This post is a more complete statement of my conclusions based on the analysis in Parts One and Two of this series. As I’ve explained in Part Two, there’s no reason in the Reinhart-Rogoff (R-R) data to believe that the debt-to-GDP ratio has a negative impact on growth. Ironically, that’s because their data set is terribly biased in its incompleteness, and was constructed to try to prove that there was a negative relationship between the debt-to-GDP ratio and economic growth. The interests supporting the RR work, both in its inception, and in disseminating its original results, were clearly trying to develop a basis for saying that since there is such a negative relationship, the right thing to do when the ratio gets too high (over 90%) is to implement a program of austerity aimed at deficit reduction, more or less drastic, depending on the individual case.

Of course, there may well be a relationship between debt-to-GDP ratios and economic growth in nations lacking non-convertible fiat currencies and floating exchange rates, and and/or having external debts in currencies they cannot issue. However, the R-R data set didn’t include those variables, so that analysis can’t be done without augmenting the data set. In such nations, MMT theory suggests that Government Budget Constraints (GBCs) on deficit spending, such as those we find in Eurozone nations would create a negative relationship between debt-to-GDP ratios and growth.

In fiat sovereign nations, such as the US, the UK, Australia, Japan, etc. we might also have the presence of an indirect relationship between variations in the debt-to-GDP ratio and economic growth through the actions of politicians who believe in austerity ideology pulling back on government deficit spending and consequently having a negative impact on economic growth through that mechanism. But to test for that self-fulfilling prophecy, and also for the negative relationship in nations subject to a GBC, someone will, again, have to augment the R-R data set and re-analyze it to include currency regime variables

In addition, we need to build on the biased and incomplete R-R data set to begin to test alternative hypotheses about the effects of austerity and different types of fiscal and monetary policy on different outcome variables and on feedback relationships from those outcome variables to economic growth and much more. When Matthew Berg and Brian Hartley say: “We suggest that simultaneous equations models may offer a way forward on the “frontier question” of causality,” they are also saying that other possible causes of both economic growth and debt-to-GDP ratios must be included in richer theories of economic dynamics, if we want to understand the place of both growth and debt in the broader context of what matters to people.

What matters to them are economic and social value gaps related to the idea of Public purpose like these:

– the gap between actual output and projected “full” output;

– High involuntary unemployment vs. full employment;

– Price stability vs. inflation or hyperinflation;

– Minimum wage vs. a living wage;

– No operative right to health care for everyone;

– social exclusion and the loss of personal freedom;

– skill deterioration due to unemployment;

– psychological harm such as sense of identity, self-respect, and sense of
empowerment;

– much greater ill health and reduced life expectancy than necessary;

– loss of motivation to live a full empowered life;

– deterioration of social relations, communities, social networks, and family life;

– increasing racial and gender inequality;

– increasing educational inequality;

– decreasing equality of opportunity;

– loss of social values and sense of individual responsibility;

– increasing economic inequality over time;

– increasing poverty;

– increasing crime rates including increasing use of control frauds by
important economic institutions;

– Failure to prosecute and punish people who commit control frauds;

– The collapse of real estate values and the destruction of the wealth of
working people after the crash of 2008;

– increasing anger against economic and political elites that get more and
more and more wealthy, and more and more immune to the rule of law;

– increasing political inequality undermining political, social, and economic democracy;

– increasing political unrest and threats of political violence both from the privileged and those seeking change.

– increasing environmental degradation;

– Increasing climate change/global warming.

– the gap between current energy foundations of our economy and new energy foundations based on renewables.

It will involve more of an effort to gather the necessary data in some of these areas than in others, and doing this kind of thing is a multi-year job. But it’s imperative that something like it gets done, because the kind of narrowly focused data set created by R-R is biased towards the concern of neoliberal ideology with debts, deficits, inflation, and economic growth, and its lack of concern with the impact of its favored economic policies on a range of outcomes important for most people. We need to be gathering data on those outcomes and analyzing the past, present, and likely impacts of alternative fiscal and monetary policies on them. In short, we need to be gathering data that allows us to test the impact of alternative fiscal policies on public purpose.

Finally, we must ask why there wasn’t a greater outcry from progressive activists and economists when the R-R study first appeared and they failed to make their data available for re-analysis and replication. After all, everyone who read their work and who knows even a little about quantitative analysis in the social sciences could see that it was based on a very superficial two-variable cross-country global data analysis, and that any result they reported had to present a false picture of causality.

This is true because you can’t provide a thorough analysis of causality between two cross-country variables without including additional variables and doing time series analysis at the national level to establish causal ordering and partial out spurious correlations. This has been well-known in the social sciences for at least 50 years.

MMT economist Randy Wray has called the R-R study “crap.” He’s right; for all the reasons just advanced, it was crap from the get-go. It presents an argument of partisan advocacy, not one of economic scientists making a conscientious effort to get at the truth.

So, the question is why has it been it challenged so little since 2010? It’s true that some economists provided critiques. But the discipline as a whole was respectful. The criticism was civil, when it should have expressed outrage. Everyone treated the critical exchanges as a matter of “he said, she said,” even though every economist who does any data analysis must have recognized the very simplistic level of R-R’s data analysis.

So, again I ask, why didn’t economists make ‘em prove it? And why did policy makers accept the findings so easily? You can’t tell me that the top economists in the Obama Administration, in the UK, and the Eurozone couldn’t see the nakedness of their co-emperors. They chose not to see.

I think there’s really no mystery here. Neoliberal elites wanted to believe in the austerity fairy tale for various reasons, including perhaps a desire to widen the wealth gap between the very rich and the middle class, and also a belief that belt-tightening in welfare states has moral value for the population subjected to that belt-tightening, though not for them, of course. For them, R-R was just window dressing for the financial sadism they wanted to implement anyway. If you doubt this characterization, then pay close attention to interviews of Erskine Bowles and Alan Simpson sometime. The are exhibit A.

