This post was co-authored by Marshall Auerback and Micah Hauptman.
"Balance the budget!" It's the endlessly repeated narrative heard in Washington. Implicit in this narrative is that budget deficits are crippling our economy and the U.S. government is on the verge of insolvency. If we only imposed strict fiscal discipline like Greece, we'd be on the road to recovery in no time! Ask yourself how that's working out for Greece right now.
We are currently in what Republicans in Congress are calling "Balanced Budget Month." But it's not just Republicans who have embraced a commitment to drastically slash deficit spending. Virtually everyone in Washington agrees that budget deficits are dragging our economy down and that they must therefore be dealt with swiftly and vigorously.
The solution for many policymakers is a balanced budget amendment. But the monomaniacal focus on budget deficits tends to throw up a series of perverse policy responses, which will actually have the effect of increasing, rather than decreasing, debt. It seems counterintuitive, but the public actually needs government spending to pay for its taxes rather than the government needing taxes to pay for highways, bridge repairs, schools, national defense, etc. For households and businesses, paying back debt means they have to sacrifice current consumption (spending). For the government, no such financial constraint is imposed. Its ability to spend now is independent of how much debt it holds and what it spent yesterday.
Budget deficits themselves are best seen as barometers of economic activity: when economic activity declines, tax revenues plunge and social welfare expenditures rise as more people are thrown out of work. As a consequence, in bad economic times like these, there are higher deficits; conversely, when prosperity returns, deficits decrease. This dynamic means that expenditures that help regular Americans are even more necessary during difficult economic times because they put a floor on aggregate consumer demand, preventing the onset of another Great Depression.
The establishment of a balanced budget amendment will utterly disable this process. In fact, common sense suggests that a drop in private income flows while private debt loads are high is an invitation to debt defaults and insolvencies -- that is, unless creditors are generously willing to renegotiate existing debt contracts en masse. An unlikely scenario.
Let's keep this simple: We can divide the economy into three major sectors: the domestic private sector (including households and businesses), the foreign private sector (including the import and export of goods) and the government sector. For an economy to properly function, the three sectors' spending and saving must all balance out, meaning if one sector spends, the other sectors must save, and vice versa.
If households and businesses save, for example, $10 of every $100 they receive, then that $10 is lost from the expenditure stream. If households save by spending less than they earn, and businesses save by reinvesting less than their retained earnings, then the production level will be too high relative to demand and unsold inventories will grow. The result will be deferred consumption and firms laying off workers; that is, unless output is offset by rises in the trade sector (i.e. more exports). But the way our trade sector is configured, a trade surplus is not likely anytime soon.
Now let's consider a different situation. Assume the government passes a balanced budget amendment, taking in more tax revenue than it spends, and the private and trade sectors rack up further debt. As we know, excessive private sector debt and trade imbalances got us into our current mess and continue to threaten our financial security. Why on earth would we want to embrace this type of system?
It does not have to be this way; the government sector can easily step in to pick up the slack, while giving households and businesses an opportunity to recover. Unlike private actors who don't have the capacity to create money, the government can issue money at the tap of a keystroke and spend much more freely to get the economy going. In troubled economic times, the government must insert itself in this capacity to maintain sector balance. It can do so by promoting policies that favor full employment and mortgage relief, so that households and businesses have money to pay down their debts and consume again. Full employment is also compatible with a healthy banking system: fully employed people have a greater capacity to pay off debt, making destructive loan write-offs for banks far less likely.
Spending and debt remain intrinsic features of a capitalist economy. The key question is, which sector is best positioned to service the debt: families and businesses, or the government? With a balanced budget amendment, the burden is forced onto families and businesses. The folly of this approach is obvious.
Marshall Auerback is a Fellow at Economists for Peace and Security and a Research Associate at the Levy Economics Institute. He also works as a global portfolio strategist for Madison Street Partner, LLC, a Colorado-based investment management group. Micah Hauptman is the Financial Campaign Coordinator for Public Citizen's Congress Watch division.
Americans for a Balanced Budget Amendment
Balanced Budget Amendment Next Goal for Republicans - NYTimes ...
The other real culprit here is the U. S. FEDERAL RESERVE that has totally ignored its FULL EMPLOYMENT MANDATE. The other 'Budget Balancing Fix' is for the Federal Reserve to monetize any current accounts deficit so that no additional debt is created when revenues fall short of expenses. The stingy Monetary Policy of the Federal Reserve has not even been willing to do this in the face of Deficits in excess of $1 Trillion per year. To the voting members of the Federal Reserve, 9.1% unemployment is not a CRISIS, so they are keeping their powder dry.
You ask, ‘If we only imposed strict fiscal discipline like Greece, we'd be on the road to recovery in no time! Ask yourself how that's working out for Greece right now.’
Actually, Greece is in trouble now because it did not impose strict discipline when it should have, and now those decisions are taken out of the hands. In short their problems are caused by a prolonged lack of discipline and should stand as a cautionary tale to the United States.
Perhaps a balanced budget amendment may be a bit draconian, but we should definitely have a fiscal consolidation approach to our budget on a go forward basis, Research shows that is how most economies that have been faced with debt problems got themselves back on strong footing, including Sweden, Canada, Finland, Belgium, Ireland, etc.
ECB: ‘The study finds that ambitious expenditure retrenchment and reform coincides with large improvements in fiscal and economic growth indicators.’
http://www.ecb.int/pub/pdf/scpwps/ecbwp634.pdf
And Goldman:
http://www2.goldmansachs.com/ideas/global-economic-outlook/limiting-the-fallout-doc.pdf
Sweden:
http://www.economonitor.com/dolanecon/2011/07/31/how-smart-fiscal-rules-keep-swedens-budget-in-balance/
Canada:
http://mercatus.org/sites/default/files/publication/Canada's%20Reversed%20Budget.Henderson.5.5.11.pdf
I think you are missing the subtleties of the article, particularly with regard to Greece. The main point is that Greece is in its situation because it doesn't control its currency (it's more like a US state, not the US) and therefore cannot let automatic stabilizers run their course. Which is why Spain, Ireland, Italy etc. are all in the same boat. The US, Canada, UK etc are in their respective boats because of politics and outdated understanding of the role of federal taxes and debt. I coulnd't open your Canada link (where I live) however, it should be noted that Canada's level of private (household) debt shot up and when it attempted to impose fiscal austerity through the 90s and 2000's, is sitting more or less where US private debt levels are - which falls in-line exactly as the authors are stating.
regards,
http://www.imf.org/external/pubs/ft/issues4/index.htm
Research Paper: ‘Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases.
http://www.economics.harvard.edu/faculty/alesina/files/Large%25252Bchanges%25252Bin%25252Bfiscal%25252Bpolicy_October_2009.pdf
Research paper: ‘We find that deficit-financed tax cuts work best among these three scenarios to improve GDP, with a maximal present value multiplier of five dollars of total additional GDP per each dollar of the total cut in government revenue 5 years after the shock.’
http://onlinelibrary.wiley.com/doi/10.1002/jae.1079/abstract
Kai