Out of control US deficit spending

By Edward Harrison

April 30 — Regular readers know that, while I have a little of what Marshall Auerback calls deficit terrorism in my DNA, I fully support fiscal stimulus as a means to arrest a deep downturn.

Yes, though I like to say ‘removing fiscal drag’ but same thing.

The horrendous Keynesian nightmare

My move into Keynesian mode came in December 2008 with Confessions of an Austrian economist. In fact, I have argued the ObamaAdministration needed to use more stimulus in early 2009, not less (see January 2009’s Obama’s stimulus bill is a tough sell so far as an example).

Yes, needed to remove more drag.

As early as February 2009, I argued that Obama took a middle road on stimulus and taxes that leads nowhere which would discredit stimulus as a policy tool. And that is indeed what has happened.

Agreed. Which would be ok if they recognized it and opted for further adjustment.

Now, of course many of you don’t feel that way because you share my visceral disaffection for deficit spending.

Given there is a ‘right size’ govt based on public purpose of the public sector, and not revenues, the fiscal adjustments fall on the tax side.

So I feel the visceral disaffection for the over taxation that comes from a too small deficit.

But I laid out where the US economy is headed without stimulus in “The recession is over but the depression has just begun” six months ago. And right now we are heading exactly where I said we would. Witness my last post on the economy “US GDP growth rate is unsustainable; recovery will fade”

Anyway, the point is that the US economy will not be able to sustain recovery for long without stimulus. The likely result of withdrawing stimulus is a recession that is deeper than the last one aka a major depression.

Yes, it sure looks like the shortfall in aggregate demand calls for an immediate fiscal adjustment.

Deficits as far as the eye can see

But right now, a lot of talking heads are trying to bamboozle people with tales of woe about hyperinflation and sovereign bankruptcy in the US to support specific claims about what deficit spending can and can’t do. Deficit hawks, in particular, are on the warpath – a completely predictable outcome since I anticipated it just as Obama was elected in November 2008 (see Beware of deficit hawks).


Of course the US deficits are too large. Come on: 10% deficits as far as the eye can see are unsustainable over the long-term.

I don’t see that. Especially if govt spending isn’t ‘forced’ into the economy which would be evidenced by a closing of the output gap.

Until the output gap closes, deficits are simply offsetting non govt ‘savings desires’ for dollar financial assets.

That is, deficits add directly to non gov savings and until those savings desires are saturated govt isn’t ‘forcing’ financial assets into the economy.

The key word, however, is long-term. However, no one seems to understand the difference between short-term and long-term and the debate has become an ideological free-for-all.

It would help if they realized there is not necessarily a long term problem either.

Earlier this month, I told you I am throwing in the towel on policy makers because it’s clear that Obama has been captured by the deficit hawks and we are headed for a painful recession within the next two years (maybe even as soon as next year).


Policy is exogenous and deficits are endogenous

So let’s stop talking about policy as if we are going to change anything. I started moving away from stimulus happy talk to focus on malinvestment in December of last year.

The policy debates aren’t working because the actual mechanics of a fiat monetary system are being obscured by ideological political debates. So, what I want to do is lay the foundations of modern money with you so we can strip away the politics and ideology from the economics.

The goal is to demonstrate that fiscal deficits and surpluses are endogenous to our economic system and depend on exogenous policy decisions which are inherently political and ideological.

Let me give you an example. What if we allowed the US economy to proceed without making one economic policy decision for the next two years? What would happen? The answer is that the government would have a fiscal deficit of X billions of dollars exactly matched by X billions of surpluses in the non-government sector (remember the sectors must balance). The deficit outcome is endogenous. It is a function of the inputs i.e. of the private sectors desire to save and the government’s spending decisions.

Agreed, as above.

On the other hand, government economic policy decisions are exogenous. They are input variables which alter outcomes. This is an important point because if we know how the monetary system works, then we can get a much better handle on how different policy decisions actually affect deficits and surpluses. And remember, policy decisions are almost entirely political. That is they are driven by ideological positions.


