Paul Sancya/AP Photo
A sign of economic damage in Detroit
This is part of our economists roundtable on the corona crisis.
Recent Headlines from The Financial Times:
U.S. taps market for stimulus funds at historically low rates (April 3)
How central banks beat back the ‘bond vigilantes’; unlimited bond buying has made it near impossible for investors to punish overspending (March 31)
Fed sets up scheme to meet booming foreign demand for dollars (March 31)
The toothless inflation peril; price pressures are no reason to pull our policy punches (April 2)
China’s $13tn bond market shines as Treasuries turn treacherous (March 24)
Nothing has gotten the attention of the political and economic establishment like two back-to-back crises with the potential for Great Depression–level economic devastation. The first time around, President Obama, Larry Summers, and the other situational hawks, as Kuttner calls them, drew the reins around government spending fairly tightly and pulled them back just as soon as the serious hawks and the Obama haters shouted “boo.” This time, with a re-election obsessed, debt-ridden real-estate developer at the helm, the coronavirus consensus is “Spend, Spend, Spend,” as I wrote recently in Dollars&Sense. It is reasonable to ask, how long will these neo-Keynesian “foul-weather friends” support the needed massive deficit spending on this crisis? And looking ahead, will they try to pull the reins back in on other major social needs, including the fight against climate change?
More importantly, hawks aside, what is the right way for the U.S. to think about these questions? How big can deficits be? For how long can they continue? And for what purposes should they be incurred?
We can start by looking at the evidence. The definitive empirical analysis bearing on these questions is the work of my colleagues Michael Ash, Deepankar Basu, and Arin Dube.
Building on the critique of “the public debt cliff” by Thomas Herndon, Michael Ash, and Robert Pollin, they rigorously analyze data on public debt and economic growth for 22 developed countries from roughly 1880 until 2011. They assessed the claims in a number of research papers that high debt has a negative impact on the rate of economic growth. They also assessed the claim that there is a debt cliff, when government debt gets to around 90-100 percent of GDP, above which economic growth will take a big dive. But, in fact, the authors find no sizeable negative relationship in the full sample extending as far back as late 19th century. Moreover, they find no cliffs at all. And most relevant, they find that in the recent period, since 1970, “The relationship between government debt and economic growth is essentially zero.”
In short, the claim that high levels of government debt cause catastrophic economic outcomes simply lacks evidence.
Does this mean that for rich countries, the sky is the limit for government debt? Not necessarily. The highest ratio of debt to GDP in their data set is around 160 percent. What if debt levels go much higher outside of this range? The historical data cannot really tell us the answer. This is one reason we need to consider other factors specific to the situation at hand. These cross-country empirical studies necessarily mask specific conditions such as the cause of the debt accumulation and the domestic and international context.
The current specific environment in the U.S. is well narrated by The Financial Times quotes at the top. These are the conditions that most Keynesian economists agree can lead to benign large deficit spending for a significant period of time. When inflation is under control and relatively low, there is excess capacity in the economy or resources that can be reallocated to more productive ones, such as health care; the interest rates at which governments can borrow are well below the returns that society will get from government-spending programs; and the financial assets that the government issues to pay for these activities, be it money created by the Federal Reserve or debt (like government bonds), are in sufficient demand around the world that they will not be dumped in response to the attempts by the government and the Fed to send even more of these financial instruments into the portfolios of the world’s banks, governments, households and markets.
But none of these conditions are necessarily forever. Will investors and governments around the world be willing to accumulate and hold on to more and more U.S. dollars and dollar denominated IOUs? To be sure, the U.S. dollar is currently the dominant international currency and during crises, such as this, the global demand for dollars soars. But as the final FT quote above suggests, this is not necessarily permanent. China is working hard to make the renminbi a major key currency; and continued fumbling by the Trump administration on the global stage is giving them more and more opportunities to succeed.
Low interest rates, moreover, are not permanently feasible in the absence of strong financial market regulations. Combined with weak regulation, low rates eventually lead to financial crisis, as the current corporate-bond meltdown shows. And low inflation is not a permanent feature of capitalist economies. Shortages associated with climate change–induced droughts and food-production problems, among other factors, are bound to impact inflation over the coming decades. Higher and variable inflation can be managed but does impact the ability of financial markets to absorb low yield instruments such as money, and low interest government securities.
The need to take into account such situational factors when analyzing policies such as deficit spending constitutes a major difference between my perspective on how to analyze deficit spending, and the positions sometimes taken by Modern Monetary Theorists. What determines how big deficits can be and for how long requires close situational analysis, and cannot be inferred from first principles as MMTers try to do.
But, perhaps more important, issues of financing and full employment are not the only important potential constraints on spending. Even if had a lot of excess capacity, and even if the Fed could print as much money as it wants, it would still matter crucially what the government spends these dollars on. That is because, among other matters, unlike in Keynes’s time, we are now faced with a binding carbon budget, a climate change imperative. Now, free-lunchism doesn’t work, even from a Keynesian perspective.
That is why the question Kuttner asks about the amount of stimulus we get from different kinds of spending and tax cuts is not really the right question now. In the face of the pandemic, and in the grip of an ever-worsening climate crisis, we need to be talking not about a stimulus program, but rather a social protection and green transformation program. As my colleague James Crotty has shown in his masterful book on Keynes, Keynes Against Capitalism: His Economic Case for Liberal Socialism, even during the Great Depression, Keynes’s central argument was that in order to deal with the economic, social, and political crisis at hand, public spending and central bank policy needed to be directed not only at full employment, but, even more importantly, toward the social control and allocation of credit and investment to transform the British economy so it could meet the challenges of a new epoch.
In short, it matters enormously what we spend these trillions of dollars on. Simply insisting that we can do it without the bond-vigilantes getting us doesn’t get us far enough anymore.
