Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday, 16 February 2018

Do Trump’s deficits matter?


Should Democrats complain about the large deficits that Trump and the Republicans are creating? Or is this playing into the Republican narrative that made the stimulus in 2009 inadequate and gave us austerity from then onwards?

The answer that mainstream economics gives is straightforward. In a recession when interest rates have hit their lower bound [1] you do not worry about the deficit and you ignore those that do worry. Deficits should be whatever size is required to enable the economy to recover. Enough stimulus so that central banks feel they need to raise interest rates above their lower bound. Politicians failed to follow that advice during the last recession.

In contrast, when the economy is not in a recession, and interest rates are perfectly able to control aggregate demand, then deficits at a level where government debt starts rising may well be a problem. For various reasons, not least the chance of a recession, it is best to have deficits at a level which very gradually reduces the ratio of government debt to GDP, unless you have a good reason for doing otherwise.

There are many reasons why, outside of a recession, deficits that, if sustained, would steadily increase the debt to GDP ratio may be bad for the economy, but let me give the most obvious here. For a given level of government spending, interest on debt has to come out of taxes. The higher the debt, the higher the taxes. That is a problem because high taxes discourage people from working, and it is also unfair from an intergenerational point of view.

This last point is obvious if you think about it. The current generation could abolish taxes and pay for all spending, including any interest on debt, by borrowing more. That cannot go on forever, so at some point taxes have to rise again. A whole generation has avoided paying taxes, but at the cost of future generations paying even more.

As a result, unless there is a very good reason like a recession [2], a responsible government will not plan to sustain a deficit over time that raises the debt to GDP ratio. The problem though is that it is very tempting for a government not to be responsible. The current US government, which is essentially a plutocracy, wants above all else to cut taxes for the very wealthy, and if they do it without at the same time raising taxes on other people but instead by running a deficit they think they can get away with it. Democrats have every reason to say that is irresponsible, although of course the main thing they should focus on is that the last people who need a tax cut are the very rich.

Unfortunately being responsible can seem rather dull and boring, so it may be tempting to hype things up a bit by predicting some disaster that will come from rising deficits. That is not a good place to go, because you are crying wolf. Large deficits are like overeating. Do it once or twice and you will survive. Do it every day and you will die young. The only difference from overeating is that you do not die young, but your children do.

So much for mainstream economics. What about MMT, which is often characterised as implying that deficits do not matter? That is an incorrect characterisation: what MMT actually says is that inflation should determine what the deficit should be. If inflation looks like staying below target you can and should have a larger deficit, and vice versa. The reason they say that is that they think the central bank, in changing interest rates to control inflation, is wasting its time, because they believe rates do not have a predictable impact on demand and inflation. If that were true, then even mainstream economists would agree that the deficit should be at whatever level keeps inflation at target. The difference between MMT and the mainstream is whether the central bank is or is not wasting its time.

In an important sense, whichever perspective you take, thinking about stabilisation policy or long run deficits can just muddy the waters when it comes to the Republican tax cuts. The reason that Republicans mainly fund tax cuts for the very wealthy by borrowing is that it appears this is not costing anyone anything. If nobody’s taxes are going up, the argument goes, why should we mind too much if the richer get even richer. The key point to get across is this. There are two possibilities. The first is that if it is possible to permanently cut some taxes forever without raising others or cutting spending, why should the tax cut not go to those who need it rather than those who don’t. The second more likely possibility is that it is not sustainable, in which case at some point tax paid by ordinary people will go up or spending on ordinary people will be cut to pay for tax cuts to the very rich. Either way, ordinary people are losing out. To focus on deficits or inflation just detracts from this basic truth.

[1] The lower bound is either where the central bank thinks it is or the point that interest rate cuts become an unpredictable and therefore ineffective instrument.

[2] A natural rather than man made disaster might be another good reason to run deficits. Public investment on high return infrastructure is another.


32 comments:

  1. I'm always wary of providing eggs for you to suck as I've found before that my epiphanies turn out on reflection to be the truisms that form the unsaid assumptions of your argument. But...

