Why deficits are bad

by Stubborn Mule on 2 June 2011 · 29 comments

There have been many posts here on the blog arguing that government debt and deficits should not be feared, at least not in countries with their own free-floating currency and without foreign currency public debt*. In doing so, I have never discussed the reasons people may have for holding a contrary view. But I have now come across a rather disturbing theory on the news site Alter.net.

It may be that there are some who would like to see an end to government deficits because they adhere to the Chicago school of economics and scoff that Keynes was thoroughly discredited by the stagflation of the 1970s. There may be others who challenge supporters of government spending with a simple question: if too much debt was the cause of the financial crisis, how could more debt be the answer? (Of course, regular readers of the blog will know the answer to this one: the debt build-up before the crisis was private sector debt and for the private sector to reduce debt by saving again, the government must run a deficit**). Still others may think that deficits cause recessions (rather than recessions causing deficits).

But the theory offered by Alter.net is simpler still. Perhaps people think national debt is bad because it actually means a bad economy. Literally. They just do not understand the meaning of the words.

The evidence offered goes back to a US presidential debate from 1992. In the debate, an audience member asks the candidates the following question:

How has the national debt personally affected each of your lives. And if it hasn’t, how can you honestly find a cure for the economic problems of the common people if you have no experience in what’s ailing them?

If you watch the resulting exchange here, it quickly becomes clear that, in the questioner’s mind, “national debt” is in fact synonymous with “recession”. National debt doesn’t cause unemployment, it is unemployment!

Of course that clip is almost 20 years old and it is America, not Australia. But it still worries me. Could it be that part of the reason that it is so hard to have a rational debate about debt and deficits is that some (or even many) of the voting public do not understand what the debate is about? I hope not!

* So the eurozone is a different matter altogether!

** Either that or run a current account surplus…which is still something we have not achieved in Australia.

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{ 29 comments… read them below or add one }

1 MC June 3, 2011 at 5:53 am

On understanding the debate – see Bryan Caplan’s “The Myth of the Rational Voter”. Politicians are voters too.

On deficits and debt – I haven’t followed the debate on the blog very closely. But if I look at the intelligent debate being had on this more broadly, I think that you could be accused of erecting a straw man. I don’t think that people who prefer no deficits or public debt fear them. Rather they see the danger of them: the consistently suboptimal returns from them and hence inefficient use of economic resources. Public choice theory has a lot to say about this that standard economic theory fails to elucidate. Fiscal policy as a means of smoothing the economic cycle can be effective but that depends on which economic study you look at with whatever calibrated new Keynesian DSGE they use. As some of my previous comments suggest, I am something like a monetarist. Credible monetary stimulus in times like this will smooth the cycle (forget the lags – people work of expectations) much more efficiently.

Obviously the political rhetoric of the federal opposition to the deficit and debt of the government can be considered to be fear mongering. I would say that expecting sane argumentation in politics is a forlorn hope – from either side.

2 Stubborn Mule June 3, 2011 at 6:39 am

MC I hope you are right that this is a straw man. Until I came across the Alter.net article and the video, it had certainly never occurred to me that anyone would think this way and it may well be that no-one in Australia does.

Having said that, there are plenty of other silly things being said in the debate. Barnaby Joyce’s recent exchange with Treasury secretary Dr Martin Parkinson is a case in point: he is now getting alarmed by the percentage increase in public debt rather than the absolute amount, seemingly ignorant of the fact that when you start on a low base, percentage increases will always look large.

3 Nathan Tankus June 3, 2011 at 8:35 am

haha i’m glad my link invoked a post, and perhaps some new understanding. The opposite never occurred to me: it never occurred to me to inform you that many americans are so low information they don’t really understand what the most basic issues are and hear denouncements of something economic related and assume the person is talking about how bad the economy is generally.

4 Stubborn Mule June 3, 2011 at 9:27 am

Yes, thanks Nathan. I should have given you a hat-tip, but I have to confess that when I shot out the post last night, I couldn’t actually remember which link had put me onto it in the first place! I thought it was from the Stable (there’s so much good stuff there after all). Anyway…thanks again for the link!

5 Nathan Tankus June 3, 2011 at 9:28 am

i assumed it was something like that. no worries at all!

6 Magpie June 3, 2011 at 11:07 am

There’s something definitely Kafkian in this debate about deficit and debt.

Say, let’s start from the assumption that people “see the danger of them [deficits and debt]: the consistently suboptimal returns from them and hence inefficient use of economic resources.”