But for the progressives, and others opposed to austerity, the R-R work should have immediately become a target of opportunity for educating the public about “junk” economic studies relied upon by politicians to justify their favored policies. Opposition to the study should have taken the form of telling people never to trust simplistic two variable analyses using cross-sectional rather than time series data to develop causal explanations. It should have taken the form of a demand for the economists and policy makers to prove what they say rather than just wave around a fig leaf that couldn’t possibly, and in the end did not, prove a thing about the desirability of austerity in modern economies.

But none of this occurred. And partly as result of this dog who never barked, millions around the world live with economic hardship lasting for years. Millions lost their homes. Millions went into bankruptcy, and many thousands needlessly died from lack of medical care and are still dying today.

(Cross-posted from New Economic Perspectives.)

In Part One, I asked whether the Carmen Reinhart/Kenneth Rogoff study and book didn’t show that, on average, nations experiencing debt-to-GDP ratios above 90% had negative rates of economic growth? And I said the answer to the question was “no.” But I didn’t explain why that was true. So, here goes.

The Fall

When Reinhart and Rogoff published their work they did not make their data set available to people to replicate, analyze, critique their findings, and augment to improve the data set. They ignored the scientific norm that you do that when you’re claiming that you’ve made an important empirical discovery. Other researchers wrote them and requested access to their data set in vain for at least the past three years.

Then a few weeks, ago, they finally yielded to a request for the data set made by Thomas Herndon, a Graduate Student in economics at the University of Massachusetts (UMass) in Amherst. Herndon tried to replicate their analysis and findings and could not do so. In fact he found errors. Here’s a summary from the paper he co-authored with two of his professors, Michael Ash, and Robert Pollin, both of the economics department (hereafter called HAP).

RR has made significant errors in reaching the conclusion that countries facing public debt to GDP ratios above 90 percent will experience a major decline in GDP growth.9 The key identified errors in RR, including spreadsheet errors, omission of available data, weighting, and transcription, reduced the measured average GDP growth of countries in the high public debt category. The full extent of those errors transforms the reality of modestly diminished average GDP growth rates for countries carrying high levels of public debt into a false image that high public debt ratios inevitably entail sharp declines in GDP growth.

Moreover, as we show, there is a wide range of GDP growth performances at every level of public debt among the 20 advanced economies that RR survey.

Specifically, “actual average real growth in the high public debt category is +2:2 percent per year compared to the -0.1 percent per year published in RR.” That change in the findings is very important because even though the new average growth level found is still less than in the 60% to 90% category, where the average growth found was 3.2% annually, the claim that there’s a sharp drop-off between these two categories isn’t supported since the 1 percent difference is not statistically significant. In addition, neither the 3.2% nor the 2,2% average growth rates are representative of their debt-to-GDP ratio level categories, since as HAP say just above there’s a wide range of GDP growth performance in all the categories.

So, that does it. That one finding shows that RR did not show that, on average, nations experiencing debt-to-GDP ratios above 90% had negative rates of economic growth, or even that they had an average rate of growth significantly different from the average in the 60 – 90 % category. Given this finding, what happens to the further inference that high debt levels cause lower growth?

In Part One, I showed that even assuming that the R-R finding was correct it still would not have provided any test of the inference that high debt levels cause lower growth. I stated three reasons. First, R-R committed the ecological fallacy in implying that the high level debt category group growth average could be extended to individual nations and times in each group. We can see from the conclusions of HAP, that there was good reason to be concerned about the ecological fallacy because the group growth average was not found to be representative of individual nations and times.

Second, I pointed out that R-R ignored currency regime variables, failing to include them in the analysis, when it is very likely that any association between the debt-to-GDP ratio and economic growth would vary with these variables. Since HAP end up showing that there is only a small difference between averages in the over 90% category and the 60 – 90% category, it is even more likely that including these variables would have washed out the small differences found, or even reversed the relationship claimed by R-R.

Third, I pointed out that control variables that might have shown that the relationship stated by R-R was spurious were not included in the study, so that possible causes of both a high level of debt-to-GDP and economic growth could not be tested. HAP has nothing to say on this score, but it does raise the question of causality and the failure of R-R to analyze it in any rigorous way, and it concludes by questioning the claim that the R-R findings support the view that high levels of debt inevitably cause low growth.

After the Fall Empirical Research

The HAP analysis and the new availability of the R-R data quickly led to three other analyses, all of which began to explore the question of causality, each one by using more rigorous and more sophisticated though not novel techniques of analysis, than used in the study by Reinhart and Rogoff. A question which immediately occurs is why R-R with all the resources they cold call upon didn’t pursue the same or similar analyses either before or after publication of their results in 2010. After all, those replicating their study only a took a few days to begin to explore questions of causality once they had the R-R data set, yet R-R with three years of opportunity or more to do the same or similar analyses of their own data sets, evidently never did anything of the kind. One simply has to ask whether they were afraid of what they would find if they took a deeper dive into their own data.

Dube’s Distributed Lag Cross-country Panel Analysis

The first of the three studies following on HAP was done by Arindrajit Dube in a guest post at Next New Deal entitled “Reinhart/Rogoff and Growth in a Time Before Debt.” Professor Dube is also in the economics department at UMass. Working on 20 OECD nation corrected panel data set of R-R produced by HAP, Dube used LOWESS regressions and distributed lag models. His results speak to the question of whether slow GDP growth causes higher debt-to-GDP ratios, or whether, as R-R opine, while alternately protesting that correlation isn’t causation, higher debt-to-GDP ratios cause relatively low or even negative growth. They suggest that the causation is more likely to run from growth to debt-to-GDP ratios, than from those ratios to growth. Dube also found that 1) any negative relationship between debt ratios and growth is strongest at lower levels of debt, rather than at higher levels as found by R-R, and 2) there is a stronger association between past economic growth, and current debt ratio levels than the association between current debt ratio levels and future economic growth.