So, if I say to you that I am against government spending and it must be cut, this creates a specific outcome path. On the other hand, if I say I am pro-stimulus, this too creates a specific outcome.

Modern Money

Here’s how I am going to go about this one:

I went to a conference on Modern Monetary Theory (MMT) on Wednesday. Over the next few weeks, I will present some ideas from the Modern Money people (Randy Wray, Marshall Auerback, Bill Mitchell, etc). I’ll start the post titles with “MMT:….”

Yes, good to see you there!

I will take a somewhat antagonistic approach because I think that’s probably going to the best way to introduce this to people who have a more libertarian bent like myself.

Now, my bio says:

From an ideological perspective, Edward calls himself a libertarian realist: a firm believer in the primacy of markets over a statist approach. but not in an ideological way. Often government intervention and oversight is not just wanted but warranted.

What that essentially means is that when I think about government, I view it with suspicion and my inclination is to seek to limit its size and scope.

Yes, there is a right sized govt that serves public purpose that varies from person to person. It’s a political decision.

That means I have an innate disaffection for big government,

Ok, that’s a legitimate political position shared by tens of millions, and maybe a majority.

deficit spending,

That’s the size of additions to net non govt savings which can only come from fiscal balance. The political decision here is the outcome (growth, employment, etc.) Of the level of savings govt allows through its policy.

money printing,

That’s a gold standard term relating to the ratio of paper claims on the gold reserves to the actual gold reserves. It’s no longer applicable as originally defined, so needs to be redefined or otherwise specified.

For example, the fed buying securities is an exchange of financial assets, both of which generally fall under some monetary aggregate, at which level that aggregate remains unchanged.

etc. – but not in an ideological way. It all depends on the circumstances. (For instance, see “A brief philosophical argument about the role of government” and “A few thoughts about the limitations of government” which outline my ideological positioning).

So, my goal in this is to separate the policy and the politics from the mechanics of how our fiat money system operates. That way it will be clear what is actually happening in our monetary system right now and what is pure political posturing. You will also then probably see a lot of congruence between how I see the economic mechanics and how Marshall sees them. The difference, of course, is ideology.

The way I intend to position this is that Modern Money Theory economists are really the True Modern Money Operations economists because they present the true mechanics of modern fiat money operation, which I will show you.

Now, policy decisions are largely political, exogenous decisions about which informed decision-makers can disagree. However, if we aren’t at least informed about the mechanics of how modern money works, it is very difficult to have an intelligent debate about deficits, social security, fiscal stimulus or anything else for that matter.

I know that I have learned a lot from what the likes of Randy Wray and Bill Mitchell have said (remember, I studied economics in a time heavily influenced by the prevailing economic orthodoxy). I don’t ‘buy into’ a lot of what they propose on policy, but on modern money they have it right.

Agreed, though i probably support most of their policies as well. But not always.

The purpose is to present the underpinnings where we can all agree and separate it from the ideological piece. My ideological foil in this will be Marshall Auerback. Afterward, I hope we can have a framework from which to talk about the political piece.

I hope you enjoy the debate and a presentation of the ideas.

Looking forward to it, thanks!!!


26 Responses

  1. “Drag” is an apt term. The role of money in the economy is reducing friction in transactions. Even folks who hearken back to the barter system agree with this.

    A fiat system provides the ability to provide the right amount of money (grease) to allow the economy to operate smoothly. Too much grease gums up the works and too little causes the system to slow down and ultimately freeze up.

    Nominal aggregate demand is determined by the amount of money and the velocity of money. If the amount of money is infinite and its velocity is zero, there is no flow. If the flow decreases excessively, deflation (preference for money over goods), and if the flow increases excessively, inflation (preference for goods over money). The trick is achieving balance by adjusting the lubrication by getting it to where it is needed (deficit spending) and removing it from where it is gumming up (taxation).

    1. Tom,

      What you are saying here is actually a rendering of the quantity theory of money. I was under the impression that it was better to shy away from that frame of thinking.