So, in the American case, the same people who are worried about the “inefficient use of economic resources” are happily unconcerned with 9.4% of the workforce spent months unemployed (and I am not adding the underutilized!); not to mention the plant and equipment unused.

I mean, is it just me or is this situation contradictory?

Or, let’s try and put this in simpler terms: people don’t buy stuff because they are unemployed and don’t have money; and because they don’t buy stuff, people remain unemployed.

In ancient times, people used to starve to death because crops failed: production and supply failed, so demand went unsatisfied. That was regrettable but inevitable: call it an act of God, if you will.

In our times things are different. Our depressions, recessions however one chooses to call them, constitute a paradox unique in human history: there’s more productive capacity than demand.

And you see that in thousands of repossessed houses lying empty, rotting, while people lack a roof on top of their heads; or when European milk producers, a couple of years ago, were dumping thousands of cubic meters of milk in the Rhine, because the price of milk was too low for them.

This is inefficiency.

7 Magpie June 3, 2011 at 11:12 am

Stubborn,

In that woman’s mind “debt” was clearly synonymous with “unemployment”, I agree.

From this to conclude that is a generalized phenomenon seems a big step, though.

But then, again, I don’t have a better explanation.

8 pfh007 June 3, 2011 at 6:04 pm

I think I might rush in here…..

I don’t see there is any inconsistency between a general skepticism/distrust of governments running deficits and yet accepting that in certain circumstances they are the least worst option.

The starting point is to remember that we are talking about situations where public policy failures have resulted in gross distortions in an economy and the goal should be to get as quickly as possible to a situation where the distortions are removed and sound policies installed to reduce the risk of the distortions returning.

When people say they don’t like government debt I think they understand it is a sign that something is or has gone wrong.

By gross distortions I mean high levels of debt – private or public – and the generally common accompaniment to debt – rampant speculation on asset price rises.

Take the Balance Sheet recession scenario where huge private debts are driving borrowers to save to reduce their debts. Or the further situation where they have been sufficiently chastised by the experience of being heavily indebted that they keep on saving and refuse to borrow even when they have paid off their debts.

They argument goes that in that situation unless the government runs a deficit all those remorseful private debtors furiously rebuilding their balance sheets will cause a problem at the macro level.

The thinking is that the government should run a deficit to liberate the excess savings in the private sector and put the savings back into play in the economy. When the bashful private borrowers recover their nerve and start to lose their saving ‘bug’ the government can then reduce its deficits or run a surplus.

The problem is working out how the government should ‘liberate’ those savings so as not to cause further distortions (read pork barrels) and imbalances in the economy.

After all if the private sector is so paralysed that it cannot think of useful applications for savings why should we assume that the government can.

There is a good risk the government will just spray lots of money at ‘brilliant bold initiatives’ that don’t really stack up as sensible investments or are overpriced.

The best approach would be for the government to just hand out the ‘deficit’ as cash to the private households and businesses so they could more quickly pay down their debts and re-heat their animal spirits for industrious economic behavior.

That is clear out the ‘private debts’ with public money so the private sector’s spirits are lifted.

But then just handing money out to those who borrowed too much seems quite unjust and plus we know that the chastised may take some time to recover their borrowing nerve – ever listened to the tales of the 1930’s generations about the merits of thrift.

An alternative approach might be to accept a severe recession and purge the private debts with insolvencies and bankruptcy.

That would allow the productive assets to be bought at fire sale prices by people who are willing to take a chance and be creative.

Sure it would be de-stablising and distressing but with our modern welfare state no one need go hungry during the process and some rudimentary make work schemes could keep them out of mischief.

Perhaps then the message might get through that extreme levels of private debt (or public debt) are to be avoided in future and governments and central banks might take a bit more care policing the activities of the banking and finance sectors.

Thus I think there are very good reasons why the general public view Government debt with suspicion even if they accept they may have a role to play when the economy has run off the rails.

Though most of the current debate concerns overseas economies the extremely high level of private household debt in Australia should be a source of genuine concern.

Cheers

9 Magpie June 3, 2011 at 7:49 pm

Hi pfh007,

As you don’t mention the notion of efficiency, I’ll leave it aside. Although I am not sure why you decided to leave this subject unmentioned, I believe efficiency, the way it was presented, is the wrong argument.

I agree with you that the public has every right to mistrust government intervention, on the basis of the recent experience about what this intervention means: financial markets de-regulation, by bureaucrats that had one foot in the public sector, another foot in Wall St.

The solution, then, I would say, is government intervention in the other direction: effective financial regulation. Unfortunately, what has been done is clearly insufficient and has been done with the opposition of a large proportion of the population… because they don’t trust the government!

