You are browsing the archive for Deficit Reduction.

An Open Letter to Don Beyer, VA – 8th Candidate for Congress

8:08 am in Uncategorized by letsgetitdone

(Author’s note: My apologies: this one’s about 6 times longer than the ideal 1000 word post. I just didn’t feel right about breaking it up into parts, however, because that lose the continuity. So, please bear with it. I think a lot of candiates for Congress need to get these questions from angry constituents.)

My Congressman, Jim Moran, is retiring this year and his seat is up for grabs in the VA – 8th Congressional District. This is a solidly blue district made even more solid by the Republican gerrymander following their win in the disastrous elections (for poor people, for women, for the middle class, and for minorities) of 2010 in Virginia. So, the question is, which of the eleven candidates who are running in the primary will win it, and become the heavy favorite to win the Congressional election in November.

The heavy primary favorite is Don Beyer, a noted auto dealer in Northern Virginia, who has served as Lieutenant Governor twice, and also as Ambassador to Switzerland. My impression of Ambassador Beyer has been favorable. I have a friend who bought cars from him over many years and who had his Volvos serviced at his dealership all the while, and he had nothing but good things to say about the integrity of the service he received.

That said, however, and personal characteristics aside, I’d like Beyer to clarify his positions on the issues. So, I’m addressing this open letter to him. Read the rest of this entry →

Professor Krugman’s Nervous Tic?

10:24 am in Uncategorized by letsgetitdone

Does he genuflect slightly to conservative opinion?

Paul Krugman’s recent post makes some good points about the myth of the undeserving poor. But does he have a nervous tic? When criticizing conservative economic views, doesn’t he always seem to genuflect slightly to conservative opinion in order to appear “reasonable?” In this post he says:

I’ve noted before that conservatives seem fixated on the notion that poverty is basically the result of character problems among the poor. This may once have had a grain of truth to it, but for the past three decades and more the main obstacle facing the poor has been the lack of jobs paying decent wages. But the myth of the undeserving poor persists, and so does a counterpart myth, that of the deserving rich.

What “grain of truth” ever existed in this story? Where is the empirical evidence that the poor were ever more “lazy” than the rich or had other “character defects” (Not K’s words) that the rich don’t have in abundance, as well? I don’t think there is any. What the conservatives believe is pure BS. Some people are certainly “lazier” than others. But there’s no evidence that this aspect of character is class-based. It’s just prejudice, myth, and conservative fairy tales, which they embrace in place of authentic religion, run rampant.

Many of our most visible and celebrated “liberals” or “progressives” seem to share this nervous tic with Professor K. Bernie Sanders, for example, seems always to begin any comment he makes about fiscal policy by genuflecting to the idea that, of course, “. . . the US has a long-term debt problem, and we must have a plan for long-term deficit reduction, but . . .” Bloggers at the Campaign for the American Future are careful to mention that in order to implement progressive spending policies, of course we need to raise taxes on the rich, because the spending must be consistent with the goal of long-term deficit reduction. And while raising taxes is certainly not genuflecting to conservative religion, the idea that we need deficit reduction is.

I’m sure my readers can easily multiply examples. But the larger point here is that genuflecting just reinforces the conservative framing and we don’t need that. What we do need are full-throated statements of progressive ideas that make no full or partial validations of the myths and shibboleths of the neoliberal and conservative past.

What we need is the unvarnished truth as we see it. That is the only way to move on and away from the sad place of emerging global feudalism in which we find ourselves.

Cross-posted from New Economic Perspectives.

Read the rest of this entry →

Make ‘em Prove the Causality before They Cause Any More Suffering: Part Three, Reinhart – Rogoff Retrospective

7:31 am in Uncategorized by letsgetitdone

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.)

Make ‘em Prove the Causality before They Cause Any More Suffering: Part Two, the Fall and After

11:18 am in Uncategorized by letsgetitdone

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.)

Make ‘em Prove the Causality Before They Cause Any More Suffering: Part One

3:17 pm in Uncategorized by letsgetitdone

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: Read the rest of this entry →

These Folks are Soooo Clever . . .

6:55 pm in Uncategorized by letsgetitdone

Last week, Reps. Michael Honda, Keith Ellison, Raul Grijalva, Jan Schakowsky, John Conyers, Barbara Lee and Lynn Woolsey stalwarts of the Congressional Progressive Caucus (CPC) begged for mercy from “the Gang of Eight” in a letter.

