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PPB 111 Final:Layout 1 Levy Economics Institute of Bard College Levy Economics Institute Public Policy Brief of Bard College No. 111, 2010 DEFICIT HYSTERIA REDUX? WHY WE SHOULD STOP WORRYING ABOUT U.S. GOVERNMENT DEFICITS yeva nersisyan and l. randall wray Contents 3 Preface Dimitri B. Papadimitriou 4 Deficit Hysteria Redux? Yeva Nersisyan and L. Randall Wray 21 About the Authors The Levy Economics Institute of Bard College, founded in 1986, is an autonomous research organization. It is nonpartisan, open to the examination of diverse points of view, and dedicated to public service. The Institute is publishing this research with the conviction that it is a constructive and positive contribution to discussions and debates on relevant policy issues. Neither the Institute’s Board of Governors nor its advisers necessarily endorse any proposal made by the authors. The Institute believes in the potential for the study of economics to improve the human condition. Through scholarship and research it generates viable, effective public policy responses to important economic problems that profoundly affect the quality of life in the United States and abroad. The present research agenda includes such issues as financial instability, poverty, employment, gender, problems associated with the distribution of income and wealth, and international trade and competitiveness. In all its endeavors, the Institute places heavy emphasis on the values of personal freedom and justice. Editor: W. Ray Towle Text Editor: Barbara Ross The Public Policy Brief Series is a publication of the Levy Economics Institute of Bard College, Blithewood, PO Box 5000, Annandale-on-Hudson, NY 12504-5000. For information about the Levy Institute, call 845-758-7700 or 202-887-8464 (in Washington, D.C.), e-mail [email protected], or visit the Levy Institute website at www.levy.org. The Public Policy Brief Series is produced by the Bard Publications Office. Copyright © 2010 by the Levy Economics Institute. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information-retrieval system, without permission in writing from the publisher. ISSN 1063-5297 ISBN 978-1-936192-08-3 Preface This brief by Yeva Nersisyan and Senior Scholar L. Randall Wray authors point out that, unlike most governments, households argues that deficits do not burden future generations with debt and firms have a relatively limited lifespan, and that they do not nor do they crowd out private spending. The authors base their have the power to levy taxes, issue currency, or demand that taxes conclusions on the premise that a sovereign nation with its own be paid in the currency issued. They also point out that almost currency cannot become insolvent, and that government financ- every significant reduction of the outstanding U.S. debt has been ing is unlike that of a household or firm. Moreover, they observe followed by a depression, as budget surpluses reduce non- that automatic stabilizers, not government bailouts and the stim- government sector net saving, income, and wealth. ulus package, have prevented the U.S. economic contraction The U.S. federal government is the sole issuer of the dollar, from devolving into another Great Depression. The authors dis- and it spends by crediting bank deposits. Therefore, it can always pense with the (unsubstantiated) concerns about deficits and service its debt, since tax and bond revenues are not required in debts, noting that they mask the real issue: the unwillingness of order to spend. Thus, perpetual budget deficits are “sustainable.” deficit hawks to allow a (democratic) government to work for Moreover, large (nondiscretionary) budget deficits almost always the good of the people. result from recessions because automatic stabilizers (not discre- It is important to explain why sustained budget deficits are tionary spending) place a floor under aggregate demand. As a not a threat because further fiscal expansions may be required, result, the authors caution, taxes should not be raised while there resulting in larger and more prolonged deficits than those pro- is still danger of further unemployment and deflation. jected. The authors point out that the relevant debt figure is the Guided by flawed economic thinking, governments world- amount of Treasuries held by the public. In this case, the gov- wide have imposed unnecessary constraints on their fiscal capac- ernment liability is exactly offset by nongovernment sector assets, ity to fully utilize their labor resources. Bond sales by a sovereign and interest payments by the government generate income for government, for example, are completely voluntary and self- the nongovernment sector. In reality, we leave our grandchildren imposed. While there may be real resource constraints on gov- with government bonds that represent net financial assets and ernment spending, there are no financial constraints. wealth. Moreover, deficits today do not commit future genera- Deficit critics fail to understand the differences between the