New Deal 2.0 (ND20) is, well, more New Dealish than other web sites, so instead of the usual conflict between deficit hawks and deficit doves, we might see at, say, the New York Times. Here things are shifted to the left, and we see a debate between the deficit doves and the deficit owls. The doves and owls have posted there for awhile without really engaging one another. But recently, the appointment of Jack Lew as OMB Director and the Statement/petition by Sir Harold Evans called “Stimulus Now,” has ended an uneasy truce between these groups. Paul Davidson, Sir Robert Skidelsky, and Jamie Galbraith replied to the Evans petition with a refusal to sign it and an explanation of the deficit owl position. At about the same time, there was an exchange at Paul Krugman’s blog between deficit doves sharing Paul’s position on the deficit and deficit owls, who don’t agree with the deficit dove prescription of short-term deficits until we get a strong recovery and then a “pivot” to deficit reduction eventually resulting in a surplus when times get really good. The deficit owl prescription is to increase Government spending on programs directed toward the public purpose, until all excess productive capacity in the US economy is used, and then cut back on less valuable spending, or raise taxes as necessary to avoid inflation. Deficit owls also believe that there is no need to worry about deficits as long as Government spending hasn’t helped to created enough aggregate demand to use excess productive capacity, and that thereafter, aggregate demand needs to be cut either by reducing spending, raising taxes or both, not in order to reach some arbitrary deficit or surplus number, but rather to achieve the specific goal of avoiding inflation. Now, at ND20, blog posts have begun to appear where deficit doves and owls have been exchanging points of view.
Bo Cutter began the exchange with an enthusiastic post welcoming the appointment of Jack Lew, the former OMB Director in the closing years of the Clinton Administration, marked by notable surpluses. Bo sang Lew’s praises emphasizing his qualifications, intelligence, personality and managerial acumen. There was immediate feedback from commenters, including myself. One of the commenters pointed to Jack Lew’s stint with CitiGroup and his involvement in a deal with Goldman and Paulson whose legality is at issue. I pointed out that Jack is “. . . just another person who believes in the neo-liberal economic ideology that is so rapidly ruining the lives of so many working people in the United States. . . “ and that his appointment “is just another step along the road to plutocracy.” I also pointed out that the historical record shows that Government surpluses have shortly been followed by recessions through the history of the Republic, and the last thing we needed was someone who would seek surpluses which would shortly produce a new recession.
The real pushback, however, came one day later when Marshall Auerback, without mentioning Bo’s previous effort, posted his own opinion of the decision to appoint Lew. Marshall points to the “terrible optics” involved in appointing Lew because of his involvement with CitiGroup and hedge funds, and also points to his evident belief in the wisdom of running surpluses, and he says:
”. . . if the government could actually engineer a balanced budget, then it would also be forcing the private domestic sector into deficits on average equal to the external deficits. A budget surplus means, by definition, that the private sector is running a deficit (unless the external sector is in surplus, which is clearly not the case today in the US). It means households and firms are going ever farther into debt and losing their net wealth of government bonds. That is the legacy of Jacob Lew at the OMB. He’s a Hall of Fame deficit hawk, plain and simple. Of course, the private sector debt binge (which clearly does create huge financial fragility) ultimately caused the economy to collapse, driving government finances back into deficit when the automatic stabilizers kicked in to at least stabilize the economy. . . .
”Moving toward balanced budgets today is not only a nonsensical short-run fiscal strategy, given the debt levels the US private sector is still carrying, but it is not a sustainable growth policy in the medium-term. Eventually the private balance sheets become too fragile and they attempt to increase savings — which reduces aggregate demand further, and forces the public balance back into deficit. . . .
”I said this before, but it bears repeating: a government can cut spending, it can raise taxes, but it cannot control the size of the deficit, which is fundamentally non-discretionary, and reflects a huge job shortfall in the US. There is a fundamental incompatibility (indeed, impossibility) of running budget surpluses at the same time the private sector is reducing debt.
So, Marshall pinpoints one of the key differences between deficit doves and deficit owls. Deficit doves like Bo, believe, along with deficit hawks, that fiscal responsibility in Government budgeting involves managing one’s way along a path that should eventually reach a state of surpluses. Doves may differ from hawks in the degree to which they prioritize other, often conflicting, goals such as full employment, or health care reform, but they share a long-term goal with deficit hawks, and also, I think, the view that Government surpluses are the norm we ought to try to achieve, while deficits, no matter how frequently they occur, are deviant states of the relationship between Government and the private economy. Doves also accept the view that the Government can control, up to a point, whether it runs “a responsible deficit or surplus,” and that such an outcome is within its control. Deficit owls, in contrast, believe that the dynamics of the economy itself, coupled with the effects of automatic stabilizers, are the most important factor in producing deficits or surpluses, which are merely outcomes of the interaction of these more fundamental factors. The deficit owl position then, is that if you try to manage the deficit or surplus through mere accounting initiatives such as across the board spending or tax cuts, or by specifying some target amount of spending or tax increases without an economic and social impact analysis, you won’t be able to manage either the effects of your actions, or their impact on deficits or surpluses. As Marshall says, the size of the deficit is non-discretionary, if all you’re going to do is cut spending or raise taxes to eliminate it. You can’t get rid of it that way. You have to improve economic conditions and let the automatic stabilizers do the elimination. This deficit owl position implies something about CBO and its projections of the likely budgetary impact of new legislation, namely that such projections can’t possibly be reliable, because CBO tracks only the immediate impact of legislation on the budget, but not the economic impact of legislation and the feedback effect of its contribution to deficits and surpluses down the road.