There is a final subject that I think should be mentioned: the nature of government debt and deficits.

(Probably Stubborn or the other blog regulars should intervene here, as they are way better qualified and much more knowledgeable on this subject than yours truly.)

I will only repeat this paragraph:

“Perhaps then the message might get through that extreme levels of private debt (or public debt) are to be avoided in future and governments and central banks might take a bit more care policing the activities of the banking and finance sectors.”

And let’s ask ourselves, why is public debt so readily considered a bad thing? That was, I believe, the point of the article!

Is private debt in any way equivalent to public debt?

10 Stubborn Mule June 3, 2011 at 8:13 pm

pfh007 there is another option to consider for government spending rather than ill-advised schemes such as insulation or digital set-up boxes that avoids the simple cash hand-out (which strikes me as a bit of a cop out): a job guarantee! Being based on the idea of a buffer stock, this has the important advantage that when private sector aggregate demand picks up once the deleveraging is complete, the government spending will naturally drop as the private sector starts bidding workers away from the job guarantee program. Certainly direct handouts would, politically, be very hard to cut once the economy strengthen and then the very real prospect government spending exacerbating inflation arises.

11 pfh007 June 3, 2011 at 8:58 pm

Hi Magpie,

By the notion of efficiency do you mean your reference to the way some people carry on about government debt and deficits as involving ‘waste’ but seem unconcerned about the losses associated with having a significant portion of the population unemployed or underemployed?

I agree that it is a great waste of potential productivity that so many people are unable to generate forms of self employment or secure employment. It is a matter of importance concern for the entire community and should be focus of the public debate.

I guess my concern is that engaging those potential but under-utilized human resources is very difficult to do well, particularly for government departments. Certainly, the notion of work crews and public projects of the type conducted in the US and Australia during the 1930’s have attractions but ultimately I think the solutions to the problem of disengagement and underemployment must be resolved by genuine sustainable demand from within the community.

Needless to say there has to be a willingness on the part of the under-utilized to meet the demand but I have met very few people who actively resist productive activity, within their capacity, once there is an acceptance it is part of the obligations associated with being a member of the broader community.

Unless the community generates a sustainable level of demand for the services and products that can be produced by the members of the community we will remain dependent on government pump priming in one form or another to ‘stimulate’ demand.

This issue often arise in connection with remote or rural communities where there is no longer sufficient community demand (eg the decline in the use of labour on farms) and the choice is artificial demand – ‘make work’ schemes – by government or gradual decline into ghost town status. I would say once a community no longer has a sustainable economy it is not really a community and the members are better off relocating to a viable one.

This is not to say there is no role for government in the economy. Clearly there is an important role for government to provide services that the community agrees are important and would/may not otherwise be provided.

But providing temporary services for the purposes of generating temporary demand – to fill a hole while there is a slump in community demand – seems to me problematic. One possible legitimate role may be to assist the re-training or re-location of community members when a significant form of demand disappears.

As you may gather i am deeply skeptical about arguments that there is no role for government in terms of providing services (free market purists) and those who place too much faith in the ability of technicians to pull the levers of economic control (fiscal and monetary) with such delicacy and balance as to produce a sustainable, stable and responsive economy.

So yes I agree that the public, pollies and media seem to have a double standard about public v private debt but I think both types should be treated with great caution as they have great potential to distort and destabilize and thereby undermine the development of genuine sustainable levels of demand and a sustainable national economy.

In summary put leverage of all kinds on a short leash.

12 pfh007 June 3, 2011 at 9:43 pm

Hi Stubborn

The concept of a buffer stock as great appeal simply because it seems like complete madness to have 5% according to the dodgy def or 12-15% of the population, according to more realistic measures, unemployed or under-employed. It is such a waste of human potential.

I guess my view is that we should be trying to generate ongoing conditions where the community produces sustainable demand to draw down that unused potential human resource rather than trying to generate that demand via fiscal and monetary stimulus and government programs.

I haven’t done much reading on the work in the area of job guarantees and buffer stocks so I may be pleasantly surprised when I do but I find it really hard to see how the government could provide a job guarantee that was not in practice much more than a complicated make work scheme.

The reason is that if the jobs that were guaranteed were not being performed previously it is hard to claim there is a real community demand for the services the jobs involve.

But then if the guarantee jobs do actually meet a demand for services that previously the private sector was not delivering it would seem strange to wind down those services when the private sector recovers and starts out ‘bidding’ the government for the guarantee work force.

Does it make sense for the government to employ a lot of aged companions for example as job guarantee positions and then let that service fade away when the private sector draws away the job guarantee carers. One day the oldies need a companion – the next day they don’t?

