What I would add to his fine review is wherever Professor Davidson indicates ‘increased government spending’ I would add ‘and/or tax cuts depending one’s politics.

Published in the Summer 2010 issue of the JOURNAL OF POST KEYNESIAN ECONOMICS by Paul Davidson:

Making Dollars And Sense Of The United States Government Debt

21 Responses

  1. Warren, do you see the relationship of tax cuts and spending as chiefly a matter of political choice based on norms and preferences, or are there economic reasons behind the relative balance in terms of changing conditions? I would suspect the latter instead of the matter being normal and preferential.

    1. It’s both, for any given point in time the politically determined ‘right size’ for gov is a function of the appropriate politically determined/desired public infrastructure.

      Public infrastructure can include the military, the legal system, social security, education (direct or a voucher system), my health care plan, the payments system, targeted bank lending, the internet, public roads, etc. It’s all a political choice and different economies lend themselves to different public infrastructure.

      the balance is more people in gov means fewer in the private sector. same with other real resources. The choice to build the Erie canal was the choice to use those resources to build it vs the benefit of what became of NYC, the penalty for a too small military can be severe, the cost of a private sector power grid sized to have a few brownouts to max profits might warrant regulation due to the collective losses of having less power than needed for peak loads, etc. etc. etc.

  2. Tom Hickey:

    Warren support internal trade, which produces real gains, and taxation causes dead weight loss which benefits no one. Also, if you take realistic view of Govt spending, it is obvious that it does not support real output in most cases.

    In a low taxation economy, (1930s) then I think Govt spending is right option. In high taxation economy (now) there is so much room to cut taxes that would be better option.

    It comes down to distribution question, and therefore power, which is political.

  3. In reality, it does come down to political power and distribution, and that’s why political solutions are always biased in favor of the influential and powerful. That’s history.

    But Warren suggested above that there is a political preference between spending and tax cuts. I’m contending that there’s more to it that that, and that’s where intelligent people from the left and right can find common ground based on operational realities and evidence.

  4. Tom –

    As per Abba Lerner’s “Functional Finance”, there should be no connection whatsoever between what a government spends and what it taxes – they are completely separate activities, undertaken for different reasons. Therefore, government should only spend money on an activity if it furthers some public purpose for it to do so – and obviously, there can be a big a debate over what is properly a public responsibility and what is better left in the private sector.

    But in general, if there is something that is worth doing by the government, it should always be worth doing – and increasing government spending in recessionary times just to “stimulate” the economy is a recipe for a lot of ill-conceived projects and political payoffs. Far better to simply reduce taxes, particularly regressive taxes like the payroll tax, when a fiscal adjustment is necessary. Why take people’s money, then send it back in dribs and drabs (enriching favored constiuancies in the process), when you have the option of just not taking their money in the first place?

    Note: I believe that there are many things the Feds could be spending money on (like healthcare and infrastructure) that they aren’t doing now, and many others (like pointless wars) that it shouldn’t be. But those judgments aren’t changed by the state of the economy. Spend on that which it makes sense to spend on, and set taxes at a level that allows for full employment without inflation.

    1. Jim Baird: “But in general, if there is something that is worth doing by the government, it should always be worth doing – and increasing government spending in recessionary times just to “stimulate” the economy is a recipe for a lot of ill-conceived projects and political payoffs.”

      Mebbe so, mebbe not. We have plenty of pork in good times. Spending to stimulate the economy is not just spending. What spending has been most stimulative currently? Unemployment benefits are number one or number two. Why? Because the people who get that money spend it. OTOH, the bank bailout billions, whatever the virtue of the bailout, have not been lent out, so their stimulative effect has been relatively small. Providing jobs, even temporary jobs, to the unemployed, would also be stimulative, because most of them are lower class, and would spend the money. Stimulative spending is not just pork, or even mainly pork.

      “Far better to simply reduce taxes, particularly regressive taxes like the payroll tax, when a fiscal adjustment is necessary.”

