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.