Bill Mitchell on good and bad deficits in Eurozone battle lines being drawn again with Germany on the other side

Bill Mitchell on good and bad deficits. You might want to Evernote this.

Regular readers will know I don’t automatically use the term deterioration to describe an increasing fiscal deficit. I differentiate between good and bad. 

The national government has a choice – maintain full employment by ensuring there is no overall spending gap which means that the necessary deficit is defined by this political goal. It will be whatever is required to ensure there is enough spending in the economy to generate sufficient jobs to satisfy the preferences of the workers for work. 

However, it is also possible that the political goals may be to maintain some slack in the economy (persistent unemployment and underemployment) which means that the government deficit will be somewhat smaller and perhaps even, for a time, a budget surplus will be possible. 

But the second option would introduce fiscal drag (deflationary forces) into the economy which will ultimately cause firms to reduce production and income and drive the budget outcome towards increasing deficits. 

Ultimately, the spending gap is closed by the automatic stabilisers because falling national income ensures that the leakages (saving, taxation and imports) equal the injections (investment, government spending and exports) so that the sectoral balances hold (being accounting constructs). 

But at that point, the economy will support lower employment levels and rising unemployment. The budget will also be in deficit – but in this situation, the deficits will be what I call “bad” deficits. Deficits driven by a declining economy and rising unemployment. 

So fiscal sustainability requires that the government fills the spending gap with ‘good’ deficits at levels of economic activity consistent with full employment. 

Fiscal sustainability cannot be defined independently of full employment. Once the link between full employment and the conduct of fiscal policy is abandoned, we are effectively admitting that we do not want government to take responsibility of full employment (and the equity advantages that accompany that end). 

You might like this blog from the past – A voice from the past – budget deficits are neither good nor bad. 

In that context, the deficits in France and Italy are at present ‘bad’ because they are being sustained by the deliberately created recessed states and entrenched mass unemployment.

Bill Mitchell – billy blog
Eurozone battle lines being drawn again with Germany on the other side
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at the Charles Darwin University, Northern Territory, Australia