    Your intergenerational fairness argument is surely incomplete. Clearly abolishing taxes and borrowing (or printing) to fund spending ad (a hoped for) infinitum would not end well. But surely spending from borrowing and at least some taxation wouldn't necessarily have the same effect. An equilibrium could at least be sought at higher levels of borrowing and higher levels of economic activity. Particularly with spending on education of course (where in any case the intergenerational fairness argument is weaker). If we really believe that "your bloody GDP" can become ours we are already assuming that there is vast economic potential in the badly or futilely educated. We just need to find out how much: anything else is to share the Newcastle heckler's despair.

    Jonathan

    Love reading your stuff btw. Thanks

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    1. Borrowing in order to spend on something that is beneficial to future generations is clearly different, and not problematic. As I said somewhere, deficits to fund public investment are fine.

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    2. There is one other intergenerational aspect to taxes v. borrowing. The US raised payroll taxes in 1983 to prefund Social Security benefits for people just now going into retirement. Of course the early 1980's was a period when Republicans paid for a military buildup and tax cuts for the rich by basically counting those Social Security surpluses as if they were part of the general fund.

      Add to that the projected rise in health care costs from what I recently called the Baumol Cost Disease. Future Federal healthcare payments are another distributional debate in the US. In my little quibble over at Econospeak with Jeffrey Miron - this issue is a big deal.

      For various reasons, I have promised to say more about paying for health care in the future. I'm pondering how to bring your insight here into the discussion. Stay tuned.

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    3. Spending without taxing or borrowing (printing if you will) will not be inflationary if there are excess resources in the economy (unemployed folk) if its part of a Job Gty as part of a Full Employment Fiscal Policy. (see the Doggy's blurb:http://mmt-inbulletpoints.blogspot.com/2017/09/im-just-responding-to-various-economic.html )
      - Why? Because public sector workers produce public sector goods and services, who then wave their money in front of the noses of business people who then go waky waky and produce MORE private sector GOODS AND SERVICES. These offset the added currency issued.

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  2. I rather thought that MMT considered borrowing as corporate welfare. The govt can create money without borrowing anything. That's why interest rates are effectively a waste of time.

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    1. I was very careful to divide up my post between a mainstream view (where government creating money messes with inflation control) and an MMT view where it is the inflation constraint that bites.

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  3. "The current generation could abolish taxes and pay for all spending, including any interest on debt, by borrowing more."

    The private sector creates promises that circulate as money; when the promises come due, they can be rolled over, forgiven, or paid from insurance. The insurance can pay using promises that come due later, but circulate as money today. When those promises come due, they can be rolled over, forgiven, or paid from insurance. The insurance can pay using future promises circulating as money, and thus the endless cycle of putting off final settlement for another day continues.

    In a crisis, the Fed has proven it can supply unlimited liquidity to rescue world markets from themselves.

    Fees in the private sector are really icing on the cake, just a way to manipulate and distract. Wells Fargo made more profit from the riskless balance sheet expansion involved in creating fake accounts than from fees on those accounts.

    Central banks should expand their existing unlimited currency swap network to ensure unlimited access to whatever is the world's best money. Since World War II, the US Dollar has been the unit preferred by the private sector for settlement. After 2008, the ECB received an aggregated $8 trillion in currency swaps from the Fed to bail out European banks with dollar-denominated obligations and no dollar funding source. The rates on the swaps were policy-determined, away-from-market.

    Conclusion: central banks can print without consequence. Inflation can be treated as psychological or arbitrary, and handled with further printing to raise all incomes with prices, thus maintaining real income purchasing power. Nominal prices can be converted to units of purchasing power and inflation ceases to be something we need worry about.

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  4. Wouldn't MMT supporters argue that any deficit should be funded by printing money rather than borrowing ? If this were done in practice, then presuambly the points you make about the damaging effects of tax raised to pay interest would not apply ?

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    1. They would. But I was talking there about what the mainstream view, where monetary policy matters and therefore the central bank determines how much money is created. Under MMT, as I implied, the deficit and debt are whatever they have to be to keep inflation constant.

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  5. Genuinely thought this was going to be about Trump's cognitive deficit, his empathy deficit, his moral deficit...

