Nine times out of 10, Joe Stiglitz is on the right side of the issue. But his response in a recent exchange with our own Lynn Parramore highlights a problem that progressives need to consider in the debate on fiscal stimulus:
Lynn Parramore: People have said that before the crash, the U.S. provided the world’s consumer of last resort. How much has the world changed in that respect?
Joseph Stiglitz: Well, before the crisis, the United States was living beyond its means, and much of what it was spending beyond its means was consumption. It is still the case that the United States is living beyond its means, but the good news is that the households are now beginning to save. But on the other hand, the government deficits have actually increased. So the fact is, the U.S. is continuing to spend beyond its means. Now in the long run, this can’t continue, and that is what is sometimes referred to as the problem of global imbalances. It changed a little bit since the crisis, but the fundamental problems that have given rise to it have not been corrected.
Statements like this are potentially misread. In my view, the size of the public sector deficits per se are of no economic consequence until they become inflationary. At this stage, they are a very useful tool to help reduce private sector indebtedness, and should therefore be seen as a good thing, not a necessary evil. The alternative is 1930s-style debt deflation.
There is no doubt in my mind that the case for fiscal austerity is based on the ideological hatred of government intervention rather than any sound economic theory that the cutbacks will improve the aggregates we are usually concerned with — output and income growth, reduced unemployment, low inflation, etc. It is clear to me that the fiscal austerity approach — epitomized by the announcement in the UK earlier this week — will further damage employment growth and undermine economic growth.
Bill Mitchell provides a good, simple example. He poses the question: what happens in a simplified economy if the government spends $120 and taxes remain at $100? The result is that private saving is 20 dollars, and this can be accumulated as financial assets — initially in the form of numbers in the spreadsheet under private currency holdings. The government might call these holdings “private bank deposits” if it liked.
Where did the 20 dollars in savings come from? Answer: the initial net deficit spending by the government. The person who now has the $20 in additional financial assets can spend the money, thereby creating a multiplier effect in the real economy. Alternatively, (but not before), the government person might then say to the non-government person that they are prepared to encourage further saving and will issue an interest-bearing bond. So a column in the spreadsheet is created to record any “bond sales”, which just amount to reducing a number in the “private bank deposits” column and putting that number into the bond sales column. Please note that the bonds do not “fund” anything. They are effectively being offered as an interest-bearing alternative to cash. The person can either spend part of the $20 or save it in the form of a bond. This enhances his net wealth.
Has the government done anything to suggest that it is “living beyond its means”? Of course not. As Mitchell notes, the government is not obliged to issue this bond. The net spending will still appear as before in the spreadsheet. The deficit does not need to be “financed” by borrowing. There is no operational imperative for the government to issue this debt as things stand. It is clear that the government is “borrowing” back what it has already spent.
The government deficit of $20 is exactly the private savings of $20, which may be stored in bonds or deposits. We could add any number of financial assets without contradicting the basic finding — over time, the accumulated private savings would equal the cumulative budget deficits.
Now, what would happen if the government person decided to run a surplus (say spend $80 and tax $100)? Answer: in the next period the private sector person would owe the government a net tax payment of 20 dollars. Where would they get that shortfall from? They would need to sell something back to the government to get the needed funds or run down their bank deposits. The result is the government generally buys back some bonds it had previously sold.
Either way, accumulated private saving is reduced dollar-for-dollar when there is a government surplus. Which is why government surpluses (rather than deficits per se) are inherently unsustainable. They drain aggregate demand in one of two ways, as Mitchell argues:
- The stock of financial assets (money or bonds) held by the private sector, which represents its wealth, falls; and
- Private disposable income also falls in line with the net taxation impost. Some may retort that government bond purchases provide the private wealth-holder with cash. That is true, but the liquidation of wealth is driven by the shortage of cash in the private sector, arising from tax demands exceeding income. The cash from the bond sales pays the government’s net tax bill. The result is exactly the same when we expand this example by allowing for private income generation and a banking sector.
So when Stiglitz describes people in the US “living beyond their means”, he has to place this in the context of governments running insufficiently large deficits (or, in the case of the Clinton era, budget surpluses), thereby constraining aggregate demand and forcing people to resort to private debt accumulation, which is clearly an unhealthy development.
The President and his economics team operate from the a flawed economic perspective, which is why he and his party is suffering so much in the polls. You can’t make a reasonable case for fiscal stimulus if the argument is predicated on notions that deficit spending is a “necessary, albeit temporary, evil” or creates a situation where we “live beyond our means”.
Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.