Explaining Why Federal Deficits Are Needed

By Thornton (Tip) Parker

Most MMT advocates probably took months to get comfortable with it.  But like a personal computer, one need not understand its innards to use its power.  The great power of MMT is its lesson that the federal government can create new dollars by running deficits to do things that should be done.  But the lesson is counterintuitive and will be rejected by voters unless it can be explained convincingly in a few minutes.  This paper offers five nuggets for explaining it quickly. NEP readers are asked to suggest ways to make the explanation simpler and better.

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Most Americans believe the federal government is like a family or business that must live within its income.  On the surface, that makes sense and the reasons why it is wrong are complex.  Here are five nuggets, or simple ways to explain why it is wrong to voters who will never be economists.  They show why federal deficits are necessary.  They can be adapted and used as appropriate.

Historical

Federal deficits are necessary and the government normally runs them.  It ran them during 129 of the past 200 years or nearly two thirds of the time.  During the other third, it ran surpluses to reduce its debt during five periods of six or more years.  Each period led to a major depression.

1823-1836: Federal debt reduced 99%  – depression began 1837.
1852-1857:        ”         ”         ”       59%  –        ”              ”      1857.
1867-1873:        ”         ”         ”       27%  –        ”              ”      1873.
1880-1893:        ”         ”         ”       57%  –        ”              ”      1893.
1920-1930:        ”         ”         ”       36%  –        ”              ”      1929.

The government had to run deficits to recover from each depression.

The Federal government is different

The economy needs a continuing influx of new dollars to grow.  The government creates new dollars when it runs deficits by spending more than it receives from taxes.

When the government collects taxes it takes dollars out of the economy.  It also appears to take dollars from the economy when it sells bonds.  But unlike taxpayers who lose their purchasing power, bond buyers get bonds and keep their purchasing power.  The deficit spending adds new dollars to the economy as if they had been “printed”.  Note these key points:

  1. Unlike reluctant taxpayers, bond buyers want the bonds to use as savings accounts to safeguard their dollars and earn interest.
  2. The government redeems the bonds when they come due, but it can roll over or sell replacements indefinitely.
  3. The total of all dollars the federal government has created this way since 1790 is called the federal debt which never has to be repaid while the nation exists. Attempts to reduce the debt significantly never worked because they took dollars from the economy that it needs to operate and grow.
  4. Because the government can create dollars, it can never run out of them and cannot be forced into bankruptcy.
  5. The federal government is not like families or companies because only it creates new dollars that stay in the economy unless it removes them by running surpluses.

This explanation is generally correct, but the details of how the government creates new dollars are more complicated.

Economic Sectoral Balances

Most people have heard of the private sector but they don’t know what “sector” means.  The economy has three major parts called the private sector, the public sector, and the foreign sector.  The total dollar flows from all buying and selling within and among the sectors always cancel out or add up to zero.  A sector has a deficit if it spends more than its income.  When this happens, one or both of the other sectors must run a corresponding surplus, and vice versa.

Since the 1970s, the private sector has bought more goods and services from other countries than it sold to them.  The dollars that flowed to other countries to pay for the net imports were foreign sector surpluses and private sector deficits.

Those deficits drained dollars from the private sector and the economy might have slowed down or even fallen into a depression for a lack of money.  That did not happen because the federal government in the public sector ran deficits that replaced the dollars sent abroad.  The country now imports about one half a trillion dollars worth of goods and services a year more than its exports.  That flow will have to be reduced eventually or the economy will become weaker and even more unbalanced.  But until that happens, the government is trapped into running deficits to compensate for the private sector’s failure to earn its living in relation to the foreign sector.  Balanced federal budgets are formulas for economic decline.

 Drive the Economy

The economy is like a car.  Government spending is the accelerator.  Taxes are the brakes.  To keep going or speed up, press the accelerator.  To slow down, ease off the accelerator or press the brakes.  Driving too fast could lead to hyper-inflation, but that never happened here because the country always slowed down in time.

Reverse the Discussion

Those who oppose federal deficits should be made to answer two basic questions:

  1. Why should the government avoid spending to meet the country’s critical needs in order to save dollars which it can create?
  2. How could the government ever run out of dollars since it can create them by running deficits?