Here’s what they said and my commentary on their “loser liberalism.”

”Thank you for your work – past and present – towards solving one of the greatest policy challenges facing us today: the unsustainable path of our national debt. We appreciate the bipartisan and collaborative spirit with which you’ve approached your negotiations. . . .”

Thanks vanguard progressives for embracing the major premise of the austerity ideology, namely that the national debt is on an unsustainable path. I’m here to tell you that this idea is false and also terribly harmful to progressive aspirations to end economic stagnation and get everyone, who wants to be, employed at a living wage. You can’t win an argument if you start by agreeing with your opponent’s false premise.

The US has a non-convertible fiat currency which it allows to freely float on international markets. It also has no debts in any currency not its own. It also has the constitutional authority to issue currency and coins in unlimited amounts to pay any debt obligations when they fall due. It also has a central bank, the Fed, that can determine the interest rates paid on new debt issuance unilaterally and in spite of any desire on the part of private markets to raise those rates. So, it should be obvious to you and everyone else that it doesn’t matter how high our national debt, or our debt-to-GDP ratio is, the US always has the capacity to deficit spend what it needs to in order to buy any goods and services for sale in USD, including the services of all the currently unemployed or under-employed who would like full-time jobs at a living wage.

So, why are they agreeing with the austerity mongers? Why are they validating what the deficit hawks have to say? Why are they engaging in “loser liberalism?” How many times do they have to be told that they’ll never persuade anyone that they’re in the right when they reinforce the framing of people who want to impoverish the poor and the middle class?

The right way to do this is to send a letter to the Gang of Eight denying that there is any debt/deficit crisis at all and pointing out that the US has many problems, the most important of which is high unemployment; but that the unsustainability of the debt path is not among them. And you should demand that they quit wasting everyone’s time and report back to the Congress that there is no debt problem; but that there are many other problems that Congress needs to solve.

”. . . .Given reports that a “down payment” is being considered to allow time to negotiate a broader budget deal, we write today to urge you to set a more balanced path and use only revenue for such a down payment in light of the billions in spending cuts agreed to so far.”

The down payment, of course, isn’t necessary because there should be no effort at deficit reduction, but rather a larger deficit than we have now to compensate for the aggregate demand leakage to domestic savings and foreign imports. You need here to point out that the full employment deficit should be more like $1.6 Trillion annually spent on the right things, rather than $1.2 Trillion incurred as a result of doing nothing to get to full employment. There are good and bad deficits. And right now the US is running bad deficits whose fiscal multipliers are relatively small. We need, instead, larger deficits spent on programs that will get people employed.

As far as using only revenue to make that down payment is concerned, it isn’t honest to deny that raising revenue from taxes, absent compensating deficit spending, won’t cost jobs. It will. If the taxes involve ending the Bush tax cuts for the rich, then the impact on the economy will be only $.30 per dollar taxed, while if it’s on the middle class and the poor it will be more like $1.25 subtracted from GDP for every dollar taxed. So clearly, it’s preferable to tax the rich, if one has to choose.

But we don’t have to choose. We don’t need to raise taxes to get money to deficit spend. The government can just create the money in the act of deficit spending. That is what it should do if one is interested in growing GDP and creating jobs.

It does make sense to have higher taxes on the wealthy, if one wants to level the paying field of economic inequality. And I am all for raising taxes on the wealthy for that purpose, since extremes of wealth are destroying our democracy. However, having said that, the issue here isn’t one of deficit/debt sustainability. And we should not pretend that it is.

There are two issues. One is getting to full-time employment for everyone, and the other is getting to greater economic equality so that the very rich can’t afford to influence politics and buy elections so easily that what most of us want becomes superfluous. Let us address both issues, but let us not conflate them by trying to raise revenue on the rich, while costing jobs for those who need them, because we legislate no compensating deficit spending for those tax increases.

