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Thoughts on government deficits


Hi Cullen,

I was wondering what your thought on government deficits are. It's always been a confusing topic to understand for me because views on deficits and government debt are very always polarizing: people either argue against them and say governments should run surpluses in order to save just like everybody else, or argue in favour of them (with MMT currently being a hot topic).

Given that most governments have run budget deficits most of the time throughout history (from what I know), I reckon there must be a very plausible reason for them. Therefore, I would like to ask you how you think about deficits and government debt, whether they are welcomed or undesireable in general or for a given country in a specific situation. Are arguments like Germany's mediatic debt break, which effectively forces Germany to run surpluses, reasonable? Is public debt really just supposed to be managed instead of paid back, as some people argue? Why shouldn't governments finance expenditure entirely from taxation instead of issuing debt?

Was hoping your lines of thought could help shine some light on this controversial topic.

Thank you!


The economy is always growing in the long-run. So, balance sheets are always expanding in the long-run. Don't just think about the fact that this means debts are growing because the flip side is that assets are always growing also. For instance, household debt is virtually always growing. So is corporate debt. So is equity issuance. In other words, the right hand side of the balance sheet is always expanding. But so is the left hand side. People like to focus on the right hand side of the BS without thinking about the fact that balance sheets always balance. But what really matter is not one side or the other, but what's being done when the BS expands.

For instance, when a corporation issues new corporate debt their balance sheet expands. An asset is created and so is a liability. But the stability and sustainability of that expansion is entirely dependent on how the corporation actually uses their debt. Do they spend it wastefully? Do they spend it productively? If they spend it productively then there's a multiplier effect in their own balance sheet because they build equity and that allows for more borrowing and more expansion.

The govt is a weird entity though. Their balance sheet isn't run like a corporation's BS. It's run more like a non-profit. And we use their BS to fund public purpose. Eg, maybe we need to go to war with Canada one day. We pool our resources and finance that via govt spending and perhaps deficits. Whether that deficit is good or bad is somewhat subjective. After all, we don't run a NPV calculation on the cost of war like we would with the cost of trying to invent a better widget.

The thing about govt deficits is that the spending tends to be rolled over because the projects tend to be somewhat perpetual. Things like Social Security and Medicare are only growing larger because the needs are increasing and the population is always rising. So the govt tends to grow over time with the economy. And that means that the deficit becomes somewhat perpetual.

The sustainability of that deficit is dependent on many things. People mistakenly think that the govt needs to pay back govt debt or that the debt is inherently unstable. This isn't necessarily true though and is mostly a fallacy of composition comparing a single household to an aggregate sector (aggregate households also don't pay back their debts). But the real constraint on govt spending is inflation. And inflation will tend to become a problem when private sector resources can't support the expansion of balance sheets. After all, the govt doesn't run into a liquidity constraint like the private sector can. Or, I should say, the liquidity constraint manifests itself as rising prices, not insolvency.

So, the context depends quite a bit on this discussion. I've long argued that there's nothing all that worrisome about the deficit in the USA because inflation is low, likely to remain low and the USA has an abundance of underlying supportive resources. Germany is similar, but arguably in an even better and more sustainable position because they're the most productive economy in the EMU and they benefit from running surpluses. So they don't even need to finance their govt spending with deficits because they get so much funding from their productive economy. But the longer answer is, it all depends.

I hope this gives some better context for how I think about it though.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Thank you for the relpy, Cullen.

Had never thought of the fact that household debt in aggregate is never paid either, but it makes perfect sense. Households and corporations both have more finite lives than governments (especially households), so individually they might pay their debts back more often, but in aggregate their nominal debt is always expanding because the money supply is created endogenously through bank money (debt) creation, correct?

Still on the deficit/government debt topic, what sort of variables/circumstance may lead you to deem a certain level of deficit or government debt unsustainable?

