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Trigger Mechanisms To Avoid the Fiscal Cliff? You’re Kidding, Right?

5:15 pm in Uncategorized by letsgetitdone

Robert Reich has been writing a series on “the Grand Bargain” and the “fiscal cliff.” In this post, I’ll do a commentary on his “The President’s Opening Bid on a Grand Bargain (II): Put a Trigger Mechanism in the Legislation”, because I think it’s a good example of self-defeating progressivism or “loser liberalism. Take your choice of epithet.

Reich begins:

When he meets with Congressional leaders this Friday to begin discussions about avoiding the upcoming “fiscal cliff,” the President should make crystal clear that America faces two big economic challenges ahead: getting the economy back on track, and getting the budget deficit under control. But the two require opposite strategies. We get the economy back on track by boosting demand through low taxes on the middle class and more government spending. We get the budget deficit under control by raising taxes and reducing government spending. (Taxes can be raised on the wealthy in the short term without harming the economy because the wealthy already spend as much as they want – that’s what it means to be rich.)

So, the good “progressive” defines the problem pretty much the same way as the rest of the Washington mainstream does. And he just assumes everyone agrees on that, especially on the idea that the budget deficit is out of control and that we need to reduce deficits by raising taxes and reducing government spending. So he gives away half the game by agreeing on essentials with the deficit hawks. But why does he agree that the deficit has to be brought “under control,” implying that the deficit is a problem? Why are WE just expected to accept that? Why isn’t there an explanation? When are we going to make these “progressives” explain exactly why the deficit, debt, debt-to-GDP ratio is such a problem for them?

After all, Robert Reich has been around long enough to know that the Government of the United States is a currency issuer and that no deficit it may incur is beyond its power just to make more money? So why do they think it’s a problem? Let’s go on and see if we get a hint of what the explanation for Reich’s concern with “the deficit problem” comes from.

But before we do that, let’s briefly note that Reich’s easy comment that taxing the rich more won’t harm the economy, isn’t quite true since since for every dollar taxed away GDP does decline by about $.30. Of course, that can easily be fixed by spending an equivalent amount to the amount taxed on something more productive than tax cuts for the rich. But since we can easily spend that amount of money on that more productive thing if we want to, anyway, there’s no reason to tax the rich more arising out of any imagined shortage of dollars. Of course, there are many more reasons to tax them, like justice, fairness, the desire to make them pay for ill-gotten gains, etc. But the need for money in order for the Government to spend on other things is just not one of them.

It all boils down to timing and sequencing: First, get the economy back on track. Then tackle the budget deficit.

Get the economy back on track, indeed. But, again, why is the deficit something that has to be “tackled”?

If we do too much deficit reduction too soon, we’re in trouble. That’s why the fiscal cliff is so dangerous. The Congressional Budget Office and most independent economists say it will suck so much demand out of the economy that it will push us back into recession. That’s the austerity trap of low growth, high unemployment, and falling government revenues Europe finds itself in. We don’t want to go there.

We certainly don’t want to go where Europe has been going lately. They’re a great example of how NOT to manage your way out of a Great Financial Crash. But what makes Reich and other progressives think they can avoid the fate of the Eurozone nations by planning for deficit reduction later ,or at all? The assumption here is that there must and will be a time when we can reduce the deficit without harming the economy. But what if there’s no such time? What if any substantial deficit reduction to under 4% of GDP, a figure envisioned in most of the deficit reduction plans being offered, means making the private sector poorer in the aggregate?

That’s not just a theoretical question. Right now, the US imports more than it exports in an amount greater than 4% of GDP. If we continue to do so, and the Government deficit is forced down to a number below 4% of GDP, then a private sector surplus in the aggregate will be literally impossible to attain, and, if we continue with such a policy, year after year, the private sector will lose more and more of its net financial assets as the Government eats the private economy in a fit of fiscal irresponsibility, that since it’s now way past 1984, the austerity advocates label fiscal responsibility.

Although the U.S. economy is picking up and unemployment trending downward, we’re still not out of the woods. So in the foreseeable future — the next six months to a year, at least — the government has to continue to spend, and the vast middle class has to keep spending as well, unimpeded by any tax increase.

Of course, that’s true, but the “vast middle class” can be impeded from consuming by cuts in discretionary Government spending and in social safety net spending equally effectively, and deficit reduction, without raising taxes on the middle class, is likely to involve a good bit of those kinds of cuts, if there’s any compromise at all with the deficit hawks on the budget.