Don’t get me wrong I am not opposed to the concept of the job guarantee but I am concerned when it is often discussed in the context of muscular pulling of fiscal and monetary levers.

I think too many levers get pulled too often.

One example:

We often hear about how the experience of the great depression seared attitudes of an entire generation. From personal experience I would say it extended to the children and grand children of that generation.

Yet interest rates which are fundamental to long term decisions to save or borrow or consume are manipulated by the Reserve Bank.

I would have thought that interest rates should reflect demand – if everyone is saving the interest paid on deposits goes down and if everyone is going debt crazy interest rates should shoot up.

Over time one would expect that in the absence of other forms of fiddling and manipulation interest rates would be relatively stable and reflect the life time balance between accumulating savings when young and then depleting them in old age.

Yet over the last 20 years it seems as interest rates have been used as economic petrol and a fire blanket. Juice it up or dampen the heat.

Perhaps interest rates should be restricted for use as a fire blanket only and whenever they get used in that fashion there should be an inquiry to find out what government policy fiddling caused the economy to overheat.

13 Magpie June 4, 2011 at 1:06 pm

pfh007

“By the notion of efficiency do you mean your reference to the way some people carry on about government debt and deficits as involving ‘waste’ but seem unconcerned about the losses associated with having a significant portion of the population unemployed or underemployed?”

Yes.

“I agree that it is a great waste of potential productivity that so many people are unable to generate forms of self employment or secure employment. It is a matter of importance concern for the entire community and should be focus of the public debate.”

Although I didn’t mention it, it’s more than that.

The USD (like the Australian) is a fiat currency. This means it exists and has “value” because the Government says so (this is a bit of a caricature, but for the present purposes, it is good enough). In particular, the Fed does not promise you to convert dollars for gold, foreign currency or anything else that has “value”.

But the notion of efficiency involves the idea of a trade-off: I put something to get something back in return; if what I receive is not worth it, then I say the exchange was inefficient: when talking about efficiency, one is considering values exchanged.

Now, imagine you spend ten thousand dollars to fix a used car that you can find in the market for 5 thousand: it’s not worth it and you are being wasteful. It’s inefficient.

That example makes good sense because you need to transform your work into money: your hourly wage rate is $X/hour, so you need to work 5K/X hours to get the $5K. You are in fact paying for a car with so many hours of work, and working certainly has a value for you: you have to spend time and energy to work, and both are limited resources.

But this is not what the Fed does: provided it has Congress approval, it just credits an account. It spends no real resources to get the money. Although the image of a printing money machine is outdated, imagine they actually used one. What the Fed would be actually doing is giving little pieces of colored paper that are worth nothing.

So, when the Government spends, it’s essentially getting something for nothing (just paper, or 0s and 1s in a hard drive). It makes no sense whatsoever to use the notion of efficiency.

But when talking about efficiency, more can be said and it gets worse.

Take the car example above. In it we’ve seen that, given the current market prices for a car repair, the repair is not worth it; go somewhere else, where the same repair costs 1/10 and the repair is suddenly efficient. Usually this is irrelevant for a small item as a car: consider then a big cruise liner or a 747.

Let’s go to a post-apocalyptic example: if that car was the last car on earth, I bet people would be willing to kill to get it fixed.

The point is that efficiency is not an absolute criterion, although this is what people usually imply when they talk about it.

But it’s not just how we value the costs and benefits involved, but what we consider as costs or benefits.

Imagine you go to your old folks’ farmhouse attic and find an old wooden box, that’s locked. You are curious to find out what’s inside. So, you grab a chisel and a hammer and break the box. You find inside some old glassware, that you take to the local antiques shop and they give you $50 for it.

So, it was worth it, right? You put in some work and got some cash for it (more than your hourly wage of $X/hour). Not so fast: it turns out that, without you knowing it, you could have sold the old wooden box itself for $200 (plus, say, $20 for anything that could be inside, but that you don’t know what could be, as you didn’t break the box).

The point is that we need to know the real values obtained and sacrificed. Often people don’t include important costs (or overstate benefits), but they go on talking about efficiency as if it was a trivial matter.

14 Zebra June 4, 2011 at 7:32 pm

Sean, your post got me thinking about the psychology of peoples attitude to debt. One of the arguments against arguments against govt debt is that we are a heavily indebted society already where many of us take on mortgages which are many multiples of our annual incomes compared to say govt debt which is a small fraction of GDP.