”Over the past few years, the only lasting and substantial contribution we’ve made to deficit reduction has come from spending cuts. While Democrats have conceded nearly $800 billion in cuts as outlined in the spending caps of the Budget Control Act, this achievement has not been matched by any real commitment on revenue. Not a single cent of our recent efforts towards paying down the debt has come from the revenue side of the ledger. Additionally, because of the lack of specificity in the Budget Control Act, the spending reductions could fall largely to the non-defense discretionary categories. From infrastructure and education to research and small businesses, these investments are critical in keeping our nation economically competitive in the 21st century. Continuing down a course of misplaced cuts is destructive, unsustainable, and an impossible route to the long-term deficit reduction we all seek.”

Right! So since we did the wrong thing by making spending cuts earlier, now we should do the wrong thing again by raising taxes on people without compensating increases in deficit spending? Have the CPC stalwarts ever heard the expression: “two wrongs don’t make a right”?

They should never have agreed to the previous spending cuts and to the ridiculous idea of long-term deficit reduction come what may; and they should not now be supporting tax increases without insisting on compensating jobs programs. They should be calling for State Revenue Sharing of $1,000 per person, a Federal Job Guarantee, and a payroll tax holiday until full employment is reached. They should also be making this pledge for progressive candidates for office.

”Therefore, we urge you to send a signal that you are truly serious about brokering a balanced deal by breaking through the revenue stalemate. We believe any “down payment” should set the tone for the hard discussions to come by sidelining intractable pledges that are at odds with basic arithmetic. We believe you can send a strong message to the markets, to the credit rating agencies, and – most importantly – to the American people by adopting a down payment entirely of revenue. . . .”

They shouldn’t be doing any deals. Deals on deficit reduction are losers for liberals and progressives. We don’t need a deal on the revenue stalemate. What we need is no more deals that sacrifice the interests of poor people and the middle class. The CPC members are in Congress to represent them, not to beg for mercy from knuckle-dragging neanderthals who want to destroy the safety net.

As for the ratings agencies and the markets, don’t worry about them. They have nothing to say about interest rates. Order the Fed to keep those interest rates near zero. Get the ratings agencies investigated, indicted and prosecuted for continuing fraud and complicity in causing the crash of 2008, and also for blatantly and fraudulently downgrading the ratings of both the US and Japan when neither nation can ever be forced to go bankrupt. That’s what they should be writing letters to the Gang of Eight and doing press releases about, not begging “the Gang” for mercy in relation to further spending cuts.

The CPC letter then goes on to further implore the gang of eight to recognize previous spending cuts falling disproportionately on part of the polulation to take “. . . . into account the policies and priorities that have shouldered a disproportionate burden in the past.”

To that all I can say is fat chance! You don’t get anywhere by begging tea party folks for fairness and justice, or mercy. The only way you’ll get anywhere is to tell them that the whole CPC will vote against any further spending cuts whatsoever including and especially proposed safety net cuts.

”We look forward to working with you to pass a balanced, economically responsible deficit reduction plan.”

That’s been the problem from the beginning. They shouldn’t be working with the austerians at all on deficit reduction. The very idea of a long-term deficit reduction plan is stupid because government deficits are private sector savings to the penny, and as long we want to have both more imports than we export and private sector savings as well, we must run deficits or, alternatively, increase private sector debts, and why would anyone in the private economy want to see their debts increase.

Of course, there are times when we might want to decrease private sector savings to dampen demand-pull inflation caused by too much private sector demand. But we haven’t had a situation like that since the US was exporting much more than it imported more than 40 years ago; and it is unlikely that we will see that kind of situation for many years to come.

So, there is no long-term deficit reduction plan over the next 10 years that could possibly be “responsible.” Any such plan would tend to depress the economy or decrease private sector savings as long as we’re still importing 3-4% of GDP more than we export, and as long as private sector households retain their desire to repair the ~40% of the losses in their balance sheets that occurred during and after the crash of 2008.

And that’s why CPC members need to “just say no” to any proposals about long-term deficit reductions, whether those proposals come from Republicans, or whether they come from the President of the United States, himself.

Whoever suggests such a plan is being “irresponsible” and is also being anything but “progressive.” CPC members owe it to the people who elected them to refuse to cooperate, and to commit to that refusal right now, before the election!

(Cross-posted from New Economic Perspectives.)