But waiting too long to reduce the deficit will also harm the economy – spooking creditors and causing interest rates to rise.

Now we’re getting an inkling of what Reich’s problem is. He’s afraid of the “bond vigilantes” and their supposed power to raise interest rates and leave us with a great big interest bill that will further increase the deficit. So, all this concern over a “deficit problem” is due to fear of the markets and, perhaps, Reich would have no problem with running continuous deficits if he thought that the Fed, along with the Treasury, control interest rate targets, and that the bond markets are powerless to impose their will on Mr. Bernanke and the Treasury Secretary if they want to keep rates near zero, or at any other level of interest they would like the US to pay? Well, if that’s true, then let me assure Professor Reich that the bond markets and the ratings agencies are powerless to drive up interest rates against the combined determination of the Fed and the Treasury to keep them low.

We can see this if we imagine what would happen if the Fed continues to target overnight rates at close to zero, and the Treasury issued mostly 3 month debt. We know that short-term debt tends strongly to the overnight rate, and that there’s nothing the markets can do about that. So, if the Fed targets that rate at say 0.25%, and if the Treasury issues only short-term debt, the result will be that the markets cannot drive the rates much higher than that even if Moody’s is follish enough to downgrade US debt to below Japan’s rating.

This is why any “grand bargain” to avert the fiscal cliff should contain a starting trigger that begins spending cuts and any middle-class tax increases only when the economy is strong enough. I’d make that trigger two consecutive quarters of 6 percent unemployment and 3 percent economic growth.

Triggers are a really bad idea, and I’d hate to be among those 6% on the U-3 measure of unemployment, or the likely 12% on the U-6 measure, when the spending cuts and tax increases specified in the trigger mechanism occur, because those levels aren’t ones associated with a booming economy or one that is anywhere prosperous enough to stand against years of reduced Government spending at a deficit level below that necessary to compensate for the loss of aggregate demand due to our trade deficit. A trigger like this would take an already fragile economy, operating at way less than full employment, and would make unemployment higher, while it reduces private sector net financial assets during the years of deficit reduction triggered by such a plan. Depending on the details of the trigger, and assuming there’s no private sector credit bubble putting off the day of reckoning, a recession is a sure thing within an unpredictable, but relatively short space of time.

And keep in mind please, that this notion of Reich’s is a proposal for Obama’s opening bid, which presumably is open to compromise. So, perhaps Reich would be willing to set the deficit reduction at a compromise level of 7% U-3 unemployment? What a “loser liberal”!

But the real mistake here is in having any “trigger” at all. The whole idea is really dumb from an economic point of view. Fiscal policy needs to be guided by our expectations about its likely effects on real outcomes; not by some scheme that assumes that deficits are “bad” and must be minimized. We no longer live under the gold standard Professor Reich! A deficit is nothing more than the amount that Government spending exceeds tax revenue. It’s just a number!

To assess its appropriateness we have to place it in the context of what the private sector wants to save, and how much it wants to import, assuming the willingness of other nations to export to the US. The best fiscal policy is one that spends what the US needs to spend to solve its serious problems and achieve public purposes, and at the same time lets the deficit float as it will given such spending.

Of course, too much deficit spending can cause demand-pull inflation. But the proper remedy for that is to raise specific taxes and lower specific spending in such a way that price stability and full employment, as well as other good outcome result from fiscal policy. The size of the deficit or surplus is not a proxy for such real outcomes, and responsible fiscal policy should not be attempting to maximize, minimize or optimize either deficits or surpluses, rather than the real outcomes of government fiscal policy. In other words, run fiscal policy in accordance with expected real outcomes, and forget about deficits and surpluses per se. They should be treated as insignificant side effects, not as as centerpieces for fiscal responsibility, as they were under the gold standard.

To make sure this doesn’t become a means of avoiding deficit reduction altogether, that trigger should be built right into any “grand bargain” legislation – irrevocable unless two-thirds of the House and Senate agree, and the President signs on.

Please, no more foolish legislation that tries to constrain the freedom of action of future Congresses! The context of fiscal policy is always changing, and the Government must be adaptive to changing conditions. Future governments have to take into account things that have gone or are likely to go wrong. We should not, and really cannot bind them to “triggers” that can’t take into account the future conditions that may present themselves.