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  6. SW-L says, “In contrast, when the economy is not in a recession, and interest rates are perfectly able to control aggregate demand…”. That actually assumes that government & central bank have curbed demand by raising interest rates rather than by cutting the deficit / running a surplus. I suggest (contrary to the conventional wisdom and in line with MMT thinking) that raising interest rates is not a brilliant option. Among other things it involves every mortgagor in the country paying extra interest just to enable government to use interest rate adjustments to control demand.

    Also, one of the main arguments for government borrowing, namely that it is justified for funding infrastructure investment etc is nonsense. First reason is that education is one huge investment, but no one ever suggests funding the entire education budget via borrowing. Second, no one in their right mind borrows to fund an investment if they have enough cash to hand, and governments have two near inexhaustible supplies of cash: tax and printing money.

    Finally, SW-L’s guardian angel, David Hume (ho ho) was obviously guiding him when he said “that it is very tempting for a government not to be responsible.” Hume said:

    “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker's shop in London, than to impower a statesman to draw bills, in this manner, upon posterity.”

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  7. A question based on ignorance. If it becomes conceded that money can indeed be created out of thin air, the next line of defence will be that this is all very well, but there is a direct correlation between money creation and inflation.
    So that spending on even worthwhile projects is irresponsible.
    I suspect that there is no direct correlation. How money moves, and where it ends up can have a major effect in reducing inflation. But what is the evidence one way or the other?

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  8. but what about the NHS?

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  9. "he first is that if it is possible to permanently cut some taxes forever without raising others or cutting spending, why should the tax cut not go to those who need it rather than those who don’t."

    Maybe because they earned the money in the first place? To me, your second objection, that huge deficits ultimately unsustainable, is much more convincing than your first.

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    1. Big earners ultimately only earn such because the resources they use to earn their wealth were invested in previously. Failing to tax wealth and invest in infrastructure is not only immoral, it's stupid, somewhat literally pulling up the ladder for future generations.

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    2. The Federal Debt is a nothingburger which can be safely ignored. If you had a printing press in your basement which can print $1,000 bills, would you worry about your Visa bill?

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  10. "The answer that mainstream economics gives is straightforward. In a recession when interest rates have hit their lower bound [1] you do not worry about the deficit and you ignore those that do worry."

    Evidently not straightforward enough for many mainstream economists - including the best:

    https://johnhcochrane.blogspot.fr/2018/02/deficits.html

    I think this divide between mainstream and non-mainstream is illusory. The divide between the two is more fundamentally about what is appropriate methodology.

    There are many in both camps (mainstream and non-mainstream) that are concerned or not-concerned about deficits - where they stand on deficits seems to have far more to do with political leanings.

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    1. Cochrane is the best?;> The federal Debt is not a problem in any way shape or form. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. We're not recommending this course of action, just pointing out that it is possible.

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    2. Cochrane did have a post that claimed that but then he completely flipped flopped on this issue. I noticed over at Econospeak and Brad DeLong also noticed. Cochrane on cutting taxes - no problem ... but uh oh - we cannot afford those "entitlements". Absurd.

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    3. Sargent and Cochrane have both argued, and the former particularly so in recent years that high taxes and entitlements are bad because of its effects on incentives. They argue that this is well-founded according to classical (mainstream) micro-economic theory and that the large welfare state is the reason for Europe's productivity slowdown.

      Sargent and Cochrane have more authority in mainstream economists than most; particularly the former - the grovelling towards the Sargent is something that has to be seen to be believed.

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  11. Problem is that the path of debt/GDP ratio depends on a host of factors, including future growth, inflation etc, as well as future spending and taxation levels.

    Funding a deficit to fund planned investment that is efficient and productive in planning and execution terms (not an insignificant 'if', unfortunately)is OK, but it is difficult to discern how an optimal level of public investment can be fitted to a set declining debt/gdp ratio target.

    Why after all postpone or cancel investment on improved connectivity infrastructure in the North in order to accommodate in the short term such a target?

    Also some education and health current expenditure is in fact investment in human capital which will produce future returns.

    Given the possible context of a future McDonnell chancellorship, minds probably need to focus on taxation sources which are politically feasible, fair, and least economically damaging, as well as to how make public investment planning more efficient.