However one difference is my mortgage is secured against the value of the property I have bought so even assuming a reasonable worse case scenario lender can only lose say 10-20% of that loan value if I am forced to sell up. Corporate debt typically has a nominal LGD of 60-80%. Being simplistic here as you know we assign corporate debt an SI which may or may not be realistic. Govt debt LGD is much harder to quantify since there is little chance of foreclosing on their assets but a typical nominal sovereign LGD is 85%, though not sure what that would mean in practice.

I guess my point is comparisons of debt: retail (mortgage vs. personal unsecured), corp and sov doesn’t take into account the level of security involved. I am less worried about an excess of personal debt related to mortgages than credit cards. Sovereign debt is just such a different beast.

J

15 pfh007 June 5, 2011 at 8:20 am

I must confess that I am struggling with this statement.

“So, when the Government spends, it’s essentially getting something for nothing (just paper, or 0s and 1s in a hard drive). It makes no sense whatsoever to use the notion of efficiency.”

If efficiency is no criterion for assessing government policy decisions then what is?

The car example was also a bit disturbing. Do you mean that the government should spend $10,000.00 fixing a car that it could have bought for $5,000 because it can just make an accounting entry to pay for it?

I don’t have a problem with the implications of a fiat currency and the notion of mere accounting entries etc but I don’t see how that provides any assistance in determining when and why the government should intervene and manipulate (or generate) ‘value’.

Lets assume that the government wishes to use its ‘fiat’ currency powers to employ people.

Now assume that all the involuntarily unemployed or underemployed (and this is distinct from those who are registered as such for the purposes of social security) were to appear on Monday morning at the government job guarantee office ready and willing to ‘work’.

That is the easy step, the tough part is working out:

* what work would have some social value (this is important as otherwise you won’t have too many people turning up for work after a few weeks of activities that they feel are pointless ‘make work’ exercises,

* what specific work/tasks is a match for each individual’s functional capacity (physical and psychological) and their education, training and experience. People must be capable of doing the work.

* what are they are motivated to do – there could be some mid-life change of career people in the mix who want to try something different.

In normal circumstances the government need not answer these impossible questions (except when trying to force the work shy back to work) because the community and individuals provide the answers by their actions and choices.

Bearing in mind the concern that modern marketing is believed to manipulate our psychological needs, to generate demand for certain goods and services, there may be a role for the government to join the party and run advertisements designed to stimulate the consumption of services and goods.

Arguably they are already doing an excellent job by creating an impenetrable swamp of regulations that require a veritable army of professional guides to assist the community and each other find a path through the undergrowth.

Taxation and superannuation are classic examples. What a mess! but what a fantastic way of generating a whole industry of skilled employment.

Hmmm, seems that I am now arguing your case that efficiency is a dangerous concept when it comes to government spending.

We should all be spending $10,0000 to fix $5,000 cars or to use the superannuation example, we should all be paying hundreds of dollars in admin and advisory fees to an army of advisers so we can save a portion of our income for our retirement.

The alternative model for lifetime saving of a simple combination of a deposit account and some term deposits that any person could understand is clearly much too efficient.

All I am saying is that even if the deficit terrorists are wrong it doesn’t mean that deficits are a magic bullet. A more lasting solution is to limit the use of debt and leverage generally.

I don’t mean to go all medieval and suggest a ban on usury but simply acknowledge that at this point in our evolution humans seem to have a limited ability to handle the magical powers of leverage.

Cheers

16 Magpie June 5, 2011 at 10:47 am

pfh007

“I must confess that I am struggling with this statement.

‘So, when the Government spends, it’s essentially getting something for nothing (just paper, or 0s and 1s in a hard drive). It makes no sense whatsoever to use the notion of efficiency.’

“If efficiency is no criterion for assessing government policy decisions then what is?”

In my reply I will focus on this question. In the process I hope to address your comments.

Bob and Jack are unemployed, thus, they have no income. Because of that, they can’t buy stuff for them or their families. But because they don’t consume, employers/producers don’t sell stuff, and don’t have a use for Bob and Jack: they remain unemployed, employers/producers don’t make money, the government doesn’t get taxes.

You are the government.

Bob and you agree on a deal. Maybe Bob has no other qualification than being a strong bloke; Dick could be a caring sort, who likes to help other people. Some could be more like military types, or doctors, teachers, gardeners.

Let’s choose a deliberately extreme case: Bob isn’t too bright, just a strong bloke. You put him to dig a hole. He digs the hole and you pay him with fiat currency.

Ten minutes after Bob left, Jack comes along and you put him to fill the hole Bob just dug. (I think you mentioned something like this in a previous message.)

