Stimulus and deficits – the irreconcilable dilemma
Conservatives are making huge gains on a fundamental inconsistency in the case for fiscal stimulus. Here is the two part position of the center-left: 1) we need to increase the public debt in order to provide needed stimulus; and 2) the level of the public debt is of critical concern and has the potential to bankrupt the nation. Given these contradicting positions, is it any wonder the public is confused? I believe these two positions cannot simultaneously be held and successfully sold to the public. Simultaneously holding both positions is, in political terms, an irreconcilable dilemma.
A New York Times article today reports increasing support for republicans among the young and quotes a spokesman for college democrats as saying people are angry because of the deficits. This is clearly a widely held position throughout the country that reinforces the point made above. Paul Krugman acknowledges it today: “Whenever the issue of fiscal stimulus comes up, you can count on someone chiming in to say, ‘Only a moron could believe that the answer to a problem created by too much debt is to create even more debt.’”
Krugman’s fighting a losing battle though and the sad thing is that he and other center-left economists are actually the enablers of the irreconcilable dilemma. Their insistence that debt matters provide no cover for a center-left party to successfully sell major fiscal stimulus. Franklin Roosevelt couldn’t fight the dilemma and was pressured to rein in spending in 1937 which led to a severe contraction that was only reversed by World War II. Contrary to all of this though, there’s very strong theoretical support for the proposition that deficits don’t matter. Society can’t be in debt to itself and the whole concept is nonsensical. Why would society ever need to enforce austerity in order to utilize unemployed resources? We have control of the currency and do not need to borrow or tax in order to spend. Inflation is not a risk when we have massive unused capacity. The government should finance its spending through the printing press and cease doing so when unemployment is eliminated. Spending should be cut back when we’re approaching capacity which provides a sound basis for inflation control.
One of the early Keynesian proponents of this view was Abba Lerner who attempted to fight the established orthodoxy in the 1940’s. He developed a principle, Functional Finance, whose central idea was that monetary and fiscal policy should be based only on results. The government should guarantee enough is spent to provide full employment and not worry about deficits since it has control of the currency. In an influential article at the time, he demonstrates his frustration with center-left economists and aptly shows the timeless nature of the irreconcilable dilemma. Here are some key quotes.
Many of our publicly minded men who have come to see that deficit spending actually works still oppose the permanent maintenance of prosperity because in their failure to see how it all works they are easily frightened by fairy tales of terrible consequences.
First there were the pump primers (Krugman, et al?), whose argument was that the government merely had to get things going and then the economy could go on by itself. There are very few pump-primers left now. … It fails because there is no reason for supposing that the spending and taxation policy which maintains full employment and prevents inflation must necessarily balance the budget over a decade any more than during a year or at the end of each fortnight.
As soon as this was seen – the lack of any guarantee that the maintenance of prosperity would permit the budget to be balanced even over longer periods – it had to be recognized that the result might be a continually increasing national debt. At this point (it) should have been made clear .. that this possibility presented no danger to society..”
But either this was not seen clearly or it was considered too shocking or too logical to be told to the public. Instead it was argued, for example by Alvin Hansen (i.e. Paul Krugman), that as long as there is a reasonable ratio between national income and debt, the interest payment on the national debt can easily come from taxes paid out of the increased national income created by the deficit financing.
This unnecessary ‘appeasement’ opened the way to an extremely effective opposition to Functional Finance. Even men who have a clear understanding of the mechanism whereby government spending in times of depression can increase the national income by several times the amount laid out by the government, and who understand perfectly well that the national debt.. is not a burden on the nation in the same way as an individual’s debt to other individuals is a burden on the individual, have come out against ‘deficit spending’.
We can clearly see how little things have changed. The irreconcilable dilemma existed then and it exists today. We will either not spend due to fear of debt and continue with massive unemployment or we will drop the notion that deficits matter. It seems clear that Obama is now opting for the former. The later can only happen if the high priests of center-left economics, starting with Krugman, allow it to happen. Krugman’s half way ‘appeasement’ will get us nowhere. It’s not sellable.