Promises for America

9:14 pm in Uncategorized by letsgetitdone

Presidential Election 2012 Word Cloud

(Photo: Vectorportal/flickr)

The polling since the conventions shows that Democrats are doing better than expected. President Obama now apparently has a clear lead over Mitt Romney. Democratic Party control of the Senate seems likely to survive this election year of many more Democratic rather than Republican Senate seats up for election. And, even in House races, it looks like the Democrats will pick up a number of seats; though whether they can pick up enough seats to take back the House is still an unlikely prospect, and without the House President Obama’s second term is likely to be much like his last year and three-quarters, rather than his first two years.

So, what ought to be done to ensure a Democratic victory in the House and perhaps even a no loss of seats Senate outcome? My view is that the Democrats need to make some strong promises to the voters, conditional on those voters returning the Democrats to majority control of both Houses of Congress. Here’s my list of promises Democratic candidates for office should make to voters to ensure a return to a majority in both Houses of Congress.

– I promise to vote No on any bill that will cut spending on Medicare, Social Security, or Medicaid during my term of office. I also promise to vote no on any procedural vote that would facilitate a vote to get such a bill out of any committee I serve on; or any procedural vote to facilitate a floor vote of any such bill. My promise includes any bill that would raise the age of eligibility for full Medicare benefits, or that would change the Social Security cost of living adjustment formula unless the change proposes increases to the COLA by taking into account the disproportionate Medical and pharmaceutical expenses seniors pay compared to people under the age of eligibility.

– I promise to vote Yes on any bill providing for $1000 per person revenue sharing payments from the Federal Government to the American States so that State and local employees who have lost their jobs since the onset of the present Wall Street-induced recession, may be hired back and State public services fully restored. I promise to vote Yes on any motion to report such a bill out of any committees I serve on, and I also promise to vote Yes on any procedural motion facilitating a floor vote on such legislation, and to vote NO on any motion blocking a floor vote on such legislation.

– I promise to vote Yes on any bill providing for a Federal Job Guarantee (JG) program, guaranteeing a job offer at a living wage with full fringe benefits to anyone who wants to work full time and is capable of performing the job. The jobs involved will defined by local community organizations and non-profit sector organizations in a variety of service sectors and will be comprised of work that creates valuable outcomes fulfilling the public purposes of the United States. I promise to vote Yes on any motion to report such a bill out of any committees I serve on, and I also promise to vote Yes on any procedural motion facilitating a floor vote on such legislation, and to vote NO on any motion blocking a floor vote on such legislation.

And for Senate candidates:
Read the rest of this entry →

Alan Grayson’s Right; But He Misses the Larger Point

5:23 pm in Uncategorized by letsgetitdone

The Cliffs of Sanity

The Cliffs of Sanity (Photo: aeu04117/flickr)

Alan Grayson’s e-mail on Moody’s warning that it might reduce the US’s AAA rating, suggested that Moody’s was either threatening a downgrade because it wants to get the Bush tax cuts for the rich extended, or, alternatively, that “Moody’s is living in what Aristophanes called “Cloud Cuckoo Land.”” He says this because Moody’s is upset about the possibility that the US may go over the so-called “fiscal cliff,” even though if it did, it would theoretically result in $560 Billion of deficit reduction annually, without further legislative changes, and it makes no sense on the surface for a ratings agency to think that the risk of US bond default is greater when the annual deficit is being reduced by $560 B per year, than by some lesser amount, which is likely to happen if Congress doesn’t take us over that “cliff.”

Grayson was right to call attention to this seeming contradiction and the possibility that Moody’s is just pressuring Congress to do more for rich people; but I think he should also have made the larger and more important point, that Moody’s warning, just like the one it delivered in January of 2010, is an empty threat without significant consequence, even if it were carried out. How do we know that? For a number of reasons.

First, as is widely known, all the ratings agencies including Moody’s gave the CDOs and CDSs that led to the collapse of AIG their highest AAA ratings. In addition, they downgraded Japan’s credit ratings a long time ago, with no measurable impact on its bond interest rates or costs, even though Japan’s debt-to-GDP ratio has continued to increase over time and is now in the neighborhood of 200%. More recently, in April of 2011, Standard & Poor’s downgraded the outlook on US debt from stable to negative. What happened thereafter? There was a flight to Treasuries on the International markets and interest rates have fallen more than 1% since S & P delivered its downgrade.

So, one may be forgiven for wondering why anyone should listen to the ratings ravings of Moody’s and the other agencies at all. In fact, one may begin to suspect that their ratings have little influence on the bond markets, and also, given the Japanese and US experiences, one might even suspect that the bond markets don’t influence to any appreciable degree or control the interest rates that Governments sovereign in their own currency must pay.