The fiscal cliff is itself an example of this principle. The “cliff”, after all, results from the sequestration trigger. And now, after agreeing to it, how’s that working for Congress and the rest of us? It’s made Congress look really, really stupid, and has only made it more obvious that the only crisis is what Congress has manufactured, and now refuses to fix in any way that won’t hurt the economy. And it has put the nation in a bind and subjected Congress to an immediate high pressure situation and the people to more “shock doctrine.” The agreement producing it was the last thing we needed. But we’ve got it, because people resorted to a “trigger.”

Now Reich wants to turn to another kind of trigger. But what we need instead is a return to real fiscal responsibility, and some education about what it means to have a non-convertible fiat currency, a floating exchange rate, and no debts in a currency not our own.

The trigger would reassure creditors we’re serious about getting our fiscal house in order. And it would allow us to achieve our two goals in the right sequence – getting the economy back on track, and then getting the budget deficit under control. It’s sensible and do-able. But will Congress and the President do it?

If the main reason for the trigger is to stop the creditors from reacting badly to attempts to create an economy that produces full employment at a living wage and prosperity for all Americans, as well as a modern economy that fulfills our health care, educational, infrastructure, education, energy, climate change, and environmental needs, then I say let’s stop issuing debt and get the bond markets out of the Treasuries business entirely. That will certainly stop our interest costs from getting out of control and also render the bond vigilantes irrelevant to the finances of the US. Then neither Professor Reich, nor anyone else will have to give a moment’s thought to what “our creditors” think about our deficits, our national debt, or anything else we do.

Last time I looked, comparatively few of the bond market investors were actual American voters. So, why should they have any influence over what we choose to do anyway?

(Cross-posted from New Economic Perspectives.)

The Fiscal “Cliff” and the Real Problem

7:02 pm in Uncategorized by letsgetitdone

so-called cliff

Like many others, I’m not worried about the so-called fiscal “cliff,” and the ravages to the economy that are likely to occur if Congress doesn’t do something about it before the end of the year. That’s because a lot of the impact can be cushioned in the short run by Executive Branch manipulations while negotiations continue to go on. But if measures aren’t taken to reverse the contractionary effect of the sequestration-induced changes, we’re looking at deficit cuts of $487 Billion over 9 months of the fiscal year.

By comparison, the American Recovery and Reinvestment (ARRA) of 2009 produced only $350 B in stimulus during its first year. And, if the full sequestration were allowed to proceed unmodified, then it would result in a “claw-back” of about 60% of the total ARRA stimulus.

Fortunately, if we do go over the “cliff” heavy pressure will then be on both parties to reintroduce the middle class tax cuts, and make them retroactive, and to restore some of the other cuts as well, so it may be possible to mitigate much, if not most, of the damage, if the Democrats are aggressive enough in pushing the negotiation advantages they appear to have now. So, the real danger of the manufactured “fiscal cliff” is more long-term.

That danger is the constant bleating from both deficit hawks and “progressives” that we have to do something long-term about the deficit/debt problem. So, they put up these long-term plans to delay deficit cutting for a year or two and then want to cut even more down the road to ‘stabilize’ the debt-to-GDP ratio. This is a non-existent problem, and any plan providing for deliberate polices to force deficit reduction by constraining Government spending to some arbitrary level is bound to damage the economy seriously when the prescribed spending cuts and increased taxes for lowering deficits take effect.

People have to come to accept reality, which is: if we want to import more than we export; and also want the private sector as a whole to save money (i.e. bank savings, pensions, other savings) then there is no alternative to having the Government deficit spend. Further, how much the deficit ought to be, without incurring the penalty of demand-pull inflation is dictated by how much we want the private sector to save, and how much of a trade deficit we want to continue to run. If we want to have a trade deficit at 4% of GDP, and we want to save 7% of GDP, then we must allow the Government to run a deficit of approximately 11% of GDP. And we must do that year after year after year, for as long as we want to save that much and import that much.

Do I need to point out that our deficits are not now anywhere near 11%? And that as a result we not only have high unemployment, an output gap of more than $3 Trillion annually in GDP, but also less in both savings (financial wealth being accumulated) and imports (real wealth being accumulated) then we otherwise would have? What will happen if even the “liberal” Center On Budget and Policy Priorities (CBPP) hits the economy with its proposed total of $3.7 Trillion (the $1.7 Trillion already agreed to last year and the additional $2 Trillion it is proposing) in deficit reduction? That is an average of $370 Billion per year in enforced deficit reduction which will come right out of savings and imports. That, in the absence of credit bubbles creating unsustainable demand, will condemn us to a stagnant economy as far as the eye can see.

