Saturday, May 29, 2010

For the opposite view...

After writing the previous post on why budget deficits are a negative thing for the economy I stumbled upon an article that justified them. The Levy Economics Institute of Bard College recently released a Public Policy Brief on why we should stop worrying about U.S. Government deficits. The authors Yeva Nersisyan and L. Randall Wray point out that a budget deficit is just a transfer from the government to the private sector and that surpluses are the exact opposite net transfers from the private to government sector.
Furthermore, they dispute the often heard claim that deficit spending today burdens our grandchildren:

"in reality we leave them with government bonds that represent net financial assets and wealth. If the decision is made to raise taxes and retire the bonds in, say, 2050, the extra taxes are matched by payments made directly to bondholders in 2050”

Today's deficit leads to debt that must be retired later, and future tax increases that are supposed to service tomorrow's debt represent a redistribution from taxpayers to bondholders. Although this may be undesirable given that bondholders are wealthier than tax payers, but if one takes into account the U.S. progressive tax system it may just represent a transfer from taxpayers back to taxpayers. This is a reasonable perspective given that we as public bondholders get repaid even if it is a discriminating redistribution of income taxes back to rich people who could afford the bonds from poor people may not hold any bonds.

A government deficit is a transfer of income from the government to the private sector in the form of non-government income.

"A government deficit generates a net injection of disposable income into the private sector that increases saving and wealth, which can be held either in the form of government liabilities (cash or Treasuries) or noninterest-earning bank liabilities (bank deposits). If the nonbank public prefers bank deposits, then banks will hold an equivalent quantity of reserves, cash, and Treasuries (government IOUs), distributed according to bank preferences."

A surplus has the opposite effect as increased tax revenue from the private sector lead to a reduction in wealth and in order to maintain the same standard of living the private non-government sector has to borrow more.

"A government budget surplus has exactly the opposite effect on private sector income and wealth: it’s a net leakage of disposable income from the nongovernment sector that reduces net saving and wealth by the same amount. When the government takes more from the public in taxes than it gives in spending, it initially results in a net debit of bank reserves and a reduction in outstanding cash balances."

One important argument made is that the largest part of the current deficit results from automatic stabilizers like transfer payments and unemployment benefits. The flipside to increased unemployment benefits as the economy goes through a contraction is their tendency to fall back down as the economy recovers. As the leading driver of the deficit they are also the main reason for the reduction in the debt/gdp ratio as the economy expands. Along with increased unemployment, tax revenues that fall during the recession pick up during the expansionary phase.

In defense of Obama's stimulus:

"These automatic stabilizers, not the bailouts or stimulus package, are the reason why the U.S. economy has not been in a free fall comparable to that of the Great Depression. When the economy slowed, the budget automatically went into a deficit, placing a floor under aggregate demand."

After reading this article, one highly theoretical argument that I can make is that if the United States was forced to monetize part of the debt it could raise interest on reserves to soak up any additional liquidity created in the system. This would represent a massive transfer of Government debt from the Treasury to the Fed in the form of excess reserves. The excess reserves could then be manipulated with the appropriate raising and lowering of the interest paid on reserves relative to the federal funds rate. This is quite an exciting premise that represents an internal transfer of funds by the U.S. Government that would keep inflation expectations stable while also calming the fears of deficit hawks.

No comments:

Post a Comment