There are no good answers to those questions.

34 Responses to Explaining Why Federal Deficits Are Needed

  1. I think the average reader would understand this point ” unless it removes them by running surpluses.” better if it were worded “unless the government collects more revenue than it spends.” This is what running a surplus means, but it is less technical to a lay reader.

  2. This is an excellent initiative, and a good start. I want to take a while to craft some suggestions, but In general these words to break the spell of the “general consensus” will want to be pretty short. 75-100 words max.

    My question is how a candidate can bring themselves to say “asking how to pay” for societal objectives such as infrastructure, housing, education, research and health care is a WRONG HEADED question. Especially since even the most progressive such as Bernie willingly offer tax schemes to accompany their program proposals.

    • Thanks, you are right about brevity. That is what I’m searching for.

      At this stage, I don’t think candidates can take on the “how to pay” issue. They need support from others that they can point to. Those who use this blog can help build the case for them in the media. An example of this is a letter to the editor in the Washington Post about the importance of the trade deficit as opposed to the budget deficit.

      I’m hoping that many organizations than need federal funding will come together and make the point that the “how to pay” issue is far less important than what will happen if the needs they represent do not get adequate support. Compared with that, fears of deficits, which have been around for 200 years but have yet to come true are trivial. Somehow, we need to organization a campaign among those that need the funding.

  3. Dear Mr. Parker

    Your “Pearls of Wisdom” are a much needed posting.

    But I think you should add something like the following about inflation.

    “Of course, if too much money is printed, or deficits are too large,
    inflation can occur.

    No one knows how much is too much, because the economic
    equations and models are just not good enough to give that
    answer. But it is easy to tell empirically BY OBSERVATION
    when too much printing (i.e., too large deficits) are occuring.
    JUST WATCH THE INTEREST RATES.

    When interest rates rise above X per cent, decrease printing,
    and decrease deficits.

    When interest rates are nearly zero, there is no risk of
    inflation caused by printing money.

    Ever yours
    Bob Eisenberg
    Bard Endowed Professor and Chairman emeritus
    Dept of Molecular Biophysics
    Rush University Medical Center
    Chicago

    • Thanks, you make a good point. I think we will have to see how the comments to this evolve before deciding to add more detail. Many of the people for whom these nuggets are intended will have no idea of how interest rates are set and can be interpreted.

  4. Peter Barbour

    Could you please explain this. Why does the Government issue bonds, if it can just create money by running a deficit? Do they issue bonds for the same reason that they tax and that is to make room for government spending that does not cause inflation? My understanding of what you are saying is that the government does not need to issue bonds or tax to create new money by deficit spending. Is that correct?

    • To further the comment, here’s a thought exercise:
      – imagine an all digital govt
      – it has no employees, no cost and collects no taxes (it doesn’t distort)
      – it issues no bonds
      – it only “prints” the amount of money needed to sustain a set inflation rate(say 2.5%)

      Would that be a good thing?

    • Mr. Barbour, other posts on this blog have gone extensively into why the Government issues bonds. For example, they are a legal and management control technique, buyers want them, and banks get upset when the Government just prints money as it did with the Greenbacks. But my purpose here is to explain that, for whatever reason, the Government does issue bonds as part of its normal routine. I am trying to avoid discussing economics and finance as much as possible. Rather, the intent is to explain that deficits are absolutely necessary, that fears of them are wildly overblown, and the country has always used them as part of its development.

    • Thomas Bergbusch

      Bill Mitchell says it plainly (Basic Concepts from the Billy Blog, Sept 18, 2015):

      “Issuing debt is unnecessary and should for the most part be abandoned as it is unnecessary ‘corporate welfare’.”

      I think there may be good case for the government to issue public debt because in doing so it provides low/zero risk assets that serve to stabilize financial markets.

    • As I understand it a reason to issue bonds is to maintain the central bank’s interest rate. The issuing of bonds drains excess reserves. An alternative option would be to let the interest rate fall to zero.