Today, Bo Cutter replied to both the criticisms of his views on Jack Lew, and to Marshall’s views on the paradigm shared by both deficit hawks and doves. On Jack Lew’s appointment, he neglected to reply to my comments on his first post, but focused entirely on Marshall’s post, and after citing Jack Lew’s formal qualifications for the post of OMB director he characterized Marshall’s evaluation as “inaccurate, unfair, wrong, and a tactic I would have expected from the worst of the right wing, not from this direction.”
Bo never does say exactly why Marshall’s evaluation merits these labels. Nor does he say why he thinks the right wing would have delivered a similar evaluation. However, he leaves the subject of Jack Lew to discuss “the common ground” he thinks that Marshall and he share on the question of the deficit.
Bo starts out by agreeing that Marshall’s emphasis on sectoral “financial flows” is a good place to start. He also says:
”I’ll start by asserting that the objective is economic growth: growth with equity, growth with as few spectacular 2008-2009 financial crises and great recessions as possible, and growth with low inflation. Neither deficits nor surpluses should be ends in themselves. (I acknowledge that some do see one or the other as ends.). . . .
”This is one point at which financial flows enter the picture. Marshall Auerback is quite right to say that reducing the deficit cannot be done or seen as an isolated event, but in my view his reading of the balances is too limited and misses the heart of the policy issue. . . . “
So, here Bo doesn’t sound like a deficit hawk or dove, but more like an owl. He continues:
”First, I’ll skip all the interim steps and say, all other things being equal, Marshall Auerback is right that reducing the deficit will reduce economic growth — which seems to me to be about the last thing we need. So, given the state of our economy today, in the short term — say, the next two years — deficit reduction is not the right fiscal policy. But the Obama Administration isn’t advocating short term deficit reduction, quite the opposite. And the much maligned budget commission has zero chance of affecting the deficit any time in the next two years. . . .
”But, second, that is not the full story these balances tell. If one looks at the three balances — net private savings, foreign flows, and the government deficit — over the last 50 years, what stands out is that they have never been as out of alignment as they are today. These balances sum to zero, as they must by identity. But zero is reached today by the combination of 7.7% (of GDP) net private savings, 3.3% foreign capital inflows, and 10.9% total government deficit. This is not a stable combination. It suggests exactly the wrong kind of economy for our nation’s needs. It implies the growth of public debt at a rate about 3 1/2 times anything we can sustain. And it sets us up for the next disastrous crisis. . . .
”What this all says is that from the beginning of his presidency, President Obama has faced the necessity of pursuing a sophisticated, hard-to-explain macro-policy. . . .
”In other writings, I have called this “the pivot”. First, he had to stimulate the economy, necessarily raising the deficit. Then, as soon as possible, he would have to pivot and focus on long term sustainability, which — also necessarily — will require lowering the deficit over time. If we do not pull this off as a society, we will see continued slow growth, high unemployment, and another financial crisis.”
Marshall replied to Bo’s post in short order. He says little about Bo’s comments on Jack Lew, except to say that he will defer to Bo and withhold judgment about Jack until he actually takes office. He has a lot to say about the economics of Bo’s argument, however, and begins with Bo’s claim that the three financial sectors reflect an “unstable” combination.” Marshall says:
”Why is this an unstable combination? It seems to me that under the Clinton Administration, we had household savings close to zero, a budget in surplus, and a huge rise in public debt. I would argue that this is a far more unsustainable combination than our current state because private debt does represent an inherent external constraint and does force one to forgo today’s consumption to save and pay off that debt. Not so with sovereign government debt. . . .
”We can debate these issues all day, but it would be nice to do so with a presentation of facts, rather than assertions. Over the past 80 years, each time the government tried to push its budget into surplus, a major recession followed which forced the budget via the automatic stabilisers back into deficit. . . .
”These deficits have provided support for private domestic saving over most of this period. That’s why private sector savings have risen recently as well. The US current account was in surplus (very small though) up until the 1970s and then has been more or less in deficit since the mid-1980s and increasingly so in the 1990s and beyond. . . .
”In times of crisis – the Great Depression and World War 2 – the deficit grew relatively large and national debt followed it upwards as a percentage of GDP. I would argue that we have a comparable crisis today, exacerbated by the fact that fiscal resources have been wastefully deployed toward bailing out insolvent banks, rather than sustaining growth and employment. . . .
” . . . it is always the case that as growth resumed and stability was re-established the deficit fell back as a percentage of GDP to the level required to support private domestic saving and maintain aggregate demand to support relatively high (but not high enough) employment levels. . . . .
