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Home Publications Blogs Beat the Press How Is It Silly to Ask If Higher Deficits Will Have a Negative Impact on Growth?

How Is It Silly to Ask If Higher Deficits Will Have a Negative Impact on Growth?

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Wednesday, 05 June 2013 05:13

Clive Crook told readers in a Bloomberg column that:

"It’s silly to ask whether high public debt causes lower growth or vice versa as though it must be one or the other. Almost certainly, both are true. This reinforces the case for fiscal consolidation as the recovery strengthens -- not just to restore fiscal room for maneuver but also to support longer-term growth."

Both parts of this statement are close to ridiculous. How do we know that higher debt everywhere and always leads to slower growth; because Clive Crook asserts it? What is the logic? In the prior paragraph Crook gave the traditional crowding out story, with high interest rates crowding out investment and other spending, but in the sort of severe slump that we are now seeing crowding out is not an issue. So how do we know that higher debt will slow growth?

Furthermore, Crook apparently has never heard of a balance sheet. If there is a curse of debt, then all countries (the United States in particular) have an enormous amount of assets (e.g. land, fishing rights, carbon emission permits) that can be sold to reduce debt. Since he claims that debt has a negative impact on growth it would be possible to avoid this negative impact through a sale of assets that would reduce the debt.

But the real absurdity is Crook's blanket assertion that "it is silly to ask." Let's go a step further, it is unbelievably silly not just to ask, but to try to quantify. Suppose that debt does indeed have a negative impact on growth and for some bizarre reason we can never sell assets. In order for this to be relevant to policy we have to know how much.

The original Excel spreadsheet error cliff implied a growth penalty of more than 1.0 percentage point for having debt-to-GDP ratios in excess of 90 percent. That would be a powerful argument against allowing our debt to rise above this level. But now that the Reinhart-Rogoff debt cliff has been destroyed by accurate arithmetic, we don't know the size of the growth penalty from high debt, even assuming that it is not zero.

Suppose that the penalty is 0.01 percentage point. Would this be a strong argument against policies that might quickly employ millions of workers? Probably not in most people's books, but hey, serious people like Clive Crook says it's silly to even ask such questions.

 

Note: "Crook" is now correctly spelled.

Comments (20)Add Comment
When Media Journalists Regress to an Idiotic Closed Loop of Circular Redundancy
written by Last Mover, June 05, 2013 6:33
This column by Clive Crook could just as well read as follows:

Assume there is water in the tank. Sometimes there is not enough water, sometimes there is too much water, and sometimes there is just the right amount of water.

When water is drained from the tank there is less water unless more water is put in to replace it. When water is added to the tank there is more water unless more is drained to take away what was added.

Therefore it is silly to ask whether the level of water in the tank is determined by the water coming in or the water going out because it's always both.

Specifically, any idiot columnist can see that with a little effort, all of macro-economics is readily reduced to elementary engineering mechanics of flow analysis that change the size of a stock up or down over time.
It's Crook
written by Sandwichman, June 05, 2013 6:36
Clive Crook
Larger Costs to Austerity Are Ignored
written by Juan, June 05, 2013 7:03
Clive Cook obviously has not done his homework.

