What is Responsible Fiscal Policy?

By Pavlina R. Tcherneva

I can’t fault the taxpayer for being upset with the deficit. I blame my profession, which has been spewing nonsense about government spending for decades. Economics is long-overdue for a renaissance. The deficit phobia, not the deficit itself, should be made public enemy #1. Taxpayers are decidedly working against their own interests when they demand that the government reduce or eliminate its deficit. Here is why:
Government deficits create non-government surpluses. It is a simple mathematical proposition; it is neither high theory, nor rocket science. If one sector spends more than it earns, another, by the rules of double-entry bookeeping, earns more than it spends. And so it is with the government—if it spends more than it collects in taxes, it runs a deficit, which is exactly equal to the surplus accumulated by the non-government sector. Deficits create income and profits for the private sector in excess of the taxes the private sector pays to the government. My fellow bloggers have explained this clearly many times before (e.g. here, here and here).
What I’d like to impress upon the taxpayers is a simple logical flaw in their anger with the deficit itself.
If we want the government to “correct” its budget stance, then we must necessarily be offering to reverse ours. If we demand that the government run a surplus, then we are demanding that we, the private sector, run a deficit. If we are demanding that the government pay off its entire debt, then we must be demanding that every single private portfolio, retirement account, or college fund sacrifice its Treasury securities. Surely the private sector does not want that. The government’s deficit is someone else’s surplus and the government’s debt is someone else’s asset. If you would like to wipe out one, then you must be offering to wipe out the other.
Recall the Clinton surpluses. What was then considered to be a very ‘prudent’ government stance was in fact only possible because the private sector acted ‘imprudently’ and ran negative savings for many years. So, take your pick: would you like the private sector be in surplus or the government? You cannot have both. Presumably, we’d prefer the private sector to save and accumulate financial assets, which means that the government must run a deficit and accumulate financial liabilities (note again, that the foreign sector balance does not change this story). Because most people do not think about this basic accounting result, they tend to think that a responsible government is one that acts like a household, without recognizing that a ‘responsible’ government is possible only with an ‘irresponsible’ private sector behavior and vice versa. As Rob Parenteau has argued previously, the quest for fiscal sustainability may very well destabilize the private sector.
Since all of us agree that it is prudent for the private sector to accumulate savings, we must be in agreement that the prudent thing for the government to do is to allow us to be prudent by running deficits. In other words, a truly prudent government is one that does not mimic the behavior of the private sector, but one that offsets it.*
Even after people grasp this very basic logic, they still get hung up on the question “how long can the government keep running deficits and what if it goes bankrupt?” Here, too, we have to remember that government deficits are unlike those of the private sector. This is because the private sector cannot pay by issuing its own currency or create reserves at the stroke of a pen, but the federal government can. By constitutional right, it has monopoly powers over its currency and bank reserves and, therefore, always pays by creating such reserves when it credits the private bank accounts of its payees (see how the Fed and Treasury interact to make payments). The US government has a Central Bank that never bounces government checks and always makes good on government commitments.
In other words, there are no technical reasons why a nation with sovereign control over its currency, like the U.S., should ever go bankrupt—unless of course a misguided Congress places arbitrary political restrictions on the government to meet its financial obligations.
But just because government deficits can always be financed and just because government deficits create private sector surpluses, does it mean that all kinds of government spending are equally responsible? And the answer is clearly, NO.
A responsible government spending policy is not measured by some arbitrary accounting result called the deficit, but by the impact it has had on the real economy. This same sentiment has been echoed by others. (see here and here).


Different fiscal policies will have different effects on output, employment and inflation. It is on the basis of these effects that fiscal policy should be judged. Those of us, who have gone to great lengths to explain how such a modern money system works, have never advocated ‘printing money’ or deficit spending in unlimited amounts for anything and everything. I have argued elsewhere that a responsible government policy is not one that waits for months and years for the economy to recover to see job growth, but acts immediately and directly to create jobs without delay. In the latter case, spending is intimately linked to actual production and employment. The absence of direct job creation programs indicates a government that has not taken its responsibility to the unemployed seriously. Surely, unemployment insurance helps, but unemployed men and women want jobs, not the dole. Paying a pittance to the unemployed (who are not producing) is not the same thing as paying a living wage to those producing something of value.
If government deficit spending fills the coffers of the non-government sector with net financial assets, then a responsible government does so for all private sub-sectors in need, and links its deficit spending to actual employment and production. So while the government could not sit idly by and watch the global financial system collapse, a responsible policy would have immediately provided relief for households, small business owners, and states, all of whom have received inadequate assistance in comparison with the financial sector.
So while it is true that government deficits create non-government surpluses, the real question that taxpayers should be asking is, not how large the deficit is, but who benefits from the deficit and whose coffers does it fill?
If the deficit went to bailing out banks, then we know exactly who accumulated net financial assets. If we knew that the deficit saved state programs and prevented school shut downs, teacher layoffs and civil servant furloughs, then we would know that it is they who ‘received’ the deficit. If the deficit went towards massive infrastructure investment and direct job creation, we would know exactly which individuals and which firms got the funds and how many jobs and projects were created.
The taxpayers should not be angry with the deficit itself, but they are right to ask the question which sector is earning and accumulating net financial assets as a result of the government’s deficit spending. And with unemployment still close to 10 percent, personal bankruptcies and foreclosures unacceptably high, broken state budgets and disappearing public programs, and Wall Street bonuses sky high, I think the answer is quite clear.
Wall Street knows all too well that the government cannot go bankrupt, which is why it never objects when the government socializes its losses. Notice how financial gurus temporarily suspend their own deficit phobia until Wall Street’s balance sheets and incomes are restored. The average person, however, does not know that deficits are forever sustainable and that the government is not obligated to raise anyone’s taxes to ‘pay’ for them (see here a discussion on the role of taxes). And so the taxpayer does not demand from its government what the taxpayer genuinely wants and needs: more jobs, more infrastructure, better education, higher quality public services, and a standard of living that only a resource-rich nation as the U.S. can provide. It is time to stop buying into the deficit phobia and demand that the government deficit spend … responsibly.
*I thank Jan Kregel for putting it so succinctly.

