Are Deficits Getting a Bad Rap From Republicans and Democrats? – Part 1

I recently heard a talk by a prominent economist, Dr. Stephanie Kelton, discussing the national debt and what to do about it.  The narrative we’ve all heard forever is that the deficits are BAD.  We’ve even got a “debt clock” that scares the bejeezus out of us.

Everyone agrees on this but, according to Kelton and like-minded economists, everyone is wrong. The standard argument is that if we ran our household finances like the Government we’d all be in bankruptcy court.   But there is no equivalency, Kelton says, because while households depend on a finite income flow, our fiat monetary system means that the Government can create pretty much whatever supply of money it needs, which means that the Government cannot be insolvent in terms of its own currency. The National Debt is, after all, the pool of Treasury bonds—most of them owned by ourselves and owed to ourselves.

The world by and large acknowledges this reality, which is why there is always a market for safe U.S. Government debt. This is not to say the deficit can’t be harmful if it is too big – it certainly can.  But Kelton says that it is arguably just as harmful, or even more harmful, if it is too small.

Why?

Because ours is a capitalist economy.  Productivity is essential to our economic well-being – we need to make enough to stuff to stave off inflation.  How to achieve that productivity?  Invest in fundamentals such as education and infrastructure.  Dr. Kelton argues that we need to balance the economy, not the budget, since we are no longer on the gold standard.  Again, money, for the Government, is not a finite resource.

When the Government cuts spending and reduces the deficit we can find ourselves facing the Paradox of Thrift and the Paradox of Deleveraging. That is, savings and paying down debts are great for the individual, but if everybody gets on that bandwagon it is harmful for the overall economy because we need to invest and make stuff.  Capitalism runs on spending, and both private and public spending create income, which creates sales, which creates jobs, which leads to more spending… a virtuous circle that benefits everyone.

If that ‘everyone’ spends less and the Government pays down too much debt via spending cuts we risk starving the private sector of the lubricant it needs to keep the economic wheels turning through investment and consumption.

Historically, says Dr. Kelton, when the Government deleverages, reducing the deficit, even to the point of running a surplus, it triggers recessions.   Want to understand why the recent economic recovery was tepid?  I would look at the Sequester and Congress’s refusal to deploy fiscal stimulus, leaving it all to the Fed.  The result was slow growth—except for stocks and bonds.

The obvious question then is, what policies will serve us best as an economy and as citizens? And that’s the subject of Part II.  Hint: Mostly, politicians and their constituents don’t get this right either, according to Kelton.

Dr.Stephanie Kelton née Bell is an American economist and a professor of Economics at the University of Missouri–Kansas City. She is a leading proponent of Modern Monetary Theory

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