Deficits Saved the World - PowerPoint Presentation

Slide1

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, 2014Slide2

Who (or What) Saved Capitalism?

Great Recession and not GD 2.0

Minsky (1982) Can ‘It’ Happen Again?

Could but need notBig Gov & Big BankSlide3
Slide4

GFC

Began in 2007 as a

liquidity

crisisTriggered 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

systemSlide5

“Big Bank” Response

LOLR

Domestically and internationally

TAF provided funding to US banksSwap lines with other central banks for financial institutions in other jurisdictionsPeaked at $580b

Open-ended liquidity provision by Big Bank

$29T?Slide6

“Big Government”

Winter ‘08 job losses 800k/mo

Feb. 17, 2009 ARRA

$275B tax cuts and $500B+ increased spending3-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, 2014Slide7

stimulus signedSlide8

Deficits Saved The World

But not ARRA

Krugman: the

auto-stabilizers did the heavy liftingMinksy and Godley Stabilizing Role of Big Govt Deficit as source of NFAsSlide9

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 indebtednessSlide10

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, 2009Slide11

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, 2012Slide12

Deficits Exploded EndogenouslySlide13

Facilitating Deleveraging

Figure 3: Private Sector vs. Public Sector Balance (% GDP)

1952Q1 - 2013Q3

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, 2010Slide14

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 assetsSlide15

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 nationsRisk premiums soaredThe bailouts beganGreece €100B in May 2010 and €130B in Feb 2012

Ireland €67.5B in Nov. 2011

Portugal €78B in May 2011Slide16

The Fiscal Lurch

Obama orders creation of deficit reduction commission (2010)

Meanwhile, deficit quietly falls

By 2012, CBO reports shrinking fastest pace since demobilizationWithout any effort to reduce it!Slide17

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)Slide18

The Monetary Plunge

Growing pressure on the Fed as ‘fiscal cliff’ approached

Woodford (August 2012) Jackson Hole

By September, Bernanke had gone all-inOpen-ended bond-buying (QE3) and “forward guidance”Slide19

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 2013Slide20

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?Slide21

Emerging Consensus

Monetary policy

can

counteract fiscal tightening, even at the ZLBWorked 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-takingSlide22

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 2014Slide23

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 necessaryWhen the next crisis comes, the Fed has shown that it has an effective toolkit at its disposalFiscal policy isn’t really neededSlide24

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/ResearchSlide25

Thank You