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TechnoratiDeficits and the Future
Right now there's intense debate about how aggressive the United States government should be in its attempts to turn the economy around. Many economists, myself included, are calling for a very large fiscal expansion to keep the economy from going into free fall. Others, however, worry about the burden that large budget deficits will place on future generations.
But the deficit worriers have it all wrong. Under current conditions, there's no trade-off between what's good in the short run and what's good for the long run; strong fiscal expansion would actually enhance the economy's long-run prospects.
The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing "crowds out" private investment - that the government, by issuing lots of debt, drives up interest rates, which makes businesses unwilling to spend on new plant and equipment, and that this in turn reduces the economy's long-run rate of growth. Under normal circumstances there's a lot to this argument.
But circumstances right now are anything but normal. Consider what would happen next year if the Obama administration gave in to the deficit hawks and scaled back its fiscal plans.
Would this lead to lower interest rates? It certainly wouldn't lead to a reduction in short-term interest rates, which are more or less controlled by the Federal Reserve. The Fed is already keeping those rates as low as it can - virtually at zero - and won't change that policy unless it sees signs that the economy is threatening to overheat. And that doesn't seem like a realistic prospect any time soon.
What about longer-term rates? These rates, which are already at a half-century low, mainly reflect expected future short-term rates. Fiscal austerity could push them even lower - but only by creating expectations that the economy would remain deeply depressed for a long time, which would reduce, not increase, private investment.
The idea that tight fiscal policy when the economy is depressed actually reduces private investment isn't just a hypothetical argument: it's exactly what happened in two important episodes in history.
The first took place in 1937, when Franklin Roosevelt mistakenly heeded the advice of his own era's deficit worriers. He sharply reduced government spending, among other things cutting the Works Progress Administration in half, and also raised taxes. The result was a severe recession, and a steep fall in private investment.
The second episode took place 60 years later, in Japan. In 1996-97 the Japanese government tried to balance its budget, cutting spending and raising taxes. And again the recession that followed led to a steep fall in private investment.
Just to be clear, I'm not arguing that trying to reduce the budget deficit is always bad for private investment. You can make a reasonable case that Bill Clinton's fiscal restraint in the 1990s helped fuel the great U.S. investment boom of that decade, which in turn helped cause a resurgence in productivity growth.
What made fiscal austerity such a bad idea both in Roosevelt's America and in 1990s Japan were special circumstances: in both cases the government pulled back in the face of a liquidity trap, a situation in which the monetary authority had cut interest rates as far as it could, yet the economy was still operating far below capacity.
And we're in the same kind of trap today - which is why deficit worries are misplaced.
One more thing: Fiscal expansion will be even better for America's future if a large part of the expansion takes the form of public investment - of building roads, repairing bridges and developing new technologies, all of which make the nation richer in the long run.
Should the government have a permanent policy of running large budget deficits? Of course not. Although public debt isn't as bad a thing as many people believe - it's basically money we owe to ourselves - in the long run the government, like private individuals, has to match its spending to its income.
But right now we have a fundamental shortfall in private spending: consumers are rediscovering the virtues of saving at the same moment that businesses, burned by past excesses and hamstrung by the troubles of the financial system, are cutting back on investment. That gap will eventually close, but until it does, government spending must take up the slack. Otherwise, private investment, and the economy as a whole, will plunge even more.
The bottom line, then, is that people who think that fiscal expansion today is bad for future generations have got it exactly wrong. The best course of action, both for today's workers and for their children, is to do whatever it takes to get this economy on the road to recovery.
22 Comments so far
Show Alljonabark
2 things about Krugman. 1) he failed to see this mortgage/derivative/housing bubble coming. This puts a big hole it his predictive credibility 2) he fails to acknowledge the ecological aspects of the economy: loss of water, farming dependence on fossil fuels, decreasing soil health, loss of fish, water contamination, nuclear contamination, oil spills, climate change. All of these things are rising and promising to get worse. Add peak oil, the demographic shift caused by the fat aging med sucking baby boomers, terrorism , the greed of the powerful, and the proliferation of weapons everywhere and stir and at that point the plan of building roads and bridges which we have a hell of a lot of already so we can all keep driving around does not sound like Nobel advice to me.
Also what happens if the Chinese decide to invest more in Yen, Euros and Rubles .
The only circumstance in which Krugman is right, is if bondholders - APART FROM THE FED - are prepared to accept negative real returns.
If the US government spends a dollar, it has to get that dollar from somewhere (in fact it has to get about $1.30 due to government waste).
If can get that dollar in taxes, that's a dollar less that the private sector has to allocate.
If instead the government spends the dollar and issues a bond to pay for it, private sector buyers of bonds will require that the risk-adjusted present value of the coupons, plus the risk-and-inflation adjusted redemption of principle, equals the price of the bond.
