It's What You Know for Sure that Just Ain't So

Its What You Know for Sure That Just Aint So Stephanie Kelton Associate Professor, Economics UMKC

A New Brand of Macro• The Washington Post, The New York Times, The Economist, CNBC and many more• Discovering an emerging school of economic theory• Modern Money Theory (MMT)• Exposes the fallacies in conventional economic theories• Views unemployment as socially harmful and economically inefﬁcient• Supports a full employment economy

The High Price of Unemployment• Direct Costs • Loss of output/income• Indirect Costs • Social exclusion and the loss of freedom • Skill degradation • Psychological harm, including increased suicide rates • Poor health and reduced life expectancy • The loss of motivation • The undermining of human relations and family life • Loss of social values and responsibility• Can be hard to quantify• But there are estimates

The Annual Social Costs

The Lifetime Social Burden

The Aggregate Loss of Output

The Daily Losses Due to Unemployment"[E]very day the US government is allowing $9.7 billion to go down the drain in lost income just because it is too stupid it implement sensible job creation strategies." ~Bill Mitchell

What is Sensible Job Creation?

ECON 101• Sales Create Jobs• Income Creates Sales• Spending Creates Income• Cutting the Deficit Will: • Reduce Income • Reduce Sales • Destroy Jobs

Every Government MustChoose Which One to Accept• Pure Unemployment • Labor Buffer Stock with zero wage and no tasks• Unemployment Compensation • Labor Buffer Stock with a wage and no tasks• Transition Job/Employer of Last Resort (ELR) • Labor Buffer Stock with a wage and a task

MMT Favors the Transition Job • ELR provides a transition job, something useful to do until the private sector is ready to reemploy people • Performs the job of a true automatic stabilizer • Absorbs workers into the ELR pool when the economy turns down • Releases workers from the pool when the economy improves • Reduces losses borne by the private sector (indirect costs)

Other Beneﬁts• Maintains wages and benefits for those who lose jobs in a downturn• Helps support aggregate demand• Prevents skills from degrading • Makes workers more employable• Gives people a sense of purpose

The New Deal• Roosevelt’s WPA, CCC, NYA and other job programs• Built hospitals, schools, parks, bridges, roadways, airports, stadiums, etc.• Employed millions in productive and socially useful jobs (roughly 4.3 million per month or 8-9% of the labor force)• Hired builders, architects, engineers, painters, poets, actors

A Deﬁcit Hawk• Opposes deficit spending on principle• Often favors “sound money” (e.g. Gold Standard or 100% reserve backing)• Would legislate rules to mandate balanced budgets at all times• Believes that there is no such thing as a “good deficit”• Supports immediate austerity to sharply reduce budget deficits

A Deﬁcit Dove• Supports limited deficit spending in tough economic times• Wants government budget balanced over the business cycle• Supports rules to limit the size of the deficit (e.g. Stability and Growth Pact)• Prefers to wait until after the economy recovers to impose austerity

Why Do They Worry?• The hawks and the doves both worry about the negative consequences of running a deficit• They are convinced that at some point markets will refuse to lend at reasonable rates• They think governments will face a rising debt burden• And they believe that spending financed by issuing money will lead to inflation

MMT Knows Better• If the government takes advantage of its status as the issuer of the currency, the government can finance its deficit without borrowing at all• This means no discipline from bond markets• No solvency problem to deal with• Interest rates will be lower, not higher• What about inflation?• MMT advocates deficits only when there is slack in the economy• As long as resources are available, demand-pull inflation should not become a serious problem

The MMT Deﬁcit Owl• Would allow the deficit to expand as needed to maintain full employment• Assigns no arbitrary limit to the size or duration of the deficit• Accepts that it is the government’s responsibility (as monopoly issuer of the currency) to offset a rise in unemployment

Stadium Analogy• Suppose you’re watching a football match• Think of the government as the scorekeeper• Question: Where does the scorekeeper get the points he gives out when one team scores?• Answer: The points don’t come from anywhere• Spreadsheet entries created by fiat

How Does a Government with a Sovereign Currency Spend?• By directing its bank (usually the central bank) to credit someone’s account• This frequently happens without even a writing a check• In the Modern Money era, government spending is accomplished through keystrokes (Bernanke)• The monopoly issuer of the currency can never run out of money (Greenspan)

Becoming an Owl• You cannot examine the government’s budget in isolation• The government is only one sector• It’s useless to focus on a single sector when the economy is multi-sectoral• We need to understand how the government’s budget is related to the rest of the economy• A basic understanding of sectoral balances is all we need

What They Show• In any given period, sectoral balances show whether a particular part of the economy is: • Spending more than its income • Running a Deficit • Spending less than its income • Running a Surplus • Spending just equal to its income • Balancing its Budget