  5. I see you made the flaw made by many MMTer’s that keeps MMT from becoming more widely accepted. Under driving the economy you say “To slow down, ease off the accelerator (cut spending) or press the brakes (increase taxes)”. But “To keep going or speed up, press the accelerator (increase spending). What about letting off the brake to keep going or speed up? Many people read this and say “yep…MMT’s only answer is to increase spending” Tax cuts on the middle class can be just as effective in “speeding things up” (just look at 2008 gdp when the tax rebate was sent out). You will get more people on board with MMT if you put middle class tax cuts up front and put necessary spending (JG, SS, infrastructure) on the back burner.

    • Good point. I just assumed that one would let off the brake before pressing the accelerator. I’ll add you point.

  6. John kissinger

    Most people instantly worry about inflation when you advocate unending deficits. I have written a paper that explains inflation nearly always comes from shortages of critical goods or labor, and not from excessive printing.
    This, along with a discussion of the demand leakages, helps prepare people to consider MMT principles. If you are interested I could email the paper.
    Beyond this, your history only mentions what happened when deficits fall… Add
    A) recession followed clinton’s surplus,
    B) many elite worried massive WWII deficits would destroy our future even if we won the war. A second worry was that we would go back into depression when the war ended. Those debts were never repaid, but few nowadays worry about them. The mountain of private sector debts had mostly defaulted to low levels while the population had money they were unable to spend during the war; high growth for decades shrunk war debts as a percentage of gDP.
    John

    • Yes, in addition to those that you mention, there are many other reasons for runaway inflation, including losing a war, civil disruption, and an ineffective tax system. But the purpose here is to show what is possible and practical, not list all the cautions.

      Yes, the Great Recession did follow the Clinton surpluses, but it is not as closely linked as those I mentioned.

      And yes, your WWII points are valid. But again, I think we should try to make my nuggets shorter, not longer.

  7. Okay let’s game this out.

    1) Why should the government avoid spending to meet the country’s critical needs in order to save dollars which it can create?
    2) How could the government ever run out of dollars since it can create them by running deficits?

    I imagine someone’s answer to both questions would be “The government can not and should not create dollars in that way because it would lead to inflation.”

    Me: “But there’s no evidence that it does. We’ve never had major inflation as a result of government running a budget deficit.”

    Someone: “That’s because we’ve been fiscally responsible!”

    Me: “But there’s no correlation, why do you think this it’s such a risk?”

    Someone: “What about Weimar Germany? Inflation!!!!!”

    Me: Starts talking about the economic system in Weimar Germany… nobody is convinced about anything.

    What’s the “Please stop worrying about inflation” killer counter-argument?

    • There may be a need for a follow-on set of Qs and As for people who get involved in such discussions. But one arguing that Social Security is not in trouble should try to avoid them.

  8. Gliftor Draken

    People not familiar with these ideas will not make the connection between depressions and something as “virtuous” as government surpluses. We need to say explicitly that because of sectoral balances, government surpluses make it necessary to finance economic expansion with increased private debt and banker-created bubble money.

    • I had hoped to avoid getting into a discussion of how banks create money. The person for whom this is intended thinks of a deposit as what she puts into a bank, not what a bank creates when she uses her credit card.

      • Gliftor Draken

        The problem I see with depending on the historical relationship between surpluses and depressions is that everyone knows the Great Recession was preceded by a deficit-boosting period of tax cuts and wars. I’m not convinced that people will take the historical argument very seriously if they don’t see some kind of mechanism that relates it to what they already know. You have taken on a very difficult problem!

        • Mr. Draken,

          You are surely right about many people. My reply to your original comment was too brief. I should have said that where you said, “government surpluses make it necessary to finance expansion with increased private debt and banker-created bubble money” I would stop after the word expansion, and not get into the private debt and bank-created money.

          I also think that there is no single way to explain this to everyone. We all use our own quirky filters. But my reply to Mr. Denn (below) it the main point. Are we willing to avoid taking the actions listed in it because we don’t have enough money, when the government creates money?

  9. It may be necessary to make your point, but I hope to avoid getting into how banks create money if possible. To the person this is intended for, a deposit is what she puts into a bank, not something the bank creates when she uses her credit card.