Second, since the United States is a nation with a fiat non-convertible currency system, with a floating exchange rate, and no debt denominated in any foreign currency, it is impossible for the United States to be forced into a default by any external party, simply because its ability to create the currency it owes its obligations in, is unlimited. Voluntary default could be caused by a Congress which acts stupidly, and in a manner contrary to the 14th Amendment of the Constitution, to constrain the Treasury from paying its obligations when they come due, coupled with a Treasury that accepts Congress’s constraint in conflict with the clear admonition of the Constitution that the debts of the United State shall not be questioned.
Read the rest of this entry →

No Plan B?

7:47 pm in Uncategorized by letsgetitdone

Woodward (photo: Bektour / wikimedia)

Bob Woodward’s releasing a new book, so we are now seeing articles based on it. A few days back, The Washington Post published the ”Inside story of Obama’s struggle to keep Congress from controlling outcome of debt ceiling crisis.” This account is a pretty downbeat one of how our political leaders and President Obama handled the debt ceiling crisis of the summer of 2011. I want to comment on what for me was the most salient point: that during the crisis, the President had no “Plan B” to get around the debt ceiling beyond negotiating a deal with Congress.

According to Woodward, the President asked his Senior staff to come up with a Plan B, because the compromise Congressional leaders first proposed to him would have required a two-step increase in the debt limit, with the second step coming near the time of the 2012 election, opening the possibility that the House Republicans would be able to hold the country and the financial world hostage in the run-up to the election. The President rejected the deal, and sent Harry Reid and his Chief of Staff David Krone back to get another that would not require the hostage taking two-step. Meanwhile, Obama’s staff tried to put together a Plan B.

But when Harry Reid couldn’t get a deal from John Boehner, and the House Republicans passed a two-step plan on July 29th, the President again called for more options. Woodward reports none except for accepting the Republican deal, which Geithner favored, and vetoing the House Bill if Harry Reid “folded” and the Senate passed it, which the President favored. The President, concerned about the likely continuance of Republican blackmail and hostage taking, and believing that he was out of options, indicated that he would veto a two-step deal even if the Democrats folded. However:

”Obama never had to confront the veto question. A few days later, House Republicans dropped their insistence on the two-step plan. The final plan accepted a debt limit increase that would take the country through the 2012 presidential contest. It also postponed $2.4 trillion in spending cuts until early 2013.”

So, the President, and according Geithner, the world financial markets, survived that confrontation because the Republicans folded. But, if Woodward is right, if the Republicans had stood firm, Obama would have vetoed the bill, because no other options had been developed by the White House staff.

Yet there were at least four other options that were offered in the blogosphere and the news media at the time, three of them at CNN, that a well-informed White House might have been expected to know about. So, the obvious question is why is there no indication in Woodward’s account that the White House was aware of other options except a veto or surrender to the House Republicans to handle the crisis?

The four options were: Read the rest of this entry →

No, Barack, It Just Ain’t Gonna Happen!

1:50 pm in Uncategorized by letsgetitdone

Who else thinks the President’s speech didn’t include any plans to create the 29 million full-time jobs for the dis-employed? Please raise your hand!

About jobs he said:

”We can help big factories and small businesses double their exports, and if we choose this path, we can create a million new manufacturing jobs in the next four years.”

”If you choose this path, we can cut our oil imports in half by 2020 and support more than 600,000 new jobs in natural gas alone.”

And, except to say he wants time to finish the job, that’s it! Over the next 4 years the economy will probably need another 4 million jobs just to employ new entrants into the job market, and not even to reduce that 29 million dis-employment figure. So he needs 33 million new full-time jobs to get to full employment, and he’s talking about 1.6 million in his acceptance speech. What planet is he living on?

Maybe, like Herbert Hoover, if he keeps saying prosperity is just around the corner, and does almost nothing to make it happen, then he thinks his beloved private sector will quit generating profits from financial manipulation and start creating jobs at a living wage. I think we’ve seen this movie; and it doesn’t end happily for working Americans.

