Sunday, June 5, 2011

Countering a common misconception about MMT and deficits

Here is a comment I posted over at FireDogLake in response to Larry Mishel, president of the Economic Policy Institute:

tjfxh June 5th, 2011 at 7:22 pm

In response to Economic Policy Institute @ 106

Larry wrote: “I don’t agree completely with Jamie Galbraith’s and R Wray’s position on deficits (i.e., they never matter)”

It not the case that Galbraith, Wray and cohort say “deficits never matter.” That was Dick Cheney. They specify precisely HOW deficits matter. This is determined by sectoral balances and national accounting principles wrt macro.

The government fiscal balance, the domestic private balance and the external balance sum to zero as an national accounting identity. That is Macro 101. So if the domestic private balance is in surplus (S>I) and the country is running a CAD (foreigners saving in the nation’s currency), then the government fiscal balance must offset the demand leakage to saving or else private saving desire cannot be met.

As long as the US is deleveraging and rebuilding savings and also running an external deficit, the government fiscal balance must offset that leakage. Otherwise, either economy contracts, private debt increases, or the private sector draws down savings/sells assets. In a deflationary environment such the US now experiencing, this can result in mounting defaults and classic debt-deflation.

If there is insufficient fiscal offset of demand leakage to saving, as is the case now, then the economy will underperform and unemployment increase, Thus, we see that deficits have a very specific purpose and their appropriate size is determined by fluctuating saving desire.

Moreover, these economists say that the problem is never financial but real. As long as there are real resources available for purchase, the government can always fund their purchase. The balance between public and private is a political matter, but the government’s ability to fund its purchases is never an issue when it issues a non-convertible floating rate currency.

The only contraint on the government’s ability to fund itself as it wishes is the availability of real resources wrt money supply. If more money is created than the economy can expand to produce real resources to meet this demand, then inflation will result. As long as there is unemployment, the economy is capable of expanding and demand side inflation is remote. (This does not mean that supply side inflation cannot occur, e..g, due to an oil shock or natural disaster. But this is an entirely different matter.)

There is no problem with deficits in the short term, and the long term issue is a political one, that is, how the country decides to allocate its real resources wrt public purpose in the future — how much to defense, how much to health care, how much to the safety net, how much to infrastructure, etc. Decisions taken now will affect the quantity and quality of real resources in the future. Inappropriate concern with deficits and debt, which are pseudo-problems, will simply set the entire country back, and everyone will be worse off than otherwise.


Mario said...

yes. great job Tom. maybe he'll respond too. Love it ;)

Calgacus said...

People who say MMTers say "deficits don't matter" don't ever tell anyone just how deficits "matter". Their mischaracterization just expresses confused adherence to thoughtless, meaningless prejudice - "Lots of people say deficits matter, so I'd better nod and agree that the emperor is wearing a beautiful suit, or I'll look stupid and Not Serious."

A good response is to ask - "OK, just how do deficits matter?" They'll either come out with the MMT response, or they'll repeat the mainstream credo "gibber - drool - the scary deficit monster is going to EAT US unless we pull these blankets over our heads."

Oliver said...

Tom, I've just been through the postst and comments at FDL, ND2.0 and NC regarding the Peterson scandal. It's nothing new, instead of the full-on fighting between MMT and the deficit hawks à la Mike Norman on Fox, it's just infighting with the resident deficit doves. And I'm beginning to wonder whether MMT itself is actually above the framing of the debate and not, in some unintended and perverse way, also playing along with the Peterson script, by constantly repeating the word 'deficit' ad nauseam. Sure, any discerning reader should be able to distinguish between deficit hawks, doves, MMTers and Dick Cheney. But there is a common denominator: the deficit.

Maybe there should be an outright ban of the word deficit on all MMT blogs and forums? In fact, maybe neither the deficit nor the national debt should ever be released as numbers at all? How about only publishing ratios of net saving between sectors? Warren has suggested calling it the national savings clock, after all, and I think that's the way to go. And, since you're stressing the point on 'how deficits matter', maybe the focus should be on where and when saving matters and makes sense instead? Or something along those lines.

Impractical and futile, I guess, but it certainly is very clear who is framing the debate.

Keep up the good work!


Tom Hickey said...

Oliver, the problem is that terms like "deficit" and "debt" are standard economic and accounting terms, so they cannot easily be changed.

But they have acquired a negative connotation that can be changed. They are descriptive terms that have taken on normative meaning. MMT shows the folly of that.

Oliver said...

True, but considering there's a surplus for every deficit, it is revealing to see which of the two is stressed, depending on who's agenda is being promoted.

Mario said...

exactly Oliver

Tom Hickey said...

Right, and MMT makes that point clearly. The government's fiscal balance is the inverse of non-government's balance by national accounting identity, i.e., "always." Once the accounting is clarified, the mystique disappears and it is difficult to impossible to game the debate rhetorically by injecting normatives masquerading as descriptives.