Any issuance that is not taken up by private buyers, will be absorbed by the Fed... with the concomitant that the money supply will grow as a result. Hence inflation.
Bond buyers - most notably FOREIGN buyers (the US does NOT owe the debt 'to itself'... it owes a goodly chunk of it to China) - have been swindled (by both inflation and currency movements) in the past, and have already shown that they have learned this (most foreign bond buyers are governments, so you should not expect them to learn quickly as they don't pay the direct price of their errors).
Somehow Krugman wants to suspend the laws of supply and demand for government debt - he knows of some magical world where there can be massive issuance without altering the present value of the cash flows to bond holders (either through capital losses as the price of the bonds falls due to increased perception of risk, or through inflation as the Fed takes up the slack).
Jefferson said it best: deficit spending is swindling the nation's futurity.
Cheers
GT
GT's Market Rant
"Bond buyers - most notably FOREIGN buyers (the US does NOT owe the debt 'to itself'... it owes a goodly chunk of it to China) - have been swindled (by both inflation and currency movements) in the past,"
How so exactly? The U.S. government has *never* defaulted on any of it's bond issues. Inflation and currency markets and their associated risks are much more transparent concerning the U.S. as compared to, say, China.
"Somehow Krugman wants to suspend the laws of supply and demand for government debt "
How so exactly? Key to the market for U.S debt is the idea of "full fath and credit". Given the *global* nature of the current troubles, who else should individuals and governments place their faith in? You may have noticed the recent improvements of the dollar vs. the Euro.
"Jefferson said it best: deficit spending is swindling the nation's futurity."
He was wrong. It depends on what exactly you spend the borrowed funds on. And besides, there was a National Debt before him and ever since.
Perhaps in your rush to defend the US government's shell game you missed the point: by inflating, the US pays back debt using dollars of a lower purchasing power.
Note - I have no sympathy for those who were stung... only an idiot loans to an institution that has the capacity to print its own means of payment, as anyone who knows who "John Law" was will aver.
USDX declines from 120 to 70-odd, then bounces to 88 and idiots are blathering about USD 'strength'. Fuck me drunk - talk about National Amnesia...
The recent 'strength' of the dollar has nothing whatsoever to do with relative faith in the US economy. It was due to a load of US firms having to repatriate money from overseas (buy USD) in order to fund things that they would ordinarily have funded by issuing commercial paper.
The same thing had to happen for Japanese businesses, which is why JPY has been on a mad rush EVEN THOUGH USD has been appreciating.
Tell you what - if you have full faith in the US government, find someone who is currently 55 and offer to fund their healthcare and Social Security when they retire if the US government welshes. They (future retirees) think they have already paid (through SocSec taxes). Offer to pay on reimbursement rather than accepting the government's CPI indexation.
If your bet is right, you won't have to pay a cent...
Finally, it doesn't depend what you spend the funds on.
Debt is debt - and trying to fund it through coin-clipping is the ultimate Empire-killer, as the US is currently finding out.
And Krugman (whose work I have enjoyed - to a point - ever since "The Myth of Asia's Miracle" when I was a PhD student) HAS tried to skate around the idea that massive new supply of US debt will not be either inflationary (if the Fed has to absorb it) or lead to a rise in interest rates (if the market has t oabsorb it). Or both.
Notice that SWFs are no longer in a mad rush to recycle USD balances back into Treasuries, nor to buy out US companies... they have started to use the proceeds of trade surpluses to fund domestic infrastructure projects (here I'm thinking of the Middle East more than Asia, but China's fiscal package is similar).
"Perhaps in your rush to defend the US government's shell game "
Thank you for your response. The term "shell game" implies cheating. Where is the U.S., or any other government that issues debt instruments for that matter, cheating by selling bonds to *willing* buyers?
"you missed the point: by inflating, the US pays back debt using dollars of a lower purchasing power."
But *everyone* playing the game knows that already, so what? The long term growth of the U.S. economy is expressed as "real" GDP, which accounts for inflation. And while that isn't the last word on the worthiness of U.S. debt as an investment, people look to that when they decide what to do with their money.
"The recent 'strength' of the dollar has nothing whatsoever to do with relative faith in the US economy. It was due to a load of US firms having to repatriate money from overseas (buy USD) in order to fund things that they would ordinarily have funded by issuing commercial paper. "
I don't see how you can say this. The above ignores the increasing amount of debt held by other countries, as well as the current dismal prospects in equities markets everywhere.
"Tell you what - if you have full faith in the US government, find someone who is currently 55 and offer to fund their healthcare and Social Security when they retire if the US government welshes. They (future retirees) think they have already paid (through SocSec taxes). Offer to pay on reimbursement rather than accepting the government's CPI indexation."
