Summary: Economics is one of the central sciences of our time, especially about one of the frontier subjects: the macroeconomic effect of debt. Yesterday’s post centered on a graph from Ed Dolan. Today we have a rebuttal by Prof William K. Black. There are few aspects of economic theory more important today.
This is the second in a series. Other posts are:
(1) America’s strength is an illusion created by foolish borrowing, 10 October 2012
(3) Ed Dolan talks to us about modern monetary theory. Can it save us?, 12 October 2012
(4) Ed Dolan Asks What Does it Mean for Fiscal Policy to be “Sustainable”? MMT and Other Perspectives, 30 November 2012
This discusses yesterday’s post, in particular the source of its centerpiece, a graph from “By One Key Budget Indicator, the Structural Primary Balance, Even Greece Is Doing Better Than the United States. Why That Should Worry Us.“, Ed Dolan (bio), Roubini’s Economonitor, 8 October 2012.
Contents
- Prof Black’s reply
- About the author
- Update: Ed Dolan replies
- About Modern Monetary Theory
- For More Information
(1) Prof Black’s reply
The argument that began the discussion relies on this fundamental assertion {from the post}:
“A fundamental measure of a nation’s financial condition is the structural primary budget balance. AKA the cyclically adjusted budget balance. As in this graph from “By One Key Budget Indicator, the Structural Primary Balance, Even Greece Is Doing Better Than the United States. Why That Should Worry Us.” by Ed Dolan. “
He is a very conservative scholar as you can see from his blogs and his associations with George Mason University and Cato. Dolan’s piece includes the admission that our present deficit
- is largely the product of the Recession and
- during the recovery from the Great Recession fiscal stimulus acts as an “automatic stabilizer,” i.e., a “counter-cyclical” policy that speeds recovery and reduces the severity of the recession.
Europe and Chile as economic experiments
Note that the world has provided a “natural experiment.” The EU responded to the Great Recession with austerity, a pro-cyclical policy that makes the recession more severe and longer. Moreover, EU and ECB leaders’ mantra is “there is no alternative” (a phrase that should send warning chills up any veteran’s spine) — because nations that joined the Eurozone gave up their sovereign currency they no longer have the ability to adopt rational automatic stabilizers. More precisely, they crippled the effectiveness of their automatic stabilizers through the limitations of their “Stability and Growth Pact.”
Note that this has not prevented budget deficits from occurring but it has greatly reduced fiscal stimulus.
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The result has been a gratuitous Eurozone recession and Great Depression levels of unemployment in Spain and Greece. Nations like Spain, Iceland, and Ireland did not run significant budget deficits in the lead-up to the crisis. Indeed, they often ran surpluses. Their “debt crisis” is a result, not cause, of the Great Recession (and dropping a sovereign currency). (Please read my colleague Stephanie Kelton’s work on why a nation in a severe recession cannot simply “choose” to end a budget deficit — the austerity measures that are purportedly put in place to reduce deficits can actually increase the deficit by throwing the nation back into a recession.)
Dolan argues, however, that once fiscal stimulus helps us recover from the Great Recession the U.S. will need to face a “structural” deficit problem that is not the product of the Great Recession. The structural deficit argument is that we face a spiraling, untenable deficit because of the interactions of tax cuts and increases in costs for social security/medicare/medicaid. He argues that if the national debt increases as a percentage of GDP it must become untenable and he discusses three means of preventing the national debt from increasing as a percentage of GDP.
He chooses Chile as his exemplar for the first means: “Chile has achieved excellent fiscal health by following the cyclically neutral pattern.” I begin with the preliminary observation that his example shows the grave limits of his concept of “excellent fiscal health.” Check out the Chilean statistics on unemployment, poverty, and inequality under Pinochet and the improvements under his socialist successor. A low budget deficit does not translate to a healthy economy or, from a military perspective, a stable economy.
Deficit bad, surplus good?
