Tuesday, September 6, 2011

Does Anyone Understand Macroeconomics - Part 2

So why does it matter if we have two, apparently competing schools of economic thinking? Let me try putting down a list of questions. Try answering them one by one before reading ahead. Here they are:

          1. Are deficits bad?
          2. Are deficits inflationary?
          3. Will deficits cause interest rates to rise?
          4. Does Government need taxes to fund spending?
          5. Does Government need to issue debt to fund deficits?
          6. When/if Government "prints money" (called "monetizing the debt"), is this inflationary?
          7. Does Government spending cause GDP to grow?
          8. Is Government spending different from Consumer or Business spending?
          9. Can the US go broke?
          10. Would the US be in serious trouble if China dumped its $2 trillion in US Government bonds?

Six months ago, I would have answered Yes to all the above questions. Conservative economists would answer yes to all of these questions, except number 7, where they would argue that Government spending causes an equal reduction in Private spending, so there is no or minimal effect on GDP.

Here are my answers now:

          1. Only when the economy is operating at capacity.
          2. Same answer as #1.
          3. If the economy is not at or near capacity, no. In fact, there will be downward pressure on rates, depending on whether the Fed is paying an interest rate on excess reserves.
          4. No
          5. No
          6. No, unless it translates into increased spending when the economy is at capacity.
          7. Yes
          8. No
          9. No
          10. No

I do not expect you to take my word for it. I want you to seriously consider the possibility that I might be right, and to begin to investigate for yourselves. You will find there is an opinion spectrum. The MMT views (mine) will be on one end of the continuum; conservative economists will be on the other end; and Keynesians will be in the middle, with perhaps a slight leaning towards the MMT end.

Paul Krugman, a dedicated Keynesian, engages in argument with MMTers from time to time. His primary disagreement areas would be questions 6, 9, and 10. He thinks the US can go broke, if not through default, then through hyperinflation. And he puts much more emphasis on inflationary monetary impacts, except in times (like now) when the economy is in a "liquidity trap", which is derived from Keynes and means that interest rates have become ineffective; cash and short term debt is interchangeable; and there is an apparently endless demand for more Government paper. In "normal times", however, "printing money" will move us into headlong inflation. If not stopped, this can tun into hyperinflation, like Weimar Germany. MMTers are scornful of this position.

Now try this thought experiment: consider the implications that MMTers might be right. Some of you will simply not be able to do this, because it will go deeply against the grain of how you have learned to perceive and understand the world. But as a thought experiment, what would it mean if the MMT view were correct? I will suggest just a few possibilities:

     1. As a nation, we would be less afraid.
     2. We would understand that there is no "debt crisis".
     3. We would understand that deficits are normal, in fact, necessary. If the private sector wants to save (like now) and the trade sector is in deficit (which it almost always is in the US), then the Government must be in deficit.
     4. We would know that when the economy has huge excess capacity (high unemployment, low plant utilization), deficits are not inflationary. When the economy tightens, they are.
     5. We would know that high unemployment is not necessary, that there is much we can and must do to put people back to work.
     6. We would know that China does not own us, that if they dumped our bonds (which they have little incentive to do), the Fed would buy them up and interest rates would not skyrocket.
     7. We would know that our debt does not need to overwhelm us, and that if real interest rates stay below the rate of GDP growth, our debt to GDP rates will stabilize at very manageable levels.
     8. We would know that the unfunded entitlement scare is just that, a scare. With reasonable, even modest tweaks, Social Security will be self-funding again. Healthcare costs, which have grown faster than GDP, are a problem. But we don't need to give up on it and turn Medicare/Medicaid into a premium support program.
     9. America was strong, is strong, and will remain strong into the future. It's not that there is no work to do. It's just that the work and the horizons are much less constrained than we have been thinking.

Imagine that you are a Republican strategist. What I have just written would be terrible news. Almost your entire agenda would be rendered meaningless. You could still push for lower taxes, which the MMTers would applaud. But deficit/debt cutting would be mostly out. There would be very apparent reasons to support and improve Government, so they can institute and implement positive, employment-building policies. And worst of all, for some on the Right, the attack on entitlements would have no more rationale. We would have come to know that the US can set broad, inclusive and just policy goals, and that they have the resources to accomplish them. We need not be a country of fear. We can seriously become a nation of hope.

More soon. For those interested in learning more, Professor Bill Mitchell's blog is a good place to start. Every Friday afternoon, he has a five or six question quiz, and on Saturday he puts out incredibly detailed answers. In four months of trying, I have gotten one 5, a couple of fours, but mostly 3s' and below. A great teaching vehicle.

Also try New Economic Perspectives. Started by a group in the Economics Department at the University of Missouri - Kansas City, but has expanded to gather many of the MMTers writing today.

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