      You are right about regressive taxes, but in general reducing taxes does not mean that the money that is not taxed would be spent. Generally, taxpayers can afford to save.

      Reducing taxes is also indirect. We hope that the taxpayers spent their untaxed money. They may or may not. Indirection may be best in normal times, but these are not normal times.

      Reducing taxes has the advantage of being quick. It takes time to set up spending projects, in general. But downturns accompanied by financial crises tend to last for years, and that suggests that sustained stimulative spending should play a role. After all, in a prolonged downturn, incomes drop, tax revenues drop, and the stimulative effects of reducing taxes also drops.

      “Why take people’s money, then send it back in dribs and drabs (enriching favored constiuancies in the process), when you have the option of just not taking their money in the first place?”

      MMT says that you do not give it back, anyway. 😉

      1. True, reduced taxes will not necessarily be spent. But so what? If that’s the case, just cut them more. Adding savings to the private economy (especially at the bottom end) is a feature, not a bug. Once you get over the idea that you need “revenue”, you can see that taxing money that would be saved anyway is the height of lunacy.

        And downturns don’t have to last for years – just remove the fiscal drag, and stand back.

        And yes, I know that it’s not “taking and giving back” from the government’s perspective – but it sure feels like it to my wallet. 😉

  5. I don’t disagree with the thrust of your argument, Jim, but it’s not something that is worked up in terms of data and operations. That’s what I am talking about. Too much of the banter is between people with different norms and preferences, whose notions are ill-defined, on one hand, and biased, on the other. I would want to see actual economic plans based on numbers and justified in terms of operational reality. Then, the argument can be about matters that are decidable on the evidence.

  6. In reference to the article and government spending during WWII, what was the role of raising war bonds to help “pay” for the war effort? Was it in reality an interest rate management tool rather than a “fundraising effort”, i.e a monetary operation instead of fiscal operation?

    Thanks for the help!

    1. Paul, during ww2 the generals in charge of the cyclotrons of the manhattan project needed silver to help make the nuclear material for the first nukes. They so heavily manipulated the silver markets no one found out. There was no silver left for trade that all those “financial markets” were busying themselves with 🙂

      Later the cyclotrons were destroyed and the silver gradually returned.

      Tom Hickey, a thought experiment for you – based on star trek’s kobayahi naru “no win scenario”

      You are in a room and a man with a 9mm won’t let you leave unless you give him some of warren’s business cards. A texas pilot is hurtling towards your room using his airplane as a missle. What to do? Either get shot by trying to leave, or get blowed up by staying – kobayashi naru indeed!

      1. Neil, I have one for you. Why isn’t the space program a commercial venture instead of on the government tab?

      2. Tom I think it is because too many of our children watched cowboy movies and taught in school the importance of football. Not enough watched space movies and read heinlein and asimov. It all starts with the children. I deal with a lot of bankers, they are all excited to loan for a new sports complex, marina, housing complex, you start talking to them about the Xprize and sending people into outerspace and you are quickly escorted out of the bank 🙁

        Warren has pointed out it was all these silly bonuses and rules regarding house lending that got so much capital tied up in that sector – the corrupt loan officers went gaga over making new real estate loans – why can’t we do the same thing for space company startups? Mr. WAMU officer can tell his underlings they must approve so many space related loans to get a bonus, and the regulators can turn a blind eye.

        Tom that is assuming there is even the demand for those loans, even some of my friends at Nasa would rather go get loans for a mcmansion and a new SUV than go get a loan for a space business, they just aren’t thinking the right way – got socialized incorrectly as young children to think the wrong things. I have heard MMT talk here about hiring workers to build roads, revamp decaying infrastructure, but what about hiring workers to work in space related industries? Kennedy put this nation to a task involving the moon, I don’t see that greatness from our executive branch today. If all the economic policies are directed at increasing chinese junk output and building another 1000 mega malls, how does that get star trek here?

