Keep the Deficit. Ditch the Doves.

I just read another disappointing piece dealing with the preliminary recommendations from President Obama’s fiscal commission, this time from a contributor at The Huffington Post. Like any good deficit “dove,” he concedes the existence of the crisis, which he says any idiot with a third-grade education could recognize:

“The magnitude of the financial management of our government does not require algebra, calculus or knowledge of algorithms.”

And while it is true that you do not need differential calculus or linear algebra to understand finance, it does help a great deal if you can read a balance sheet. Unfortunately, this Stanford academic — like so many on the “left” — apparently cannot.

What follows is a highly truncated statement that stems from a set of arguments that have appeared many times on this site. For those who haven’t been following along, it may serve as a primer.

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.

Arguments in favor of “fiscal responsibility” miss this fundamental point completely and, in so doing, end up supporting the kinds of policies that will worsen (rather than improve) the private sector’s financial well-being. Taxes are a “leakage.” They remove money from the private sector. Government spending, in contrast, is an “injection.” It adds money to private sector balances. When the government spends (injects) more than it taxes (withdraws), the resulting deficit ADDS to the private sector’s holding of net financial assets. And, should the government run a surplus by collecting (withdrawing) more than it spends (injects), the private sector will end up with FEWER financial assets.

The same holds true for an open economy, where imports are a “leakage” and exports an “injection.” Thus, like a government SURPLUS, a trade DEFICIT reduces the private sector SURPLUS, which creates an even bigger need for a public sector deficit. 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?

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About Stephanie Kelton 24 Articles

Affiliation: University of Missouri

Stephanie Kelton, Ph.D. is Associate Professor of Economics at the University of Missouri-Kansas City, Research Scholar at The Levy Economics Institute and Director of Graduate Student Research at the Center for Full Employment and Price Stability.

Her research expertise is in: Federal Reserve operations, fiscal policy, social security, health care, international finance and employment policy.

Visit: Economic Perspectives

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