The President had a lot more to say about deficits, then about jobs; showing that he lives in a fantasy world of faux problems:

”You can choose a future where we reduce our deficit without sticking it to the middle class. Independent experts say that my plan would cut our deficits by $4 trillion. And last summer, I worked with Republicans in Congress to cut billions in spending because those of us who believe government can be a force for good should work harder than anyone to reform it, so that it’s leaner, and more efficient, and more responsive to the American people.”

But why reduce our deficit at all? Have we got an inflation problem? Does either the level of our debt at $16 T, or our debt-to-GDP ratio of more than 100 percent either impair our ability to deficit spend in the future, or to pay off the debt without either taxing or borrowing? The answers to these questions are: There’s no reason to do it; No, and No! Here’s more from O:

“I want to reform the tax code so that it’s simple, fair, and asks the wealthiest households to pay higher taxes on incomes over $250,000, the same rate we had when Bill Clinton was president; the same rate we had when our economy created nearly 23 million new jobs, the biggest surplus in history, and a whole lot of millionaires to boot.

I love higher taxes on the wealthy, as much as the next person. I wouldn’t mind going back to the marginal tax rates of World War II and the inheritance tax rates of Harry Truman’s times. But does anyone really think that the same tax rates we had under Bill Clinton really caused the 23 million new jobs during his Administration; so that if we want to have that kind of job growth again, we really must have Clinton’s tax rates? Give me a break!

We know that the prosperity of the 1990s was primarily fueled by debt bubbles, and had little to do with Clinton’s higher tax rates. In fact, his surpluses, coupled with the Internet bust, produced the recession he bequeathed to Bush 43, a recession that was ameliorated, but never really ended for most working people by Bush’s deficit spending.

“Now, I’m still eager to reach an agreement based on the principles of my bipartisan debt commission. No party has a monopoly on wisdom. No democracy works without compromise. I want to get this done, and we can get it done. But when Governor Romney and his friends in Congress tell us we can somehow lower our deficits by spending trillions more on new tax breaks for the wealthy, well, what’d Bill Clinton call it? You do the arithmetic, you do the math.”

The problem, Mr. President, is that there’s more than arithmetic involved here, which is why the Bill Clinton/Jack Lew surpluses produced that recession at the end of their term, the one that played a part in Al Gore’s defeat. The economy is dynamic. If you try to cut deficit spending or run surpluses by raising taxes and cutting Government spending, then you had better estimate what impact that’s going to have on non-Government, including private, savings and investment, and the trade balance; because cutting deficit spending can lead to a net reduction or elimination in net savings and investment, as well as a reduction in the trade deficit.

Then the President told us what he wouldn’t do to cut the deficit:

“I refuse to go along with that. And as long as I’m President, I never will.

“I refuse to ask middle class families to give up their deductions for owning a home or raising their kids just to pay for another millionaire’s tax cut.

“I refuse to ask students to pay more for college; or kick children out of Head Start programs, to eliminate health insurance for millions of Americans who are poor, and elderly, or disabled, all so those with the most can pay less.

“I’m not going along with that.

“And I will — I will never turn Medicare into a voucher.

“No American should ever have to spend their golden years at the mercy of insurance companies. They should retire with the care and the dignity they have earned. Yes, we will reform and strengthen Medicare for the long haul, but we’ll do it by reducing the cost of health care, not by asking seniors to pay thousands of dollars more. And we will keep the promise of Social Security by taking the responsible steps to strengthen it, not by turning it over to Wall Street.”

I’m glad for all these refusals and lines in the sand. He’s told us what he won’t do to make things even easier for the wealthy; but as Digby says, that doesn’t mean he won’t trade some or all of these things, for tax hikes on the wealthy. Tax hikes on the rich will please people wanting greater fairness; but that will be cold comfort for people whose safety net benefits are traded away for a smidgeon of greater fairness.

There’s also another thing he hasn’t told us. Maybe someone will make him do it in the debates. And that is what he plans to do to solve that 29 million jobs problem. That question is a really interesting one considering that he plans for the US Government to average $400 Billion in deficit reduction over the next 10 years. That is really, really a bad idea, because in doing that he’s pretty much condemning the US to a stagnant economy with perpetually high unemployment for the next 10 years, giving us a 14 year period of high unemployment, Obama’s “new normal” legacy to future generations.

Why do I say that? Well let’s look at some basic macroeconomics from Bill Mitchell:

”The basic income-expenditure model in macroeconomics can be viewed in (at least) two ways: (a) from the perspective of the sources of spending; and (b) from the perspective of the uses of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.

