Bill Mitchell-en Fiscal space has nothing to do with public debt ratios or the size of deficits
“(…) In this blog post, I discuss Jeffrey Frankel’s latest UK Guardian article (August 29, 2018) – US will lack fiscal space to respond when next recession comes – which was syndicated from Project Syndicate. Frankel thinks that the US is about to experience a major recession and that its government has run out of fiscal space because it is not running surpluses. We could summarise my conclusion in one word – nonsense. But a more civilised response follows.(…)”
(i) Enplegu osoa eta defizit fiskala1
(G – T) = S(Yf) + M(Yf) – I(Yf) – X
(iii) Superabit fiskala3
(iv) Ekonomia monetario modernoa eta espazio fiskala4
The facts are:
1. We can never conclude that the coexistence of a fiscal deficit and strong growth requires the government push back into surplus. Sometimes yes, usually no.
2. Fiscal space has nothing to do with what the current fiscal balance is or has been and what the current public debt ratio is or has been.
1 Ingelesez: “In this blog post – The full employment fiscal deficit condition (April 13, 2011) – which I consider to be core MMT, I showed the conditions that determine the fiscal deficit, once the government assumes its responsibility to achieve and sustain full employment.
The lessons, in summary are:
1. A macroeconomy is in a steady-state (that is, at rest or in equilibrium) when the sum of the injections equals the sum of the leakages. The point is that whenever this relationship is disturbed (by a change in the level of injections, however sourced), national income adjusts and brings the income-sensitive spending drains into line with the new level of injections. At that point the system is at rest.
2. The injections come from export spending, investment spending (capital formation) and government spending.
3. The leakages are household saving, taxation and import spending.
4. An economy at rest is not necessarily one that coincides with full employment.
5. When an economy is ‘at rest’ and there is high unemployment, there must be a spending gap given that mass unemployment is the result of deficient demand (in relation to the spending required to provide enough jobs overall).
6. If there is no dynamic which would lead to an increase in private (or non-government) spending then the only way the economy will increase its level of activity is if there is increased net government spending – this means that the injection via increasing government spending (G) has to more than offset the increased drain (leakage) coming from taxation revenue (T).”
2 Ingelesez: “So in sectoral balance parlance, the following rule hold.
To sustain full employment the condition for stable national income defines what I named the Full-employment fiscal deficit condition:
(G – T) = S(Yf) + M(Yf) – I(Yf) – X
The sum of the terms S(Yf) and M(Yf) represent drains on aggregate demand when the economy is at full employment and the sum of the terms I(Yf) and X represents spending injections at full employment.
If the drains outweigh the injections then for national income to remain stable, there has to be a fiscal deficit (G – T) sufficient to offset that gap in aggregate demand.
If the fiscal deficit is not sufficient, then national income will fall and full employment will be lost. If the government tries to expand the fiscal deficit beyond the full employment limit (G – T)(Yf) then nominal spending will outstrip the capacity of the economy to respond by increasing real output and while income will rise it will be all due to price effects (that is, inflation would occur).
What that means in relation to the issues I identified above is that there is a difficulty in defining pro-cyclicality in terms of a given fiscal balance.
It is nonsensical to say a fiscal surplus is always pro-cyclical and a deficit is always counter-cyclical. It all depends on the spending and saving patterns of the non-government sector.
We can only really appraise the impact of the fiscal balance in terms of changes at specific points in the cycle.
So if an economy was at full employment and the fiscal deficit was, say 2 per cent of GDP and that satisfied the condition specified above.
That is not a pro-cyclical position even if the economy is growing – it is maintaining a steady-state growth path.
Should the government, with no other changes evident, increase its net spending to say 3 per cent of GDP, under those circumstances, we might consider that a pro-cyclical policy change because it is pushing the cycle beyond its full employment steady-state growth path.
So the fact there is a fiscal deficit coinciding with strong GDP growth should not be taken as a case of irresponsible and dangerous policy.”
3 Ingelesez: “What about running surpluses when recovery is apparent?
The same logic holds. It might be that the non-government spending and saving decisions drive overall spending so fast that total spending then starts to outstrip capacity.
Then, to restore the full employment steady-state (and this also requires stable inflation), the fiscal stance has to contractionary – which might require a fiscal surplus.
For example, nations such as Norway will typically solve the Full-employment fiscal deficit condition with a fiscal surplus given how strong their external sector is (energy resources).
The second issue relates to Jeffrey Frankel’s notion of ‘fiscal space’.
I considered that issue in these blog posts:
1. Fiscal sustainability 101 – Part 1 (June 15, 2009).
2. Fiscal sustainability 101 – Part 2 (June 16, 2009).
3. Fiscal sustainability 101 – Part 3 (June 17, 2009).
Frankel claims that the:
The US deficit is being blown up on both the revenue and expenditure sides … As a result, when the next recession comes, the US will lack fiscal space to respond.
The next recession, when it comes, will coincide with millions of workers in need of jobs, capital equipment lying idle, and other productive resources looking for a buyer (user).”
4 Ingelesez: “That is what fiscal space relates to in a modern monetary economy.
It has nothing to do with what the current fiscal balance is or has been and what the current public debt ratio is or has been.
A sovereign government can purchase any idle resources that are for sale in its own currency, including all idle labour.
That is the fiscal space the US will have.
And, it can never run out of funds to do that.
So a past deficit poses no particular constraints on what the US government can do in the future, except to say that if the deficit has been properly calibrated to satisfy the Full-employment fiscal deficit condition then there will be less to do should the private sector contract.
The rest of Frankel’s article is irrelevant to this discussion.
The questions that the US policy makers have to answer are:
1. How close the economy is to being at full capacity – labour, capital and other productive resources.
2. If, it is, is the current net public spending position driving total spending beyond the Full-employment fiscal deficit condition.
My assessment of Question 1 is that there is still some idle capacity in the US economy. Just look at wages growth and the broader indicators like participation rates.
There is a massive public infrastructure shortfall – in terms of quality and scope.
Inflation is benign as is wages growth.”