      The way I’ve come to think about MMT is that gov spending must fill the output gap, inflation only serving as a proxy. This is best accomplished by via a job guarantee at the minimum wage, without any budgetary restriction by virtue of a fiat currency system.

      As a first approximation, money’s lubricating role doesn’t even enter the picture, but I could be wrong. I just want to be sure I’m not missing something here.

      1. I am not proposing this as a way to explain MMT, but as an analogy to assist people to think about the role of money and what money does for the economy. Most people tend to think of money as some “thing” having intrinsic value instead of as a medium of exchange. As a medium of exchange money removes the “friction” (hassle) that would otherwise be involved in barter transactions. For this reason, the use of money as a universal commodity, so to speak, is one of humankind’s greatest inventions. This is an analogy about money’s role as a medium of exchange.

        When fiat money is compared with commodity money, then the “lubricant” aspect of money becomes obvious. Fiat money has no intrinsic value. It serves as a token. It’s chief economic value is in facilitating transactions. This is a huge conceptual advance with momentous real implications. Yet, this remains largely unrecognized and grossly underestimated. MMT clarifies this.

        Generally, people get it that if there is “too much money” then there will be inflation, but they don’t get that if there too little money then the opposite will result and they might lose their job, and their house, too, if they are deep in debt.

        This is an analogy to illustrate that there has to be enough money in the system to make it work efficiently and effectively, and neither too much nor to little so that it neither overstimulates nor understimulates demand relative to supply.

        And as I said, demand is a function of both money and its velocity. I believe that this is pretty much agreed upon. Velocity is determined to a degree by amount. If money is scarce it gets hoarded (demand for money/liquidity increases) and this is deflationary. If money so abundant that prices begin to rise excessively, then people run out of money (demand for money/liquidity decreases) into other things, and prices rise further, faster, accelerating inflation.

  2. Harrison: “Of course the US deficits are too large. Come on: 10% deficits as far as the eye can see are unsustainable over the long-term.”

    Mosler: “I don’t see that. Especially if govt spending isn’t ‘forced’ into the economy which would be evidenced by a closing of the output gap.

    “Until the output gap closes, deficits are simply offsetting non govt ’savings desires’ for dollar financial assets.”

    Wait! You’re both right! 😉

    FWIW, here is a rule of thumb. Deficits should grow at population growth plus 4-5%. Sound reasonable? That’s less than 10%.

    However, we have an immediate need for stimulus to counteract the downturn and unemployment, which will need to last for years. In addition, we need massive restructuring to reduce our dependence on oil. As in the past, such restructuring will require government subsidies. Furthermore, we have found that the market fundamentalist approach of the last 30 years or so has meant a crumbling infrastructure. We need to make repairs and to do maintenance into the future.

    Add it all up, and we probably need to run double digit deficits until at least 2050.

    1. We have crumbling infrastructure? How do you know? How much do you propose that we invest to fix our “crumbling” infrastructure and what kind of yield do you expect we’ll get on that investment?

      1. 1. How many lives were lost when that bridge on i-35 collapsed. What were they worth?

        2. Do you travel much in the Third World?

      2. 1. 13. I guess about $6MM x 13 = $78MM, according to the metric the EPA uses. Should we also count how many deaths are caused by poorly designed construction work areas and unnecessary repair projects?

        2. No, I don’t. Not sure what you’re driving at here.

        By the way, the I-35 bridge collapse was due to a design flaw, and ongoing repair work on the bridge contributed to the failure. Read the wiki page on the collapse. It is not a good example of what I think you’re implying.

        Also, by the way, I am drinking boiled water at this very moment because the state of the art water treatment system put in place for the Boston metropolitan area less than 5 years ago just suffered a catastrophic failure. Stuff happens. Every time an infrastructure disaster happens anywhere in the country, you hear about it immediately. Therefore, I’m not convinced that our infrastructure is crumbling just based on a few anecdotes.