“From the sources perspective we write:

GDP = C + I + G + (X – M)

which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X – M).”

That is, X is exports and M is imports. So, if X is greater than M, we have what is colloquially called a “trade surplus”; but if M is greater than X then we have a “trade deficit,” which is what the United States has enjoyed for many years. I say enjoyed, because people in other nations send us goods, real wealth, and we send them electronic bits of information called US Dollar electronic credits. Seems like we’d have the better of that kind of deal, if we had sense enough to employ the people put out of work by our persistent trade deficit on things that are valuable for people living here in the United States.

However, that aside, we should note that the US seems to be running a trade deficit of 4% of GDP right now. We’ll see shortly the importance of this number. Bill continues:

“From the uses perspective, national income (GDP) can be used for:

GDP = C + S + T

which says that GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.

Equating these two perspectives we get:

C + S + T = GDP = C + I + G + (X – M)

So after simplification (but obeying the equation) we get the sectoral balances view of the national accounts.

(I – S) + (G – T) + (X – M) = 0

That is, the three balances have to sum to zero.”

So, we have an investment/savings balance, a Government spending/tax balance, and a foreign trade (exports/imports) balance. The sum of these balances must equal zero, and this is true by definition alone. It is what economists call “an accounting identity.” Are accounting identities always “true”?

They are always “true” in the sense that they are logically valid. But reasoning from them can result in false conclusions, because 1) the wrong data is correlated to the one or more of the terms of the identity, or 2) further reasoning about the causal relations among the terms in an identity may give false conclusions, and/or 3) reasoning about the dynamics relating the terms in an identity over time may be in error.

If we want the private sector to collectively save, then S must be greater than I, and we must have an investment/savings balance deficit, or, in other words the private sector as a whole must be accumulating nominal financial wealth within some time period.

If we want to import more than we export, then M must be greater than X, and we must have a “trade deficit”, which means that US entities as a whole must be accumulating more goods and services from abroad and must be sending more dollars into accounts at the Federal Reserve owned by foreign entities than they are receiving from them in return for our own exports.

Notice here, that the USD provided to foreign nations when we run a trade deficit, go into their accounts at the Federal Reserve. They never do leave this country. So, don’t listen to people who constantly tell you that our trading dollars are going overseas. They’re not. They’re in our own central bank.

Lastly, according to the model, if we want the private sector to collectively save, and if we want it to collectively spend more on foreign goods and services than it receives in nominal financial wealth for our goods and services, then the Government sector will have to spend more than it taxes. That is, it will have to run a deficit in the Government balance to accommodate the savings and import desires of the private sector by replacing the leakage in aggregate demand that savings and more imports than export represent. But just how much of a deficit will the Government sector need to make sure that the balance called for in the model happens without decreasing savings or reducing the size of our trade deficit?

Well, I said earlier that we’re running roughly a 4% of GDP trade deficit in the US. We also know that the private sector needs to save to repair household balance sheets after the disaster of the financial crisis of 2008, coupled with the housing crash. Let’s say that US private savings desires are currently 6% of GDP, a reasonable estimate given behavior over the past few years.

Then, we’re saying that we want (I – S) to be – 6% of GDP and (X-M ) to be – 4% of GDP, which implies that we also want (G – T), the Government balance to be positive and equal to 10% of GDP. In other words, we’re saying that the Government ought to be running a budget deficit of $1.6 Trillion this fiscal year, which judging from how things are going is approximately $400 Billion more than we will actually be spending.

So, it should be clear that the Federal Government, far from running too large a deficit, is now running a deficit that is $400 Billion smaller than it should be to accommodate the desires of the private sector to import and save, and to replace the aggregate demand lost to savings and more imports than exports. Do you suppose this shortfall in the Government deficit spending we need could have anything to do with our stubbornly high unemployment rates?

Now, let’s say the Obama Administration compromises on a deficit reduction bill specifying $4 Trillion in Government deficit spending reductions over 10 years phased something like this: 8%; 8%, 6%, 6%, 6%, 4%, 4%, 3%, 3% and 2%, where the percents refer to the deficit spending levels as a percent of GDP. Then, there will be increasingly less space for private savings and imports.

