Reader Doug Smith was not happy with an article in the Christian Science Monitor yesterday, titled, “Does US need a second stimulus to create jobs? His remarks:
Could you, Edward or someone consider reading this article and responding to it? My sense is that it perfectly captures ‘conventional wisdom’ and, in that sense, is a bell weather for what our nation is confronting when it comes to just how far conventional wisdom lies from real insight that matters.
I am up to my elbows in alligators right now, and Ed Harrison and Marshall Auerback have offered to take this one on, with Marshall’s reaction below.
As an aside, I have to say it has been a bit disturbing to see readers resort to knee-jerk reactions when they see the mention of deficit spending, and then badly distort the arguments made in support of it. Marshall has repeatedly made the point that a government is not operationally constrained in running a deficit. It faces a practical constraint, which is inflation. We are so far from having inflation that those concerns seem badly misplaced right now and for the foreseeable future. And before you point to the massive Fed balance sheet, let me remind you of Japan, which has had massive money supply creation and still remains mired in mild deflation (now to me, that suggests we have wrong policy mix, advanced economies rely overmuch on liquidity creation because it’s easy to do, but that’s another topic).
The second issue is that deficit spending is likely inevitable. If you go into Mellonite liquidationist mode, you see collapsing government revenues versus certain minimum government service requirements, made worse by a vast increase in the debt burden in real terms. So the issue is not fiscal deficit versus no deficit; the issue is how much deficit and how to deploy the funds to maximum effect. Marshall argues for trying to compensate for the fall in private sector demand; other might argue for a lesser goal of simply trying to prevent deflation.
The Christian Science Monitor article says:
Simon Johnson, a former International Monetary Fund economist now at the Massachusetts Institute of Technology, takes a similar view of the challenge.
“With such countries that have ‘lived beyond their means’ … it is a mistake to try to prevent this process of competitive adjustment,” he told a congressional panel last month. “The adjustment can be cushioned by fiscal policy…. But attempting to postpone adjustment with repeated fiscal stimulus is almost always a mistake.”
Marshall Auerback responds:
“First of all, I’m sort of surprised to hear Simon Johnson say this, as he’s made a lot of very astute comments on the financial crisis, but then again, he is an ex-IMF economist and clearly not well versed in Modern Monetary Theory (MMT).
Obama’s attempts at using the public sector to facilitate private sector debt deleveraging to date have been pitiful. There has been very little focused on creating jobs and a lot spent on the top-end-of-town. If I was to give his stimulus package a score out of 10 for effectiveness it would be around 3/10. Doesn’t that tell you something about the quality of his advisors and the sort of connections they have and the theories they are using to design policy initiatives?
Why design inefficient fiscal interventions that have benefitted Wall Street enormously despite the fact they create very little real output or employment and then turn around with this lame story that the Chinese are to blame because our citizens voluntarily buy the junk they make?
What we desperately need to do is to increase our deficit by several percentage points of GDP and offer public sector jobs to all those who want one. Government as Employer of Last Resort is one idea I have been pushing (along with Randy Wray, Bill Mitchell and a host of other people). As I said in an earlier post,
The U.S. Government can proceed directly to zero unemployment by hiring all of the labor that cannot find private sector employment. Furthermore, by fixing the wage paid under this ELR program at a level that does not disrupt existing labor markets, i.e., a wage level close to the existing minimum wage, substantive price stability can be expected. Other benefits could be provided, including vacation and sick leave, and contributions to Social Security and, most importantly, health care benefits, providing scope for a bottom up reform of the current patchwork health care system.
Obama’s attempts at deficit expansion to date have been pitiful. There has been very little focused on creating jobs and instead have constituted a massive subsidy to Wall Street, in effect providing a direct financial incentive to reward bad behaviour. In spite of their pitiful attempts at apology, the likes of Goldman Sachs understand that better than most. To aid the recovery, Goldman launched a scheme to help 10,000 small businesses, to which it will donate $500m over five years. Some were left unimpressed; Goldman pulled in at least $82 billion … trading just in the 2nd & 3rd quarters of 2009. It has set aside $16.7 billion for pay and compensation so far this year, according to the NY Times.
Why design inefficient fiscal interventions that have benefitted Wall Street enormously despite the fact they create very little real output or employment and then turn around with this lame story that the Chinese are to blame because your citizens voluntary buy the junk they make? How is a revaluation of the yuan going to bring back jobs to America? China should not revalue, certainly not abruptly. Slow appreciation may be optimal, since it keeps the foreign money in. A big appreciation yields a capital gain, and would precipitate both a profits crash in the export sector (social disaster) and a rapid outflow as hot money cashes in and checks out. It would do nothing for the US current account, since (of course) any loss of competitiveness in China would be taken up by other countries.
At any rate, what we desperately need to do is to increase our deficit by several percentage points of GDP and offer public sector jobs to all those who want one. We thus have to aim to ensure public spending fills the gap left by non-government saving (a consolidated position combining the private domestic and foreign sectors) and keeps aggregate demand growing at such a rate that it provides scope for the private savings desires to be realised without compromising our public purpose goal to ensure there is sustained full employment and inclusive income distribution outcomes.