      3. ESM, 1) I was suggesting that infrastructure is a safety issue that really can’t be estimated quantitatively. I am now living in Iowa where the majority of infrastructure problems involve bridges in need of maintenance or repair. Deferred maintenance began in the 80’s, By now it is getting to be a serious issue in some areas, and one that cannot be deferred much longer without degradation occurring.

        2) Anyone who has travelled much in the Third World realizes the immense value and importance of infrastructure, not only economically but also relative to quality of life. I admit that “crumbling” might be a bit of hyperbole, but the US has to maintain and upgrade its infrastructure to stay competitive. There are significant areas in which the US is lagging, such as alternative energy, high speed rail, and broadband access.

  3. Mosler: “The key word, however, is long-term. However, no one seems to understand the difference between short-term and long-term and the debate has become an ideological free-for-all.”

    The mainstream seems to use “long-term” to mean an end-state, a static equilibrium, like when the waitress puts the bill on the table. Under that scenario, the budget constraint holds – equal to the cash in your wallet – otherwise you’re doing dishes out back.

    Since there is no budget constraint under current monetary arrangements, the use of an abstract “long-term” does more harm than good. The long term is just a series of short-terms into perpetuity.

    Neoclassical economics needs the “long-term” concept to reconcile short-run Keynesian conditions (nominalism) with long-run Classical conditions (real). That’s their problem.

    1. My two cents in this debate is that it’s harder to convince people that they should give up a constraint (on debt, say), if you don’t give them a new one, so they can be at peace.

      Therefore, perhaps, the output gap should be called the Real Budget Constraint.

      Add the prefix Stringent to Real Budget Constraint when addressing a puritan crowd 😉

      1. Bx12, That makes a lot of sense actually, especially since the first rejoinder to MMT is always, “why not give everyone a million dollars”.

        Maybe we should go back to Nixon’s Full Employment Budget.
        “the full employment budget counts as revenue the amount the nation’ tax system would yield if the economy was running at full blast. When business is sluggish – as it is today – the actual tax yield is substantially less”.

  4. Actually, the EPA puts the statistical value per life saved at $6.9 million, so 13 lives lost has an economic value of about $90 million. And while civil engineers may have a vested interest in, well, engineering projects, they seem to be playing straight with their regular and increasingly dismal “report cards” on America’s infrastructure (warning, link autostarts a loud video, so turn down your volume).

    I’ll outsource this question to Tom Hickey– if (to use Mark Zamdi’s numbers) every dollar of infrastructure spending creates a $1.59 of GDP, what would be the monetary effect of Tsy spending (without borrowing except for interest on reserves) $300 billion or so every year on infrastructure? Am I crazy to think that contrary to the Austrian inflationary fears, it might actually be deflationary because every dollar created is generating $1.59 in goods and services?

    1. You’re right about the EPA’s value Beowulf. I was going from memory, but to tell you the truth, the current number should probably be lowered somewhat to account for the massive amount of wealth lost in the last few years. The EPA bases it’s value based on economic studies of what people are willing to pay to avoid certain risks (or be paid to bear certain risks). This number should go down if people become less affluent.

      As for your link, well, as you implied, it is more of an advertisement than an economic analysis. I am certainly open to the idea of spending more on infrastructure, perhaps a lot more, but whenever I see the phrase “crumbling infrastructure,” conclusory statements and unsupported claims follow. I feel the same way about our “failing schools.”

      We need more economic analysis and less hyperbole.

    2. Beowulf, it is difficult to put an economic estimate on public investment in infrastructure beyond the actual spending, but that is really only a very small aspect of the effects “in the long run.” This is a big reason that MMT’ers would prefer to see fiscal policy used to manage the economy efficiently and effectively instead of letting “nature” take is course and relying on automatic stabilizers when an avoidable output gap opens. Wise fiscal policy would involve capacity utilization, full employment (less frictional), and price stability, while providing public investment that would grow the economy and increase its efficiency through innovation.

      Just what exactly is the return on the highway system that began under President Eisenhower? I would say it is inestimably great. IT was justified initially as a matter of national security but its economic benefits and convenience are what we think of now, rather than as a resource for moving troops and supplies around quickly in national emergencies.