Does this hole digging/filling exercise make any sense? It depends on what you are considering (just as the car repair example does).

You are getting nothing to show for Bob’s and Jack’s pay, true. There was a flat patch of land before, and this is what is there now. But what is it you are giving them? This is not a rhetorical question: think about it.

You are paying with fiat currency: paper, of which you have a virtually infinite supply!

So, was the whole exercise inefficient? I’d say obviously not. You didn’t get anything done (on the most stringent interpretation, that seems implicit in your objection), but you didn’t give anything valuable in return, either.

So far, and in the worst case scenario, the exercise is not inefficient. Could it be pointless?

Let’s stop and see what happens when Bob and Jack make it home. They give their pay to their wives, who go to the grocer’s and buy stuff. The grocers make money and start hiring people. And the government will start to collect taxes again.

So, in the most extreme case (and with the most stringent interpretation of what the government gets in exchange for its money!), the exercise is not pointless, either. There was something you did not consider that you get: the economy is working again (the old box example).

So far, I have argued that the exercise isn’t inefficient and isn’t pointless, even though Bob and Jack didn’t do anything useful.

But let’s suppose that you (the government, keep that in mind) have a bit more sense than just ordering people to dig and fill holes. That is, you put people to do “work that have some social value”). You order the guys to fix a road, or build an airport, or do a public garden’s landscape. Or fight the Nazis and the Japanese (like FDR did).

Or you sent Dick, the caring but unfit guy, to deliver food through Meals on Wheels (“what specific work/tasks is a match for each individual’s functional capacity”). Daisy is a nurse, and you put her to look after sick people. Mary goes into a research career that will lead to a cure to cancer or a first settlement on Mars.

I mean: in the worst case scenario, you got the economy started again. With just a little sense, you get “things” done and photo opportunities to show off.

All these things you could get done with a little sense, are bonuses.

It’s not that the government should not try to achieve them, or that they are not desirable: they do have “some social value”, but they are not needed to assess the policy itself, because the policy was meant to re-start the economy. You spent fiat money to re-start the economy and that’s what you got, regardless of what else you achieved.

So, where is the problem with efficiency?

Somewhere else you ask:

“The car example was also a bit disturbing. Do you mean that the government should spend $10,000.00 fixing a car that it could have bought for $5,000 because it can just make an accounting entry to pay for it?”

Just so that you can suggest the answer:

“We should all be spending $10,000 to fix $5,000 cars or to use the superannuation example, we should all be paying hundreds of dollars in admin and advisory fees to an army of advisers so we can save a portion of our income for our retirement.”

Conclusion: I’m obviously delusional.

Come on! I’ll assume here you didn’t mean to draw a strawman, but only add a lighthearted comment, that unfortunately backfired.

But to answer the question: clearly, what I mean is that $10K and $5K don’t tell the whole story. You do remember this, don’t you:

“go somewhere else, where the same repair costs 1/10 and the repair is suddenly efficient.

(…)

“The point is that efficiency is not an absolute criterion, although this is what people usually imply when they talk about it.”

To further quote myself:

“The point is that we need to know the real values obtained and sacrificed. Often people don’t include important costs (or overstate benefits), but they go on talking about efficiency as if it was a trivial matter.”

17 pfh007 June 5, 2011 at 5:55 pm

Magpie

I am not out to start some flame war so I apologise for any offense caused. I don’t think you are delusional and I certainly did not mean to imply it.

My argument is that just because politicians (left and right) like to bang on about public deficits and debt essentially for political advantage and some ideologues use anti-deficit/debt rhetoric as part of their strategy to produce ‘smaller’ government, we shouldn’t assume that intervention by the government by way of deficits and debt / printing money / accounting entries is a good practice.

But to some extent we seem to be at cross purposes as I am not arguing the government should never print money or making accounting entries to stimulate economic activity.

Just that they should do so very carefully and only when absolutely necessary e.g autonomic stabilizers.

And to keep to the subject of the original post I think it is quite reasonable for a citizen to be concerned/suspicious that a situation has arisen where it is considered necessary to run large deficits, incur public debts and print money/make accounting entries.

Out of abundant caution I emphasis that I am not pushing a smaller government agenda. I think there are a wide range of issues and activities where the role of government/public service is important/critical.

Let’s work out what they are and then fund the government appropriately to do them well.

But the idea of the government intervening in the economy outside of those agreed areas of government responsibility to create ‘additional’ demand to fill a hole due to a collapse in private demand is much more problematic in practice (in theory it sounds quite brilliant).