Basu’s Time-Series Analysis of the US, Italy and Japan

The second new follow-on to the R-R and HAP studies was done by yet another UMass economics professor, Deepankar Basu and reported at Next New Deal. He addressed the question of causality by examining time series data in Italy, Japan, and the United States, using vector autoregression (VAR) models, accompanied by Granger non-causality tests and impulse response analysis. VAR analysis isn’t enough to determine causality without making additional assumptions about an underlying causal model. But in cases, where one is analyzing a two-variable relationship using time series data and one assumes that causality can only run way or another, or perhaps both ways, the VAR technique can produce evidence about which of the two variables, if any, is prior to the other. I’ll quote Basu’s summary of his results

To summarize, I find that the time series pattern of the dynamic relationship between public debt and economic growth in the postwar U.S., Italian, and Japanese economies is consistent with low growth causing high debt rather than the high debt causing low growth. I draw this conclusion from two types of analyses: Granger non-causality tests and an investigation of impulse response function plots.

Granger non-causality tests allow one to ask the following questions: (a) do debt levels in the past help in better predicting current economic growth, and (b) does economic growth in the past help in improving predictions of current debt levels? The evidence suggests that for the U.S., Italy, and Japan, the answer to the first question is a NO and the answer to the second is a YES.

Impulse response analysis allows one to address the following questions: (a) what is the impact of an unexpected increase in current debt levels on the future time path of economic growth, and (b) how does an unexpected decline in economic growth affect future levels of debt? The data suggests that an unexpected increase in debt levels has only a small effect on future economic growth but an unexpected decline in economic growth is associated with large and long-lasting increases in public debt levels.

So, Basu’s analysis further extends HAP’s suggestion that it’s more likely that growth causes debt than debt causes growth. Like Dube’s it falsifies the austerity conjecture that debt causes growth at least in the context of a two variable model.

Berg and Hartley’s 20 Nation Panel Study

Perhaps the most important of the recent analyses of the R-R data comes from Matthew Berg and Brian Hartley who are Graduate Students in the economics department at the University of Missouri at Kansas City. They followed Dube in analyzing the R-R 20 nation panel data, used and corrected by HAP, using LOWESS regressions, and distributed lag with impulse response analysis.

First, they addressed the important question of whether the relationship between current debt-to-GDP levels and future growth is the same or at least similar across nations. They found (through an examination of individual “backwards/forwards” graphs) that this relationship varied widely across nations. That is, nations were heterogeneous, not homogeneous with respect to this key relationship. They say:

. . . Even if some sort of relationship between debt-to-GDP and growth can in fact be found in cross-country panel analysis, that relationship does not appear to hold up on the level of individual countries. Because economic policy is made on the level of individual countries, this heterogeneity appears to undercut the rationale for any given particular country to make important policy decisions on the basis of government debt-to-GDP ratios.

I’ve italicized their key point in the paragraph for emphasis. Any attempt to generalize across all the 20 nation panel data, such as the R-R attempt to say that a debt-to-GDP ratio above 90% leads to relatively low or negative economic growth contradicts what the data show at the individual nation level for the two key variables, and is therefore just a false inference.

Second, Berg and Hartley also say:

We find that the correlation between government debt-to-GDP ratios and future growth in Reinhart and Rogoff’s . . . dataset results from outliers which come from the country most suggestive of the hypothesis that slow growth causes high levels of government debt – Japan. . . .

That is, the Japanese data disproportionately distort the overall relationship and create a misleading picture, because of the unique history of Japan. But, nevertheless historical examination of both Japan and the other nations provide evidence consistent with the “reverse causation” causation hypothesis that growth causes debt to-GDP ratio levels rather than the alternative hypothesis of a debt-GDP ratio causal ordering priority. Berg and Hartley show this with distributed lag/impulse response analyses and LOWESS regressions with and without the Japanese data. The analysis, for all practical purposes, shows that there is no relationship between current year association between GDP growth and the debt-to-GDP ratio as claimed by R-R.

They also summarize:

. . . This evidence strengthens and reinforces criticisms recently made by Herndon, Ash, and Pollin . . . of research suggesting a negative relationship between government debt-to-GDP ratios and real GDP growth rates. . . . we . . . find evidence suggesting that correlation of government debt-to-GDP ratios and future growth are much more likely explained by “reverse” causation running from slow GDP growth to high government debt-to-GDP ratios than by “forward” causation running from high government debt-to-GDP ratios to slow growth. Furthermore, what little evidence there is for forward causation appears to stem almost entirely from Japanese outliers. Because – as economists generally recognize – Japan is the clearest of all cases of reverse causation, this considerably weakens the argument for forward causation. In addition, we find tremendous heterogeneity on the level of individual countries in the relationship between current government debt-to-GDP ratios and future growth. This suggests that even if substantial evidence for forward causation is eventually discovered in cross-country studies, the effect will likely be small in size and unreliable, and therefore not relevant to economic policy decisions in any particular individual country. Our findings are suggestive, but not conclusive, and more research is needed. We suggest that simultaneous equations models may offer a way forward on the “frontier question” of causality.

Conclusion: You Can’t Generalize Across All Nations and Times About the Impact of the Debt-to-GDP Ratio on Economic Growth

Actually, I think the findings of Berg and Hartley following on and taking into account the findings of HAP, Dube, and Basu are pretty conclusive and not just suggestive. What they say is that the data included in the two-variable analyses flatly contradict the idea that the debt-to-GDP ratio causes economic growth in the individual nations comprising the 20 nation OECD panel. If anything, the evidence is much more consistent with the idea that it is growth that impacts the debt-to-GDP ratio.

I think there has hardly ever been a clearer finding in the Social Sciences than this one. After all, it took HAP, Dube, Basu, and Berg and Hartley only a matter of days to arrive at it. The only way R-R could have missed it is if they weren’t looking for it. It’s as if they just weren’t looking for the truth; but were only looking for an argument that could be used to justify the austerity policies they favored. That’s not economic science. It’s bias, pure and simple.