Then back up to Dolan’s fundamental assertion. In fact, the U.S. deficit has frequently increased as a percentage of GDP and it has never had such a ruinous result. Indeed, the increasing deficit typically had the opposite effect — it is associated with increased GDP growth in subsequent years. Conversely, every sharp, sustained drop in deficits and debt has been followed by a depression (or in the current case, a Great Recession). See the work of my colleague Randy Wray {see his articles at Roubini’s Economonitor}
Dolan writes:
“The chart shows a healthy surplus of the structural primary balance — 1.7% of GDP, on average – from 1994 to 2001. Over that period, net government debt, by the OECD’s measure, fell from 54.4% of GDP to 34.6%. Countercyclical considerations could justify the sharp reduction in the surplus during the brief and mild recession of March to November 2001, but after that, things went badly off course.”
His terms betray his “moralization” of finance in a manner that impedes sound fiscal policies. Note his use of the term “healthy surplus.” A budgetary surplus is supposedly “healthy.” A deficit, implicitly, must be “unhealthy.” The problem is understandable — everyone’s first instinct is to generalize from the only budget we really understand and live with our entire adult lives: the household budget.
One of the commentators asserts that a government with a sovereign currency is exactly like a household — except it is a thief. The commentator does not see how much his inaccurate gibe discloses. Who is the government “stealing” from when it creates a national currency? It is, of course, a trick question for their is no “theft,” but it is a question that will force the commentator to come up with a series of assertions that will share a common characteristic — the government is not like a private household.
Try the following as a thought exercise. Governments are also not “just like corporations,” but the corporation is at least a less obviously inappropriate comparison. As least corporations share the characteristic with government of being organized almost invariably for perpetuity. Why aren’t the deficit hawks demanding that U.S. corporations eliminate their debts? Why isn’t corporate debt viewed as “immoral?” Why is a corporation that has no debt not viewed as “healthy” by investors and corporations with substantial debt (e.g., the vast bulk of corporations) disdained by the financial markets as “unhealthy?” Why don’t potential CEOs campaign for promotion by promising to end the corporation’s debt and never borrow again?
That was just a thought exercise to try to end the autonomic response we all have on the basis of our experience with household debt that government debt must be bad, unhealthy, and immoral. Please read Randy Wray’s brief piece on why the government is nothing like a household. It’s concise and analytical. You may disagree with aspects of his analytics, but you will no longer find yourself making the mistake of simply extrapolating from your experiences with your household budget.
Back to Dolan’s “health surplus” language about the budget deficit. The Clinton/Republican grand bargain did produce a budgetary surplus. Indeed, go back to the transcript of the Lieberman v. Cheney VP debate on October 5, 2000 and see Lieberman’s statement:
“Al Gore and I are committed to balancing the budget every year. In fact, the paying off the debt by the year 2012, when by our calculation our opponent’s economic plan still leaves America $2.8 trillion in debt.”
The point is that running large surpluses and having as a goal “paying off the debt” is not in fact a “health” policy, particularly for a nation whose currency serves as the global reserve currency. Indeed, the policy can be downright unhealthy.
Modern Monetary Theory
Moving forward. Modern Monetary Theory (MMT) is in large part a description of how sovereign monetary operations actually function. That is one of the reasons that MMT has so many supporters among financial participants. The other reason is that MMT proponents have shown far greater predictive strength than other paradigms. MMT also leads to excellent policy recommendations that large numbers of Americans support.
Here are some of the things MMT’s academic proponents do not believe.
- They do not believe that national budget deficits inherently have no effect (for good or ill) on the world.
- MMT scholars emphasize the real economy and whether shortages are being created or assets allocated improperly as a result of fiscal flows.
- MMT scholars, and reality, have shown that nations with (a) sovereign currencies, (b) with freely floating exchange rates, and (c) that borrow in their own currency are not vulnerable to the “bond vigilantes” and have run deficits for decades that neo-classical economists have claimed were unsustainable without triggering high interest rates or hyper-inflation.
- MMT also stresses that it is possible for a government to adopt policies that produce hyper-inflation.
Note that MMT isn’t a partisan issue. There are conservative, liberal, and libertarian supporters of MMT and we criticize or support politicians because of their policies rather than their party affiliations.
We can strengthen the nation now by adopting a jobs guarantee program that provides jobs to those willing and able to work. Unemployment represents a massive waste of resources and the psychological and social harms of unemployment to the household are often devastating. It is obscene that returning veterans who wish to work are left without jobs. Unemployment has long been known to be one of the triggers of male suicide.