We don’t have to run those 11% of GDP deficits, and also have them drive 11% of GDP further debt accumulation. Deficits and debt accumulation are not the same things, and can be decoupled. We can have the deficits and use Proof Platinum Coin Seigniorage (PPCS) to underwrite the deficit spending; or we can change the rules preventing the Fed from monetizing deficit spending by just creating the necessary credits for spending Congressional deficit appropriations and placing them in the Treasury General Account (TGA) when needed. So having the increased debt along with the continuing deficits isn’t necessary. And if we don’t like the debt, then we can get rid of it.

But, again, if we want the imports and if we want the savings, then we must have the deficits, and we must never have deficit reduction unless we also have savings reduction and/or trade deficit reduction. So the bottom line here is: We need to have the “loser liberal” message we’re hearing from Bernie Sanders, Robert Reich, The Center On Budget and Policy Priorities, and various “progressive” pundits and organizations, just stop!

Keynes’s idea that a fiscally responsible nation incurs deficit/debt in bad times, and pays it back in good times with surpluses, is wrong in the context of fiat currency nations. The gold standard’s been gone since 1971. Nations have much more fiscal space. Some nations want to run trade surpluses all the time, and accumulate nominal financial wealth, and others want to accommodate them and accumulate the real wealth of their imports instead.

So, this makes it impossible for those others to have both aggregate private sector savings and full employment, without Government deficits compensating for the demand leakages. The accommodating nations need to run permanent deficits to serve their own populations. And, if other nations, object to that, then they need simply to stop having export-led economies.

We have no national debt, or debt-to-GDP ratio problem, because we are a nation with a non-convertible fiat currency, a floating exchange rate, and debts in currencies not our own. This means we can always generate new currency to pay our obligations using the methods I just mentioned. And it also means that 1) our levels of debt and debt-to-GDP ratio have no impact on the fiscal sustainability of our fiscal policy; and 2) fiscal responsibility can’t mean targeting fiscal policy at particular levels of the national debt, or the debt-to-GDP ratio.

Nor can the bond markets create rising interest rates on US public debt because “we,” that is the Fed and the Treasury together, control those rates and can keep them as low as they want to even if every ratings agencies downgrades US paper to its lowest rating. Put simply, our creditors have zero power over our interest rates. Reich’s talk about persuading our creditors that we’re serious about getting our fiscal house in order is just errant nonsense. What we really need to do about them is to use PPCS to fill the public purse, repay our debt instruments as they come due, and take their bond market in USD away from them entirely. It’s only a source of “welfare” payments to rich people and foreign nations anyway. What do we need it for, anyway?

(Cross-posted from New Economic Perspectives.)


Photo by tbennett under Creative Commons license.

Deficit Hawks, Deficit Doves, and Deficit Owls

11:12 pm in Uncategorized by letsgetitdone

Congratulations to the folks at UMKC for giving us a new addition to the deficit aviary. Until now the media only had mind space for “deficit hawks” and “deficit doves.” Deficit hawks include folks like Mike Pence, and Judd Gregg, who insist that the Government run deficits only for wars, and tax cuts for rich Americans, but insist on paying for extensions of unemployment insurance, health care reforms, infrastructure, jobs programs, educational programs, transportation projects, and any Government spending for regular folks with taxes.

Deficit doves include folks like many, but not all, Democrats in Congress, Paul Krugman, Joe Stieglitz, Dean Baker, and all the signatories of this recent Sir Harold Evans, "Stimulus Now" petition, who want to run deficits to end the recession but who say:

"We recognize the necessity of a program to cut the mid-and long-term federal deficit…"

Now, on the occasion of a letter from Paul Davidson, James K. Galbraith and Lord Robert Skidelsky, in reply to the Evans petition, also signed by many very prominent “deficit dove” economists, the UMKC folks say:

”A number of bloggers on this site were asked to support their deficit-dove petition. We declined, and so did the three wise owls who wrote the following statement, which first appeared at New Deal 2.0.”