In Part Three, I’ll end this series on the R-R affair with a retrospective.

(Cross-posted from New Economic Perspectives.)

OK, austerity has always been about the causality. The people who are trying their best to get us to cut more and more spending, somewhat less than their best to get us to raise taxes, and who are doing nothing to fix our fraud-laden financial system, or the worst period of dis-employment we’ve experienced since the Great Depression, have been making other people (never themselves) suffer, because they believe the theory that excessive public debt hurts economic growth, and that to get rid of it we must follow a plan of long-term deficit reduction. And I’m being very charitable when I opine that they believe in this theory, because the alternative is that they don’t believe it, but are just using it as an excuse to make other people suffer, and widen the wealth gap between themselves and the rest of the population.

Either way it’s important for the rest of us to demand that before we do anything more based on that theory, they should be forced to prove that it is the best theory out there about the causal relationship between public debt and economy growth. Actually, we should have made them prove that before we allowed Congress and President Obama to start playing austerity games with us way back in 2009 – 2010, because there’s been a lot of water under the bridge since then, including continuing very high disemployment, thousands and thousands of people dying due to lack of health insurance, suicide, depression-related illnesses, crime that need not have occurred, and all the effects of hopelessness that afflict the poor and the middle class during bad economic times. And now, our wonderful leaders have managed to inflict the sequestration upon us, while planning to inflict entitlement cuts on the old and the sick.

Lately, of course, the armor of the austerians, and their claims of empirical support for their view that high levels of the debt-to-GDP ratio are associated with and/or cause very low or even negative rates of economic growth has suffered repeated blows from Economics Graduate Students and Professors at the University of Massachusetts and the University of Missouri at Kansas City, in recent papers. I’ll review those studies in Part Two. In the rest of this part, I’ll evaluate the proof austerians had for their policies before this new research work appeared.

What Proof Did They Have?

So, what proof did they have, before the recent research appeared, that austerity is the best course to follow? Well, it’s been practiced all over Europe for years now, and what are the results? Only record unemployment, shrinking economies, increasing public debt, crime, public unrest, increasing suicide rates, damaged health care systems denying care to people who need them, no improvement to speak of in the economic outlook, and immense dissatisfaction all over the continent.

How about here? A stagnant economy, three steps forward, two steps back, high youth unemployment, no jobs for college graduates, layoffs in the public sector and declining services, low wages, recovery limited to the financial sector and the stock market — the kinds of results that in not so many years will produce a plutocracy, if one doesn’t exist already.

Everywhere austerity is being practiced we see a slowed economy. In some places, like Japan, we see short periods of it followed by some backing off, producing stagnation for close to a quarter of a century. In other places, like Australia and Canada we’ve seen enough of it that the prosperity they could have enjoyed is beyond their grasp.

Sure, Germany, hasn’t hit real hard times yet because their export-led economy gives them more policy space to run surpluses, but most of the nations of the Eurozone can’t run a trade surplus, so for them, continuing government austerity results in private sector losses, year after year, absent a change in rules by the Eurozone. Even the German economy has been slowing as its neighbors can afford less and less German goods, and France is seeing more than 10% unemployment and is rapidly becoming another basket case, creating the need for changing the well known Eurozone acronym to the PFIIGS. Is there an unambiguous success for austerity since the Second World War in a country running a trade deficit? I don’t know of one.

So, what about the work of Carmen Reinhart and Kenneth Rogoff? Didn’t it show that, on average, nations experiencing debt-to-GDP ratios above 90% had negative rates of economic growth? And doesn’t this provide evidence that excessive debt does cause low economic growth and even economic contraction, so that if we value economic growth, we must reduce the debt-to-GDP ratio to a much lower level than 90% before we try to use deficit spending to try again to grow?

Well, the answer to these questions is no, and no. I’ll explain the second “no” first, and consider the first “no” later on in Part Two.

Common Fallacies: First, Reinhart and Rogoff never claimed that the findings of their analysis of their very extensive cross-national, historical database supported causal inference. It’s true that after they wrote their paper and published their book reporting on their data and analysis, they recommended austerity policies and either referred to their work in that context, or have been identified by others hosting an appearance or publishing an article as having done that work to support their “expertise.” So, they talked out of both sides of their mouths; but in their work itself they acknowledge that correlation isn’t causation, and that they hadn’t proved cause and effect. And they urged further research to explore cause-and-effect relationships.

In addition, critics of their work have long emphasized that the reported association between high debt-to-GDP levels and low economic growth for all nations, had nothing to say about cause and effect in individual nations and therefore could not serve as the basis for a fiscal policy of austerity, or for Reinhart and Rogoff’s mere opinions that such a policy, expressed in other contexts should be implemented. One problem is that the association between debt-to-GDP and economic growth at levels of debt-to-GDP above 90% doesn’t apply to every instance in every nation. It’s an average, a mean or a median which is reported.

So, the association is ecological across all instances. It is the well-known ecological fallacy of social science to conclude that it applies to all or even most instances in the high debt-to-GDP category. To go on from there, and then suggest that the association is causally relevant in individual systems, is to compound the ecological fallacy with the correlation is causation fallacy. To do that is just terrible social science.

Currency Regime Variables:

Warren B. Mosler

(Cross-posted with permission of the author from The Center of the Universe)

The intellectual dishonesty continues. As before, it’s the lie of omission.
R and R are familiar with my book ‘The 7 Deadly Innocent Frauds of Economic Policy’ and, when pressed, agree with the dynamics.

They know there is a more than material difference between floating and fixed exchange rate regimes that they continue to exclude from their analysis.

They know that one agents ‘deficit’ is another’s ‘surplus’ to the penny, a critical understanding they continue to exclude.

They know that ‘demand leakages’ mean some other agent must spend more than its income to sustain output and employment.

They know federal spending is via the Fed crediting a member bank reserve account, a process that is not operationally constrained by revenues. That is, there is no dollar solvency issue for the US government.