  10. Chris McGlock

    Mr Parker saying Bonds are necessary is akin to saying tumors are really necessary for chemotherapy.
    Of course the whole paradigm of Debt is what this government and the USA Inc is run on since the bankruptcy of 1933.
    That’s when you as a person we collateralized for all future debt and a BOND issues agains your birth certificate. Now that it’s becoming more clear and people are waking up we try and obsfucate and belittle the messenger .
    The truth shall set you free.

  11. Format:
    There is a writing process called BRIEF. It’s an anagram which stands for Background, Relevance, Information, Ending, Follow up. You get one sentence for each. Summarize each point in five sentences. Debate response in five sentences. Attention spans are short, these are complex concepts, and need to be in tidy but salient packages. As Einstein said, if you can’t explain it simply you don’t understand it well enough.

    Content (in BRIEF)
    The biggest pushback I get from non-MMTers is the slippery slope. So, if every sovereign government with a free floating currency without significant debt denominated in foreign currency (and perhaps some that don’t) issue currency to stockpile real goods and services—then there will be real shortages. This would result in economic chaos—essentially a massive third world war. And poorer countries will be the hardest hit by the shortages—so how do you prevent the abuse of sovereign stockpiling? In-other-words, what is the new constraint (besides conservatism) to avoid unintended consequences of inevitable national greed?

    • Let’s turn that around. Do you believe that this country should help cities on its East and Gulf coasts prepare for rising sea levels, convert from its dependence on fossil fuels, create jobs for those who will never be able to keep up with technology, give adequate care to its thousands of veterans, reduce consumption of fresh water, rebuild its obsolete and crumbling infrastructure, provide health care to all, and allow its citizens to age with dignity? If you think it should do any or all of those things, how can it “pay” for them?

      In the face of those needs, why should it be delayed by worst-case visions of what might happen but have not happened in 200 years?

    • Question: Don’t we already have some countries, First World designated, stockpiling real goods and services to the detriment of poorer, Third World, countries? Isn’t the outcome more likely to be mass migration from Third to First World, which we are already experiencing?

  12. Hi Tip,

    I’m not personally debating with you. I was simply telling you what pushback I get from non MMTers. If, let’s say, Japan or Japanese firms with Yen issued to them decided to buy up all the rare earth elements in the world, or coffee, or medicines, or anything for that matter with massive funds issued with keystrokes, the US people would likely get REALLY pissed off. Turn it around, the world could get really pissed off at the US if we did. If there were a treaty for the use of sovereign spending without taxing and borrowing—that would go a long way to not destabilizing the world.

    I think what makes those not familiar with MMT uncomfortable is not taking each of the items like in your list separately an thoughtfully and in priority order, perhaps get a law passed to test just one. This would prove to the other nations of the world that this Modern way of looking at money is not an act of economic war—but used properly a way to make lives better for those who are involuntarily poor, or for pubic projects that either don’t or don’t unduly compete with the liberties of the private sector, or to protect the planet.

    • Jon,

      I don’t disagree with you, but there is more that I want to say to you and haven’t the time. I’ll be away until Sunday and will pick this up as soon as I can.

  13. Joe Firestone

    I think many here may be making the assumption that we need arguments that every one will find acceptable when answering a common objection to deficit spending. That’s not necessary, we only need, for example, counter-arguments to the Zimbabwe/Weimar terrorists that point out differences between their situations and ours and that also explain why these differences make it impossible for that kind of inflation to occur under our conditions in the presence of deficit spending that doesn’t continue past full employment. We have those arguments already. Now what we need is a demonstration that the Government truly is unlimited in the amount of electronic reserves it can create.

    Once we have that demonstration, then we can start exchanging with people about what specific policies will and will not cause appreciable inflation. We need to take fiscal policies one by one and evaluate their likely impact. Then we can make a decision about whether to pass a particular policy based on its real costs and benefits, including inflation.

  14. Jon,

    Using your BRIEF approach, the single question I wanted to ask is how Americans can learn that the country is wasting time while many things get worse because of the mistaken belief that the government can’t continue to run deficits? This may or may not be an MMT issue.

    Yes, undisciplined money creation could lead to troubles. But the possibility of using borrowed money to corner a market already happened in 1979 when the Hunt brothers tried to corner the silver market. Somehow, we survived it.