There are likely to be very good reasons that private demand has collapsed but working out how to replace that demand (particularly its composition) is an exceedingly complex undertaking.

Take the housing market in Australia as an example:

That beast is deeply and profoundly embedded in the economy like Ripley’s alien.

Crikey, I have seen shops that only specialise in fancy imported taps – do they make the water taste better?.

Expanding private debt has been supporting the demand for granite, stainless steel, tasteful renovations of workman’s cottages, a multitude of professional services, casual jobs at Bunnings etc etc.

Our economy is hooked on ever rising housing debt (debt = crack cocaine of economics – makes you feel good when you spend it and horrible when you have been using too much and run out)

Should, God forbid, the private demand for housing collapse in Australia as it has in the USA and elsewhere we are going to have a enormous demand hole to fill.

It will take a long time for all those people who have been fed and watered by the credit boom in private housing to find something useful to do with their day light hours.

While I can understand (and support) the government running a deficit by printing welfare cheques and sending them to all the newly unemployed by a housing bust I don’t see why the government should try to second guess what they should be doing in the post ‘housing era’ and providing them with actual employment.

Welfare payments in this instance would be pure autonomic stabiliser deficit, clearly supportable and i have no doubt the public would support it.

But your position goes far beyond this and would appear to legitimise the use of deficit spending to give everyone who is willing a job (chosen by a government committee).

Why not just pay them welfare with appropriate carrot and sticks to discourage passive welfare.

Let the community work out what goods and services are required and the individual decide what they wish to provide (as self employed or employees) in the post housing tundra.

Arguably the ‘enlightened’ response of government over the last 20+ years has been just to enable our housing debt habit.

Why trust them to come up with good ideas for substitute private demand?

Cheers
Paul.

18 Magpie June 6, 2011 at 11:01 am

Paul,

“I am not out to start some flame war so I apologise for any offense caused. I don’t think you are delusional and I certainly did not mean to imply it.”

No worries!

19 Jimbo Jones June 6, 2011 at 2:45 pm

Interesting to note that one of the reasons posited for deficit reduction is the potential for a positive feedback loop from the government budget position, i.e. a reducing deficit is considered to be a sign of good economic times which can elicit further economic growth through a confidence premium. In fact, perhaps the major justification for the UK’s fiscal austerity policy is this confidence premium kick back to the general economy, despite economic growth being anaemic. In some ways one of Bernanke’s key justifications for the QE programme is the feedback loop (as well as the wealth effects) that rising stock markets and asset prices have on general economic activity through confidence benefits, and so its not unreasonable for government deficits to also play a similar role. It could also be put forward that investment decisions within the general economy are impacted by the inflationary expectation mechanism that interest rates and inflation will go up in the context of large and growing fiscal deficits.

You would have to question whether any of these effects will of course outweigh the impact of austerity precisely at a time when private consumption is not returning as quickly as hoped. This is the expected course of events following a financial crisis induced recession in which households/corporates and ultimately governments repair leveraged balance sheets, delay consumption and increase savings rates. It is also clear, in terms of a measure of efficiency, that the fiscal multiplier effects of government spending in financial crises are large, and that therefore a reduction of stimulus will have a corresponding large negative multiplier effect.

The crowding out effects are also well less pronounced in recessionary times as monetary policy sets rates to zero and beyond.

I think therefore the real key for politicians is to set up a nuanced approach and to elicit community support for long term deficit reduction strategies within the context of short term stimulatory fiscal policies aimed at ensuring that the recovery doesn’t fizzle and elicit more short term budget pain as the automatic stabilisers start going the wrong way. Implementing structural cuts to programes that kick in over the term of the budget estimates and replacing these with short term jobs/skills/training/infrastructure boosts for example may serve this purpose.

20 Pfh007 June 7, 2011 at 1:16 pm

This is an interesting paper from the BIS questioning the view that the credit boom in the USA and the west was due to a glut of savings from the developing world.

http://www.bis.org/publ/work346.htm

21 Magpie June 12, 2011 at 5:14 pm

Hey Stubborn

Here’s a short note from Krugman’s blog at NY Times that glimpses at why there is opposition to deficit and debt:

“The Rentier Regime”. June 6, 2011.

“People generally manage to believe whatever is in their interests. And maybe not even that.”

It’s an insightful comment, which I fully share. I just wish Prof. Krugman applied the same logic to himself.

If you want to explore further on this subject, here’s a comment by Richard Wolff, referring to Krugman:

“Ongoing Crisis and Liberal Blindness”. June 6, 2011.