      3. Neil, I said that tongue in cheek, just to make the point that there are preferences involved in arriving at the balance of public and private. Through understanding MMT, we realize that government has the financial power to purchase what it desires through currency issuance, so the question becomes what appropriate public policy is. Should the US be committing such large funding to defense, space exploration, and other favorites of the right instead of committing more to education, health care, infrastructure, and other favorites of the left. Should the public/private ratio be weighted in favor of public, as radicals prefer, or heavily toward the private, as libertarians prefer?

        These are the debates the country should be having, not “whether we afford it.” Government disbursements don’t need to be funded by taxation or financed by debt, so it is a matter of choice how currency is created and allocated relative to real resources. It’s not the currency that is limited. It is the real resources. So the question becomes what share the public should have a claim on and what share should be private, given the preamble:

        We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.

        This can be interpreted in a variety of ways, across the political spectrum. The question is how to achieve balance and harmony in light of our shared tradition and common aspiration. That’s what liberal democracy is supposed to be about. Presently, it is being hijacked by interest politics and partisan factionalism, against which the founders warned.

        Politics is said to be the art of the possible. We should be figuring out what is possible financially in light of MMT and proposing policies that take advantage of opportunity. Then we can argue over the proper mix of public and private intelligently — instead of being sidetracked by what we can “afford” when it is a non-issue.

    2. Paul, prior to August 15, 1971, when President Nixon shut the gold window, the US was using a convertible fixed rate currency and was operating on those rules.

      1. Tom –

        Not during WWII, when the gold standard was suspended and the Fed set rates at 3/8% for the duration.

        Paul –

        The selling of War bonds during WWII was actually more of an inflation management tool. People were working and making money for the first time in a decade, but there were few consumer goods to buy. Taxes were raised, but it was felt that raising them enough to “apy for the war” would be demoralizing. So instead workers were offered interest paying war bonds as a savings vehicle, which gave them something to do with teir extra earnings that would prevent inflation.

        Remember, according to MMT, a dollar saved is the same as a dollar taxed in it’s macro effect.

      2. Well, for one thing, in the runup to it’s entry into the war it sold vast amounts of war materiel to the allies. “Lend Lease” only began after Uncle Sam had pretty much drained all the gold from the British vaults.

  7. I see things a bit differently Warren et al.,

    Two issues strike me as I review Davidson’s piece:

    1. Aggregate demand as a construct takes place within the theoretical vacuum of a just and relatively fraud-free financial environment. Davidson’s apparent assumptions vis-a-vis Aggregate Demand seems to imply the de facto existence some manner of systemic oversight and regulation that allows individuals, corporations, and indeed sovereign states, to trust both the ongoing viability of the fiat currency regime in question AND the belief that “demand” is REAL and not the result of myriad instances of gaming and moral hazard. I would posit that ONE of the reasons for the failure of current Fed QE policy (to promote real economic recovery) is that Wall Street [sic] is proving that no crisis is too big for them to actually reform their ways (I point in particular to the effort to resist any manner of oversight in the OTC derivatives marketplace, but other examples exist.)

    2. The stark reality is this: any attempt to address the massive and incipient deleveraging of private debt by “allowing” it to happen—in other words, by ending the FED’s loose monetary policies—would turn the USA into a cauldron of despair. As things currently stand, the only reason we’re not witnessing 1930’s-like social conditions is because we’ve got food stamps, unemployment insurance, and banks that refuse to foreclose on homes (not because they are altruistic, but because most underwater mortgages have attendant 2nd notes, HELOCS, and these notes on underwater properties are 100% UN-recoverable. Turn off the federal ‘printing’ presses (I know, I know), and the world as we know it falls apart.

  8. Tom,
    I think the U.S. came off the gold standard during the depression and did not go back until Bretton Woods after the war.

    1. FDR ended gold convertibility for private parties but international trade was settled in gold until 1971.

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