No doubt the President would like to see a shrinking percentage of GDP spent on imports over the next decade because that means that the budget deficit can be smaller if private savings stay the same. But, it’s pretty clear that in the next two years, we won’t be able to shrink the trade deficit by even 1% of GDP or roughly $160 – $170 B annually.

So, that means that if we follow the plan for deficits I just stated, then the savings desires of the private sector can’t be accommodated at 6%, and household balance sheets won’t continue to build. As, deficits move down to 6% in 2015 – 17, imports will be squeezed further, as will savings. By the second half of the decade, both imports and savings will be subjected to very high downward pressure.

The result will be that our trading partners will resist efforts to re-balance trade. They will lower prices of their goods and services in an effort to maintain the balance. We, in turn, will also have to lower costs, and that probably means lower wages – a race to the bottom to continue to increase our levels of exports. That will feed back to domestic private savings, and also to aggregate demand here, which will both decrease; though maybe not by as much as demand will increase from the decrease in imports. Causality moves in conflicting directions and without rigorous modeling we can say what the overall increase in demand outcome will be.

In addition, the decreased space for savings will result in people seeking to save more and in increased economic conflict in the private sector with people and classes fighting over a shrinking pie. In the US currently, political power is arranged in such a way that an increasingly small group is able to direct nominal financial income its way by using the political system to its advantage.

So, austerity will mean that a very few wealthy people will grab the shrinking pie of savings, and more people will be faced with the choice of maintaining their consumption levels by going into debt, or maintaining their rate of savings by cutting back on consumption. This developing situation will be unsustainable; and the second half of the decade, after a period of a stagnating economy, will surely see a deepening depression, and a strengthened economic and political oligarchy.

That’s the scenario if things go smoothly with austerity policies being planned by the elite led by Peter G. Peterson and the President of the United States. However, it is likely that things will not go according to plan and that the politicians will not be able to maintain the deficit targets in any long-term deficit reduction plan. The reason is that if demand flags because people try to buck the program by imposing strict spending discipline on themselves, or if foreign demand for our exports flags so that export industries must cut employees, causing a weakening of demand here; then rising unemployment here will impact the automatic stabilizers like unemployment insurance food stamp benefits, and Medicaid, driving up deficits beyond the levels in the deficit reduction plan.

The experience of Europe tells us that ideological neo-liberal austerians will not then admit that they were wrong about austerity and the possibility of implementing a deficit reduction plan successfully. But that, instead, they will double-down on it, shrinking aggregate demand even more, and driving the economy down even further, as they have in every European nation where austerity is being tried.

What if the President, or Mr. Romney succeeds in making the “grand bargain” to raise a few taxes, and cut 3 times as much spending, including entitlements in the process of passing a long-term deficit reduction plan, and what happens if in the first three years the plan fails to meet its targets and also creates a new recession in our fragile economy?

Will the austerians then admit they were wrong and start paying attention to the sectoral balances and people’s needs? Or will political necessity prevent them from admitting error and force them to double- down on austerity because that is the only viable political choice? We know what they will do, because no politician ever admits they were wrong, until perhaps they’re thrown out of office, and not very frequently even then.

Look at Obama himself, it was apparent by the Fall of 2009, that his ARRA was too small to do the job of creating a full recovery. Did he and the Democrats admit it? Did they pull out all the stops to pass a jobs bills in the rest of 2009 and take care of their unfinished business? Or did they double-down on insisting that the stimulus worked, and move on increasingly to a health care bill that bailed out the insurance companies, and burned all their political capital, that coupled with the tepid recovery, lost them the election of 2010?

I think we know what will happen if President O wins on his “austerity grand bargain.” First, it will never succeed because it is inconsistent with what the sectoral balances tell us. And, second, when it doesn’t he will double-down and then plunge us into a worse recession than ever, and in 2016 an impoverished population will face at least four more years of looting by the 1%, and increasing poverty from the other corporatist party of the emerging plutocracy.

So, Mr. President, and Paul Krugman, don’t tell me we’re going to have both an economic recovery and a forced move towards a lower deficit over the next four years, because the sectoral financial balances model says, that without a new credit bubble, that will lead to an expansion of aggregate demand coming from rapidly increasing private debt, that will eventually burst and give us a new great financial crisis:

It just ain’t gonna happen.

(Cross-posted from New Economic Perspectives.)