I am awarding this week’s worst piece of economics journalism to an article that appeared in Saturday’s Australian newspaper and was written by high-profile economics correspondent George Megalogenis. The article makes a sequence of statements that cannot be supported by any credible macroeconomic theory. Why do journalists write things that they do not seem to understand? Anyway, in case any of my readers happened to waste their time reading this article I offer the following clean-up job. Yes, its that time again. Time to debrief.
The Australian economics journalist wrote in his article The live now, pay later trap (Saturday, March 28) that
… the public must brace for a rather messy bargain with government whereby the budget deficit continues to balloon until the economy turns the corner. At that point, government must hit taxpayers for the interest with a wind-back of middle class and grey power welfare so the budget can return to some semblance of balance when recovery is under way.
Sorry, this is a statement that combines erroneous reasoning with sops to the uninformed debt scaremongering that is now entering the public debate.
The The Debt Baby blog which incorporated the aforementioned article was in reply to a reader who had railed against George and demanded “… a piece on the reduction of debt, and Rudd’s capacity to pay it all off, after the recession.”
What is clear in the current period is that households are now trying to save again. This attempt to restore household balance sheets was always going to happen … it was only a matter of when.
In relation to this topic, I wrote the following in an academic paper in 2001 (after developing the argument for Australia in a chapter I wrote in 1996 which was finally published in 1998 – see reference below):
Pursuing budget surpluses is necessarily equivalent to the pursuit of non-government sector deficits. They are the two sides of the same coin. In recent years, financial engineers have empowered consumers with innovative forms of credit, enabling them to sustain spending far in excess of income even as their net nominal wealth (savings) declines. Financial engineering has also empowered private-sector firms to increase their debt as they finance the increased investment and production. The resulting sharp decline in the desire to net save temporarily allowed the US government to realise a budget surplus, but the process was not sustainable … The decreasing levels of net savings ‘financing’ the government surplus increasingly leverage the private sector. Increasing financial fragility accompanies the deteriorating debt to income ratios and the system finally succumbs to the ongoing demand-draining fiscal drag through a slow-down in real activity. A similar trend has occurred in Australia …
In a related paper (2002 with Luke Reedman), I wrote:
… a major shift in monetary and fiscal policy is required and must begin with an acceptance that public deficits are typically required to maintain stable growth rates in spending and sustainable levels of private sector debt. The government can clearly run surpluses for a time by exploiting the willingness of the private sector to increase its debt levels. But this strategy becomes highly deflationary once private agents seek to restore their balance sheets. The resulting output corrections force the public sector into deficit with accompanying private wealth losses and rising unemployment. In this context, the argument that budget surpluses are needed to ‘fire-proof’ the economy is nonsensical.
So George has now recognised this is showing up in the national accounts data:
What is obvious from the data so far is that Australian households will take every extra dollar government gives them straight to the bank, to reduce the amount owing on the mortgage or credit card, or to make a deposit.
So what! Well George’s next statement in relation to this is very interesting. He writes:
… the macro picture is easy to digest. The Rudd Government is, in effect, allowing the federal budget to plunge into deficit so household budgets can be repaired.
So this obvious accounting realisation seems to be a revelation for George. But it is just what modern monetary theorists such as myself have been writing about for years: budget deficits finance private saving as a matter of national income accounting. But George, the reverse is also true. Budget surpluses undermine private saving as a matter of national income accounting. The processes are mirror images. You cannot have one side of the accounting identity without accepting the other.
Which allows us to conclude from this next statements – that he doesn’t get it at all!
It is not a pretty picture because it suggests years of eye-popping budget deficits to come, because the debts that Australian households carried into this downturn have no precedent. In the past, the job of making it easier for families to see past their loan obligations and begin spending again was left mainly to monetary policy, through lower interest rates.
They have no precedent because we never had to suffer neo-liberal budget surpluses before like those that have ravaged our economies in the last two decades.
And historically, the statement about monetary policy is plain wrong. Fiscal policy has been typically in deficit in the Post Second World War period which is why the household sector was able to save and the economy was able to grow.
But fiscal policy is sharing the load now, with handouts being delivered ahead of any official confirmation of recession. That households have chosen to save the entire value of their windfalls so far is not necessarily a bad thing. But it is not what politicians want them to do, so a couple of telling questions arise.
Are the handouts being wasted? If they are, then the Rudd Government may need to consider letting the downturn run its course rather than gamble on an even deeper budget deficit without an obvious pay-off in consumer demand. The next cash splash may be misread by consumers as a sign the economy is in terrible shape.
The fact that the net spending by government is restoring the capacity of the household sector (as a whole) to save again is excellent and will provide some underpinning to a return to sustainable growth. But what it tells us is that the Federal government (and governments around the World) have to do more by way of net spending in areas that will directly stimulate employment growth. If the private sector is using the deficits to restore their own “balance sheet” viability, then the Government has to directly create jobs or undertake large-scale public infrastructure projects which will create employment.