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    1. The object should be a) unemployment at ZERO at all times, and b) inflation at a low comfortable level: 4%? Everything else is reading tea leaves.

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  12. Deficits matter for distribution
    Comment on Simon Wren-Lewis on ‘Do Trump’s deficits matter?’

    The essential point about deficit spending/public debt is this: the axiomatically correct macroeconomic Profit Law is given as Q=Yd+(I−S)+(G−T)+(X−M) which reduces to Q=G−T for Yd, I, S, X, M=0. The simplified equation says that the profit of the business sector Q is equal to the deficit G−T of the public sector. It holds Public Deficit = Private Profit.

    So, from the standpoint of simple self-interest, the one-percenters and their useful academic/journalistic spokespersons should consistently argue FOR deficit spending#1 and the ninety-nine-percenters and their academic/journalistic spokespersons should consistently argue AGAINST it. Curiously, just the OPPOSITE happens. So, either economists are stupid and do not know how the economy works or they are complicit in a communicative charade.

    The main argument against the MMT championship of deficit spending ― inflation ― is beside the point because it rests on a false inflation theory.#2

    The correct argument against deficit spending is that it is NOT in the interest of the ninety-nine-percenters and that it produces the distribution of income/wealth that everybody considers now as real danger for society/democracy.#3

    The fact of the matter is that ― because Public Deficit = Private Profit ― the one-percenters have achieved their goal hands down by simply letting scientifically incompetent spokespersons of the ninety-nine-percenters like Paul Krugman or Stephanie Kelton brilliantly perform their roles as useful idiots by busily spreading Warren Mosler’s false Deficits-Do-Not-Matter doctrine.

    Egmont Kakarot-Handtke

    #1 Keynes, Lerner, MMT, Trump and exploding profit
    https://axecorg.blogspot.de/2017/12/keynes-lerner-mmt-trump-and-exploding.html

    #2 MMT was right all along: Gov-Deficits do NOT cause inflation
    https://axecorg.blogspot.de/2017/10/mmt-was-always-right-gov-deficits-do.html

    # 3 MMT is ALWAYS a bad deal for the 99-percenters
    http://axecorg.blogspot.de/2017/12/mmt-is-always-bad-deal-for-ninety-nine.html

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    1. Your simplifying assumptions zeroing almost all of the variables in the full equation are heroic and render the remainder of the analysis near-pointless. You assume your argument, you do not demonstrate it.

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    2. Dominic Johnson

      MMT policy guidance has no sound scientific foundations.

      Bill Mitchell, for example, argues “A rising fiscal deficit is neither good nor bad. It all depends on the saving and spending desires of the non-government sector and the state of capacity utilisation. A rising deficit associated with a growing economy and full employment with stable prices is to be desired.”#1

      The MMT mistake/error/fraud lies in the word “non-government sector”. There is NO such thing as the “non-government sector”, there are TWO sectors, the business and the household sector. And the business sector does NOT save. Saving/dissaving is the balance of the household sector, profit/loss is the balance of the business sector. The word profit, though, does not appear once in Bill Mitchell’s analysis. Why? Because it holds Public Deficit = Private Profit which means that Bill Mitchell does not really care about poor Britain but about the wellness of the one-percenters.#2

      Egmont Kakarot-Handtke

      #1 billy blog “Oh poor Britain …”
      http://bilbo.economicoutlook.net/blog/?p=37942

      #2 For the full-spectrum refutation see cross-references MMT
      http://axecorg.blogspot.de/2017/07/mmt-cross-references.html

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  13. Don't isolate Trump/GOP deficits from their greater goals of plutocracy.
    Set the tax system and employer/employee rules to favor the rich and stifle redistribution.
    Set the rules to favor monopolies that collect rents.
    Create a deficit and use the deficit as a reason to cut spending on social programs.

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  14. Economics is simply down to common sense, the story perpetuated by Neo-Liberals is that our country is just like a household and has to earn money before it spends.

    That of course is simply not true.

    The Bank of England explains that that is not the case and Universities still preach it as though it were. If the Bank of England goes to the trouble of making that point, why do economists preach false hoods?