They know that ‘debt management’, operationally, is a matter of the Fed simply debiting and crediting securities accounts and reserve accounts, both at the Fed.

They know that if there is no problem of excess demand, there is no ‘deficit problem’ regardless of the magnitudes, short term or long term.

They know unemployment is the evidence deficit spending is too low and a tax cut and/or spending increase is in order, and that a fiscal adjustment will restore output and employment, regardless of the magnitude of deficits or debt.

Carmen’s husband Vince was the head of monetary affairs at the Fed for many years, serving both Alan Greenspan and Ben Bernanke. He knows implicitly how the accounts clear and how the accounting works, to the penny. He knows the currency itself is a case of monopoly. He knows the Fed, not ‘the market’ necessarily sets rates. He knows that, operationally, US Treasury securities function as interest rate, and not to fund expenditures. He knows it all!

Carmen, Vince, please come home! I hereby offer my personal amnesty- come clean NOW and all is forgiven! As you well know, coming clean NOW will profoundly change the world. As you well know, coming clean NOW will profoundly alter the course of our civilization!

Carmen, Vince, either you believe in an informed electorate or you don’t!?

Deficit spending by the government is merely the counterpart of private sector saving. What government deficit spending does is to permit the private sector to achieve its level of desired saving. When the latter changes, government spending ought to be adjusting in the opposite direction to offset it (unless the current account balance happens to do the job).

This very simple statement by Marshall Auerback reflects the Sector Financial Balances (SFB) Model I discussed in “A Plague On All Your Budgets.” The Sector Financial Balances Model:

Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0;

once again, is an accounting identity that provides a focus for macroeconomic analysis, explanation, and prediction by economists applying the Modern Money Theory (MMT) approach. The terms refer to flows among the three sectors of the economy in any defined period of time. Since we’re dealing with an accounting identity, the equation must always be valid.

So, for example, when the domestic private sector balance is positive that means that more financial wealth is flowing to that sector taken as a whole than it is sending to the other two sectors. Similarly when the foreign sector balance is positive that means that more financial wealth is being sent to that sector than it is sending to the other two sectors. When the private sector balance is negative that means that the private sector is sending more to the other two sectors and so on.

In “A Plague On All Your Budgets,” I used the SFB model to show that all four sets of projections of budget deficits then current by: the Congressional Progressive Caucus (CPC), the CBO, the House, and the Senate; all implied austerity over a 10 year period assuming that the foreign balance (the US trade deficit ) would remain at 3% of GDP or greater. Why?

Simple. Look at the equation. If the foreign balance is greater than or equal to 3% of GDP in any year, then unless the Government runs a deficit of 3% or greater, the domestic private balance must be negative. That doesn’t mean every private sector person or organization would lose nominal financial wealth over that year, but it would mean that other than temporary and illusory financial gains due to credit bubbles and accompanying excessive evaluation of assets, the accumulation of financial wealth in the private sector would be a zero sum game, with some people and organizations winning and some losing every year the private sector balance was negative because the foreign balance was at +3% and the government balance was greater than -3%. If the Government ran a surplus of say 2% of GDP in any year, then private sector wealth would decline by 5% of GDP in that year. Of course, three years of that would be an economic catastrophe

Over a period of years, and again, neglecting the effect of credit bubbles, the result sooner or later has to be constriction in aggregate demand, economic stagnation, and recession or depression. In my previous post, I concluded that even under the most “liberal” 10 year projection planned by the CPC we could expect domestic private sector savings losses from 2016 on, and even perhaps in 2015 if there were a slight deviation in the projection. We could not have too many years of those losses without hitting another great recession.

So, the CPC budget may be better than others for a couple of years, but the danger in it is that if the CPC plan were taken seriously and the budget course projected was actually implemented, then it would be deterred eventually only by the inevitable crash. Hopefully this crash would occur in very short order, rather than being postponed by another credit bubble, only to be even more severe later on.

Since my earlier post, the White House has weighed in with its budget and 10 year projection. One item in the President’s budget has received an enormous amount of attention, and that is the chained CPI proposal. I’ve written rather trenchantly about that immoral proposal here and here. But, the overall implications of his austerity budget from a macroeconomic point of view haven’t been widely discussed. The Table below includes these new projections.

You can see that the White House budget has increasingly serious austerity implications as the years go by. In my previous post, I said that all four of the budget projections in the earlier table, if implemented, could only correspond to a bleak, stagnating economic future for the United States, with the House Budget producing the worst result by far. The addition of the White House budget as a fifth alternative doesn’t change that conclusion at all.

You can see that, with the exception of the CPC “back to work” budget, the President’s budget is the most expansive of all of them in 2013 – 2015. Still, it doesn’t allow for much private sector savings in a nation still recovering from the crash of 2008, and the CPC budget is quite a bit more expansive in these early years of the projections than the President’s plan. Beginning in 2016, however, the White House budget implies that private savings must be increasingly negative with greater and greater losses of private financial wealth to 2023. Its implications for negative savings in these years are less serious than the CPC budget, but, nevertheless, the fact that the White House either can’t or won’t recognize that its budget condemns the country to a recession within “the long depression” we are experiencing now, only makes the prognosis for the economy that much more serious, because it means that, like the Europeans, the White House is likely to double down on its austerity budget in the future if its deficit/debt projections are wrong. Like Herbert Hoover, and the Eurozone oligarchs, it will believe that “prosperity is just around the corner,” if only it stays the austerity course it has been increasingly setting.

Also, apart from the SFB model’s macroeconomic considerations and their significance for declining domestic private sector wealth over time, the situation looks even worse when we take economic and political power considerations and their likely effect on the economy into account. The history of the US since 1970 shows clearly that when the private sector gets a cold, the household sector gets pneumonia.

Big businesses, the financial sector, and wealthy oligarchs will use their economic and political power to see to it that their nominal financial wealth will continue to increase even as the private sector as a whole is losing 20% – 30% of its financial wealth, over the period of a decade. That will exacerbate the already ridiculous level of inequality we see in American society, and accelerate the movement toward plutocracy in America if we allow any of these austerity plans, or any variations between the “liberal” CPC proposal and the “right-wing” House proposal to be passed and implemented.