I don't see the relevency of your example. Faith in the U.S. is demonstrated *directly* by those zillions who continue to buy Tbills. Whether you or I have such faith is irrelevent unless we also but Tbills or otherwise invest in the U.S.
"Finally, it doesn't depend what you spend the funds on. "
It is reasonable to go into debt to finance reasonable things, and to avoid building bridges to nowhere or subsidizing mohair farmers.
"Debt is debt "
This says nothing, everything is equal to itself. We actually say something when we compare things to other things. Debt is commonly and properly compared to assets, income, GDP, etc.
I was gonna make some derogatory remarks about the author until I saw that he's a Noble Prize winning economist.
He must know what he's talking about. Mustn't he?
But what about the fact that we're poisoning our world and it's costing a lot more to safely manufacture stuff from raw materials that are becoming more scarce.
What about the fact that our chinese slaves are becoming somewhat affluent themselves and demanding more money and making our toys and fuel cost us more.
What about the fact that all that bailout money is to keep a system going that has no basis in reality and is simply a money making scheme for a lot of rich people.
As I read the article I was thinking about my basic economics text from back in the 70s. That made me remember Zero population growth (which has increased about 30% since then). And 100% recycling (joke). And that made me realize that economists don't care about basic human needs and quality of life and sustaining human civilization on the planet earth.
They are concerned with growth. Only growth makes money. And we all know that money is what life is all about. Right?
There is no Nobel Prize in Economics. There the "Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel"; my former PhD supervisor (himself a former student of Wasilly Leontief, who got that prize in 1973) gets a vote, if i recall correctly. He is a mate of Dale Jorgenson's.
It's nitpicking, but Alfred Nobel never endowed a prize in Economics.
Cheers
GT
GT's Market Rant
"He must know what he's talking about."
Economists are always disagreeing with each other and they are all wrong on at least some of the things they think to be true.
WRONG.
Economics concerns itself with HAPPINESS. It assumes that individuals will do things in order to make themselves HAPPIER than they otherwise would have been.
Consumption is one - but only one - of the sources of happiness: having stuff is better than having no stuff. Eating is better than not eating.
Extra stuff adds LESS to the happiness of 'economic man', the more he has of it.
And sadly, there are some for whom the GAP between themselves and the masses, appears in the 'happiness functional' with a positive coefficient. I call these people "Cheneys" or "homo politicus cheneyensis". {I say this as a dedicated free-market akrato-libertarian... do not take me for a leftie}
Otherwise put: there is a subspecies of homo sapiens that would reduce the world pie, so long as their share increased and they retained 'consumption satiety' (which they already have).
They would also deliberately thwart GROWTH in the pie if their share fell, even if the absolute amount they obtained grew.
So if you want a social policy agenda to work with - one that will definitively put an end to a system that kills the innocent in their millions - then it is as follows:
The non-symbiotic parasitic subspecies (homo politicus) must be excised from human society - the way you would treat a dog for worms or ticks.
Neanderthal faced the same evolutionary pressure from a rival species (us)... we killed them off. Homo cheneyensis has to be confronted and destroyed or it will do the same to us.
Cheerio
GT
GT's Market Rant
"Economics concerns itself with HAPPINESS. It assumes that individuals will do things in order to make themselves HAPPIER than they otherwise would have been."
I agree in part, but I would replace HAPPINESS with UTILITY. The assumption is that in a free market both parties enter an agreement each thinking that there is a gain of utility for them in doing so, and I guess that thinking overlaps somehow with the idea of a gain of happiness much of the time. But I generally have faith that most people can distinguish between happiness and pleasure, and it wasn't clear to me that you were doing so.
I sort of agree - but only to a point. "Utility" and "Felicity" are generally viewed as interchangeable terms (at least outside of the US).
It is absolutely true that both sides of a voluntary transaction expect to be made 'better off' by the transaction. It is one of the most extraordinary insights of economics, and one that 99% of the population don't understand (because the largest single transaction they undertake every week - the extortion of their taxes - is NOT voluntary).
From what I can gather, a bunch of Yank economists thought that a 'felicity' functional was a bit of a girly thing to maximise, so they started using the term 'utility' instead - taking their cue from Bentham and J.S. Mill. In Mill and Bentham, 'utility' and 'happiness' are more or less interchangeable. Mill goes on and on for PAGES about it.
They were in turn inspired by works like Nichomachean Ethics, in which Aristotle bangs on at length about how Happiness is the thing we are all after.
I'm biased though; I like to think that our job is to analyse the ways in which people try to be happy.
Cheerio
GT
GT's Market Rant
If there is OVERproduction in an economy all the fiscal expansion in the world will not help.