But by far the majority of the unemployed workers could be offered a minimum wage job to work on community and environmental care projects for as long as they desired. I would suggest we also raise the minimum wage so that everyone has access to decent housing and health care etc. But the ELR scheme would only be offering a wage to workers who have no market bid for their services by definition. It will give them a job, some income security, will add to aggregate demand and help stimulate a broader recovery and, in itself, will not be inflationary.
Consider these facts:
- US capacity utilisation rates are around 70 per cent and even lower in Manufacturing.
- The official unemployment rate was 10.2 per cent in October 2009.
- The BLS U6 broader labour underutilisation rate is at 17.5 per cent in October … can I repeat that … 17.5 per cent. That, as Ed Harrison has pointed out repeatedly, is a depression-like number.
- Foreclosures are still rising and are at dangerously high levels in terms of the viability of the overall housing market
- Our children are increasingly being fed by food stamps. In some black neighbourhoods “around 90 per cent live in homes that receive food stamps at one stage or another” .
The US Government is a monopoly issuer of the US dollar and is not revenue-constrained The facts I presented above would tell anyone who knows the slightest bit about how our currency operates that anyone who talks about “neutral deficit” outcome at present is an irresponsible lunatic.
The recognition of the national accounting relationships which underpin modern monetary theory are not matters of opinion. These include (but the list is not exhaustive):
- That a government deficit (surplus) will be exactly equal ($-for-$) to a non-government surplus (deficit).
- That a deficiency of spending overall relative to full capacity output will cause output to contract and employment to fall.
- That government net spending funds the private desire to save while at the same ensuring output levels are high.
- That a national government which issues its own currency is not revenue-constrained in its own spending, irrespective of the voluntary (political) arrangements it puts in place which may constrain it in spending in any number of ways.
- That public debt issuance of a sovereign government is about interest-rate maintenance and has nothing to do with “funding” net government spending.
- That a sovereign government can buy whatever is for sale at any time but should only net spend up to the desire by the non-government sector to save otherwise nominal spending will outstrip the real capacity of the economy to respond in quantity terms and inflation will result.
Note the last point in bold. I do not, as the caricatures suggest, advocate completely unrestrained government spending, paying no heed to inflation. But inflation is the constraint on government spending, not a uninformed ideas about ‘solvency’.
Consider Obama’s claim that “if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the US economy in a way that could actually lead to a double-dip recession”.
Where did he get that idea from? Did the moronic Larry Summers read it out to you from Greg Mankiw or something? People have already lost confidence in the US economy – that is why they are not spending. That is why your deficit has risen sharply mostly via the automatic stabilisers as your revenue side collapsed.
We don’t need that revenue to allow you to spend. Not in the least. All I am noting is that in an accounting sense, government revenue has fallen off a cliff and our net spending has risen which is a good thing because the automatic stabilisers are not called that for nothing. They start adding to demand as soon as they start working to push our net spending up.
People who think that investors will lose confidence in the US Government and somehow that will stop them spending even more because your spending is helping to put some semblance of a floor into aggregate demand which is retarding the jobs loss somewhat? If you think that tell Larry to close Mankiw for a while and learn something about how your monetary operations actually work.
The other dubious idea is that the government spending gets conflated with some idea of “fiscal insolvency”.
I can certainly see how government overspending creates inflation, but is that what you mean by “fiscal insolvency” in the sense that the inflation represents the de facto default?
That to me is a separate issue.
The inflation would be from too much aggregate demand and a too small output gap.
That would mean that fatefull day would be an economy with maybe 4% unemployment and 90%+ capacity utilization and an overheating economy in general.
Yves here. I have to interject. I imagine some readers will say, “But what about about 1970s stagflation?” We had inflation BEFORE the stagnation. The economy was overheating in the late 1960s. The 1973 oil crisis both kicked up inflation a notch higher (and labor had bargaining power, so wages would rise in response to inflation, creating a self-perpetuating cycle), and businesses and consumer were hit by the combo of not just higher oil prices but also supply uncertainty. Very different facts on the ground here. Back to Marshall:
Sounds like that’s the goal of deficit spending to me- so in fact you are indirectly confirming that deficit spending does work.
And if we do need to raise taxes to cool things down some day, we can start with a tax on interest income if we want to cut payments to bond holders or a financial transactions tax on the “polluter pays” principle.
Regarding the supposed default alternative to inflation, in the full employment and high capacity utilization scenario that might call for a tax increase to cool it down, I don’t see how default fits in or why it would even be considered. So again, I’m confused by the concept of fiscal insolvency, which would only seem to apply if there was an external constraint, such as a currency board, or large quantities of foreign debt.
In fact, with our countercyclical tax structure, strong growth that follows deficits automatically drives down the deficit, and can even drive it into surplus, as happened in the 1990’s. In that case one must be quick to reverse the growth constraining surplus should the economy fall apart as happened shortly after Clinton ran budget surpluses for 3 straight years.