      1. Thanks for your comments Tom. Its interesting that Eisenhower sold the highway system as a defense project he did the same for higher education funding post-Sputni)l. And of course the last redoubt of Keynesian economics among fiscal conservatives is the defense budget (there’s a book to be written on this, it should be titled The General and Admiral Theory). :o)

      2. Tom,
        I met Edward at the Teach-In, prince of a guy…he stayed all day and I think he got alot out of it. I think Edward is coming around to this but he is going to have to think it through for a while.

        It sounds like he was an Austrian, now he is looking at Keynesian. He writes here about being a “libertarian realist” with a suspicion of govt.

        My point; “libertarians” may recoil at the Modern Money framework as “big govt” as a lot rides on the (G-T (govt responsibility) during iimportant parts of the economic cycle, and they may generally view the national “debt” is a form of “tyranny” (think they are beholden to it).

        have you ever looked into when they wrote “life, liberty and the pursuit of happiness” what the FF meant by “liberty”. Do you think they meant “you should be able to do anything you want” (modern Libertarian interpretation) or more narrowly, that “man” had a right to live “free”, ie liberated, specifically not subject to a royal Sovereign (king/queen)?


      3. Matt, I have been reading Ed’s posts for some time, and he is clearly trying to work this through intelligently. He is creating a good model for others that will follow.

        I think that a lot of us are “realistic libertarians.” Everyone loves freedom but intelligent people — you know, those that have been potty trained — know that liberty isn’t absolute. The challenge is to work out a political system with an economic infrastructure that balances individual liberty, equality of persons with respect to law and rights, and the general welfare of society.

        I like to point out that libertarians of the right see socialism as the threat, while libertarians of the left see the corporate state as the threat. These are the extremes that liberal democracy based on free markets has to thread.

        The FF were chiefly concerned with “big government” in the form of the British Empire, ruled by the landed aristocracy and a relatively weak monarch. The Magna Charta had more or less bridled the monarchy long ago, and the ruling elite were the “corporate state” of that day. It sure wasn’t socialism that the FF were concerned about. In fact, at the time the founding documents were being prepared there was a strong Tory factor that preferred monarchy and landed aristocracy. Washington had to quash the idea of his becoming king.

        The political ideas of the FF came from 18th c. Enlightenment philosophers who developed the intellectual underpinnings of modern liberal democracy based on classical ideas derived from the ancient Greeks, especially the city state (polis) of Athens. Their idea of liberty involved basic human rights that all (white male persons of property) shared. Their notion of liberty was very different from license to pursue self-interest. There were very strict norms and institutions in place at the time to insure that didn’t happen.

        The notion of liberty is closely related to the economic concept of utility based on pursuit of self-interest, however, which began formally with the work of Jeremy Bentham. While many erroneously believe that Adam Smith is responsible for the modern notion of self-interest as the “invisible hand” that drives free markets inexorably toward equilibrium, that idea was developed long after smith, who never even suggested it. (See the work of Smith scholar Gavin Kennedy).

        There are serious problems with the utility theory. See Steve Keen, Debunking Economics, ch. 2, for a wonky explanation. (Available to read at Google Books here.) For a good summary of the argument against max U, see Maxine Udall’s post at Open Economics.

      4. Bingo.

        And this is why i laugh when people call economics a “right wing profession”.

        it’s roots are deep within Progressive movement, it is a historically left wing phenomenon. Google “dismal science” to see what I mean.

        It is seen as being right wing today because “center” has moved so far to the left.

        HICKEY: If you wish to go back further you can track enlightenment philosophers back another 300 years to THEIR origin. And you can track Puritans back to England and discover who Loyalists were.

        But this is off topic. I will go no further

      5. Right. That’s why it’s called “liberal” democracy and why classical economics is also called “liberalism.”

        This goes back to Aristotle’s politics. Aristotle’s philosophy was promulgated in Europe through the medieval Church, specifically in the teaching of Thomas Aquinas. This was the intellectual milieu within which and to which the Age of Reason was responding in developing contemporary solutions to current challenges. In their day, with capitalism rising and traditional institutions becoming obsolete, these folks were the “socialists.”

