A Note on Managing the Federal Budget
George H. Blackford,
2014
There is a fundamental
difference between federal debt and non-federal debt that arises from the fact
that the federal government has the legal right to print money. This means there is no reason to
believe the federal government will ever be unable to service its debt because
it can always print the money it needs if it has to. Non-federal debtors
cannot print money. They must service their debts out of income or through the
sale of assets and, as a result, are always at risk of being unable to meet
their financial obligations.
The fact that the federal
government has the power to print money does not mean we do not have to worry
about federal debt or that “deficits
don’t matter” as was the mantra of the Bush
II administration. It matters a lot just how those deficits are created and how
they are financed. The fact that the federal government has the power to
print money only means that the federal debt problem is a much easier problem to deal
with than the non-federal debt problem and that the federal
government has the power to mitigate its overall debt problem through
the judicious management of its budget in a way that non-federal debtors do not.
When the federal government
borrows and uses the proceeds to finance an increase in expenditures for goods
and services in the face of an economic downturn it increases spending in the
economy directly and thereby directly increases the demand for goods and
services.
The same is true when the
government borrows in this situation to increase transfer payments (such as
increased payments for agricultural subsidies, unemployment compensation, or aid
to municipalities) or to finance tax cuts that created the need to borrow in the
first place, though here the effect on the demands for goods and services is
less certain in that these effects are indirect. They can have an effect on the
demands for goods and services only to the extent that those who received the
transfer payments or tax cuts increase their spending on newly produced goods
and services as a result. There is, of course, no guarantee this will occur.
Deficits that occur during an
economic downturn that help to maintain or increase expenditures on education,
scientific research, public health systems, police and fire protection, water
and sanitary treatment facilities, bridges, highways, and other forms of public
transportation all have the direct effect of stimulating the economy. Even
expenditures that arise from increases in the kinds of transfer payments
embodied in food stamps, unemployment compensation, school lunch programs,
Medicaid, and other kinds of social welfare programs that tend to increase
during an economic downturn help to stimulate the economy since most of these
transfers go to people who live hand to mouth, and, therefore, are more or less
forced to spend. In addition, most, if not all of
these kinds of expenditures, whether direct expenditures or social welfare
transfers, have the added benefit of making it possible to improve productivity
in the future by improving our public infrastructure and warding off the
malnutrition and other health problems that are the inevitable consequence of
people becoming destitute in the wake of an economic downturn. Thus, running a
deficit to finance these kinds of expenditures and transfer payments during an
economic downturn adds stability to the system and has the potential to help the
economy grow and, thereby, to reduce the burden of servicing the debt that
deficits create.
By the same token,
deficits that occur during prosperous times that are not associated with
investments in human or physical capital do not have the potential to improve
productivity in the future, and those that are created in the midst of an
economic downturn by giving tax cuts and increasing transfer payments to the
ultra wealthy who, in turn, use the proceeds to buy the bonds needed to finance
the deficits created by the transfers and tax cuts in the first place do not
stimulate the economy even in the short run. They simply increase the transfer
burden from debtors (i.e., taxpayers) to creditors (i.e., government bond
holders) as they distort the allocation of resources within the system and
increase the concentration of wealth within the system to the extent the
resulting debt is purchased domestically. In
addition, this kind of fiscal irresponsibility on the part of the government has
the potential to create chaos within the economic system.
Even though there is no default
risk to federal debt, when federal debt grows faster than the GDP it increases
the burden of transfers from debtors to creditors which can lead to serious
problems, especially if the debt is foreign owned. In addition, there is a huge
risk of inflation as the federal debt grows if it reaches the point where the
government cannot raise the money to service its debt through taxes or borrowing
and is forced to print money. The resulting inflation can have the effect of
increasing interest rates and, thereby, making the transfer problem worse as it
weakens our position in international markets. If severe enough,
hyperinflation
can lead to a total collapse of the monetary system as creditors refuse to enter
into contracts of any sort that are written in terms of the domestic currency.
Thus, the ability of the federal
government to print money is not a blank check that allows the federal
government to do whatever it chooses. It gives the federal government a
degree of flexibility in managing its affairs that no other entity within the
economic system has, but the federal budget must be managed responsibly if
catastrophe is to be avoided. This does not mean that the budget should always
be balanced or that federal debt should be paid off as quickly as possible. Attempting to do so can have disastrous consequences.
What it does mean, however, is
that during an economic downturn the deficit and debt must be increased in such
a way as to maximize the economic stimulus while, at the same time, alleviating
human misery and building up our public infrastructure as much as possible in
order to minimize the economic decline and increase our ability to produce in
the future. It also means eliminating unproductive or wasteful programs and
expenditures during prosperous times. But most important, it means raising the
taxes necessary to pay for the government programs and expenditures that are
essential to our economic and social wellbeing when the system is at its full
potential and in such a way as to eliminate the imbalances in the system.
As I try to explain in
Ch. 12: Less
Government, Lower Taxes, and Deregulation,
not managing the budget in this
way and, in particular, not raising the taxes necessary to pay for the government programs
and expenditures that are essential to our economic and social wellbeing and not
eliminating the imbalances in the system is courting disaster. (Stiglitz
Klein
Johnson
Crotty
Bhagwati
Philips
Galbraith
Morris
Reinhart
Kindleberger
Smith
Eichengreen
Rodrik
Krugman
Amy)