Forget the ‘fiscal cliff’

By Stephanie Kelton

Dec 21 (LA Times) — Look, up in the sky! It’s a “fiscal cliff.” It’s a slope. It’s an obstacle course.

The truth is, it doesn’t really matter what we call it. It only matters what it is: a lamebrained package of economic depressants bearing down on a lame-duck Congress.

This hastily concocted mix of across-the-board spending cuts and tax increases for all was supposed to force Congress to get serious about dealing with our nation’s debt and deficit. The question everyone’s asking is this: On whose backs should we balance the federal budget? One side wants higher taxes; the other wants spending cuts. And while that debate rages, the right question is being ignored: Why are we worried about balancing the federal budget at all?

You read that right. We may strive to balance our work and leisure time and to eat a balanced diet. Our Constitution enshrines the principle of balance among our three branches of government. And when it comes to our personal finances, we know that the family checkbook must balance.

So when we hear that the federal government hasn’t balanced its books in more than a decade, it seems sensible to demand a return to that kind of balance in Washington as well. But that would actually be a huge mistake.

History tells the tale. The federal government has achieved fiscal balance (even surpluses) in just seven periods since 1776, bringing in enough revenue to cover all of its spending during 1817-21, 1823-36, 1852-57, 1867-73, 1880-93, 1920-30 and 1998-2001. We have also experienced six depressions. They began in 1819, 1837, 1857, 1873, 1893 and 1929.

Do you see the correlation? The one exception to this pattern occurred in the late 1990s and early 2000s, when the dot-com and housing bubbles fueled a consumption binge that delayed the harmful effects of the Clinton surpluses until the Great Recession of 2007-09.

Why does something that sounds like good economics balancing the budget and paying down debt end up harming the economy? The answers may surprise you.

Spending is the lifeblood of our economy. Without it, there would be no sales, and without sales, no profits and no reason for any private firm to produce anything for the marketplace. We tend to forget that one person’s spending becomes another person’s income. At its most basic level, macroeconomics teaches that spending creates income, income creates sales and sales create jobs.

And creating jobs is what we need to do. Until the fiscal cliff distracted us, we all understood that. Today, we have roughly 3.4 people competing for every available job in America. The unemployment rate is like a macroeconomic thermometer when it registers a high rate, it’s an indication that the deficit is too small.

So in our current circumstance a growing but fragile economy policymakers are wrong to focus on the fact that there is a deficit. It’s just a symptom. Instituting tax increases and spending cuts will pull the rug out from under consumers, thereby disrupting the income-sales-jobs relationship. Slashing trillions from the deficit will only depress spending for year to come, worsening unemployment and setting back economic growth.

Conveying this is an uphill battle. The public has been badly misinformed. We do not have a debt crisis, and our deficit is not a national disgrace. We are not at the mercy of the Chinese, and we’re in no danger of becoming Greece. That’s because the U.S. government is not like a household, or a private business, or a municipality, or a country in the Eurozone. Those entities are all users of currency; the U.S. government is an issuer of currency. It can never run out of its own money or face the kinds of problems we face when our books don’t balance.

The effort to balance the books that’s at the heart of the fiscal cliff is simply misguided. Instead of butting heads over whose taxes to raise and which programs to cut, lawmakers should be haggling over how to use the tool of a federal deficit to boost incomes, employment and growth. That’s the balancing act we need.

Stephanie Kelton is an associate professor of economics at the University of Missouri-Kansas City and the founder and editor of New Economic Perspectives. @deficitowl

48 Responses

  1. Check the poll results out (about the article, via latimes link above):

    Do we need a balanced federal budget?
    Yes: 24%
    No: 76%

    Maybe more people than not get it.

  2. Cut all defense related spending by 50%, this includes official and unofficial, direct and indirect such as research grants to politically connected defense contractors. Close all overseas military bases.

    Convert all pensions given to defense department, congressmen and senators into medicaid.

    That would be great start.

      1. @WARREN MOSLER,

        Warren – Given the size of the military budget, do you think that a dollar cut from military spending is equal in terms of economic gain to a dollar cut in taxes and/or a dollar spent on domestic programs of one kind or another?

      2. Maybe, maybe not. Why does it matter? If the military is deemed too large for public purpose, cut it!
        If public purpose is deemed served by other spending, do it!

        And then maker sure taxes are at full employment levels.

        Doesn’t matter how large the dollar adjustments are or aren’t

      3. @Ed Rombach,

        Why does it matter? I am puzzled about how you seem so ambivalent on this issue. Of course there is public purpose justification for any country spending whatever scarce resources it has to defend itself from foreign enemies. However, the U.S. spends more on defense than all the countries with the next 13 highest defense budgets combined. Military spending beyond what is necessary to defend the country is just a subsidy to the military industrial complex which keeps getting us involved in undeclared wars that go on forever. What exactly is the public purpose of the war in Afghanistan or Iraq?