I’ll be writing something about this, you know, one of these days. :-)

22 Stubborn Mule June 12, 2011 at 6:14 pm

Magpie that is a very timely remark. I am currently mulling over a post on cognitive dissonance which goes a long way to explaining this sort of behaviour.

23 Magpie June 12, 2011 at 7:00 pm

“I am currently mulling over a post on cognitive dissonance which goes a long way to explaining this sort of behaviour.”

Looking forward to it!

BTW: that’s the link to Wolff’s comments on Krugman
http://www.truth-out.org/ongoing-crisis-and-liberal-blindness/1307391273

24 pfh007 June 12, 2011 at 7:41 pm

“Liberalism’s outdated antipathy to Marxism – and ignorance of the new developments in Marxian thinking of recent decades – is its key problem, a debilitating legacy of the Cold War.”

What are those new developments?

Any pointers to websites that discuss them would be of interest.

Never hurts to pressure test one’s false consciousness.

25 Magpie July 13, 2011 at 4:22 pm

Coincidences!

Prof. Mitchell on waste and efficiency:

“Third, for a sovereign government that issues its own currency there is not meaningful concept of waste that is specified in terms of $A net outlays. This is a controversial point I suspect.

“Take two projects: A and B. They both deliver a building of similar dimensions and quality in different regions. Contractors providing building A charge twice as much as the contractors who provide B and the government officials lack oversight to determine why? The buildings are delivered on time and appear to be satisfactory against the specification.

“Question: Is there any waste in Project B relative to Project A?

“Answer: From a Modern Monetary Theory (MMT) perspective, there is no waste.”
http://bilbo.economicoutlook.net/blog/?p=15211

26 Magpie August 8, 2011 at 10:09 am

Today I had an interesting conversation with a young friend.

In my friend’s view, fiscal stimulus don’t work, in general. For instance, Rudd’s “cash splash” did not work, because “people saved the money, instead of spending it”.

He asked me if I had spent that money. “Of course I did”, said I.

“I didn’t”, he said. “I saved the whole $900″.

“Why would you do that?”, I asked rather puzzled, as my friend has a low-wages job.

“Because I was saving to give the deposit for the unit”.

So I asked: “And when did you sign the contract?”

It turns out, he signed the contract and made the down payment like 6 to 8 months after he received the $900, thanks also to the FHB money!

And yet, my friend still thinks his case illustrates why the stimulus didn’t work!

27 Stubborn Mule August 11, 2011 at 9:47 pm

@Magpie: there’s no convincing some people. In fact, I am planning a blog post on that very topic.

28 Magpie August 15, 2011 at 4:16 am

@Stubborn

Sounds interesting!

I myself have some ideas about this, as I had similar conversations with other people.

In my friend’s case, when remarked that he didn’t keep the $900 (i.e. they were no longer in his savings account), he acknowledged the fact: “Oh, well… You save money only to spend it… eventually”.

In his mind, the lag between the reception of the money and the act of “eventually” spending it (the 6 to 8 months during which he “saved the money”) made all the difference.

However, the $900 bonus was never conditioned upon the money being spent quickly (say, within 24 hours of reception). Certainly, the government itself never did that, nor did Keynes either for fiscal stimulus in general.

It’s true that my friend, by postponing spending the money, also postponed his bit of the effect of increasing effective demand as a concentrated surge of sales, as it would have done if he had spent it immediately. But it did not fail to increase effective demand!

Like I said: I did spend the whole money. But not even I rushed madly to spend it in things I did not need. I took my time (a much shorter time, btw!) deciding how to spend the money best. Within 1 to 2 months, I had nothing left.

A similar (although not identical) reasoning applies to people who argue that the FHBB did not increase effective housing demand (i.e. it only made it faster to acquire a home for those who had already decided to do so).

29 Magpie August 16, 2011 at 7:30 pm

I just found this piece at The L.A. Times:

“Companies are afraid to hire, even if business is improving” by Alana Semuels. August 14, 2011.
http://www.latimes.com/business/la-fi-nohiring-20110814,0,7476876,full.story

I consider this piece should be part of the required readings for a macroeconomics course.

It explains (1) the relationship between unemployment and underconsumption or insufficient aggregate demand (it sounds a lot like something I said above, I’ll say with some gloating, just remember my discussion and read the note ), (2) it explains why productivity and profits tend to grow during recessions, (3) it shows that Say’s Law is madness.

All the Keynes fan-boys and girls around (which includes me) will feel satisfied.

But if anyone, other than me, is a fan of Onkel Karl (Da Man from Trier), he or she will know that before Johnny, Chuck said pretty much the same things, plus others (like the productivity thing!).

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