Download Deficits Saved the World (And then Went AWOL)

Deficits Saved the World
(And then Went AWOL)
Stephanie Kelton, Ph.D.
Economists for Peace and Security, Bernard L. Swartz Symposium
Hyatt Regency Capitol Hill, Washington DC
November 17, 2014
Who (or What) Saved Capitalism?
• Great Recession and
not GD 2.0
• Minsky (1982) Can
‘It’ Happen Again?
– Could but need not
– Big Gov & Big Bank
GFC
• Began in 2007 as a liquidity crisis
• Triggered when credit markets seized up and “shadow
banks” like Lehman Brothers and Bear Stearns found it
impossible to refinance their positions in assets
• Next came the wave of insolvencies that led to the failing or
shoring up of a large number of home mortgage specialists
like AIG and Merrill Lynch
• The world watched as central banks around the world
sprung into action to contain the unfolding crisis in the
financial system
“Big Bank” Response
• LOLR
– Domestically and internationally
• TAF provided funding to US banks
• Swap lines with other central banks for financial
institutions in other jurisdictions
– Peaked at $580b
• Open-ended liquidity provision by Big Bank
– $29T?
“Big Government”
• Winter ‘08 job losses 800k/mo
• Feb. 17, 2009 ARRA
– $275B tax cuts and $500B+
increased spending
• 3-year “stimulus”
• White House hails it
unequivocal success
– Saving or creating 1.6m jobs
(Romer & Bernstein, 2009)
• Deserved?
Matthew O’Brien, The Atlantic,
Feb.20, 2014
stimulus signed
Deficits Saved The World
• But not ARRA
• Krugman: the autostabilizers did the heavy
lifting
• Minksy and Godley
• Stabilizing Role of Big
Govt
• Deficit as source of NFAs
Private Sector Financial Balance
• Private sector’s financial
balance deteriorated over
much of the 90s
• By ‘97, it had forsaken its
habitual state of surplus
• The crisis unfolded at a
time of record private
sector indebtedness
13.13%
Figure 1: U.S. Private Sector Balance (% GDP)
1952Q1 - 2007Q4
8.75%
4.38%
0.00%
-4.38%
-8.75%
1952119572196231967419731197821983319884199411999220043
Deficits Saved The World
In the 1930s the public sector was very small…This time
around, the fall in GDP didn’t have to be as large, because
falling GDP led to rising deficits, which absorbed some of
the rise in the private surplus…The initial shock – the surge
in desired private surplus – was if anything larger this time
than it was in the 1930s. This says that absent the absorbing
role of budget deficits, we would have had a full Great
Depression experience. What we’re actually having is awful,
but not that awful – and it’s all because of the rise in
deficits. Deficits, in other words, saved the world.
~Paul Krugman, 2009
A “Passive” Fiscal Response
I look at this through the lens of sectoral financial
balances…The idea that the huge fiscal deficits of
recent years have been the result of decisions taken
by the current administration is nonsense. No fiscal
policy changes explain the collapse into massive
deficit between 2007 and 2009, because there was
none of any importance. The collapse is explained
by the massive shift of the private sector from
financial deficit into surplus…The government
responds in a largely passive way.
~ Martin Wolf, 2012
Deficits Exploded Endogenously
Facilitating Deleveraging
• Figure 3: Private Sector vs. Public Sector Balance (% GDP)
1952Q1 - 2013Q3
12.25%
6.13%
0.00%
-6.13%
-12.25%
-18.38%
19521 19552 19583 19614 19651 19682 19713 19744 19781 19812 19843 19874 19911 19942 19973 20004 20041 20072 20103
Fiscal deficits are facilitating the private sector’s desire to save more, delevering
their balance sheets. Remember, the government sector’s liability is the private
sector’s asset!
Paul McCulley, 2010
Helping to Heal Balance Sheets
• Deficits are a flow of funds that increase the stock of
NFAs to the non-government sector
• Deficits (flow) accumulate to financial debt (stock)
• But deficits have a counterpart in terms of
accounting, showing up as surpluses in some other
part of the economy
• Deficits provision non-government with net
financial assets
The Fiscal Retreat
• Fear of ending up like the so-called PIIGS
• Hardest hit blew through Maastricht limits
• Markets developed an aversion to bonds of
highly-indebted nations
• Risk premiums soared
• The bailouts began
– Greece €100B in May 2010 and €130B in Feb 2012
– Ireland €67.5B in Nov. 2011
– Portugal €78B in May 2011
The Fiscal Lurch
• Obama orders creation of
deficit reduction
commission (2010)
• Meanwhile, deficit quietly
falls
• By 2012, CBO reports
shrinking fastest pace
since demobilization
• Without any effort to
reduce it!
A Cry For Help
• While Congress fought over
ways to reduce the deficit, many
worried that fiscal had become
too tight
• In testimony before Congress,
Bernanke confessed:
“Monetary policy is not a panacea.
It’s not even the ideal tool. I’d like
to see other parts of the government
play their roles.” (June 2017)
The Monetary Plunge
• Growing pressure on the
Fed as ‘fiscal cliff’
approached
• Woodford (August 2012)
Jackson Hole
• By September, Bernanke
had gone all-in
– Open-ended bond-buying
(QE3) and “forward guidance”
2013
• Likely to be the subject of debate for years to come
• Fiscal policy tightened as government raised taxes
(effective Jan. 1) and initiated more than $1T in
spending cuts (the “sequester”) beginning March 1
• Austerity had come to America
• Forecasters predicted slowdown 0.6-1.5% of GDP
• Bernanke urged Congress to consider a more gradualist
approach to deficit reduction
• Yet growth accelerated from 2% to 2.6% in 2013
Why?
• Were the fiscal headwinds
exaggerated?
• Was this proof that
austerity worked?
• Had Bernanke been too
pessimistic about the
power of monetary policy
at the ZLB?
• Had monetary policy saved
the world?
Emerging Consensus
• Monetary policy can counteract fiscal tightening, even at
the ZLB
• Worked primarily through “wealth effect” as investors
reached for yield, driving up prices across a range of asset
classes (esp. equities, housing and corporate bonds)
• Disproportionately benefiting those at the top of the
income ladder
• May have laid the groundwork for the next crisis by
encouraging too much risk-taking
Yellen
[M]onetary policy has powerful effects on risk taking.
Indeed, the accommodative policy stance of recent
years has supported the recovery, in part, by
providing increased incentives for households and
businesses to take on the risk of potentially
productive investments. But such risk-taking can go
too far, thereby contributing to fragility in the
financial system.
~Janet Yelln, July 2014
Dangerous Lessons
• If we just “normalize” rates, then we can go back
to using conventional monetary policy to
stabilize the economy
• New Consensus is new again
• Fiscal policy isn’t really necessary
• When the next crisis comes, the Fed has shown
that it has an effective toolkit at its disposal
• Fiscal policy isn’t really needed
Fiscal Ambitions
• Must go beyond allowing deficits to cushion downturns
• Need a renewed interest in (and commitment to) fiscal
policy if deficits are truly going to save the world
– Climate
– Joblessness
– Inequality
– Infrastructure
– Education
– Innovation/Research
Thank You