        What is the difference between public spending to build another nuclear aircraft carrier or submarine vs. an equivalent amount of public spending on domestic infrastructure, cancer research, public education or an equivalent amount of tax cuts? The return on investment in terms of use value to our society is the difference. Development and construction of aircraft carriers and nuclear submarines and a host of other military expenditures consumes the most sophisticated technology and labor power in the world to produce something that working families cannot consume in any productive way that can upgrade their own standards of living, education levels and general well being.

        A certain amount of defense spending may always be necessary, but it represents a pure overhead cost to society and foregoes other unmet needs. You can’t house a family in an Abrams tank or educate the children in a stealth bomber. It seems somehow appropriate to characterize excessive military spending as a graveyard or dead end for skilled labor power and advanced technology because while it may have a price tag, it doesn’t create any productive wealth that can be recycled and consumed by society in any way that increases the potential of society to reproduce itself at even existing living standards no less higher levels.

        My point is that there is more potential bang for the buck from useful public spending and or growth inducing tax cuts than in equivalent military spending. By extension this also means that a given amount of military spending cuts can be offset by a smaller amount of public spending on productive infrastructure and/or tax cuts.

  3. Very nicely written! Of course, they’re still going to cry hyperinflation, so she probably should have mentioned it. Could have cited Italy as a country that survived hyperinflation (but which suffers badly with Euro austerity)

      1. @WARREN MOSLER, I’ll do it for free: govt spends $2 for every $1 it creates in debt. wamo!…:-)

        But it would require bypassing “self imposed constraints” and rearranging “current institutional relationships”

      2. have a quick read of ‘soft currency economics’ thanks.
        whether or not you call it ‘debt’ govt spending is simply a credit to an account of one kind or another the fed.
        that is, for all practical purposes the US can spend what it wants and pay or not pay interest as desired even under current arrangements.
        it’s about political will

      3. @WARREN MOSLER,

        Take our military and blow-up every known agricultural field in the world. That would cause instant inflation. You could even cut the money supply to a fraction of what it is right now, and the inflation would still be rampant.

  4. The historical correlation between the fiscal balance years and the immediate corresponding depressions is hardcore factual evidence of results to the govt spending.

    This should be the first and foremost emphasis to EVERY economic policy discussion.

    not once or twice, but 6X!!!!! history has provided the results for our future reference….omg

    i have to say, i have superficially taken notice of those different periods as separate events, but never noticed them collectively before now. looking at them in the collective sense is beyond astonishing.

    so, after accepting the historical fact fiscal balance produces dire economic results, i believe the major debate continues to be:
    1)how much to deficit spend,
    2)where to spend the deficit/taxes
    3)who gets how much of a benefit of govt spend
    4)who pays how much back in taxes.
    seems like we’ll never get an agreement on these points

      1. @WARREN MOSLER,
        but apparently at the moment, a continued tax cut for 98% of folks with current level or marginally higher spending isn’t enough to compromise for those who unyieldingly demand continued tax cut for 99.6% and venomous spending cuts to social benefit programs….ughhhh

      2. @Ed,

        One person’s lack of a continued tax cut is another person’s tax hike.

        But I’ll go one step further and state that only an unreasonable person would call continuing a tax rate that has been in existence for over 10 years a tax cut.

      3. @Ed, esm, that’s why in my first post to this thread, I called it a major debating point.

        “One person’s lack of a continued tax cut is another person’s tax hike.”….. i would say it’s more like “one persons lack of continued tax cut would be that persons tax hike”

        “But I’ll go one step further and state that only an unreasonable person would call continuing a tax rate that has been in existence for over 10 years a tax cut.”

        i think a unreasonable person doesn’t acknowledge facts. the current tax fact is: without a deal, as a matter of current law, taxes are going back to what they were for 100% of folks, it’s that ol’ self imposed constraint thing again. what you call doing that is just semantics or personal perspective.

        everyone hates paying taxes. who pays how much is where the debate is.

        for what its worth, i will say that my best years have been the ones where i paid the most in taxes

      4. What seems strange to me is that no one is mentioning in govt or the media that the Bush tax cuts were purposely temporary to “distribute the surplus” that had accumulated and was expected to accumulate over the next ten years. Then the idea was to review it. Well, that surplus is long gone, so on the original argument, the obvious conclusion is to let the tax cuts expire, if reducing the deficit and debt are the existential priority that fiscal conservatives make it out to be.

        Of course, that’s silly from the MMT POV, and so is the conservative argument that letting the cuts expire as scheduled is “raising taxes.” That’s just a mis-framing of the debate.