For instance, in the case of Germany, many argue they're only able to sustain those budget surpluses because of their massive current account surpluses, which from a sectoral balances perspective means they can sustain rising private financial net worth even running budget surpluses. However, shouldn't those current account suprluses and, a little by extension, budget surpluses be deemed unsustainable?

At what point will employers be forced to pay more to attract the talent they demand?   With record low unemployment, the laws of economics would tell you that the increased demand for labor should put upward pressure on what companies are willing to pay an employee.   That isn’t happening, therefore we aren’t seeing any meaningful inflation.

The Fed is going to now lower interest rates.  This is an incentive to the American Households (and businesses) to borrow/spend more and save less.    The hope is that this leads to inflation.

We need inflation so that borrowers can pay back nominal debts with less valuable money in real terms.

As long as we are all ok playing along with this system, it will remain sustainable.   The most important part of MMT is that we all agree to live by it.   Once people start hoarding or exploiting it, then we have chaos.




@mftg, I don't think there's some magical level that makes govt debt bad or good. It really depends. For instance, there isn't some magical level of corporate debt to equity that causes corporations to perform poorly. Same basic thing with a govt.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

"Still on the deficit/government debt topic, what sort of variables/circumstance may lead you to deem a certain level of deficit or government debt unsustainable?"

It is not absolute govt deficit level that  makes our economy good or bad.  It is a relative govt surplus rate unsustainable.  Said relative govt surplus rate can be measured by  FFR + Govt Deficit(-) or Surplus(+) / GDP (red line in chart below).  Before or when this relative govt surplus rate is trending up to a certain point,  real GDP growth rate(green line in chart) must be trending down. This is because private sector is in deficits and private sector is the main driving force for real GDP growth.



For your reference, real FFR rate (= FFR - Inflation) is also unsustainable for causing slow real GDP growth.

PLIU412: It seems to me the controlling factor is PCE per capita (which may be what you said in the last sentence of your 12:17PM post). If personal consumption falls off, it seems to me that business spending is destined to fall off (unless government spending or increased exports rise to compensate). Is there some fundamental reason that a constant GDP per capita would not be sustainable?


Yes, the controlling factor is FFR - %P(inflation). The following unsustainable rates are fundamentally related for causing  %RGDP  growth in a downward trend eventually and rates are inverted in a downward trend as well.

(a) FFR - %P,
(b) FFR - %NGDP,
(c) FFR + Govt Surplus(+) or Deficit(-)/NGDP
(d) FFR -  Pvt Surplus(+) or Deficit(-)/NGDP

The fundamental constraint is

%P + %RGDP = %NGDP  since accounting identity: P * RGDP = NGDP

Federal Fund Rate(FFR) hike puts pressure on %NGDP growth.  FFR hike is a double-edge sword and can push down either %P or %RGDP  according to this identity constraint. But continuous real FFR (= FFR - %P) hike will cause %RGDP in a downward trend eventually and real FFR inverted.

Rate (FFR - %NGDP) measures the difference between real FFR and %RGDP  since
real FFR - %RGDP
= FFR - %P - %RGDP
= FFR - (%NGDP -%RGDP) - %RGDP

Thus,  continuous rate (FFR - %NGDP)  hike  has a similar effect as continuous real FFR hike causes %RGDP in a downward trend eventually.

Line FFR + Govt Surplus(+) or Deficit(-)/NGDP  has similar and qualitative characteristics as Line FFR - %NGDP

FFR -  Prvt Surplus(+) or Deficit(-)/NGDP has similar characteristics as line FFR +  Govt Surplus(+) or Deficit(-)/NGDP  since Govt Surplus(+) or Deficit(-)/NGDP + Prvt Surplus(+) or Deficit(-)/NGDP = 0  assumed private sector including ROW.





Strategy for circumventing a depression:

Step 1: Lower interest rates.   Create a massive amount of Public and Private Debt.

Step 2: Pray for a miracle.

Step 3: If Step 2 doesn’t happen, repeat Step 1.