Anyway, there seems to be serious omissions to the discussions on socio-economic impact of austerity. When authors discuss austerity they fail to quantify the actual costs when, for example, the severe cuts to the education system in Chicago which were recently announced by the city leadership. Sure, we get how much the school system is in "debt" and we also understand how the city will impose the remedies. But what is not quantified are the costs for short changing the kids education. The socio-economic costs are missing.
...
written by Mark Jamison, June 05, 2013 7:03
I'm skeptical of the crowding out argument because it seems to presume a fairyland of perfectly free markets where government is not just another entity but ever and always an evil and inefficient entity.
In the modern world government is a necessary entity with varying efficient and inefficient impacts, sometimes both at once depending on perspective. For example, Dr. Baker often points out the inefficiencies of patent and other intellectual property systems. If you're a drug company you might consider the current system, not necessarily efficient but perhaps effective. Government spending supports a considerable amount of consumption which otherwise might not occur. Without Social Security many seniors wouldn't be very active in the economy. Without government spending supporting medical care there might be a whole lot less of it; and less innovation as well. Without infrastructures provided by government there would likely be significantly more rent seeking (for an example of this we have a real life experiment as we watch the Postal Service disappear) and it's likely that valuable public goods would disappear with considerable negative effect.
Deficits, spent wisely, are investments that provide measurable returns. An alternative to deficits might be sufficient taxation which, again if invested wisely, becomes a form of savings. The argument that actions of government always crowd out more efficient uses is a sort of religiously held counterfactual that depends on an unerring faith that markets are always perfect and immune from human nature. Yes, there is a point where government crowds out or becomes all consuming but not anywhere near the levels of spending and taxation we currently see.
Deficits matter but not in the way that has become conventional thinking. When government becomes a means of ensuring privilege or a means to sustain plutocracy, when deficit spending is not investment but simply redistribution upward (see Bush tax cuts), when deficits become a means of crowding out public goods, useful services, or serve as a means to contract basic safety nets, then yes they are unproductive. But worrying about deficits while millions remain unproductively unemployed seems a wholly inefficient way of reducing the productive capacity of the economy, particularly when the intent is to assure the reservation of growth and profits to the selective few.
Crook has it backwards
written by Matt McOsker, June 05, 2013 8:02
1) The R&R paper is utter nonsense that compares apples with oranges - e.g. fiat currency issuers to non-issuers.

2) The following formula (Last Mover, this is the formula for your water tank):
(G-T) = (S-I) – NX

G = Gov Spending
T = Taxes
S = Saving
I = Investment
NX = Net Exports

The two sides must be equal. If you reduce the left side, then the right goes down as well - lower private savings. Lower deficits crowd out, not higher deficits. This is because higher deficits increase private savings.

We only need to increase taxes, and reduce spending if we have an inflation problem. We do not have an inflation problem. Even if inflation was 5% - I'd say right now that is not a problem.
...
written by JSeydl, June 05, 2013 9:01
Can I please make a very simple point about this whole silly debate?

The assertion that high debt is associated with weak growth tells us nothing whatsoever. In fact, it just tells us what the definition of a fraction is. Because we define "debt" as a country's debt-to-GDP ratio, the fact that there is a negative relationship between debt and growth is definitional - in the same way that in the definition of every fraction, reducing the denominator always increases the value of the fraction.

What I'm trying to say is that without the finding that there is a certain debt threshold above which growth slows sharply, R-R have absolutely nothing. They claim that they still have a negative correlation between debt and growth, but that tells us nothing that we didn't already know. If R-R simply repeated the definition of a fraction in their original paper, would it have been published in the AER?
Naming Names
written by Jeffrey Stewart, June 05, 2013 9:10
I always thought it was Clive Cook, but after that column Crook is much more accurate.
JSeydl - R&R ignored too much
written by Matt McOsker, June 05, 2013 9:41
JSeydl - R&R ignored important factors such as trade deficits and surpluses which greatly effect sectoral balances.
Summers on Weed
written by tyler healey, June 05, 2013 2:20
Recently, Larry Summers said the following to Congress: "Fortunately, ... the debt-GDP ratio is now expected to decline through 2020."

Summers probably still thinks a balanced federal budget is a good idea.
Other options ...
written by Bashera, June 05, 2013 3:13
Crook has it backwards
written by Matt McOsker, June 05, 2013 8:02

...
(G-T) = (S-I) – NX
...
The two sides must be equal. If you reduce the left side, then the right goes down as well - lower private savings. Lower deficits crowd out, not higher deficits. ...


Good point. I'd also add that the right side might reduce through increased investment or increased net exports as well. And indeed I think we've seen all three: S has decreased (which on top of the SS issue, should cause VSPs some concern), I keeps rising (makes the majority of the right hand side adjustment), and NX rose (sliding again the past year). In any event, it's all in all a hugely wasteful strategy. I thought conservatives hated waste?

S probably can't drop much lower, NX won't go up much more (strong dollar conservatives say so), so it mainly goes into I, but that's slowing. So the moment of truth is arriving. Someone's going to have to make a Decision. Maybe it will be Obama and Congress?