        MMT proponents should be arguing that the original rationale was erroneous and explain not only why but also why allowing taxes to increase now is also fallacious, as is even being concerned with the absolute size of the deficit and debt, or its direction.

        Otherwise, we are arguing within someone else’s framing. That’s swimming upstream.

      5. Don’t forget, I was there in early 2003 at the West Wing with Andy Card, Bush Chief of Staff, explaining the urgent need for a larger deficit.
        He got it and got it done!

      6. @Ed,


        “…Bush tax cuts were purposely temporary to “distribute the surplus” that had accumulated and was expected to accumulate over the next ten years.”

        You know something else Tom? The Clinton tax hikes in 1993 were also supposed to be temporary. In fact, there is a reason why the top marginal rate was that funny number 39.6%. It was supposed to be a temporary 10% surcharge on the top income people (on top of the highest bracket rate of 36%) to bring down the deficit.

        The Clinton tax rates were extant for 8 years. The Bush tax rates, including a 2yr transition period from 2001 to 2003 have been extant for 12 years. Which rates represent the base line?

        Also remember that the tax code changed dramatically in 1986 (first applied to 1987 and fully implemented for 1988), so it is like apples and oranges to compare pre-1988 tax rates to post-1987 tax rates. So, the Clinton tax rates were the highest rates have ever been post-1987, and they were in place for 8 years out of the 25 post-1987 years we’ve had so far.

      7. @Ed,


        Also, the reason the Bush tax rates sunsetted after ten years was that the Dems in the Senate filibustered, which forced the Repubs to pass the bill via reconciliation, and reconciliation bills automatically sunset. It was not by design that the tax rates were temporary. It was a political necessity.

      8. The true, ESM, but my point is that our side should be pointing out that the rationale we are opposing is not only in error but history has changed and it no longer make sense — the expected surpluses never manifested.

        There is a big difference between “raising taxes” (takes a tax bill) and letting temporary tax cuts expire (which happens if Congress does nothing). In other words, the Grover Norquist argument is unsound on the face of, in addition to being bad policy on the MMT analysis.

        The opposition doesn’t even have a consistent argument, let alone a sound one. Conclusion, their argument ideologically motivated rather than reality-based. The MMT argument is simple arithmetic, basic algebra, and double-entry SFC.

      9. @Ed, warren, can we get an elaboration into the andy card meeting? interested in knowing what made this one different from the ones you write about in 7difs with summers/rubin….:-)

      10. @Ed,
        esm, i think we can both agree lower taxes = better for private sect. higher taxes = less better for prvt sect.
        i will add that i’m tired of the debate over and over. the best thing we could do is simplify it.

        i’m for no deductions period, determine the %’s at the income levels desired, have everyone file a one page 1040-ez and lets move on….:-) it will allow us to more productively deploy our efforts to other things.

        tom, all good points. norquist is a selfish sadist. when you talk about the opposition holding to an ideology instead of acknowledging facts, you are no longer dealing with a person of reason, but instead a member of a cult. krugman did his oped yesterday on the right wing cult,pretty good piece.

        merry-x all

  5. “That’s because the U.S. government is not like a household, or a private business, or a municipality, or a country in the Eurozone. Those entities are all users of currency; the U.S. government is an issuer of currency. It can never run out of its own money”

    When I mention this to most folks, that just confirms in their mind that the whole business is hocus-pocus, that the currency is worthless, etc.

    I think Stephanie is a wonderful lady, as are the other great MMT writers, but I really think things will not advance in a definitive manner until you find a way of transcending the current way the matter is framed–which politically and financially also happens to suit the 1% to keep propagating. The meme you are fighting against is just too intuitively clear, whereas MMT comes across as a nerdy abstraction. People cannot accept an alternative to their experience that money needs to be earned. This is the great stumbling block. For milennia, people have sought wealth as a commodity. They don’t see the abstraction, the “idea” behind money.

    1. @Sandy,

      I like to frame it in real (labor, resources, capital infrastructure) versus non-real (money, debt, etc.)

      For example, if someone is discussing NASA’s budget and say something like, “space exploration leads to many benefits for mankind and we should be increasing it but we just do not have the money for it.” I reply, “Money has nothing to do with space exploration. The cost of space exploration is man hours, engineering, resources, etc. Are you telling me we have no astronauts, scientist and engineers that want to engage in space exploration and are you saying we do not have the physical resources for them to use to do it?”

      In other words the mind-shift to get behind MMT is not the accounting and economic formula derivation nor the understanding of banking but the realization that money is a non-real tool used to provide liquidity for the exchange of goods and services. The real constraint with what we can or cannot do is real things (labor, resources, infrastructure.) Also, letting those things sit is a real opportunity cost and a reduction to the wealth we could have.