The wise “deficit owls” supported “the central objective of the letter — a full employment policy now, based on sharply expanded public effort.” But they disagreed profoundly with the idea that there is any medium, or long-term deficit problem at all. Because:

”. . . apart from the effects of unemployment itself the United States does not in fact face a serious deficit problem over the next generation, and for this reason there is no "necessity [for] a program to cut the mid-and long-term deficit.”

”On the contrary: If unemployment can be cured, the deficits we presently face will necessarily shrink. This is the universal experience of rapid economic growth: tax revenues rise, public welfare spending falls, and the budget moves toward balance. There is indeed no other experience in modern peacetime American history, most recently in the late 1990s when the budget went into surplus as full employment was reached.”

The deficit owls say that rapidly increasing health care costs are a problem, but one faced by both the private and public sectors whose solution is a matter of health care policy and not budget policy, and they object to cutting the public costs alone as “. . . just a way of invidiously targeting the elderly.” They also say that Social Security is an extremely successful “. . . transfer program and indefinitely sustainable as it is.”

They also say that:

”The long-term deficit scare story plays into the hands of those who will argue, very soon, for cuts in Social Security as though these were necessary for economic reasons.”

And then finish with:

”We call on fellow economists to reconsider their casual willingness to concede to an unfounded hysteria over supposed long-term deficits, and to concentrate instead on solving the vast problems we presently face. It would be tragic if the Evans letter and similar efforts – whose basic purpose we strongly support – led to acquiescence in Social Security and Medicare cuts that impoverish America’s elderly just a few years from now.”

This exchange defines very clearly the distinction between “deficit doves” and “deficit owls,” as did the recent exchanges here and here, between Paul and Jamie Galbraith, supported by Scott Fullwiler, L. Randall Wray, Marshall Auerback, and one “chartalist,” and also by Warren Mosler and myself elsewhere.

Deficit owls, believe that there is no structural deficit, and that most of the present deficit will go away when the recession ends. They also believe that in times of unused productive capacity like these, deficits are caused by the state of the economic system and that explicitly managing them by taxing more or spending less will not improve its condition, but only result in a downward economic spiral making conditions still worse. On the other hand, if real economic problems like unemployment, alternative energy capacity and production, infrastructure renewal, education, and industrial innovations are addressed through Government spending, then aggregate demand spurring private sector business activity ending the recession will result, and the deficits will largely go away except for those resulting from excessive private sector saving in the economy. In addition deficit owls believe that in a fiat money system, where there is no debt in foreign currencies, and no “peg” to such currencies, solvency is never a problem for the Government, and that while inflation partly caused by Government deficit spending can become a problem in such a system, this can only happen when full employment is achieved.

So, now we have three clear deficit hawk, deficit dove, and deficit owl positions that have very different implications for public policy. Until now, our friends in the MSM have recognized only the first two positions in discussing budget policy. But now that the third “deficit owl” position finally has an evocative name that is easy to remember, maybe our very busy MSM columnists and editorial writers will add “owls” to their narratives about hawks and doves in budget policy debates. After all, a narrative including “owls” outsmarting both “hawks” and “doves” may enliven their budget stories enough to get people to read, listen to, and watch them. In fact, it may even make the subject interesting enough that they themselves can begin to see that both hawks and doves make big, big, economic messes, and only owls can be trusted if we want policies that will bring back economic opportunity and hope to most of the American people.

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

Obama’s Choice Is Not Faith In the Market vs. Cardigans

9:32 pm in Uncategorized by letsgetitdone

WaPo op eds are getting increasingly irritating with the passage of time. Yesterday, this formerly great American newspaper in free fall ran an article by Matt Welch and Nick Gillespie called “What’s Next Mr. President – Cardigans?” Welch and Gillespie think that Obama’s less than stellar results thus far suggest that he may be reviewing the history of past Democratic administrations to find a “road map” out of his difficulties, and also that “he seems to be skipping the chapter on Bill Clinton and his generally free-market economic policies and instead flipping back to the themes and comportment of Jimmy Carter.” In this way, they begin a transparent framing exercise suggesting that Obama is at a turning point, and that he must stop “running government as a perpetual crisis machine,” and “. . . stop doing harm. Throwing money all over the economy (and especially to sectors that match up with Democratic interests) . . . “ And also that: “. . . there’s no question that Obama’s massively ambitious domestic agenda is at a fork in the road: One route leads to Plains, Ga., and early retirement, the other to Hope, Ark., a second term and the revitalization of the American economy.” And later they say: Read the rest of this entry →