    But it is a waste of time to fret about all the things that might go wrong when so many things are going wrong and will get worse until we do something about them. Compare the points you made with what will happen if global warming continues and hundreds of millions of people are driven from their homes and businesses by rising sea levels, There may be more refugee than Americans.

    Why not reverse the pushback you get from non MMTers by asking them how the private sector and a market economy will pay for dealing with any problems like those I mentioned above since it has not done so yet?

    Enjoyed the discussion.

    Tip

  15. Tip,

    As a mind experiment it might be interesting to rank the public policies that could be funded with federal spending not tied to taxing or borrowing—on three scales. 1) Least likelihood of directly creating unwanted inflation of goods and services. 2) How much it otherwise competes with private sector liberties. 3) Statistically significant polling to infer what % of voters would be in favor of a specific policy. A thorough list producing a few clear winners would be something a pol could use to get votes. Inotherwords, if there were an idea with say 90% public support, that wouldn’t cause unwanted inflation, and it wasn’t something the private sector had a burning desire to make a profit (create jobs) from—wouldn’t that start the phase shift?

    What comes to mind are things like massive water desalinization projects. A JG program but only in the worst economic areas in the country, first, and focused on intrastate business/concerns not interstate. Solar subsidies on steroids. Treating illegal drug use as a health problem not a crime. These might be candidates. Sea walls probably would not poll well initially, cause shortages in building materials for non coastal economies, and might cause labor shortages for private construction projects or in industries with inelastic pricing that can’t compete with the better wages. I’ve written here previously about Friedman’s support of Negative Income Tax, and if it were for those already employed but under the poverty line for their region, it might score well on the 3 scales, too.

    There are conservative and progressive MMTers. My point is, it is in the overlap of the two where a new way of knowing sovereign money, in otherwise mostly self sufficient nations, can be born.

    In a way the rating system is the opposite of the Misery Index. Perhaps it could be called the Opportunity Index?

    Cheers,
    Jon

  16. Regarding Peter Barbour’s question: “Why does the Government issue bonds, if it can just create money by running a deficit?”:

    The short answer, per my understanding, is that the Treasury is legally required by Congressional mandate to sell bonds in the amount of deficit spending (up to the debt ceiling). Then, of course, the follow on question becomes the one that is really being asked: “why was that mandate created?” I have casually looked unsuccessfully for the law, or whatever it is, that requires that sale of bonds, but I am sure someone on this site can quote it. I would love to read it. I think most people don’t even realize that the federal “debt” is the sum of outstanding Treasury securities, they think it’s something else entirely, but I think the people who do know would differentiate bond sales from “federal debt” more easily if they knew that selling bonds is just an artificial legal requirement and not a source of funds.

    If the bond sale requirement were dropped, then could not the Treasury continue to sell bonds voluntarily if desired, independently of any deficit and independently of any notion of “unsustainable” federal debt? If so, then federal spending would no longer be constrained (if it ever really was) by a debt ceiling.

  17. Robert Bostick

    1. There needs to be more work on describing “The Private Sector Surplus.”
    Non-MMTers should be asked to consider the fact that “Where ever there’s a deficit there’s a surplus.” Too much is said about the public sector deficit which scares the average Joe. Turn the discussion and explanations focusing on what the average Joe loses when his surpluss (net financial assets) are reduced.

    2. When taxes are paid, dollars are destroyed and never recycled. The government issues and allows the commercial bank issue of dollars, electronically. It does not need to save, store, hoard its own fiat dollars so that it can fund itself.

    3. Taxes for funding the federal government are obsolete. Our government doesn’t need to “get” dollars since it creates them electronically, like points on a scoreboard. Therefore, tax policy in America manages inflation by taking dollars out of the economy and destroying them.

  18. Jon,

    That approach makes sense. The list could include a few more factors like: who would be the first to benefit from increased federal funding; what actions or causes have the strongest advocates; and what actions will do the most to reduce wealth and income concentration.

    On a different path, it is just a matter of time until there is another recession. Who should be prepared in advance to argue that deficit funding must be part of the recovery.

    All these approaches will depend on finding a good way to explain the practicality of using federal deficits than many will understand. Have you suggestions for improving what I have started?

    Tip