If we are making 10 million widgets a year and the market for widgets is 5 million maximimum, neither producing more widgets or lowering interest rates so people can borrow and buy widgets they do not need will help.
In other words , it is not consumption that has to be stimulated here.
Overconsumption is the problem.
"strong fiscal expansion would actually enhance the economy's long-run prospects"
Maybe it's just me, but I didn't see any proof of this actually presented. I normally agree with Paul K. but in this he case couldn't be more wrong - in fact dead wrong.
The planet has reached the upturn point of exponential growth in the population, consumption and depletion as well as degradation of resources, debt financing and environmental impact. The current system is not sustainable now, and expanding it can only hasten the demise.
The only thing that can improve the long-run prospects for the human race is a more humble simplistic synchronistic view of ourselves and the world - not one of financial investment but of social investment.
The misnomer is thinking that expansion does not come with equal offsetting cost and depletion. It does. We must pay the piper and balance the scales. The examples Paul K. cite were necessary adjustments. Postponing the inevitable will only make the matter exponentially worse. How many times will it take before we figure this out? We're running out of chances.
Seventy-five per cent(!)of the economy of this country is (or was) generated by consumer spending. However, for nearly forty years the money we consumers earn and what we could buy for it has been sliding backwards, fast enough for it to be visible to everyone. Now it's like an elevator that just dropped ten stories before stopping. Manufacturing accounts for only twelve per cent of GDP. The housing boom propped up the economy for over a decade before it crashed. The so-called financial services "industry" became the largest part of our economy. It too is has flown into the side of a mountain. So what's left beside war?
it's been clear for a long while the monopoly game is over..everything goes back to the bank..the bank give each a stipend..we roll the dice..the next game is on..
ken
I said elsewhere, that I think in many ways it is too late. I think we have passed the point of no return. This country is no longer salvageable. For starters are consume-once and no-recycle economy cannot sustain the collapse of more and more frequent and bigger and bigger bubbles. We cannot sustain ourselves with perpetual war, either. I just finished Chalmers Johnson's Blowback trilogy and I think in one sense he hit the nail on the head: This country is headed for a military dictatorship and when it happens, we won't even know about it. Perhaps this, the collapsing economy, is the crisis that people high up want/need to make that a reality. The only thing that I think will "save" us is to break up the empire: lose all the foreign bases, and split up the United States into more manageable pieces, that hopefully won't be such a threat to the world at large, politically, militarily or economically. The first thing these new countries will need to do is wipe the past debt clean. Can we really expect to pay back to all the investors of our debt over $10 Trillion? Is that even possible? The American experiment is over, we just don't know it yet.
Can we really expect to pay back to all the investors of our debt over $10 Trillion? Is that even possible?
Who can even conceive of that much money? The figure is truly mind boggling.
"Can we really expect to pay back to all the investors of our debt over $10 Trillion? Is that even possible?"
It's a continuous process. The debt is structured by bonds that have a specific maturity date and interest rate. The US has *never* defaulted on any of it's debt obligations. That means every single bond issued has paid both princpal and interest to the bond holder.
ALso keep in mind that the debt is an aggregate figure. Compare it to GDP, around $14 trillion, for *each* year.
"Who can even conceive of that much money? The figure is truly mind boggling."
It's not that hard. Brush up on "scientific notation" and "order of magnitude".
"do whatever it takes to get this economy on the road to recovery."
Take care of all the people instead of just the fat cats with the Lear Jets, and the economy will take care of itself.
In the end, the american economy and lifestyle will have to descend to such level as could be imagined sustainable if the whole human population would copy it. That's globalization, after all!
Clearly, it will have to come down a lot. Why not use this recession as a first small step in the inevitable contraction and convergence?
The roads we need to build, would probably be called bicycle paths as the oil to run the cars will be diminishing in the near future.
Krugman pens; “One more thing: Fiscal expansion will be even better for America's future if a large part of the expansion takes the form of public investment - of building roads, repairing bridges and developing new technologies, all of which make the nation richer in the long run.”
During the Great Depression this statement would have been true, however in today’s technologically advanced economy the impact of deficit spending will be far less as a much smaller percentage of the costs of these programs go to labor while a much larger percentage now goes to capital investments and profits. In the 1930’s hundreds of men with shovels and wheelbarrows were needed to clear a path for a new road that today would be taken care of by a handful of men with a backhoe, dozer and dump truck.
While I in no way disagree with Krugman’s observation that improvements in America’s infrastructure are much needed. I would suggest however that to stimulate the economy that industries that are more labor intensive like health care, care for the aging, and micro-environmental improvements like watershed maintenance be targeted.
If you have ever visited a “for profit” nursing home that receives most of its income from the Federal government you would know that improving the quality of the service there would also make our nation “much richer.”