Making The Case Against Austerity

By Stephanie Kelton

Neil Irwin at Wonkblog has a new post up:  The Deficit is Falling Fast. Can Washington Accept Victory?

He quotes John Makin of the American Enterprise Institute, who says, approvingly, that the U.S. has probably imposed enough austerity “for now.”  Then he shows us the evidence.

Irwin makes the obvious point that deficits tend to come down during the recovery phase of the cycle:

The economy is gradually healing, leading to higher tax revenue and reducing social welfare spending.

What he doesn’t show you is this:

It’s the same graph, but with recessions (grey bars) added.  So what does it show?  Basically, that the economy tends to go into recession whenever fiscal policy becomes too tight — a point made routinely by contributors to this blogUnfortunately, it’s not something Irwin points out.  Instead, he quotes Jan Hatzius (Chief Economist  at Goldman Sachs), who says he expects the federal deficit to continue its downward trend, falling from its current level (about 4.5 percent of GDP) to 3 percent or less in FY2015.  

Instead of raising a red flag about the consequences of letting the deficit get too small, Irwin offers this as prima facie good news.  The basic argument being that we will have reduced the size of the deficit enough to keep us out of trouble — for the time being — so we can pause for a moment while we put together a plan to address our really pressing problem: unemployment the long-term deficit.

The lesson out of all this for Congress should be this: Focus on the long-term, not the short-term. The falling deficits of the next few years don’t solve the bigger longer-term problems the United States faces, on reining in rapidly rising health care costs and an unwieldy and frequently unfair tax code.

Alright, I can’t argue with the point about the tax code; it is unwieldy and frequently unfair, but let’s stop and examine Irwin’s other claim — the notion that we need to rein in rapidly rising health care costs because they are the drivers of the long-term fiscal woes.

What?  Wait a minute.  Health care costs are already being “reined in,” as Irwin’s Wonkblog co-contributor Sarah Kliff has shown.  Health care costs have been growing at their slowest rate in decades.  (It’s ironic that Irwin’s post is about how the deficit is actually falling, yet he fails to point out that something similar is happening with health care costs.)

And this is an important dragon to slay, because runaway health care costs are widely considered (by majorities in both parties) to be the primary driver of our long-term debt and deficit woes.  Rather than slay it, Irwin feeds the beast.

Next time, he could reference this important analysis from two staffers at the Federal Reserve.  It does to the CBO’s forecast of rising health care costs (and subsequently long-term debt and deficits) what Herndon, Ash and Pollin recently did to Reinhart & Rogoff’s “tipping point” predictions.

Even better, Irwin could go back to what Hatzius said here and ask him whether he thinks Goldman’s 3 percent deficit forecast is: (a) desirable or (b) sustainable.  Specifically, he should ask Hatzius to explain what it would mean for the domestic private sector in a world in which the U.S. is running a current account deficit that exceeds 3 percent of GDP.  (I’ve already traced out the implications here.)

The fundamental problems with so much of what’s written about debt and deficits are twofold: (1) Almost no one distinguishes those who are merely users of the currency from those who are currency issuers.  It’s a huge oversight, and it leads to grave errors when predicting things like sustainability (or “tipping points”);  (2)  Almost no thinks about the government’s deficit in the proper (balance sheet) context.  We are connected, domestically and globally, by our balance sheets.  Outflows from one sector of the economy show up as inflows elsewhere, and government deficits are an important source of corporate profits.

It’s time more people stopped to think about what this necessarily implies when the government tightens its belt.


14 responses to “Making The Case Against Austerity

  1. Auburn Parks

    The real surprise is that Handzius isn’t sounding the alarm bell about the decreasing deficit like crazy. Its a fact that he knows all about and uses, as a part of his analysis, sectoral balance accounting.\

    So it should be obvious to him that a new recession will be in order if the Govt deficit gets below the trade deficit and the private sector isn’t willing to increase its debt load to compensate.

    • I don’t think Hatzius is in the business of making policy recommendations or blowing whistles..

      • Auburn Parks

        That makes sense, I just didn’t think about it from a dirt bag Goldman POV…..I am Hatzius, and I know a recession will occur following my above comments…..why would I broadcast that information instead of keeping it private and making investments based off of my insight…..that sounds much more like. I retract my previous comment.

    • reserveporto

      Jan Hatzius gives some rather insightful answers in that interview. I found the comment about interest rates being a policy tool quite direct. He may not read NEP, but it seems at least some of the insights propounded here have be used to generate vast personal or corporate wealth.

      • reve_etrange

        *cough*Warren Mosler*cough*

        • reserveporto

          Didn’t he get his start through arbitrage transactions well before figuring all this out? I haven’t really looked at the bio beyond the anecdotes in 7DIF.

          Anyways, thinking about the Eurozone, it looks like, for that system to work under sectoral balances, every single country in the Eurozone, all 17, would require a current account surplus of at least between 2% and 5% of GDP. That’s the only way they could achieve balanced budgets while at the same time satisfying the domestic private sector’s desire to accumulate financial assets. It’s an absurd proposition. Especially in a world where so many other countries design their economies to starve domestic consumption to leave a large surplus for buying foreign commodities and assets. The Eurozone countries that have weaker social welfare would require even larger surpluses to account for the private sector’s higher demand for savings.

  2. The link to the analysis from the two Federal Reserve staffers appears incorrectly typed. It is:

  3. Budget deficits should be called “wealth enchanting spending”.

    Government spending gives us wealth. Government taxation removes wealth. A balanced budged is wealth neutral budget. Government spending that is not covered in taxes and therefore neutralized is wealth enchanting spending.

    Another thing is that governments tax revenue depend on what non-government sector decides to do. Let’s say government spends 100, private sector saves 20 and gives 80 back to the government as tax revenue. If government decreases it’s spending to 90, and private sector is still going to save 20, government is going to receive 70 in tax revenue. I don’t know why policy makers think they can control budget deficits. In Britain, all this austerity was supposed to bring budged deficits down but it hasn’t. All forecasts about austerity bringing budget deficits down have been wrong.

    • Correction: wealth enhancing spending.

      • Quite right. Most of the population are fooled by the NAME given to anything. If the national debt was called the “national giraffe”, then austerians, Republicans, the Peterson Institute, etc would all be earnestly discussing the length of the giraffe’s neck.

  4. Joe Firestone

    A number of the links don’t work, including the one to your presentation, Stephanie. Also, this one supports this great post very strongly.

    The table in it shows that all the alternative budget projections for the next ten years commit to plans that will keep the deficit at less than 3% for most years. So, every one of them including the Progressive Caucus Budget puts the private sector in a net loss mode. Long before the ten years are up, this will mean another recession within what has already become “the long depression,” which, of course, would invalidate every one these projections.

    No one in the Washington/New York/global “village” has a clue. They never have a clue because they only talk to and read each other. Prisoners of their own mutual illusions about reality.

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