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Why not cut the deficit?–answering a noneconomist’s question

A friend sends an investment advice newsletter from a broker-economist type. The letter–a propos of the current effort to ramp up tax reform work in Congress after the health-care flop–discusses debt and the deficit in the United States. Typical of the deficit hysteria-entitlement reform camp, the article mentions amounts amounts of  government debt per U.S. resident, drawing an analogy to debt taken on by a household or business. It argues that the bulk of expected spending is taken up by “entitlements” such as Social Security and Medicare and hence that cuts in these programs are needed. I subscribe to the modern money theory (MMT) position that this frequently heard line of argument is faulty as a way of thinking about questions in U.S. budget and tax policy. Why in my view would a good economist of  any type find such arguments wrong in the context of the United States?  Here is my (slightly edited) response to my friend, who has a Ph.D. in another subject.

Thanks for sending the article. My reaction may or may not surprise you. The views expressed about the federal deficit in the piece reflect a misunderstanding of their meaning in my view.

The analogy to debt that a household must pay off is false, or at least misleading. Federal government debt is not in any way similar to debt incurred directly by a household. Consider the following:

1) The federal government never pays off its debt. Maturing government securities are routinely rolled over. In other words, new debt is sold to pay off old debt. Hence it will almost certainly not be paid back by the end of the lifetime of you, me, or any other particular U.S. resident.

2) Government bonds are not issued to “finance” spending–perhaps a surprising idea. In essence, paying the U.S. government’s bills is not contingent on such sales. The fact that there is much federal debt reflects the preferences of investors and traders around the world, more than a need to issue debt to pay for things, as a business might for example have to do. If debt holders wish to sell their debt, generally it is purchased routinely by the banking system and ultimately the Federal Reserve. This is a system in essence developed by England centuries ago.

3) I use the term federal debt, because the analysis above does not apply to U.S state and local governments or to some countries with different kinds of monetary systems. The latter include countries in currency unions such as the euro area and countries that peg their currencies to the dollar or some other major reserve currency. They do face a different situation than the U.S. government.

4) The government deficit plus the “deficit” run by the private sector is equal to the current account deficit of the country. It is often a mistake to analyze one or two of these deficits without considering the implications for the others.

The view above is a quick reaction based on a set of views known in the blogosphere and elsewhere as MMT. There is more that can be said, including caveats for countries with debt in foreign currencies. Here is an interesting MMT blog. For other resources on the worldwide web, you might have a look at the link page at my site.

By the way, in this quick critique of an “exploding government debt” school of thought on the federal government budget, I have mentioned the term “entitlements,” as in “entitlement reform.” It may be of interest that this is a relatively new (1970s-vintage) term, developed by people who were trying to reform (cut spending on) entitlements–and not a term with deep historical roots in, say, the founders of U.S. constitutional thought or old intermediate macroeconomics textbooks.  Here is the interesting “word story” from the New Yorker a few  years back–a bonus link for those reading the story at this blog. 


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