By William K. Black
June 11, 2018 Kansas City, MO
Ben Bernanke recently gave a speech predicting that President Trump’s deficits will cause the economy to “go off a cliff in 2020.” Many Democratic Party politicians, of course, will rush to embrace the criticism and prove that they are the true party of fiscal responsibility. They can then get back to pushing for increased taxation and cuts to the safety net “to save it” from collapse – and feeling virtuous. These Democrats will glory in their supposed virtue and gravitas as they oppose ‘excessive’ stimulus, cut the safety net to ‘save it,’ oh-so-judiciously cut funding for social programs, and push for higher taxes. They know this is bad politics, but that adds to their faith that the more bitter the medicine the greater the curative properties. Faith-based federal deficit phobia, however, is terrible economics and terrible politics.
Bernanke is one of the worst of the anti-regulators most culpable for creating the criminogenic environment that created the three great epidemics of “control fraud” that drove the financial crisis and the Great Recession. The Democrats’ cast their eagerness to join in the Bernanke chorus as realpolitik – the enemy of my enemy is my ally. It is common that the enemy of your enemy is peddling terrible ideas that will harm the public.
Myth Number One: ‘Full Employment’ is the Worst Possible Time for Fiscal Stimulus
Bernanke is peddling multiple, harmful financial myths about federal budget deficits that were falsified decades ago – and then falsified again five years ago. The first myth is the base myth – that running a federal deficit when the Nation is not in or recovering from a recession is harmful and irresponsible. Bernanke does not discuss the implications of the fact that the United States has a freely-floating sovereign currency and borrows in that currency. Bernanke is apoplectic that Trump is using fiscal stimulus “at the very worst moment” – “full employment.”
The overwhelming majority of economists, including Paul Krugman, share Bernanke’s core myth. It is important to understand that while it is a myth, it is paradoxically sometimes nearly true. It is a myth because it is the wrong concept. Modern monetary theory (MMT) does not predict that a Nation with a sovereign currency’s fiscal deficits are economically irrelevant or inherently desirable. MMT focuses on real constraints, such as shortages in important resources needed for innovation and growth. MMT cautions that such resource shortages can produce inflation and that substantial inflation is harmful to the overall economy and individuals. Very low levels of inflation that have characterized the last two decades have often been too low according to central bank ‘targets’. Even small levels of negative inflation (deflation) can cause serious harm by discouraging consumption, which prolongs and deepens a recession.
“Full employment” sounds like a real resource constraint. Labor is a resource to conventional economists. Edmund Burke, drawing on Adam Smith, insisted that labor was a “commodity.” (To us, labor is far more than a “resource” and never a “commodity” – workers are human beings.) Conventional economists want us to treat “full employment” as a constraint. Neoclassical economists seek to present “full employment” as such a severe resource constraint that we should not aim to achieve full employment because it will supposedly cause large wage increases that will produce substantial inflation. I am describing the mythical Phillips curve that purports to describe the inherent tradeoff between reducing unemployment and increasing inflation.
Conservative economists view unemployment as a minor problem and often begin warning about the supposed risk of severe inflation when unemployment falls to around five percent. Five percent unemployment leaves over ten million Americans who desire full time employment unemployed, underemployed, or withdrawn from the labor force because they are discouraged from seeking work or can only find work at wages that pay them less than the child care and transportation costs they would have to bear if they worked outside the home.
For roughly the last eight years, dramatically decreasing unemployment has led to inflation rates so low that they do not even meet the Fed’s ‘target’ rate for inflation. Wages continue to stagnate or increase well below the rate of productivity increases. ‘Full employment’ has proven to be an illusory concept rather than a hard resource constraint.
The term has no precise meaning, even to economists. The definition of unemployment is unsuccessfully seeking employment. This means that people who have withdrawn from the labor force, whether because they are discouraged about their job prospects or ill, are not classified as unemployed. Our ‘unemployed’ statistics classify the underemployed as ‘employed.’ What all of this means is that “full employment” is rarely a hard resource limit and that approaching supposed ‘full employment’ often produces minimal inflation and weak wage growth.