tions to raise taxes. The historical approach is to retain inherited monetary arrangements of sovereign and nonsovereign nations, debt and rely on a growing economy to reduce the debt ratio. and that eurozone countries such as Greece have given up their Fear that countries such as China will suddenly stop buying monetary sovereignty. By divorcing their fiscal and monetary Treasuries, and thus “financing,” the U.S. economy is misplaced, authorities, these nonsovereign nations have relinquished their since the United States is willing to simultaneously run trade and public sector’s capacity to provide high levels of employment and government budget deficits. Other countries’ eagerness to run a output. In lieu of exiting the eurozone and regaining control of trade surplus with the United States is linked to the desire for dol- domestic policy space, Nersisyan and Wray suggest that the euro- lar assets, so these are not independent decisions. The complex zone countries create a supranational fiscal authority similar to linkages between balance sheets and actions will ensure that tran- the U.S. Treasury that is able to spend like a sovereign government. sitions are moderate and slow. Thus, the current relationships will As always, I welcome your comments. persist much longer than presumed by most commentators. In terms of the notion that balanced budgets are desirable Dimitri B. Papadimitriou, President for households and firms, and therefore for governments, the May 2010 Levy Economics Institute of Bard College 3 Deficit Hysteria Redux In this brief, we present a third view that receives virtually no media attention. We argue that today’s deficits do not burden future generations with debt that must be repaid, nor do they crowd out private spending now or in the future. The Reinhart Introduction and Rogoff findings and both of the conventional views cannot When it comes to federal budget deficits there appear to be only be applied to the situation of the United States, or to any other two respectable positions. The first is the “deficit hawk” position: nation that operates with a sovereign currency (that is, a national deficits are never acceptable because they lead to complete currency with a floating exchange rate, and with no promise to crowding-out; that is, every dollar of government spending is off- convert to another currency at a fixed exchange rate). set by a dollar of private spending. Indeed, for the long run it is Our arguments are not really new—they can be found in even worse, because government debt will have to be repaid in the numerous Levy Institute publications over the past two decades. future, which means higher taxes and less private spending. Hence, Nor is the deficit hysteria new; it returns predictably on cue, like the stimulus package did not save any jobs and will actually cost us an undead monster in a horror flick, to constrain rational policy jobs later. This is a minority view among economists and policy- when a downturn causes the deficit to grow. In the current case, makers, although it remains popular among some Republicans however, the stakes are higher than they have been since the who have a political interest in denying that the Democrats and 1930s. Our economy faces such strong headwinds that it requires the Obama administration have done anything right. a fiscal expansion that could result in even larger and perhaps The second view is the “deficit dove” position: deficits are more prolonged deficits than those now projected. Thus, it is probably acceptable for the short run, and perhaps even neces- more important than ever to explain why sustained budget sary to save the economy from another Great Depression. deficits do not threaten our future. However, the benefits we receive today are partially offset by costs in the future, when we will need to tighten our belts to repay the debt. Even President Obama has argued that today’s deficits will Deficit and Debt Facts impose a heavy burden on our grandchildren, and warned that We first present some data on federal budget deficits and debt “we cannot continue to borrow against our children’s future” because there is so much misinformation surrounding these (February 1, 2010). This is why he is already proposing budget measures. Budget deficits add to the outstanding stock of federal freezes for the year after next. Other deficit doves are somewhat government debt. These data are often presented relative to the more tolerant of near-term budget shortfalls than the president, size of GDP, helping to scale the nominal numbers and provide but they still worry about long-term pain, citing the imminent some perspective. Unfortunately, this approach is often not pur- retirement of baby boomers and concomitant increase in “enti- sued by scaremongers who talk of “tens of trillions of dollars of tlement” spending. Thus, it is all the more necessary to get the unfunded entitlements” when the baby boomers retire, since the budget “under control” as quickly as possible.
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