terrorists never reflect on history or, if they do, they use it in a distorted manner to weave their lies.<\/p>\n

The Guardian authors note that if you examine history and analyse cases where nations did get into trouble with their debt holdings you will see that “(t)hey had some combination of the following conditions that limited their debt-carrying capacity”:<\/p>\n

\n… first, a lack of government control of the money supply of the currency in which most of its debt is denominated; second, debt owed in or convertible into gold; third, the lack of a long history of political stability and an effective means of tax collection; fourth, the lack of a large, liquid market for government debt; and fifth, debt owed personally by a king or other supreme ruler. Not one of these conditions applies to the United States.\n<\/p><\/blockquote>\n

So the Reinhart-Rogoff myths are usually wheeled out by the terrorists without them noting that the monetary systems that operated when the debt defaults occurred were not commensurate with those in place now, or that the debt was in a foreign currency, or some other constraint on the sovereignty of the nation was in place.<\/p>\n

As I have said often – there has never been a sovereign default in the modern era among nations that issue their own currency, issue debt exclusively in that currency and float that currency on foreign exchange markets. Japan did default during the Second World War but that was politically-motivated and had nothing to do with their financial capacity.<\/p>\n

The deficit terrorists, however, always avoid such empirical scrutiny and historical accuracy. Even so-called historians like Niall Ferguson misrepresent the historical record in the ways I have noted above and written about previously.<\/p>\n

Please read my blogs – The deficit terrorists have found a new hero. Not!<\/a> – Ladies and gentleman, civilisation is ending<\/a> – Person the lifeboats!<\/a> – for more discussion on this point.<\/p>\n

The Guardian authors also note that:<\/p>\n

\nSadly, discussions about the implications of rising public debt are riddled with many other myths and misplaced fears as well: that there will be insufficient “savings” to absorb the continued massive issuance of public debt securities; that the central bank will always be able to generate inflation to lower the real debt service burden; that the public debt ratio can only be lowered by onerous future tax hikes; and so on … For now, slashing the deficit would be hurtful to the economy and self-defeating. Such well-meaning but wrong-headed action would cause renewed recession and plunging tax revenues. Until the private economy completes the multiyear balance sheet adjustments underlying the current depression, federal debt will continue to swell.\n<\/p><\/blockquote>\n

The argument here is that rising public debt ratios per se<\/em> do not promote economic growth and business profits etc. Rather, it is the fiscal deficits which are matched $-for-$ with debt-issuance that drive the positive dynamics via their impact on aggregate demand. If the government gave up its “gold standard” practice of issuing debt but still maintained a expansionary fiscal stance these positive impacts would still evolve and there would just be more bank reserves in the system.<\/p>\n

As an aside, I am writing a paper on this point at present – that these reserves would also provide increased stability for the private banking system. I will publish a blog on that point once I have finished the academic paper which I will present at the American Social Science meetings in Denver in early January 2011.<\/p>\n

Anyway, back to my textbook writing today which will help you to understand what most people fail to understand – the macroeconomic origin of profits.<\/p>\n

In a recent blog – The fiscal stimulus worked but was captured by profits<\/a> – I outlined the key findings of Morgan Stanley market briefing which demonstrated that:<\/p>\n

\nBusiness was the biggest beneficiary of policy stimulus: it didn’t have to pay for the recovery. Consequently, the profit recovery was strong even though the growth recovery was weak.\n<\/p><\/blockquote>\n

In that blog I did not go into any detail how fiscal deficits underpin private sector profits at the macro level. That is what I am writing about today.<\/p>\n

One of my favourite economists – Michal Kalecki<\/a> was one of the early pioneers in developing an understanding of the origins of profits from a macroeconomics perspective. Another original contribution – somewhat earlier – which was derived in a different manner but has the same implications came from the US businessman-cum-economist Jerome Levy<\/a>.<\/p>\n

Levy wrote his famous contribution in 1914 but it was published as Economics Is an Exact Science<\/em> (New Economics Library, New York) in 1943.<\/p>\n

I have written about Kalecki previously in this blog – Michal Kalecki – The Political Aspects of Full Employment<\/a>.<\/p>\n

Kalecki’s Theory of Profits<\/strong><\/p>\n

The key articles\/books that outline Kalecki’s approach to profits are:<\/p>\n