The Nail
written by nassim sabba, June 05, 2013 9:07
"accurate arithmetic"

That says it all. It is such a mind bogglingly difficult subject to learn. Numbers and the cross sign and hyphen and that slanty thing too. Add to it when the cross is sometimes turned on its side, and looks like an x, as in X-men. Let alone when you put the two circly things on either side of the slanty thing. Wow, arithmetic is hard, let alone an accurate one. It can destroy wealth, if you are not looking.
Silly is as silly does
written by Capt. J Parker, June 05, 2013 11:52
I'll grant that Crook makes a flat assertion about debt causing low growth. But the two counter arguments are equally silly. If you build up huge debt in a downturn there's nothing to prevent crowding out when you'er back at full employment. You have to believe short term stimulus (if it works) ALWAYS trumps long term growth for that argument not to be silly. The balance sheet argument is worse. Why, oh, why would Greece, Spain, Italy, Cyprus or any Euro country, unable to do their own monetary policy, not simply sell assets to retire debt rather than suffer austerity like they are doing? Could all those peripheral Europeans be that silly?
Huh?
written by squeezed turnip, June 06, 2013 8:00
Silly is as silly does
written by Capt. J Parker, June 05, 2013 11:52
... If you build up huge debt in a downturn there's nothing to prevent crowding out when you'er back at full employment.


First of all, we won't be back at full employment until 2030 or so, at the current rate of recovery, so don't you worry your pretty little head, son.

As rates (still near zero) and employment begin to creep back up, then the debt burden needs to be paid down, via taxes on what can only hope will be higher incomes. That is a small price to pay for getting 10+ million people re-employed.

We have a long long time, given the current policies, before we have to get that debt down. But for those of us who think about the future, there is a way to get from now, with stimulus/deficit spending being a necessity, to then, where a lower debt is desirable, with a proper plan. They aren't mutually exclusive events. You buy the truckload of potatoes at a huge discount. Then you and your family store them and eat them over an extended period of years. Do you get sick of potatoes? Sure. But it's better than family members starving and you don't have to eat them all at once. Maybe if you'd lived through the Great Depression, you'd know this better.
I think we agree on the economics but not the politics
written by Capt. J Parker, June 06, 2013 9:04
Huh? written by squeezed turnip, June 06, 2013 8:0 As rates (still near zero) and employment begin to creep back up, then the debt burden needs to be paid down, via taxes on what can only hope will be higher incomes. That is a small price to pay for getting 10+ million people re-employed.
Glad we agree the debt needs to be paid down. We don't agree on the likelyhood it will be paid down. Rinehart-Rogoff point out that high debt seems to last a long time at least in the historical data. The US has shown no capacity to reduce debt since 1970 except briefly at the end of a long period of above average growth. So, there won't be a debt reduction anytime before we get whacked with the Boomer social security bill which will make ARRA look like chump change. Nope, any debt is here to stay and that means kiss those higer wages goodbye. Don't take my word for it, look at Italy through the 90s till now - debt ballooned and growth stagnated, leaving them with one mell of a hess. So, like I said, the argument isn't silly if you believe stimulus now always trumps growth later. I don't.
Crook has it forwards - reply to Matt Osker post
written by Capt. J Parker, June 06, 2013 11:26
(G-T) = (S-I) – NX

If G-T inccreases then any or all of the following must happen.
S increases. This means government is spending and the private sector is saving. Government consumption is CROWDING OUT private consumption. I'll spend my own money, thank you. I don't trust the government not spend on IRS boondoggles, Solyndra pipe dreams and foreign wars.
I decreases. This means government spending is CROWDING OUT private investment. Low investment can lead to low growth. So Crook can be right.
NX gets even more negative. This means that we are big time in debt with the Chinese or they buy our land, real estate or companies. Basically government sells us into foreign ownership. Ni hao ma!
I'll grant you there is a case to be made that stimulus financed by deficit spending can increase GDP but, the sectoral balance eguation doesn't prove that since sectoral balance treats GDP as extrinsic. Nice try though.
Capt Parker
written by Matt McOsker, June 07, 2013 7:50
Your first sentence was my point:
If G-T goes up than any one or combination of the right side increases - period. How the government spends is important to get the best results. Direct job creation is probably better than a tax rebate that might go to NX. If S goes up that means there is a demand for net financial assets from pensions etc. I is probably only going up if there is more demand.

