Size of Deficit 101

Note this does not match up with Professor Bill Mitchell’s Size of Deficit 101 but “How large should the deficit be?”

Regular readers  will know that when I talk about budget deficits I typically stress two points: (a) that the Government is not financially constrained and therefore all the hoopla about debt and future tax burdens are just a waste of time. But just because the Government can buy whatever is for sale by crediting relevant bank accounts doesn’t mean they should not place limits on the size of the deficit; and so (b) given the federal deficit “finances” private saving, it should therefore be aim to “fill” the spending gap left by the private desire to save. If the Government does that then it can maintain full employment and price stability and move towards a more equitable society. So it is important that we have some idea of the size of this spending (or output) gap.

The first thing that the Government has to understand, which it currently does not, is that the size of the deficit is a totally useless thing to become obsessed with. The size of the deficit – which is just an accounting statement after all – is not a viable or legitimate policy target.

The fact that the Government is still thinking it has to worry about the particular deficit figure reflects the destructive neo-liberal overhang that still dominates macroeconomic policy.

I am reminded here of a statement that the doyen of Monetarism, Milton Friedman, made when talking about so-called Balance of Payments problems. He said …. more or less … that we would all be happier if governments did not calculate or publish balance of payments data.

The suppression of information was a hallmark of the previous federal government. For example, their refusal to publish wage data once WorkChoices was imposed on us was one of many examples of the way they tried to censor information and restrict what researchers like me could do. Censorship is, therefore, not a palatable option. But I have some sympathy with the view that if we stopped publishing the deficit data we would realise the sky isn’t falling in and might actually start focusing on the problem at hand.

The entire World economy is in the grip of a very substantial recession which in some countries is bordering on depression. For Australia, the backlog of primary commodity orders has helped delay the onset of this destructive tide but now it is clear that our economy is falling fast. All those years of fiscal drag – the surpluses that were praised – are now coming back to haunt us. During those years of surplus, we failed to build structures that would really insulate us from the worst ravages of recession.

We allowed our public infrastructure to degenerate; we ran down our higher education and research capacities; we allowed hundreds of thousands of workers to languish in unemployment and promoted legislation that created record levels of underemployment – the low-skill, low-wage, low productivity path to job creation. The surpluses undermined the nation’s future and imposed huge costs of certain segments of the population who had to carry the burden of persistent labour underutilisation.

All this when we could instead have creatively implemented a Job Guarantee, which would have re-engaged all those we were leaving behind. It would have allowed the nation to integrate a forward-looking skills development framework within a paid-work environment. Instead, we chose to run the disadvantaged around in circles of Centrelink office abuse, pernicious work tests, and futile training courses divorced from any real paid work environment. It was stupid policy and wasteful of the potential of the future generations.

Far from deficits “mortgaging the futures of our children”, it was the surpluses that undermined their future by wasting the opportunities available every day for people to re-skill, to work and accumulate savings. This would have allowed them to develop risk management systems which would have increased their capacity to cope with economic uncertainty. Now we are back in recession – as we were always going to be at some point – and we have hundreds of thousands of workers without sufficient skills to cope, many households so indebted that they are highly exposed to the slightest changes in their economic circumstances, and a Government without any real policy structures in place to lead the nation out of this.

And now on a daily basis we have to endure these nonsensical claims that whether the deficit is too large already,  that a tough budget is going to be necessary to keep the budget deficit at a minimum and that hard decisions are going to be made to ensure the deficit doesn’t blowout, along with all the rest of the absurd rhetoric that dominates the so-called policy debate.

Journalists and business economists (mostly bankers who clearly have vested corporate interests such that most of their comments should be taken with a grain of salt) feed this conservative torrent daily with their use of terms such as “runaway deficit”, “deficit blowout”, “debt mountain”, “deficit spike”, “unchecked borrowing” and other alarmist rhetoric . All of this is designed to frighten us back into the conservative hole that we have been cowering in for the last several years. While we were cowering, we stood by and allowed our national government to abuse office by maintaining high levels of labour underutilisation and then punishing the victims of their policy folly with their pernicious welfare-to-work type policies.

So in the recent budget the size of the deficit should not be a target. The target should be on correctly estimating the spending gap and filling it in the most effective way possible. By that I mean creating as many jobs as are necessary to ensure that we finally return to full employment (taken here to mean 2 per cent or less official unemployment and zero underemployment) while also ensuring that government spending does not create production bottlenecks which could generate inflationary biases once higher rates of capacity utilisation return. As I have argued relentlessly, the first place to start is to generate “loose” full employment via a Job Guarantee.

The fiscal injection needed to accomplish this policy goal is the minimum necessary to get us back to full employment and represents a considerably smaller impulse than that required if the Government tried to create the same number of jobs through private market stimulus. After all, the Job Guarantee requires only that the Government offer a job to anyone who wants one at the current minimum wage. By definition, the unemployed are not currently required by the private sector. There is no demand for their services and so no market pressure occurs as a result of the Government offering them a job. The extra spending on the Job Guarantee workers would be fairly trivial given we are supporting them on unemployment benefits anyway. Once you have the safety net Job Guarantee in place then you can think about what other public investments are desirable.

In the current debate I have heard no statement from the Prime Minister, the Treasurer, the Finance Minister, the Minister for Employment nor any of their Opposition counterparts as to what they think the spending gap actually is. Lots of hot air about the size of the deficit but no discussion at all about the extent to which the economy needs further net government spending.  The recession is being politicised and this represents a clear failure of our political process to deliver responsible government policy.

If we are facing the worst recession since the 1930s and some countries are bordering on being in depression, then it is clear that any federal budget will have to be very expansionary. I read in The Australian the other day that the best advice for Government was to just hold still and try to achieve “balance”. To try to build a path back to a balanced budget with this coming budget, which is the advice being given by all and sundry, would be the height of irresponsibility. We will need a much larger deficit as a percentage of GDP than we have envisioned to date. How large? Well that depends on what we think the spending gap is going to be and for how long it is likely to persist. That should be the topic of attention not the size of the deficit.

First, we know that the private sector (particularly those heavily indebted households) is now saving like they haven’t for years. The most recent National Accounts verifies a sharp rise in saving out of disposable income. A good proportion of the fiscal injections to date will have reinforced this trend as households struggle to restructure their precarious balance sheets and to get some risk margin back into their lives.

When the private sector increases its saving rate, aggregate demand (spending) falls, inventories accumulate, and firms reduce production levels and employment. If uncertainty increases as the employment growth falters and unemployment starts to rise, then people may try to save even more to increase their security. The problem is that this makes the situation worse – the so-called “paradox of thrift”.

The only way out of this malaise is for the Government to use it unique fiscal capacity to fill the void. Despite what the conservatives say – there is no other show in town!

Reference Link: Bill Mitchell


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