        Since then, the movement has been chiefly leftward overall. If one reads the Communist Manifesto now, much if not most of what it proposes has already been in place for some time. In the developed world, serfs are not only a thing of the past, so are servants, for the most part.

      6. aristotle called democracy a pervert.

        you are dragging too much into your net with your atavistic greed. progressive was schism out of old european church, not central to it for all times.

        in developed world, serfs, servants are thing of past but there are some new things that have developed that are much much worse.

      7. “aristotle called democracy a pervert”


        Aristotle’s discussions of democracy are nuanced. While he does admit that democracy can be perverted, he posited the rule of the many as potentially superior to the rule of one or few if it is not perverted. Unlike Plato, Aristotle did not see democracy necessarily descending into the rule of the rabble.

        Aristotle on Democracy: Excerpt from a collection of Hans Morgenthau’s teachings

        Aquinas inserted Aristotle into the center of European thought. This is significant because change happened incrementally, building on the past. The Greeks had a proto-idea of the person as it would later be developed when Greek thought and Roman law intersected with Christian theology. The resulting concept of the person as embodied “spirit” constituted of intellect (reason) and will (freedom) was inherent in late Medieval thought. This created an inherent contradiction between the individual as a person with freedom and rights and the hierarchical society that resulted from the morphing of the Roman empire into Christendom.

        The outcome was the Renaissance and Reformation, which affirmed the value of the person and emphasized personal freedom. This fit well with the growing spirit of capitalism. All this came together in the 18th c. in the Age of Reason aka the Enlightenment. This led to the “great experiment” that is still playing itself out on the world stage.

        The FF were divided into republicans and democrats. The former can be represented by Alexander Hamilton, who distrusted direct democracy and sought to prevent the rule of the rabble arising through representative governance and ca strong centralized federal government rather than a more decentralized system. Thomas Jefferson, usually considered founder of the Democratic Party, took a more liberal stance and preferred more decentralization of power, since he distrusted the power of special interests.

        Of course, this is a broad brush approach to a complex history that hardly does it justice, but it hits the high points, I think.

    1. And not a single failing grade – from people whose jobs depend on more spending on civil engineering projects.

      Depending on the context, a passing grade is good enough.

      1. I figured you’d say that. Having briefly looked for another source, it seems most others seem to trust the ASCE, and posting links to those articles would to some extent be redundant.

        However, this might be similar to trusting a doctor when they tell you need to exercise and loose weight. You may live until 65 with your current habits, and that might be “good enough,” but that doesn’t mean the doctor isn’t right either. And given the fact we have plenty of idle labor at the moment, this isn’t really about what we would have to give up to get better infrastructure.

        On the question of how we choose our investments, that’s obviously up for debate, but as an example:


        Spain spent a lot of money on high speed rail. And it’s been hugely popular. But was it worth it? Tough to say, I’m not even sure you can really calculate something like that.

        My other example would be anecdotal. There are many cities in Ohio whose water systems are incredibly old and literally crumbling.


        Thunderstorms frequently overwhelm the system and wash raw sewage into the rivers.


      2. Also remember, civil engineers today (a biased lot, sure, but I would trust engineers over most other government employees including academics) operate in very politically constrained environment.

        building new bridge, repairing old bridge, it all takes decades and you end up with stupid solution. Google “viaduct” and “seattle” and you will see problems.

        compare to china and dubai, US no longer capable of making anything. Not saying china and dubai are making RIGHT thing, but you can actually put up crane.

        in my neighbourhood we have active blocking of cell tower construction even through reception is typical poor. Why? children, radiation, cancer, eye soar. we do not even put up the hosues because people do not want the traffic and children that new tenants may bring!

        you need permit to cut down sick tree in backyard. and even thrn they turn down permit, so you resort to poison in dead of night (in your own back yard) and make tree sick enough so you can cut the damn thing down already

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