”Over this period. movements in interest rates and inflation rates and changes to US tax regimes bear no statistically significant relationship with the fiscal parameters over this entire period. These are FACTS, not assertions. The strongest relationship that can be established is the relationship between deficits and expenditure and hence economic growth (and employment growth), which is why many of us argue that “fiscal sustainability” per se is not a legitimate goal of government policy. It reflects the incoherence at the heart of government policy. If Bo Cutter can provide a cogent argument which explains exactly why we have to focus on “long term sustainability” (whatever that means), I’m more than happy to debate him on this. But simply saying something is so doesn’t make it so.”
So, this exchange, between Bo and Marshall highlights the central disagreement between the doves and the owls. Bo says that deficits should not be viewed as isolated events and that neither deficits nor surpluses should be ends in themselves, but then he begins to talk about sectoral balances being out of alignment and certainly implies that the Government deficit is too large to be “sustainable” over time. He also clearly believes that there is some kind of need, in the medium term, for Obama to quickly “pivot” to bring the deficit down. So, he is certainly saying that Government spending management is deficit and surplus management. In contrast, Marshall thinks that Bo’s notion of fiscal sustainability is unspecified and unclear, and that his view that we have an unstable combination in our sectoral balance has no basis in theory or in fact. He also thinks that “fiscal sustainability” interpreted as some pre-determined level of the debt, the deficit, or the debt-to-GDP ratio is not a legitimate goal of Government policy. And that rather than concentrating on fiscal sustainability the Administration should focus on recovery and economic growth, and that when that is achieved the deficits will subside to the level needed to support private savings. In short, deficit doves like Bo believe the deficit should be managed by the Government, while deficit owls believe that the economy is what needs managing, and that if that is done well, deficits will disappear as we reach full employment and full use of our productive capacity.
I provided my own reply to Bo’s second post at about the same time as Marshall, posting it a few minutes later, and before I had the opportunity to read Marshall’s reply. Since it’s my reply I won’t quote it here, but will just repeat it with a bit of editing. In some ways it’s quite parallel to Marshall’s, but it also offers other information.
First, when the economy recovers, all previous history indicates that the deficit will mostly disappear, including that part of our economic history associated with Jack Lew’s previous tenure as OMB Director, due to the action of the economy’s automatic stabilizers. ND20 Braintrusters Jamie Galbraith, Marshall Auerback, L. Randall Wray, and Rob Parenteau have frequently written about this. I’d appreciate it if Bo Cutter could reference their arguments and point out why he thinks they are in error, because if they are right, there is no fiscal sustainability problem, either short-term or long-term and we can simply stop talking about it and start concerning ourselves with the myriad real issues we face.
And second, I also think that sustainability is a false issue since it refers to the possibility that the US can become insolvent if it continues to run high deficits. However, since the US is a Government sovereign in its currency, forced insolvency can never become an issue. Bo might respond by saying continued deficits would cause interest rates to rise in the Bond Market. But here the reply is, 1) that this still wouldn’t effect the power of the US create money to pay both the debts and interest it was incurring and 2) if this is really a worry the US could just stop issuing debt (See, for example, Randy Way’s piece) and then there will be no further problem about rising interest costs.
Bo might reply still further by saying that unsustainability doesn’t refer to the danger of insolvency, but rather to the danger of hyperinflation. But to get hyperinflation you need to encounter a particular confluence of factors including the ability of working people to push wages up in response to price increases, also the creation of money that exceeds the productive capacity of the economy, as well as very vigorous Government spending, and most often debt in foreign currencies. These conditions don’t and will not exist in the United States. See Rob Parenteau on this, and also Marshall Auerback.
Moving to Jack Lew, It’s one thing to claim unfairness in the characterization of Jack Lew, and quite another to prove it. No one doubts the credentials of Jack Lew as someone who will manage OMB quite well, or doubts his acumen or zeal when it comes to minimizing Government spending. But, it is this last that critics like myself are worried about.
Jack Lew has shown that he knows how to preside over a drive toward Government surpluses. That’s why he was called a "hall of fame deficit hawk" by Marshall.
The problem of us deficit owls is that Jack Lew will not be an internal advocate for evaluating Government spending according to its real world consequences, apart from the immediate implications of that spending for deficits, the national debt, and the debt-to-GDP ratio. In our view, fiscal responsibility means Government spending that is expected to achieve public purposes, regardless of the immediate impact of such spending on deficits or surpluses. If such spending is effective then, it will bring full and sustained recovery and this kind of recovery, coupled with the automatic stabilizers will take care of the deficit without deliberate targeting by the Government.
In fact, insofar as deliberate targeting of deficit numbers is undertaken by Government, we think this will be counter-productive because it will inevitably lead to cuts in Government spending for the public purpose. So, finally, our worry is that Jack Lew is an expert at targeting deficits per se, but that he is not an expert when it comes to advocating for Government spending for the public purpose. And also that in his single-minded pursuit of the goal of reducing the debt-to-GDP ratio, he and the Administration may well act in a fiscally irresponsible way by cutting Government spending that would achieve public purposes, simply because such spending would have a negative impact on the deficit numbers they are targeting so irrationally.