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Stephanie Kelton and the Catfood Commission: “I know which scenario benefits me. Do you?”

letsgetitdone's picture

In a beautifully simple post that should crystallize everything for you, Professor Stephanie Kelton of the University of Missouri at Kansas City crystallizes the logic of the Sectoral Financial Balance Model for President, Obama, the Catfood Commission, the deficit hawks and doves and you and me. She says:

In a 'closed economy' (one without foreign trade), the government's budget position is, by accounting logic -- the negative of the private sector's (firms and households combined) position. Thus, a public sector DEFICIT is equal to the private sector's SURPLUS. To the penny.

So, in a closed economy, a Federal Government budget deficit adds to private sector financial assets, while a Government surplus represents a leakage and subtracts financial assets from the private sector. Or more briefly, Government deficits make private individuals richer; Government surpluses make private individuals poorer.

Of course, we don't have a closed economy, we have an open one. We have to consider the foreign trade sector too. So:

. . . like a government SURPLUS, a trade DEFICIT reduces the private sector SURPLUS, which creates an even bigger need for a public sector deficit.

Or, in other words, a trade deficit makes the private sector poorer in financial assets, while a trade surplus adds to private sector financial assets. Combining all three sectors and the current condition of the United States, Stephanie concludes:

As long as we (Americans) continue to run trade deficits, there are only two options: (1) the government runs deficits (and they must be at least as large as the trade deficit), or (2) the rest of us do. I know which scenario benefits me. Do you?

I think that most of us, including the President and all the other hawks either don't, or are deliberately trying to make people poorer, or there wouldn't be any Catfood Commission. Think about it. The Catfooders want to reduce or eliminate the deficit and one day even get to a surplus. And they want to do that by implementing cuts that will take effect on a time schedule without regard to economic conditions at that time.

So, Government spending is to be cut beginning in 2012. But what if we're not out of our sick economy then and still have high levels of unemployed? Then we'll be taking away demand from the private sector and, assuming we still have a trade deficit, condemning the economy to either a downturn, or a private debt-financed expansion (credit bubbles again). And what if we're still in a depressed state by 2015? Then we'll be facing mandated spending cuts of $427 Billion or so (according to Jan Schakowsky's new “progressive” deficit reduction plan), at a time when we will still need the additions to private sector financial assets that Government deficits provide.

Even worse, larger cuts over the years proposed by the Commission will provide a continuous drag on the economy and the well-being of our children and grandchildren without regard to current economic conditions in the out tears. The insanity of the Catfood Commission and the deficit hawks is that Government economic policy ought to be put into a framework of constraints by us now without regard to economic conditions that may obtain in the future. This is an engineer's newtonian approach to the economy. The economy, however, is a complex adaptive system and both it and we have to adapt as we go along.

Our most important tool for adaptation is the capability of the Federal Government to add financial assets to the private sector when demand is slack and those assets are needed, and to subtract such assets by taxing when demand is overheated and we see inflation. These powers of the Federal Government should never be constrained or compromised on the basis of a long-term plan of any kind, because they are our most important tools for coping with unexpected and unwelcome change.

The President, the deficit hawks, and even the deficit doves, by focusing on a non-existent long-term debt/insolvency fantasy (see Stephanie Kelton on solvency too), rather than trying to produce full employment and price stability in the here and now, don't know what's good for them and us. We need them off our backs. They're the problem; not the solution!

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

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Submitted by gob on

I'm thick about these things. I'm still working on the "why" of the accounting identity. Is it true that, given a closed economy, we could slice it into two parts by any criterion whatsoever, say entities with names beginning with A-M and versus those with names beginning with N-Z, and it would be true that any deficit run by the A-M group would equal (to the penny) the surplus of the N-Z group?

If the answer is yes, there will be much mental rejoicing and I'll reread Jamie Galbraith's book.

letsgetitdone's picture
Submitted by letsgetitdone on

Also if one of the sectors has a Government running a non-convertible fiat currency system with a floating exchange rate and no debt in a currency not its own, then that sector can run a deficit without needing to finance it by borrowing money. It can simply spend what it wants to and ignore the deficit, which is just an accounting artifact having no practical effect until the deficit creates enough demand in the non-Government sector to fully employ all the productive capacity in the non-Government sector.

katiebird's picture
Submitted by katiebird on

It kind of feels like we're living in the opening chapters of a doomsday story.

(one correction, I'm sure she's at University of Missouri at Kansas City).