18 responses to “What is Responsible Fiscal Policy?

  1. I would appreciate it if someone at UMKC can respond to Bill White's recent speech at the Institute for "New" Economic "Thinking".http://www.youtube.com/watch?v=lkyG6fLdRpESpecifically, White claims that the following imbalances created the crisis, and that these imbalances remain:1. Asset prices rose to unprecedented heights in 2003;2. Credit standard lowered, with end result that banks were enormously exposed;3. Sharp reduction in savings rates in western countries;4. Massive investment rise in China which contributed to trade imbalances;5. Supply structure of economy adopting to new demand structure, which was rapidly changing.I was unable to locate an email address for a blog point of contact, so I cam posting here. Please feel free to delete this post. Thank you.

  2. Best post on this subject I've ever seen! Thanks.

  3. We want sectors with a nice futures to run deficits, sectors with a rotten futures to save. A rule that applies to all sectors. That is the basic logic.

  4. Following the above logic, Greece should have a very productive private society. Think again. It's possible to have a very high private AND public debt. One does not preclude the other. I fail to follow the logic of the above article.

  5. To Anonymous @623amThe wrinkle you miss is that the non-govt sector must be in a net saving position in the long run, as it is the currency user. The govt sector, as the currency issuer is the only sector that can actually sustain a net deficit position.To Anonymous @553pmYou're completely wrong on all counts. As you've admitted yourself, you've clearly failed to follow the logic. Of course it's possible to have a high private and public debt, but it's NOT possible to have a nigh govt and net non-govt DEFICIT . . . including the current account in the non-govt. But, you can have a domestic private deficit and a govt deficit together given a current account deficit . . . just as the US did during Bush II. This is just an accounting identity, and the logic is thus irrefutable.

  6. Proof positive "Progressive" Economists will mindlessly cling to their emotion based political dogmas despite all data that show their notions absurd nonsense. Rather then continually spinning these Demand side fables, they should try reading this. Japan's Lost Decade: Origins, Consequences and Prospects for Recovery (World Economy Special Issues) by Gary Saxonhouse and Robert Stern (Paperback – Mar. 12, 2004)Japan followed these theories of Demand driven fiscal policy all during the 1990s. Those theories failed completely.The data does not lie unlike certain "Economists" who seem more wedded to propagandizing for a certain political ideology then honestly considering the facts.

  7. The Japanese case illustrates that we need to measure the success of government policy in terms of the impact of deficit spending, not in terms of the size of the government debt or deficit–precisely the point of Modern Money Theory and this blog post. Japan demonstrates that for a sovereign-currency nation, deficits and debts are sustainable, but the decade was lost because 'pouring money' into the banking sector did not solve the economy's economic woes. Only after spending was targeted to employment and production did we see some recovery…until the currency crisis hit and wiped out those gains.

  8. So what happens 100 or 500 years from now? I know we are a short-term society, but what are the long-term impacts? Obviously inflation, but how drastic. Zimbabwe-like to the point where we have revalue the dollar and creditors get screwed over? If so, then isn't that the equivalent of renegging on your debt; which is what a lot of people worry about.Basically, this article is about theoretical deficits, not real-world. I like the caveat about politicians not messing things up. That's a pretty freaking big caveat. So big that it's almost lunacy to argue about the theoretical side.

  9. Nobody disputes that a fiat money producer can pay off all its debts with printed money nor that it can create new money to pump one sector at the expense of others.I don't see you addressing the issue that such money manipulation in the end steals value from one group who hold the existing the money and gives value to another group who receive the new money… and all of this by central dictate.Just because MMT works doesn't mean it's not morally bankrupt.

  10. Baffling. I'm neither an economist nor a regular lurker, but this article is so wrong I don't even know where to begin. If the public sector has a deficit, then the private sector does not? How do you figure that? I find that this entire article is written on that premise without the the concept itself ever being demonstrated with facts.

  11. @Anonymous on 5/5 at 9:06amWhat's really amazing is that your comment made it past the moderator, as it adds nothing to the discussion. The issue you are having so much trouble with is explained over and over again in posts to this blog, so often that it's not necessary to repeat it every single time someone posts here. At any rate, think about it for a second. If the government sector has a deficit, that means some other sector of the economy has a surplus, by definition. And which sector of the economy do you think that might be? You get 2 guesses–government sector, or non-government sector. Since we just said the government sector has a deficit, there's only one choice left, but perhaps even you could get this one wrong. And it's not a "premise." It's an accounting identity that's true by definition. Again, the data to back this up is presented in several places on this blog.

  12. This is the most ludicrous and facile backdoor defence of oligarchy I've ever read.The government takes public money and redistributes it to 'friends', and you claim this is a net gain? For the 'friends', perhaps, but not for society.

  13. So the government borrows money. The lender has the money to lend. If the government doesn't borrow money the lenders money vanishes.

  14. The comments on this post clearly illustrate why our country is in trouble – public education has failed! Is this article too long and complicated in the Twitter age? Sheesh!

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