Monday, October 08, 2012

Deficits and Growth

An outstanding question I've been thinking about is whether ever larger deficits are a requirements for economic growth. On the one hand, you can certainly have larger deficits without growth. On the other hand, as an economy increases its real assets, does it demand a larger quantity of net financial assets (equity), and if that demand is not met, does the economy begin to contract and save in the form of unemployment and unwanted inventory stockpiles? As there is only one source of NFA(e), it would follow that if the last statement is true, then we need ever larger deficits.

A different approach to this question via Sankowski:
...should an economy ever reach stationary equilibrium, all stock variables as well as all flow variables would be constant; and that if all stock variables, including government debt, were constant, government receipts would have to equal government payments. It would then follow that if the economy were moving toward stock-flow equilibrium and if taxes were levied as a proportion of income, the GDP of a (closed) economy would always be tracking, perhaps with a long lag, government outlays divided by the average tax rate – the very same concept that we call fiscal stance. Therefore, a necessary condition for the expansion of the economy, at least in the long term, is that the fiscal stance should rise: Government expenditure must rise relative to the average tax rate. If the tax rate were held constant, government expenditure would have to rise absolutely for output to grow; if government expenditure were held constant, the tax rate would have to fall.
Some important notes. First, it is obvious that real wealth can increase with no deficits at all, and this note does not seem to make a hard real/nominal distinction. The question is, in a fiat economy where there is demand for NFA(e), if that happens. Second, the model above has taxes (NFA drains) as a % of income -- for obvious reasons -- but NFA drains can be levied in other ways that make the particular dynamic this argument relies on moot.  Third, the model assumes demand for NFA(e) is constant, which begs the question I raised initially.

Still, interesting, and interesting to see a critique of Steve Keen outside the standard one of not including vertical money at all.


Blogger Ralph Musgrave said...

Re the “notes” in your 2nd last paragraph, your first “note / question is, “in a fiat economy where there is demand for NFA(e) . . . can real wealth increase with no deficits at all”. The answer is “yes” and for reasons given by Pigou. What would happen is that prices would drop, which would increase the real value of Nfas till that real value was at the desired level. That’s the “Pigou effect”.

But meantime there’s be relatively high unemployment.

Re the third “note / question” – does the desired level of nfa increase with a general increase in output per head, the answer has to be “yes”, doesn’t it? The average person nowadays wants more nfa than the average agricultural peasant five hundred years ago, and if output per head continues to increase, the trend will presumably continue. (Though the environmental effects of continued growth don’t bear thinking about.)

2:30 AM  
Blogger Dan Kervick said...

I think some of this depends on what you mean by "deficit", and how we define the "G" and "T" terms in the usual accounting equations. From an MMT perspective, you need to look at the entire consolidated government balance sheet.

That means we need to look at payments to the central bank (interest payments on assets held by the CB, purchases of assets owned by the CB, etc.) You also need to consider payments from the central bank - purchases of assets, interest payments on reserves etc. Let's call the first set of payments CB(in) and the second set of payments CB(out).

If we assume that "G" and "T" refer only to payments from and to the treasury, then we need to add in CB(in) and CB(out) to the government sector term in Godley's equation to get:

(I - S) + [(G + CB(out)) - (T + CB(in))] + (X - M) = 0

On the other hand, if we assume that G implicitly includes CB(out) and T implicitly includes CN(in), then we don't need to alter the equations.

So it is possible in principle that NFAs are increased over time solely by the central bank side of the equation. If CB(out) - CB(in) = $10 billion in Year One, and continues in that way for every year up to and including Year Ten, and if the government balance G - T is exactly zero in each of those ten years, then there is still a net government injection of $100 billion in financial assets.

However, we see that at least during certain times of low aggregate demand, growth cannot be fueled by the banking sector, and CB-engineered increases in commercial bank assets may have no real economic effect and simply pile up as excess CB reserve balances. Injections NFAs into the private economy might slosh around entirely inside the financial sector and not make their way into the real (non-financial) sector.

It seems to me that an economy can grow for a period without a net increase in financial assets. But if it does this over any extended period of time, it will suffer price deflation and the ills that go with it. On the question of growth without treasury deficits, I guess it all depends on whether you think it is possible for all growth to be bank-financed.

6:45 AM  
Blogger winterspeak said...

Ralph: I don't know if demand for NFA(e) increases with output per head. It is possible that the savings desire could be met by real assets. In third world countries, rich people do not demand more savings in the currency of that country -- they instead save in gold, land, or $USD.

Dan: I think in the Solow model that article is in reference to, the CB is considered part of a consolidated Government sector.

And whether or not growth can be entirely bank financed depends on whether demand for NFA(e) goes up or not (which is the central question) as bank financing cannot generate NFA(e).

9:41 AM  
Blogger paul said...

What in the world is "real growth"?

Sure, real stuff is produced, and as long as there are sufficient balances in the hands of consumers that stuff may have "value". Value can and does evaporate overnight, so it's a stretch to say value "grows". More like "value" is leveraged.

Without spending balances, much of that stuff would be worthless, so it exists and I suppose "growth" took place but so what?

What would growth in "Edsels" mean? Growth in inventory? Is that meaningful in any way?

Basically we take existing resources and change their "form" through "work", but nothing has been created. Matter is conserved. Energy is conserved.

6:34 AM  
Blogger kalmar said...

Nicolai Hähnle argued for a long-time budget deficit, unfortunately only in german. But maybe google-translate can help you? He produced some figures you could understand without german though.

His assumptions are constant growth with a balanced budget and then see what happens to the amount of NFA (it stays constant of course). But the amount of NFA in percent of GDP is getting lower and lower and this might not be a good idea.

Netto-Geldvermögen = NFA

12:13 AM  
Blogger kalmar said...

Forgot the link:

12:14 AM  

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