Closing Thoughts
We have tremendous areas of common ground. I’ll close in my areas of expertise.
It is the anti-regulatory policies of Cato and George Mason scholars that have been dominant since the start of the Clinton administration. The “competition in regulator laxity” with the City of London produced the inevitable “race to the bottom.” Consider what kinds of people will stay in a regulatory agency run by leaders who refuse to enforce the law. How many vigorous “troop” do you think will stay in a unit where the CO studiously avoids all contact with the enemy?
The result has been the removal of effective “regulatory cops on the beat.” When cheaters prosper, market forces become perverse and produce a “Gresham’s” dynamic in which “bad ethics drives good ethics from the marketplace.” Many military officers have substantial experience with this dynamic and how it harms military missions because they have served in nations where the Gresham’s dynamic is endemic (or in DOD procurement). They have seen the intersection of public and private sector “control fraud” — “crony capitalism” — and how destructive it is to commerce, ethics, and government.
If you are interested in our research on these issues please check my pieces on New Economic Perspectives (or SSRN for more classic academic articles).
(2) About the author
William K. Black is an Associate Professor of Economics and Law at the University of Missouri – Kansas City. From his faculty bio:
Professor Black was litigation director of the Federal Home Loan Bank Board, deputy director of the FSLIC, SVP and general counsel of the Federal Home Loan Bank of San Francisco, and senior deputy chief counsel, Office of Thrift Supervision. He was deputy director of the National Commission on Financial Institution Reform, Recovery and Enforcement.
His book, The Best Way to Rob a Bank is to Own One (2005), has been called “a classic.” Professor Black recently helped the World Bank develop anti-corruption initiatives and served as an expert for OFHEO in its enforcement action against Fannie Mae’s former senior management.
(3) Ed Dolan replies
See Ed Dolan’s reply in the comments here.
(4) About Modern Monetary Theory
This states that the government can print almost unlimted currency without ill consequences. It is the mirror image of the austerian (not Austrian) obsession with gold and inflation. They are bookends, in a sense. It is evidence of great social stress when such nonsense — fringe economic and political theories — become widely accepted. Afterwards, when the seas are calm again (as they will be, however horrific the storm), people look upon these as symptoms of the madness caused by the stress. But they seem logical at the time.
On the other hand, there are economists who advocate this theory. Such as my fellow author at Roubini’s Economonitor L. Randall Wray (Prof Economics at U of Missouri-Kansas City); see his articles here.
For a clear if somewhat long and technical explanation of Modern Monetary Theory, see:
- About MMT at New Economic Perspectives
- “
Understanding The Modern Monetary System” by Cullen O. Roche (professional money manager), 5 August 2011Now he’s a critic of MMT, with his own version.
Here are two clear explanations of MMT by Paul Krugman (also not a fan of MMT):
If you would like to really learn about MMT, here are two ebooks by Warren Mosler (hedge fund manager and banker), a founder of MMT:
- “Soft Currency Economics” — 32 pages
- Seven Deadly Frauds of Economic Policy (2010) — 63 pages
(5) For More Information
All posts about the euro-crisis are listed at the FM Reference Page Europe – on the road to division or unification.
How we got into this debt trap?
- A certain casualty of the recession: the US Government’s solvency, 25 November 2008
- Everything you need to know about government stimulus programs (read this – it’s about your money), 30 January 2009
- Government economic stimulus is financial heroin, 28 December 2009
How might this end: default or inflation?
- Inflation or Deflation? Nobody knows what path will we take., 21 July 2009
- Would a default by the US government help America?, 21 February 2010
- We might default on our governments’ debt in the future. Do you know how often we’ve done so in the past?, 5 March 2010
- Why the U.S. cannot inflate its way out of debt, 16 March 2010
- Governments cannot go bankrupt, 2 April 2010
- We can try to inflate away the government’s debt, but we’ll go broke before succeeding, 16 June 2010
About this economic cycle:
- Keynes comments on our new-found love of austerity, 21 June 2010
- The Titanic’s lessons for us about the coming economic crisis, 4 June 2012
- America is rich and powerful because we can borrow. Will this debt build a stronger America?, 5 June 2012
- US economic update. Everything that follows is a result of what you see here., 8 June 2012
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