An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
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Monday, October 8, 2012
Winterspeak — Deficits and Growth
An outstanding question I've been thinking about is whether ever larger deficits are a requirements for economic growth.
Sometimes it seems that when MMTers talk about deficits, they have this idea in mind. But it's never made any sense to me.
Let's assume arguendo that it's true. Then, in order to keep the economy growing, the deficit is going to become very large. What happens when it is, e.g., 100 percent of GDP?
How could something like this, if true, be reconciled with the observed facts of growth in industrial economies, where deficits have not grown in size consistently, yet the countries themselves have grown at fairly consistent rates?
Let's assume arguendo that it's true. Then, in order to keep the economy growing, the deficit is going to become very large. What happens when it is, e.g., 100 percent of GDP?
How could something like this, if true, be reconciled with the observed facts of growth in industrial economies, where deficits have not grown in size consistently, yet the countries themselves have grown at fairly consistent rates?
The debt to DGP ratio has a numerator and denominator that change. "Good" debt increases the denominator by contributing to growth. "Bad" debt occurs when the growth of debt exceeds the rate of growth due to unproductive expenditure. Historically, this has typically happened due to excessive military expenditure on foreign "adventures."
The size of the debt (stock) results from the sized of deficits (flow). According to MMT, the size of the deficit is determined endogenously wrt to economic conditions. When conditions are good, tax receipts rise and automatic stabilization shrinks. As conditions deteriorate, tax revenue falls and automatic stabilization increases. A "good" deficit is one that maintains the economy at near optimal performance (narrow output gap, full employment, and price stability) even during periods of adjustment, so that growth is not as adversely affected as it would be in a contraction. A 'bad" deficit does not, so that an output gap opens, employment falls, and disinflation sets in with a possibility of spreading to deflation is there is a significant amount of private debt at risk.
The point is neither the size of the debt or deficits but the effect on real (non-financial) conditions. A well-designed economic policy can ameliorate cyclical impact on real conditions, as well as the impact of shocks.
MMT looks at real conditions rather than "affordability."
"deficits have not grown in size consistently, yet the countries themselves have grown at fairly consistent rates?"
Seems like the govt currency monopolist functionally setting prices (nominal GDP growth) is a separate operation from the govt currency monopolist injecting NFAs (deficits/"debt")...
Deficits don't so much fuel growth as they monetize growth that has already happened, along with saving desires and trade deficit leakages. Ex post is the norm.
The main impetus driving the economy is taxing and spending.
If the tax/spend cycle isn't adequate to employ everyone or to clear production, deficit spending can fill the gap.
"Ever larger" is a bit ambigious because the $-value keeps rising and the statement doesn't say if one is talking of deficits or ratios.
Here is what I think (quite different from anything you may find in heteredox blogs):
A relaxation of fiscal policy by an increase in government expenditures leads to a higher output via the multiplier effect. Output will rise to bring in taxes and making the budget go into primary surpluses automatically.
Both the rise in output and higher taxes as a result of higher economic activity stabilize the debt/gdp.
Of course, inflation is a constraint so the government may have to wait till sufficient taxes are in so that it can relax again.
In an open economy, nation is quite likely to face a balance of payments constraint. For an economy with a weak external sector, a permanent rise in government expenditure may be difficult to sustain because the public debt to gdp keeps rising unlike the case of a closed economy. This is because the current account deficit keeps widening and the nation will hit a balance of payments crisis.
I will email you a 1994 article by Wynne Godley and Bob Rowthorn written in who prove this.
That's interesting. It's not obvious what Winterspeak means by larger deficits. He could just mean the dollar value of deficits, which could increase in size while the economy grows, even as the proportionate size in terms of GDP is stable.
But if so, saying "ever larger deficits" is a strange way to put it. Saying "a constant deficit-to-GDP ratio" would be a lot clearer, IMO.
Anyway, I look forward to reading that paper. Cheers!