I’ll repeat what I said in my previous post with some small changes. All of these budgets are illustrations in fiscal fantasy, or perhaps I should say, in fiscal science fiction using bad fiscal science. In taking a fiscal approach based on reducing budget deficits, all the budgets are doing the wrong thing for the economy and the wrong thing for America. They are all fiscally unsustainable and fiscally irresponsible over a decade unless a credit bubble temporarily “bails out” the Government from experiencing the ultimate effects of its actions, allowing it to run unconscionably small deficits and pretend that everything is hunky-dory until the inevitable collapse of demand forces it to face reality.

The right approach to take to fiscal policy is to design and implement programs that will guarantee full employment at a living wage for everyone who wants to work full time and is able to do so. It is not to try to force small deficits or surpluses onto an economy that is not producing them out of its own robust activity.

The government needs to let the domestic private sector determine what both the foreign balance and the domestic private sector balance should be. If it does that, then these sector balances would drive the government balance. That balance could be a surplus or a deficit of a particular size, though in the case of the United States it would probably be a large deficit, or, as I prefer to call it, a large Government addition, to domestic private sector wealth, for some years to come. But it would be determined by the wishes of people in the domestic private sector, with the Government’s role being one of accommodating the surpluses or deficits.

Seeing this conclusion, I’m sure that some readers will ask: how the United States can afford to run deficit after deficit while continuing to accumulate its national debt? Well, first, it doesn’t have to accumulate and can even pay off its national debt without inflation. I’ve explained how it can do that in my new e-book on Fixing the Debt without Breaking America.

But second, even if the US does the politically unwise thing of continuing to accumulate a larger and larger national debt, when it can avoid doing that by taking advantage of its coin seigniorage authority, it can follow that debt accumulation course without either solvency or inflation problems. Scott Fullwiler has done a very good job of explaining how that can happen in a recent series of his, which concludes here.

Scott shows that deficits can be run indefinitely by nations with non-convertible, fiat currencies, with floating exchange rates, and no external debts in currencies not their own, without either solvency or inflation problems as long as the Government doesn’t deficit spend beyond full employment. That’s the kind of fiscal policy we should be making, not fiscal policy deliberately aimed at deficit reduction. So, to all the fiscal budgeteers in Washington looking to implement long-term plans for deficit reduction, including the President: a plague on all your budgets. You’re ending America, as we’ve known it!

(Cross-posted from New Economic Perspectives.)

By
Warren Mosler
(Cross-posted with permission of the author from
The Center of the Universe)

(Editor’s note: I think this reaction of Warren’s to the death of Margaret Thatcher is pretty unique and also the best statement I’ve seen of his view of why the “stagflation” of the late 70s and early 80s went away. Hint: President Jimmy Carter had more to do with it than Paul Volcker, and Thatcher is much less important to what happened next, than the Keynesian failure to handle the stagflation, and the resulting shift to monetarist economics. Here’s Warren!)

Here’s how I remember it all.

I didn’t look anything up, with the idea that memories matter.

The ‘golden age’ from WWII was said to have ended around 1973. Inflation and employment was remembered as relatively low, productivity high, the American middle class thriving.

Why? Keynes was sort of followed. The Kennedy tax cuts come to mind. But also of consequence and ignored was the fact that the US had excess crude production capacity, with the Texas Railroad Commission setting quotas, etc. to support prices at maybe the $2.50-$3.00 price range. And stable crude prices, though maybe a bit higher than they ‘needed’ to be, meant reasonable price stability, as much was priced on a cost plus basis, and the price of oil was a cost of most everything, directly or indirectly.

But in the early 1970′s demand for crude exceeded the US’s capacity to produce it, and Saudi Arabia became the swing producer, replacing the Texas Railroad commission as price setter. And, of course, price stability wasn’t their prime objective, as they hiked price first to about $10 by maybe 1975, which caused a near panic globally, then after a too brief pause they hiked to $20, and finally $40 by maybe 1980.

With oil part of the cost structure, the consumer price index, aka ‘inflation’, soared to double digits by the late 70′s. Headline Keynesian proposals were largely the likes of price and wage controls, which Nixon actually tried for a while. But it turned out the voters preferred inflation to their government telling them what they could earn (wage controls on organized labor and others) and what they could charge. Arthur Burns had the Fed funds rate up to maybe 6%. Miller took over and quickly fell out of favor, followed by tall Paul in maybe 1979 who put on what might be the largest display of gross ignorance of monetary operations with his borrowed reserve targeting policy. However, a year or so after the price of oil broke as did inflation giving tall Paul the spin of being the man who courageously broke inflation. Overlooked was that President Jimmy Carter had allowed the deregulation of natural gas in 1978, triggering a massive increase in supply, with our electric utilities shifting from oil to nat gas, and OPEC desperately cutting production by maybe 15 million barrels/day in what turned out to be an unsuccessful effort to hold price above $30, as the supply shock was too large for them and they drowned in the flood of no longer needed oil, with prices falling to maybe the $10 range where they stayed for almost 20 years, until climbing demand again put the Saudis in the catbird seat. Meanwhile, Greenspan got credit for that goldilocks period that again was the product of stable oil prices, not the Fed (at least in my story.)

So back to the 70′s, and continuous oil price hikes by a foreign monopolist. All nations experienced pretty much the same inflation. And it all ended at about the same time as well when the price of crude fell. The ‘heroes’ were coincidental. In fact, my take is they actually made it worse than it needed to be, but it did ‘get better’ and they of course were in the right place at the right time to get credit for that.