If you cut G-T in half, what would happen in the private sector? They would be crowded out fighting over less private savings - they would be crowded out by lower G-T not higher.

PS - I would love to redirect military spending to domestic. Good discussion too.
Matt McOsker
written by Capt. J Parker, June 07, 2013 12:02
I thought your point was R-R are wrong by definition - that debt and deficits can’t hurt growth for a country with its own currency. I don’t believe you made that point at all. If (S-I)+ NX increases so what? This does not mean aggregate demand or GDP must increase. It all depends on what happens to consumption C. It is certainly possible that (for example) G increases, S increases, NX, I and T don’t change and that C decreases by the same amount that S increases. In that situation GDP doesn’t move. The increase in S goes to finance government borrowing to support higher G in excess of T. Even worse would be that I plus C decrease by the same amount G increases. In that event government spending is crowding out private investment and consumption (and still no increase in GDP.) That is a disaster for growth. There is nothing in the sectoral balance equation that disproves the idea that debt and deficits are bad for growth. That equation is really just an accounting identity. It does not predict how consumers (or aggregated consumers) will respond to an increase in G-T.

P.S. Sorry I got your name wrong earlier.
Capt Parker
written by Matt McOsker, June 07, 2013 12:23
It is more than an accounting identity, if you believe that is how net financial assets are increased in the economy through deficit spending. This is more in depth but better explains my position http://bilbo.economicoutlook.net/blog/?p=10384
Matt McOsker - be carefull with the MMT Kool-aid
written by Capt. J Parker, June 07, 2013 6:39
Oh, no, not just MMT but bad MMT!
From the link you supplied:
“First, the relationship between the government and non-government balances is just a matter of accounting. (by this I assume he means G-T=S-I +NX) But the accounting is just a measure of the underlying behaviour of the various economic sectors.”
The first sentence is correct. The second sentence is just dead wrong. The accounting is just accounting. If you want to determine what happens to GDP with deficit spending you need to model the underlying behavior of the economic actors involved. Keynesian Econ 101 will do something like this to model consumption C=Co + Cm(Y-T) where Co is subsistence consumption, Cm is the marginal propensity to consume (modeled as a number less than 1) and Y-T is disposable income. Plug this into Y=C+I+G and you get Y=1/(1-Cm) x (Co+CmT+I+G). Since Cm 1 this is the Keynesian multiplier. So the government spends a dollar an gets more than a dollar in increased Y. The sectoral balance equation won’t get you here. Here’s a more detailed treatment:
http://faculty.haas.berkeley.edu/arose/Macro8.pdf
Of course if you pick a different model for consumption, like one that has a correction because of expectations of future higher takes or future lower income you get a different multiplier and it may be less than one or even negative. The MMT dude you linked says some correct stuff but there’s just as much silliness there as you might find on the “hard money” blogs. If your heart is set on rooting for deficit spending Krugman is you man. I think Krugman is wrong in his views that government knows best but, he’ll never confuse an accounting identity with a behavioral model.
A correction Matt McOsker - be carefull with the MMT Kool-aid
written by Capt. J Parker, June 07, 2013 6:49
Sorry for my flub. Should have been:
Keynesian Econ 101 will do something like this to model consumption C=Co + Cm(Y-T) where Co is subsistence consumption, Cm is the marginal propensity to consume (modeled as a number less than 1) and Y-T is disposable income. Plug this into Y=C+I+G and you get Y=1/(1-Cm) x (Co+CmT+I+G). Since Cm is less than 1, the term 1/(1-Cm) is greater than 1 and 1/(1-Cm) is the Keynesian multiplier.

Check out http://swopec.hhs.se/hastef/papers/hastef0071.pdf for other ways to model consumption.

Enjoyed the discussion - CJP over and out.


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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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