The balances to be able to pay the interest on loans has to come from somewhere... rsp,
ReplyDeleteSometimes it seems that when MMTers talk about deficits, they have this idea in mind. But it's never made any sense to me.
ReplyDeleteLet's assume arguendo that it's true. Then, in order to keep the economy growing, the deficit is going to become very large. What happens when it is, e.g., 100 percent of GDP?
How could something like this, if true, be reconciled with the observed facts of growth in industrial economies, where deficits have not grown in size consistently, yet the countries themselves have grown at fairly consistent rates?
Let's assume arguendo that it's true. Then, in order to keep the economy growing, the deficit is going to become very large. What happens when it is, e.g., 100 percent of GDP?
ReplyDeleteHow could something like this, if true, be reconciled with the observed facts of growth in industrial economies, where deficits have not grown in size consistently, yet the countries themselves have grown at fairly consistent rates?
The debt to DGP ratio has a numerator and denominator that change. "Good" debt increases the denominator by contributing to growth. "Bad" debt occurs when the growth of debt exceeds the rate of growth due to unproductive expenditure. Historically, this has typically happened due to excessive military expenditure on foreign "adventures."
The size of the debt (stock) results from the sized of deficits (flow). According to MMT, the size of the deficit is determined endogenously wrt to economic conditions. When conditions are good, tax receipts rise and automatic stabilization shrinks. As conditions deteriorate, tax revenue falls and automatic stabilization increases. A "good" deficit is one that maintains the economy at near optimal performance (narrow output gap, full employment, and price stability) even during periods of adjustment, so that growth is not as adversely affected as it would be in a contraction. A 'bad" deficit does not, so that an output gap opens, employment falls, and disinflation sets in with a possibility of spreading to deflation is there is a significant amount of private debt at risk.
The point is neither the size of the debt or deficits but the effect on real (non-financial) conditions. A well-designed economic policy can ameliorate cyclical impact on real conditions, as well as the impact of shocks.
MMT looks at real conditions rather than "affordability."
"deficits have not grown in size consistently, yet the countries themselves have grown at fairly consistent rates?"
ReplyDeleteSeems like the govt currency monopolist functionally setting prices (nominal GDP growth) is a separate operation from the govt currency monopolist injecting NFAs (deficits/"debt")...
rsp,
Deficits don't so much fuel growth as they monetize growth that has already happened, along with saving desires and trade deficit leakages. Ex post is the norm.
ReplyDeleteThe main impetus driving the economy is taxing and spending.
If the tax/spend cycle isn't adequate to employ everyone or to clear production, deficit spending can fill the gap.
Vimothy,
ReplyDelete"Ever larger" is a bit ambigious because the $-value keeps rising and the statement doesn't say if one is talking of deficits or ratios.
Here is what I think (quite different from anything you may find in heteredox blogs):
A relaxation of fiscal policy by an increase in government expenditures leads to a higher output via the multiplier effect. Output will rise to bring in taxes and making the budget go into primary surpluses automatically.
Both the rise in output and higher taxes as a result of higher economic activity stabilize the debt/gdp.
Of course, inflation is a constraint so the government may have to wait till sufficient taxes are in so that it can relax again.
In an open economy, nation is quite likely to face a balance of payments constraint. For an economy with a weak external sector, a permanent rise in government expenditure may be difficult to sustain because the public debt to gdp keeps rising unlike the case of a closed economy. This is because the current account deficit keeps widening and the nation will hit a balance of payments crisis.
I will email you a 1994 article by Wynne Godley and Bob Rowthorn written in who prove this.
R.,
ReplyDeleteThat's interesting. It's not obvious what Winterspeak means by larger deficits. He could just mean the dollar value of deficits, which could increase in size while the economy grows, even as the proportionate size in terms of GDP is stable.
But if so, saying "ever larger deficits" is a strange way to put it. Saying "a constant deficit-to-GDP ratio" would be a lot clearer, IMO.
Anyway, I look forward to reading that paper. Cheers!