Myth Number Two: Substantial Debts Cause Economies to ‘Fall Off the Cliff’
The second myth is that when the national debt to GDP ratio approaches 90 percent economic growth rates tend to collapse – to fall off the cliff. This is the myth that Carmen Reinhart and Kenneth Rogoff spread in their initial 2010 paper and subsequent book. Reinhart and Rogoff preached their myth for the explicit policy purpose of discouraging the use of fiscal stimulus to speed the global recovery from the Great Recession. They claimed that increased fiscal stimulus would push many economies back into recession. Scholars at the University of Massachusetts at Amherst exposed this myth as the product of Reinhart and Rogoff’s data entry errors and biased coding.
Prior to this exposure, however, the British Labor Party’s chief economic minister and then Prime Minister relied on the Reinhart and Rogoff myth to abandon stimulus in favor of a self-destructive policy of austerity that ruined the UK’s economic recovery and crushed the Labor Party politically. Given the infamous nature of Reinhart and Rogoff’s failures that discredited their ‘fall off the cliff’ claim, it is bizarre that Bernanke would roll out the same myth in a speech in mid-2018. Reinhart and Rogoff failed to distinguish between nations with a sovereign currency and nations lacking such a currency.
Myth Number Three: Deficits Remove Essential ‘Fiscal Space’
The Huffington Post journalist that wrote about Bernanke’s speech wrote these sentences as if they were an indisputable fact rather than the third Bernanke myth about the dangers of deficits.
Stimulus packages are used when the economy is flagging. When the economy does slump in the future, there may be few reserves to spend to get it going again.
Neoclassical economists spread this myth. They usually refer to it as “fiscal space.” The ‘logic’ is the same as that presented by the journalist – current fiscal stimulus will cause us to have inadequate “reserves to spend to get it going again” when we face the next recession. It is hard to respond to this myth because it is so vague and logically incoherent. The word “reserves” illustrates the incoherence of the myth.
‘Reserves’ make sense for a firm, a household, a nation without a sovereign currency, or a nation with a sovereign currency that tries to maintain a fixed currency value or borrows significantly in a foreign currency. In each of those cases, creditors can make demands for repayment that the borrower cannot meet without having the ability to raise huge amounts of funds in a currency they do not control. The same reasons creditors are demanding repayment can also make it prohibitively expensive or impossible to borrow new funds in the non-sovereign currencies in which their debts are denominated. In these circumstances, it can make sense to limit liquidity risk by maintaining ‘reserves’ in those non-sovereign currencies. If a debtor uses these reserves to stave off a liquidity crisis, and the debtor does not restore those reserves, the household, firm, or nation can lack the reserves to prevent a future liquidity crisis.
Bernanke knows, however, that none of this discussion of reserves makes any sense in the context that Bernanke was discussing – the United States. We have a sovereign currency. It floats. We borrow in U.S. dollars. We can make all the dollars we want. It makes no sense for the U.S. to hold ‘reserves’ of any currency. We need never lack necessary currency stocks. We need never lack ‘fiscal space.’
We can create a self-inflicted disaster through imposing statutory limits on debt issuance and then choosing to run deficits through debt issuances. These periodic ‘debt crises,’ are artificially created by virtue of those pointless debt limits. We can, and do, increase the money supply directly through key strokes on Treasury or Federal Reserve computers without selling U.S. government notes and bonds.
Bernanke’s myths increase the likelihood that we will adopt self-inflicted fiscal pathologies – and delude ourselves into believing that pathologies made us safer. Today, Democrats are more susceptible than Republicans to that delusion. Democratic politicians will soon work, in ‘bipartisan’ bliss, to push three terrible policies. They will ‘save’ Social Security by cutting it. They will return us to fiscal ‘responsibility’ by cutting programs for the poor and increasing taxes for the wealthy and middle classes in order to ‘balance the budget.’ Most of the media will treat those multiple monetary myths as gospel and treat politicians that champion these three perverse fiscal policies as exhibiting courage and the hallmark of responsibility.
Trump’s deficits may prove too large and produce serious inflation, but that is far from certain. Democrats should criticize Trump’s budget and tax cuts for the proper reasons – Republicans designed them to enrich the wealthy and harm many non-wealthy Americans.
Revised: 2010 -> 2020