So back to the 70′s. With the price of oil being hiked by a foreign monopolist, I see two choices. The first is to try to let there be a relative value shift (as the Fed tries to do today) and not let those price hikes spill into the rest of the price level, which means wages, for the most part. This is another name for a decline in real terms of trade. It would have meant the Saudis would get more real goods and services for the oil. The other choice is to let all other price adjust upward to keep relative value the same, and try to keep real terms of trade from deteriorating. Interestingly, I never heard this argument then and I still don’t hear it now. But that’s how it is none the less. And, ultimately, the answer fell somewhere in between. Some price adjustment and some real terms of trade deterioration. But it all got very ugly along the way.

It was decided the inflation was caused by unions trying to keep up or stay ahead of things for their members, for example. It was forgotten that the power of unions was a derivative of price power of their companies, and as companies lost pricing power to foreign competition, unions lost bargaining power just as fast. And somehow a recession and high unemployment/lost output was the medicine needed for a foreign monopolist to stop hiking prices??? And there was Ford’s ‘whip inflation now’ buttons for his inflation fighting proposal, and Carter with his hostage thing adding to the feeling of vulnerability. And the nat gas dereg of 1978, the thing that actually did break the inflation two years later, hardly got a notice, before or after, and to this day.

As today, the problem back then was no one of political consequence understood the monetary system, including the mainstream Keynesians who had been the intellectual leadership for a long time. The monetarists came into vogue for real only after the failure of the Keynesians, who never did recover, and to this day I’ve heard those still alive push for price and wage controls, fixed exchange rates, etc. etc. in the name of price stability.

So in this context the rise of Thatcher types, including Reagan, makes perfect sense. And even today, those critical of Thatcher type policies have yet to propose any kind of comprehensive proposals that make any sense to me. They now all agree we have a long term deficit problem, and so put forth proposals accordingly, etc. as they are all destroying our civilization with their abject ignorance of the monetary system. Or, for some unknown reason, they are just plain subversive.

Thatcher?

It was the blind leading the blind then and it’s the same now.

And that’s how I remember it/her.

And i care a whole lot more about what happens next than about what happened then.

:(

(Editor’s note: So, we have ignorance about the fiat monetary system and “chance” to blame for the displacement of the Keynesians by the monetarists, the victories of Thatcher, Reagan, and neoliberalism, and the ensuing decades of increasing evolution to a new feudalism. This is the broad scope of change over the past 40 years. In viewing this change, we can’t forget what it’s done and is still doing to people. Bill Mitchell’s retrospective on Thatcher is very good on that. Don’t miss it!)

The underlying rationale for “a Grand Bargain” and the President’s deficit reduction budget including cuts to both Social Security (SS) and Medicare and many valuable discretionary programs, apart from the pragmatic justification, that he may be able to complete such a bargain with the Republicans and blue dog Democrats in Congress, is that the fiscal health of the United States requires that we can’t keep running annual deficits of the size we’ve been running. Why? Because that results in increases to our debt-to-GDP ratio, which in turn will cause the bond markets to drive up our interest rates higher and higher and eventually make interest on the Federal debt such a large share of the Federal Debt that we won’t have money for anything else. So, we have to implement a long-term deficit reduction plan to ensure the fiscal sustainability of the Federal Budget. To do anything else would be fiscally irresponsible.

I think that’s the essence of the President’s case for long – term deficit reduction. Then if one asks, well why make the burden fall on spending cuts rather than tax increases, the answer is that “tax increases” will never happen in today’s political climate. So, really the president has no choice, if he really wants to end this period of budgetary uncertainty, and also deal with the budget in a fiscally responsible way, then he must take the self-described “courageous” step of proposing cuts to the safety net including Social Security.

For the last few years, many of us have set forth various arguments against this case, especially with respect to safety net cuts. Some arguments are about its moral aspects showing that the “Grand Bargain” is unfair because the President’s idea of “shared sacrifice” takes no account of economic concentration of wealth over the past 40 years, or culpability for the financial/economic crash, that has created the so-called “budget crisis”. Others show that Social Security doesn’t and can’t add to the deficit. Others focus on the economic damage the spending cuts will do to the economy versus the lesser, or even little, damage that would be done by reducing the deficits through tax increases on higher incomes and wealth. Still others argue against the cuts, saying that they’re too heavily focused on domestic discretionary programs and the social safety net and are not focused on defense where we have such a large budget compared to every other nation.

All of these are good arguments and help with the pushback against the Grand Bargain. But none of them really show that the so-called problem underlying long-term deficit reduction, the eventual Federal solvency problem, is a false problem. Here’s what makes it a non-existent problem.

It’s false that If we keep running large deficits then we get increases to our debt-to-GDP ratio, which in turn will cause the bond markets to drive up our interest rates higher and higher, and eventually make interest on the Federal debt such a large share of the Federal Debt that we won’t have money for anything else.

Why?

First, running a deficit and using debt issuance to run it are not the same thing. The Congress could reorganize the Fed under the Treasury, and then the Secretary could order the Fed to create the reserves needed in the Treasury General (TGA) to deficit spend. Of course, this isn’t legal now and would require action by Congress, but it’s worth pointing out that the coupling of deficit spending to debt is due to Congressional fiscal arrangements, the rules of the game they legislated. It is not due to any immutable laws of economics, finance, or politics.

The Treasury has something else it can do to both pay down all the existing national debt, cease issuing debt instruments, and decouple continuing deficit spending from increasing debt. That option is High Value Platinum Coin Seigniorage (HVPCS).

Under authority provided by Congress in 1996 the Treasury can have the US Mint issue platinum coins with face values specified by the Secretary. So, for example, the Mint could issue a $60 Trillion coin; deposit it at the Fed, where the reserves credited to the Mint’s account for this legal tender would eventually wind up in the TGA. I’ve discussed the technicalities, history, economic, legal, and political aspects of Platinum Coin Seigniorage (PCS) in my new e-book. But the main point here, is that if the President will use HVPCS, then

– debt issuance could be ended,
– all the old debt could be paid off,

– the debt–to-GDP ratio would eventually drop to zero, and

– any possible effect of the bond markets on the solvency of the United States would be gone for as long as we conducted our deficit spending with reserves created at the Fed resulting from HVPCS.

