Deficit Spending: Time to Reframe the Debate

As followers of this blog have discovered, we work within a framework that has been dubbed Modern Money Theory (MMT). The approach itself is fundamentally descriptive, although there are logical ways to apply the principles of the approach to any number of policy-oriented (i.e. prescriptive) economic problems. Above all, we are committed to describing the way government spending works in a modern money system. Once that is understood, it becomes apparent that a government with flexible exchange rates and a sovereign currency (US dollar, British pound, Mexican peso, etc.) can afford to purchase anything that is for sale in its own sovereign currency.

This means that debates about “affordability” become inapplicable. As this becomes more widely understood, we can begin to have a completely different — and vastly more important — debate about the size and role of government.  What do we, as Americans, want? Medicare for all? A job guarantee?  High-speed rail? Renewable energy?

As promoters of MMT, we are all very keen on Abba Lerner, who was one of the first to articulate the foundations of the approach. Lerner believed that the government should maintain the level of aggregate spending in the economy (either by reducing taxes, increasing its own spending or a combination of the two) at the rate consistent with full employment. We agree. This is the overarching goal. How we get there is, as I said, a matter of (political/social) choice.

But we cannot ‘get there’ until we dispense, once-and-for-all, with the erroneous belief that deficit spending is reckless and irresponsible, something akin to “fiscal child abuse”, as Kotlikoff and Burns so disgracefully characterized it.

Insteaad, just remember this fundamental accounting identity:

For me, this is the most important identity in economics. It holds true in every nation at every point in time, and it is useful when you run thought experiments like, for example, “What will happen to the private sector’s balance sheet position if the government’s budget is cut by X% of GDP and the current account deficit remains Y% of GDP?”

So, for example, in the US we have a current account deficit of, roughly, 5% of GDP. This SUBTRACTS from the Private Sector Surplus. So, the only way the private sector can have positive net savings (i.e. a surplus) is for the government to run a deficit that is LARGER than the current account deficit. This is exactly what the government has been doing, and it is the reason the private sector has managed to sharply increase its savings in the downturn. Cutting the public sector deficit will reduce the private sector surplus one-for-one in a closed economy (i.e. one with no foreign trade and therefore no current account). It is an easy way to demonstrate that the government’s deficit is the private sector’s surplus.

So the next time someone tells you that the US government cannot “afford” to keep its promises to retirees, fund the arts, build bullet trains, and so on, ask them whether they understand any of this!

** And, no, it does not follow that because the US government “can” do something that it “should” do it.  It has the ability to puchase anything for sale in terms of its own currency.  Let us accept that point and then debate whether, when, and to what extent it should exercise this power.