The problem with the latter option is that it requires the spending to compete with the market for resources and can be inflationary unless managed properly. The first thing the Federal government should do, which will not be inflationary, is to offer a job to all those who currently haven’t got one. The offer should be at the minimum wage and in that way the Government would be buying off the bottom – that is, adding no price pressure to the economy because the unemployed labour is currently not wanted (has no demand for it and hence no price).
Alternatively, is the real job of government to help households return to the position they enjoyed for the best part of the 20th century, when they saved roughly $10 in every $100 of disposable income?
If the answer is yes, then the public must brace for a rather messy bargain with government whereby the budget deficit continues to balloon until the economy turns the corner. At that point, government must hit taxpayers for the interest with a wind-back of middle class and grey power welfare so the budget can return to some semblance of balance when recovery is under way.
If George understood modern monetary theory, he would answer his own question with a resounding YES. That is an essential role of government – to finance the private desire to save. It works like this. The national economy can produce a certain amount of goods and services in any period if it is fully employing all available resources (that is, unemployment = less than 2 per cent and no underemployment). This production generates income which can be spent or saved.
If the private sector desires to save, for example, $10 in every $100 it receives then that $10 is lost from the expenditure stream. If nothing else happens, unsold inventories will appear and firms will start to lay off workers because the production level is too high relative to demand. The decline in economic growth then reduces national income which in turn reduces saving, given that the latter is a positive function of total national income. This is the so-called paradox of thrift that has been mentioned in previous blogs.
But if the economy is to remain at full employment all the output produced has to be sold. Enter the Federal government. It is the one sector that can step in and net spend the $10 in every $100 to fill the “spending gap” left by the saving. All the output is sold and firms are happy to retain the employment levels that created the output. The system is in what economists call a “full employment equilibrium”.
Yet, notice what has happened. The net spending by the government (the deficit) ratifies the savings decisions of the private sector. The budget deficit maintains full employment aggregate demand and the resulting national income produced generates the desired private saving level. So the budget deficit finances the private saving on a daily basis.
So far from using biased or loaded terminology like “ballooning deficits”, what is going on now is a return to a sustainable growth path that was denied us by the neo-liberal budget surplus vandals. And it won’t be a matter of waiting for the economy to “turn the corner” and then we will be able to return to surpluses again. Not a chance. That would just start the debt train rolling again and bring on the next economic collapse.
Further, the reference by George to “hitting taxpayers” is totally erroneous as readers of this blog will realise by now. Taxes do not finance government spending. The terminology “taxpayer funds” is a totally misleading construction of the way governments spend. They do not spend taxpayer funds! Remember the statement by Bernanke the other day!
Household debt exploded everywhere. Australia’s household savings ratio, for example, was in the red for the first time on record in the June quarter 2000 when, not coincidentally, home buyers were trying to beat the introduction of the GST. For much of the next six years, the figure would remain in the negative, with the all-time low of minus 3.9 per cent in the second half of 2003 when the Sydney property market peaked. In other words, for every $100 in disposable income, Australians were spending $103.90. We were borrowing to consume.
While it is easy to be wise after the event, many people did warn of the dangers of an over-geared household sector. The problem is that no one could envisage, let alone guess at the consequences of a financial shock such as the one that sideswiped the global economy last September. The Reserve Bank worried for a while about the surge in household debt here but talked itself into believing that the borrowings were sustainable because asset prices—chiefly the family home—were rising by much more.
Where is the mention of the budget surpluses? All modern monetary theorists did envisage that the meltdown was coming. I certainly wrote hundreds of thousands of words on this since 1996 or so as did others. I was constantly vilified during this period by the neo-liberal sycophants in the economics profession. For example, in 1997, I presented a paper entitled The Path to Full Employment at the ‘Unemployment in Australia: In Search of Solutions Conference’ hosted by the Melbourne Institute of Applied Economic and Social Research, University of Melbourne. The paper made all the arguments about deficits, debt etc that I have been writing about for years.
Current Melbourne Institute Director, Mark Wooden presented formal comments on the paper which was published (without peer review) in the journal he edits The Australian Economic Review. Wooden’s formal written reply ‘The Path to Full Employment? They’re Dreamin!’ quoted a line from the comedy film ‘The Castle” as his ending in the formal piece. While not the style in which traditional academic discourse might proceed, the written piece was tame compared to his oral presentation at the Conference where he likened my presence at the Forum to an invasion of Martians.
There are many other examples. So George, we did see it coming. It was the neo-liberal vandals and poor journalism that supported their erroneous policy structures that didn’t and have caused this mess.
Bogan list up by one!
Mitchell, W.F. (1998) ‘Full Employment Abandoned: The Macroeconomic Story’, in M. Carman and I. Rogers (eds.), Out of the Rut, Allen and Unwin, Sydney.