    2. @Sandy,

      How about calling it the Sandpile-and-Hole Theory? The volume of the Sandpile (private dollar assets) equals the volume of the Hole (Federal Debt) because Americans live in a closed sandbox, and the Sand literally can’t come from anywhere else.

  6. Sandy — You make a valid point. The two ideas of “earning money” and “money as a commodity” are huge stumbling blocks for many people. There are ways to address them, but I agree that we need to be prepared to address them, even if they are unspoken.

  7. I hope we go over the fiscal cliff in order to cut the military budget and let the bush tax cuts expire – mostly helps the wealthy anyways – no kidding they are called the BUSH tax cuts.

    Americans have become so brainwashed with Republican fear mongering that they believe in a 1 penny cut in defense from the trillions we waste (most go to republican connected criminals) will somehow allow a bunch of Muslims with pitch forks invade some redneck white trash Texas swamp town.

    Let’s go over the fiscal cliff and then pass separate legislation to re-enstate only those pieces that help middle class Americans.

  8. What about the great epozootic of 1872, when every horse in North America came down with equine influenza and transportation came to a standstill? Don’t suppose that little event didn’t have some negative effects on the economy, do you? Maybe the railroad bubble had something to do with the panic of 1893, what do you think? The “Panic of 1857” was a world-wide affair and involved railroad financing issues as well. Blaming these events on government spending, or lack thereof, is misleading if not dishonest.

    1. when those events happen in an economy that’s ‘over leveraged’ due to the deficit being too small the results are more memorable.

      the financial debacle of 2007/8 for example happened after the deficit had fallen to only 1% of gdp.

      and the y2k and .com collapse happened during a surplus.

  9. People I talk with agree that taxes and spending can regulate inflation. However they are concerned in the long term value of the US dollar. Therefore they would rather more conservative deficits and perhaps even a redistribution of current deficits rather than an increase. This is an interesting argument since we technically could keep the deficits at current levels but get 6-10% redistributed from the wealthiest companies/people over to the middle class. There’s you FICA holiday for the middle class (not for small business though) and the wealthiest weren’t spending their cash anyway. It’s not MMT ideal but the idea does have some validity and us far more politically attainable at this time IMHO.

  10. People I talk with are very concerned about the future of the US dollar and feel that federal deficits will cause too much inflation and so need to be more careful and conservative with our spending.

    Isn’t it true that increased deficits don’t necessarily equate to inflation? The M2 money supply concern is another relic of the gold standard correct?

    Demand-pull inflation occurs not when more money is in the economy but when more spending occurs such that businesses are confident in raising their prices. Those two variables cannot be assumed particularly today would you agree?

    Also certain tax cuts and government spending carry varying likelihood a of inflation. For example a FICA holiday has more demand-pull concerns than dies a NASA program don’t you think?

    I am not personally concerned about inflation from our deficits at this time but people I talk with are. What can be said to them about that? They are concerned about the long-term value of the US dollar. I tell them in that case they should be focusing in infrastructure investment and education and space age and green technology, etc. as roger suggests to bring it back to the real tangible level.

    1. @Mario,
      What is the level of unemployment? What is the current output gap? Do we have sufficient resources available? Are there excess inventories? How are sales overall? Is the overall economy in recession. Are there demand leakages- are people saving, paying off debt or importing goods and services from abroad?
      Ask the people you talk to those questions. See how they respond. Ask the people you talk to if they or their friends were given $10 K, tax free, would they pay off debt, save it, or buy a Rolex?

      1. @chewitup,

        Totally. I hear you and agree with you. Although these friends of mine might be buying rolexes with that money! Haha

        They look at the US dollar and don’t like the low 70’s. I tell them its b/c if the emergence of the euro in 2000 an how that also became a safe haven for capital with the US more than demand-pull inflation concerns. Before the euro was created he US dollar was as strong as it was in 1970!

        Based on the reports I’m looking at, it seems inventories and sales have returned close to pre-08 levels. Private Credit levels have stabilized but are still high overall and the real estate market seems to be less liquid all around with tighter lending practices.

        Is it possible a FICA holiday would cause substantial demand-pull inflation particularly when sustained yoy?

      2. @Mario,
        Do you see a FICA holiday politically feasible? They are negotiating just to keep current 2% temporary FICA tax cut.
        I don’t see how the FICA holiday would be inflationary any time soon. It would allow those making less than $100k (or so) to breath a little by paying down debt and maybe save a bit. After that, maybe some of the durable goods will get a boost.

        The dollar was in the 60’s a few years ago. And the Euro wasn’t such a safe haven the last couple of years until the ECB removed the solvency issue.

      3. @Mario,

        Considering the state of private credit lines and the paradigm shift in real estate, I’d say low likelihood of inflationary concerns for a good long while.

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