Give Deficits a Chance

Posted by Admin on Feb 13, 2018 5:00:00 PM

Although a recession is not imminent, one will eventually occur, and when it does, policymakers will have strategies to address it, if they’re willing to use them, said Stephanie Kelton, an economics professor at Stony Brook University, recently at the Institute’s Investment Advisor Forum.

While Kelton did not predict that the current long-running expansion will end soon, she said it eventually would, “The question is when, not whether it will end.”

But, expansions do not “die of old age,” according to Kelton. Rather, they end because the Federal Reserve raises interest rates or they are “hit by a large shock that overwhelms the central bank to counter it,” quoting New York Federal Reserve President William Dudley. Or, the economy reaches its capacity and has no more room to grow.

Because the Fed lowered rates to near zero in the last recession and rates remain low, the Fed has almost no room to lower them in response to a slowdown in the near future.

But, there are other strategies the Fed could use to try to recharge the economy, such as negative interest rates, buying a broader range of securities for quantitative easing, or targeting higher inflation rates.

The other main strategy available is an expansive fiscal policy, explained Kelton. But, this strategy has been effectively rendered untouchable. Political figures from both the right and left have railed against the dangers of driving up the deficit, saying it will leave future generations drowning in debt and force the country into default.

“They only disagree on who’s to blame,” Kelton observed.

The near universal outcry is based on the notion that the U.S. government can only borrow for so long. If it borrows without restraint, “the next thing you know, you’re Greece,” Kelton said, explaining the mindset.

But, Kelton added that these ideas are misguided. Figures from Warren Buffet to former Fed Chairman Alan Greenspan to Donald Trump have said that the U.S. is in no danger of default because it can print its own money and because of its standing in the world.

Not only is the U.S. not likely to default, but running a deficit is actually desirable, Kelton observed.

Citing the work of economist Wynne Godley, Kelton explained that the world economy is a closed system such that one entity’s deficit is another entity’s surplus. From the perspective of the U.S., the three main entities are the U.S. government, the U.S. private sector, and the rest of the world.

One of the reasons there is so much alarm about deficits is that we have steadily decreased expectations about the U.S. economy’s growth potential such that we wrongly believe that the economy is near its potential, Kelton suggested.

If, for example, the economy were where, in 2007, it was projected to be now, GDP would be $2 trillion higher than it is, noted Kelton. But, over many years, there have been successive downward revisions of potential GDP growth as the indicator repeatedly came in under where it was expected.

 “We painted a different picture and called it progress,” she said.

Now the question is whether the economy can continue to grow, and if so, how fast. Many economists are highly skeptical of Trump’s boasts that the economy will grow by 6 percent during his administration. Some say the higher growth rates could be achieved, but only temporarily, and the economy in the long run would be no better off.

Higher levels of sustained growth are possible, Kelton suggests, “but only if there is investment that improves productivity. That would begin to move the growth potential back up to where it was before the U.S. started lowering its expectations.”

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