Market Extra: Budget deficits aren’t the economic threat you might think

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Economist Stephanie Kelton isn’t a fan of the tax proposals being considered by Congress, but she does welcome the opportunity they provide to argue that many economists and investors view the budget deficit in the wrong light.

Kelton, professor of public policy and economics at Stony Brook University, argues the legislation is likely to exacerbate income inequality, which in the long run is a drag on the economy. But she contends criticism focused on the estimated $1.5 trillion in cumulative deficits the legislation would produce over the next decade is misguided.

But Kelton, who is a champion of modern monetary theory, or MMT, asserts that fiscal policy, including budget deficits, can lead to a more equal and prosperous economy when used sensibly.

See: The Trump tax calculator—will you pay more or less?

The core tenets of MMT are based on the idea that sovereign governments face no purely financial budget constraints. It holds that all economies face real and ecological limits on what can be produced and consumed and that the government’s deficit is everybody else’s surplus.

“People assume that a government deficit is a result of bad, irresponsible behavior, that it’s something you have to fix or stop, but that thinking is wrong,” said Kelton in an interview with MarketWatch.

“If the government spends $100 into the economy and taxes $90, that means the government ran a negative $10 deficit. But that $10 is a surplus in some part of the economy,” Kelton argued.

Adherents of MMT contend the government creates money when it spends it, and that it need not issue bonds. Kelton has explained that the government could effectively decide to dispense with bond sales and allow the resulting excess reserve balances remain in the banking system.

But by borrowing money and paying interest on debt, the government is, essentially, giving a subsidy to those who are already wealthy, according to Kelton.

“When the government wants to spend, the Fed hits the ‘print’ key, but when it collects taxes it hits the ‘delete’ key. When the government taxes its citizens, it does not ‘get’ something it simply subtracts something from the economy,” Kelton said.

Stephanie Kelton

Stephanie Kelton, Professor of Public Policy and Economics at Stony Brook University

“Congress does not have to borrow—that’s completely optional. Instead the government can let people hold cash. That way there would not be fights over the debt and debt ceiling,” Kelton said.

Critics of MMT often argue that such policies could lead to hyperinflation. But Kelton does not see that as a threat in the U.S.

“Capacity utilization is at 75%, while the broader unemployment number is still pretty high and workers have no bargaining power. Inflation will not rise if wages continue to stagnate,” said Kelton.

“Once inflation does begin to rise, the government can use its taxing power and the central bank can use its policy tool to control it while keeping unemployment at low levels,” Kelton said.

While the debate over national debt goes back decades, history shows that deficits are the rule rather than the exception in most successful economies.

Great Britain has been running deficits for centuries, for instance. Even in the U.S. the government is almost always running deficits in any given year.

Yet, politicians are always trying to fix it, according to Kelton.

Kelton suggests that asking how big the debt can get before it becomes a problem is the wrong question to ask.

Metrics such as national debt to gross domestic product are often seen as a barometer of sustainable economic health, as people view it as the country’s ability to produce enough goods to eventually pay off its debt.

But economists so far haven’t identified what ratio is ideal for any given economy, as much depends on the country’s ability to control its own fiat currency.

“The Congressional Budget Office, instead of scoring what the debt to GDP ratio looks like, should tell us something useful: how much it widens inequality, how many kids get lifted out of poverty as a result of this piece of legislation or tell us what Gini coefficient going to be,” Kelton said. The Gini coefficient is a measure used to gauge the degree of inequality in an economy.

However, many politicians view the deficit as evidence of overspending.

“The size of the deficit itself does not tell you if you are overspending or underspending. If you are underspending you have unemployment, if you are overspending you have inflation,” Kelton said.

In other words, government spending and taxing should be two powerful levers that would keep a fine balance between the risk of inflation and the risk of rising unemployment.

Kelton welcomes the idea that politicians are finally not afraid to increase the deficit in the name of economic growth. However, she said the current proposals leave much to be desired.

“I don’t think this tax proposal is going to spur growth, I don’t think it’s going to lead to millions of new jobs and I don’t think it’s going to create shared prosperity because the benefits of the tax cuts go disproportionately to those who are already doing extraordinarily well and to wealthy corporations,” Kelton said.

“I think though that it opens the door to a new kind of conversation about deficit spending one that would allow politicians on both sides to debate the best use of the budget deficit to achieve the broad goals of shared prosperity more growth better jobs higher wages and a more prosperous economy,” she said.

This story was originally published on Dec. 4, 2017.