    Simple again, because they serve a different master, they do not serve the interests of people. Powerful elites rule the world and their gospel must be preached. https://www.washingtonpost.com/blogs/think-tanked/post/koch-brothers-cato-institute-announce-terms-of-settlement/2012/06/25/gJQAQEJ

    These bogus institutions are not there to inform the masses, they are directed to substantiating the claims of the few.


    To answer the claim that country like ours needs to borrow in order to provide public services or infrastructure, is ask a saver if they thought it wise to borrow when they already have more savings than they need to borrow.

    It is simply stupid, but that is what is happening and it is totally illogical, unless it serves the interest of a specific minority.



    The simple truth is, we have all the money we need to fund whatever the government wants to spend on within our country.

    https://www.youtube.com/watch?v=MB0bkytOdNQ









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  15. • The premise of this article is fundamnetally wrong-headed (sorry professor).

    RE: "... it is best to have deficits at a level which very gradually reduces the ratio of government debt to GDP, unless you have a good reason for doing otherwise. ... ..."
    • How's this for a good reason: Maintain Full Employment at all time as the Pup spells out for us: http://mmt-inbulletpoints.blogspot.com/2017/09/im-just-responding-to-various-economic.html

    RE: "... The higher the debt, the higher the taxes. ... ..."
    • This is simply wrong: The notion that the Federal Debt is a problem in any way shape or form is patently ridiculous. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. We're not recommending this course of action, just pointing out that it is possible.
    • (Yes, I know you have to keep a record of holders so you can mail them interest but that's about it. What needs to be measured 2 things:
    a) Unemployment - as in keep it at ZERO at all times, and
    b) Inflation - as in measure monthly and keep it at a low manageable and comfortable level at all times (3% to 4%?)

    Easy Peasy!

    RE: "... what MMT actually says is that inflation should determine what the deficit should be. ... ..."
    • That is hardly the premise of MMT. MMT is: first i) an examination of how our monetary and fiscal economy works, and second, once that is understood, ii) the implications of policy prescriptions for solving our economic problems.

    • Controlling inflation in the future is straightforward: An aggressive across the board increase in taxes - income, sales, and asset value. That would cool things off pronto. Venezuela! Are you listening?

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  16. Do taxes discourage work?
    How many people ( like my self) have a target income, what they near to sustain a certain standard of living, once this level is reached they can devote time and energy to other activities.
    I've recently had to take on extra work to pay for an unexpectedly large council tax bill.

    Is the assertion about tax and work merely an assumption or has it been tested? Does it hold in all cases?

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    1. It certainly seems to form an effort/reward mechanism. There's a rate of tax at which a lot of people seem to find things not worth the hassle, but it seems to be about 60%, which very few countries have anymore.

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  17. Actually interesting concept. Again forget govt debt or reserve deposits, just think money. Any generation at any point in time starts with some people having money and other who don't. The haves presumably got it from providing goods and services in the past.

    They have a claim on the next generation's output. But this has always been and always will be regardless of govt debt etc. I suppose it would be nice to start a generation with no rich folk, everyone starting with nothing, but that obviously has its downsides.

    So the bottom line would be to aim to have govt expenditures be for the public good overall-a productive, skilled, and knowledgeable economy - and long term infrastructure benefiting multiple generations.

    And just to drive home the point: when a generation is born, there is massive capital in place (lucky for us). But some of us are born naked with no ownership in the capital. Ownership are folks and ancestors who presumably provided goods and services to past generation. But as a naked baby, what do we care who owns it. Could be owners of capital or their creditors. We grow up, provide goods and services and get our share.

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  18. "That cannot go on forever, so at some point taxes have to rise again. A whole generation has avoided paying taxes, but at the cost of future generations paying even more."

    It cannot but that doesn't mean it's a cost for the future generations as a whole. Repayments for those who owns the debt (older cohort?) means that someone is paying (taxes) and someone is receiving (repayments). There is always a matching pairs of in and out flows. It is a wash. The general tax level may or may not be higher. Even if it is that is not a real loss - the economic output can be exactly the same. Taxes are not needed if more money is printed. So it is purely a distributional issue.

    And the private debt works exactly the same. Both can also be used wastefully or wisely.

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