So, in short, it’s up to the President. If he really wants to remove any possible political problem related to solvency, and any possible insolvency-based justification for deficit reduction and for cutting Social Security, Medicare, Medicaid, and other necessary programs that ought to be expanded rather than cut, then all he has to do is #mintthecoin; the $60 T coin, that is, not the trivial band-aid Trillion Dollar Coin (TDC) that will only bring the same “austerity” problem back next year.

Second, even if the President weren’t able to #mintthecoin; the deficit reduction/austerity argument would still be false. That’s because the bond markets don’t control the interest rates paid by the government on debt. The central bank does. If the central bank sets the overnight rate for reserves near zero, which it can always do, and the Treasury Department issues nothing but short-term debt at 3 months and under, then the Treasury can offer securities at a rate near zero, and keep the rates there whatever the debt-to-GDP ratio is, and even if that ratio is growing faster than GDP. This isn’t just theory. Japan is the test case for it.

Its debt-to-GDP ratio is what, 220% right now? Increases in it have had no effect on interest rates, and interest costs are not eating their budget. When confronted with Japan, austerians say that it’s an exception because most of its debt is owned by Japanese. But they never say why this fact should serve to keep interest rates down. Are the bond investors in Japan immune from wanting a higher rate from the Government if they can get it? I doubt it.

The austerians also say that if the Fed keeps the rates down, then one day US foreign creditors will demand higher returns. Well, they may demand them. But their choices are to buy the bonds, accept the lower interest rate the Fed pays on reserves in reserve accounts, invest in the US, or stop trading so much with us, so that our balance of trade improves and domestic labor markets can begin to come back with returning industries. Well, as they say, it’s all good for us. The choice they will not have is to get higher returns on Treasury Securities unless the Fed and the Treasury want them too. (Btw, this raises a question about the President’s budget. They have interest rates on 90 day Treasury Bills rising from 0.1% to 3.7% over the 10 year projection period. Their interest paid and deficit projections are based on that. But that won’t happen unless the ed and Treasury allow it.)

So, for these two reasons there are no legitimate solvency concerns for a nation like the US that has control over its currency including an unlimited ability to issue reserves. Since the whole case for austerity and long-term deficit reduction is that there is such a problem, then it seems like messaging against sequesters, debt ceiling crises, budgetary crises, austerity, and safety net cuts should lead with attempts to educate everyone to the fact that this is a false problem, and that the damage and suffering arising from austerity efforts both here and around the world is all in vain, unnecessary, and also immoral for that reason.

The Ultimate Pushback

My own anger at the “Grand Bargain” and other austerity measures is all the more acute because I know it is all unnecessary. So, I believe that to deliver the ultimate pushback, we need to persuade the majority of Americans that the President and other austerity partisans are in the process of inflicting needless damage on most Americans — on the young, the old, the under- and unemployed, the students, the foreclosed upon, the bankrupt, the sick, the poor, the middle class, and, in fact, on most everyone who will be victimized by unnecessary economic decline and stagnation in the once proud “land of opportunity.”

I think that the best way to persuade people that this is true is to tell the story of HVPCS and its ability to allow us to pay back the public debt and stop issuing any more, and then to describe the full implications of that. I’ve outlined what those implications are in my book linked to earlier. What’s important to emphasize here is that to the extent we can broadcast the HVPCS story from the rooftops over the next few months, the case justifying the “Grand Bargain” can be undermined at its core, because people will come to understand that it is the President’s choice to do the bargain, when a much less damaging course for all concerned is his to embrace.

Also, to the extent we can spread the message about HVPCS and the non-existent solvency problem, we can also strengthen ourselves for the next round in this fight. I don’t know whether the President can get his Grand Bargain; but I do know he’s been pushing for it since January 2010, at least. So, it’s pretty clear that he will keep pushing towards it in the future as the silly austerians have done in Europe and as they are doing in most of the world. As we begin to widen the sphere of people questioning the need for long-term deficit reduction, we will see the anger against it grow, and we will develop the political support we need to end the “Grand Bargain” and other forms of austerity.

The President’s new budget (Table S-2 in the budget) projects no savings (costs to SS recipients) during 2013 and 2014. In 2015 the bite is $3 Billion relative to the current CPI; and in 2016, it is $8 Billion. So, we can get a new Congress to repeal the chained CPI, if we can elect one in 2014, and I’m sure the same is true for the “health savings” cuts, as well. We can make these repeals important goals for 2014, along with substantial increases to SS and the safety net, including Medicare for All. With HVPCS, the Government of the United States can afford all of this and much more.

In addition, to possibly blocking the Grand Bargain before it can be passed, or also repealing it and replacing it with a much stronger safety net, we can also make more and more people recognize; that President Obama’s “Grand Bargain” is no “legacy”, for which he ought to be fondly remembered, but the beginning of a curse on the rest of us for which he should live in infamy even greater than Herbert Hoover’s. For, at least we can say of President Hoover, that he was a caring man who knew no better than what he did to try to cope with the Great Depression.

But, in Mr. Obama’s case, he had the example of FDR and the period of largely Keynesian economic policy and low unemployment until the early 1970s to instruct him. And even though we are beyond Keynes now with Modern Money Theory (MMT), we can fairly say that our early Keynesian experiences should have taught him that austerity doesn’t produce jobs and end “long depressions” (h/t Richard Eskow), and that only very major and targeted job-creating deficit spending will do that.

All of which is to say that the ultimate pushback against the Grand Bargain is to use HVPCS to ruin Mr. Obama’s “legacy” by blocking it, or repealing it, and then making it well understood that it was not a legacy inspired by courage at all; but a curse inspired by ignorance and the cowardice of a man who would not choose a course open to him that would save the 99% unnecessary pain, because he was afraid of the noise and fury it would cause among those whose plans to weaken and eventually end the safety net were thwarted.

(Cross-posted from New Economic Perspectives.)