Three Sectors• Internal Sectors • Domestic Private • households and businesses • Domestic Public • local, state or province, and national governments• External Sector • Foreign • foreign governments, foreign households and foreign businesses

Two Rules• Three Sectors • Domestic Private • Domestic Public • Foreign (Rest of the World)• Two Rules • They can’t all be in surplus • They can’t all be in deficit • Cannot have 3 “Heads” (Surpluses) or 3 “Tails” (Deficits)

The Laws of Accounting• Instinctively, we probably tend to think it’s “better” to be in surplus• But there is no way to put all three sectors in surplus at the same time• It defies the laws of accounting!• At least one of them must be in deficit

A Simple Rule  $$$$$$ Non-Government Government Sector(Public) Sector $$$$$$ (Households, Firms, International Trade)Government Surplus = Non-government DeficitGovernment Deficit = Non-government Surplus

Two Options• Two Heads, One Tail • Two Sectors in Surplus, One in Deficit• Two Tails, One Head • Two Sectors in Deficit, One in Surplus• Which is better?

The Private Sector Needs to Be in Surplus• As a general rule, the private sector needs to be in surplus• Households and firms cannot continually borrow more than their income• At some point lenders will run out of creditworthy borrowers who are willing to spend• Private debt levels may become unsustainable (Minsky)• When an expansion driven by private sector debt reaches an end, sales soften, jobless claims trend higher, and economic activity falters• Government revenues soon fall short of expenditures and the governments budget eases

The Private Sector Cannot Put Itself in Surplus• If we just take households and businesses – what we call the ‘private sector’ -- it is clear that one persons’ asset is another person’s liability• Assets and liabilities cancel each other out• For example, my bank loan is cancelled by a bank asset• The private sector cannot create its own net financial assets• Net financial wealth must come from outside the private sector

Where do Surpluses Come From?• Private Sector = Public Sector + Current Account Surplus Deficit Surplus (S – I) (G – T) (X – M)• If the Government (Public) sector is running a deficit, and the current account is in surplus, the private sector will be adding (net) financial assets to its balance sheet• The private sector’s net holding of financial assets will increase

Possible Outcomes• We have three sectors • Domestic Private, Domestic Public and Foreign• We can look at the income flows and spending flows of each sector• No reason for any individual sector to balance its income and spending flows each year• Three Possible Outcomes • Surplus: Income > Spending • Deficit: Income < Spending • Balanced Budget: Income = Spending

Deriving the Sectoral Balance Identity • Y = National Income • Sources of Income Y=C+I+G+X • Uses of Income Y=C+S+T+M Sources = Uses • C+S+T+M=Y=C+I+G+X • S+T+M=I+G+X • (S – I) = (G – T) + (X – M) • Private Surplus = Gov’t Deficit + Current Account Surplus

Compare Domestic Public andDomestic Private Balances Notice how increases in the government’s deficit Help the private sector accumulate a surplus And notice what happens to the private sector’s surplus When the government shrinks the size of its deficit

Italy 15% 11% 8%Percent of GDP 4% Government Balance Private Balance 0% -4% -8% -11% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Ireland 40% 30% 20% 10%Percent of GDP Government Balance Private Balance 0% -10% -20% -30% -40% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Greece 10% 5% 0%Percent of GDP Government Balance Private Balance -5% -10% -15% -20% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Spain 8% 4% 0%Percent of GDP Government Balance Private Balance -4% -8% -11% -15% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Germany 10% 8% 5%Percent of GDP 3% Government Balance Private Balance 0% -3% -5% -8% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Year

United Kingdom 11% 8% 4%Percent of GDP 0% Government Balance Private Sector Balance -4% -8% -11% -15% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Year

Japan 15% 11% 8% 4%Percent of GDP Government Balance Private Balance 0% -4% -8% -11% -15% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Year

United States 11% 8% 4%Percent of GDP 0% Government Balance Private Balance -4% -8% -11% -15% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Year

The Previous Slide Shows • That the private sector (blue) is almost always in surplus • That the US has been running current account deficits (green) for the last three decades as the rest of the world ran trade surpluses against us • That the governments deficits (red) have usually been big enough to keep the private sector in surplus, despite our negative trade position • That the private sector went into deficit in the late 90s, when the governments budget moved into surplus

The Next Slide Shows• That every post-WWII recession (indicated by grey bars) was preceded by a sustained decline in the private sectors budget position• Stated differently, every post-WWII recession was preceded by a sustained upturn in the government sectors budget position• MMT puts the governments budget balance in its proper context

Private Sector Balance with Recessions

www.NewEconomicPerspectives.org Twitter @deﬁcitowl

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It's What You Know for Sure that Just Ain't So

by Mitch Green on Mar 05, 2012

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