Macroeconomics Archives – Page 2 of 2

Using Minsky to Better Understand Economic Development – Part 1

The global system has seen two major shocks in 2016: the Brexit vote and Trump. What these events have in common is their populist rhetoric that promised to bring back jobs. These elections have tapped into growing anxiety over job security, which has not been addressed by most governments and has given room for demagogues to tap into the anger of the people. They reflect a problem that transcends the boundaries of any single nation: the global economy has been in a slump for almost a decade. Governments need to create jobs, and public fiscal stimulus is the way to do so. To allow it, we must rethink that system.

To understand why we have to consider the international system in which nation states currently operate in. Its current characteristics present challenges for developed and developing economies alike. There are two important features to consider: first, the system creates a deflationary bias by requiring recessionary adjustments and hoarding of the international mean of payment (i.e. dollars). Second, it lacks mechanisms to offset the chronic surpluses and deficits between nations, thus breeding financial instability. In a nutshell, it leads to poor creation and distribution of demand that is managed through capital flows. Instead of propping up demand, the global economic system props up debt.

This post will be split into two parts. This first part will employ the theories of Hyman Minsky to explain the features of our current global economy. Next week, we will follow up to discuss an alternative system that would allow for a better distribution of demand among countries and would support emerging economies’ development by freeing them from the swings of international markets.

In his Financial Instability Hypothesis, Minsky addresses the ability of a company to honor its debt commitments. Companies can finance investment through previously retained earnings (internal funds) and/or by borrowing (external funds). If retained earnings prove to be insufficient, and the company comes more and more reliant on borrowed funds, the company’s balance sheet structure shifts from being stable to unstable. As presented in a previous post on this blog, Minsky described this process as moving from a stable “hedge” profile to a riskier “speculative” profile, and finally to a dangerous “Ponzi” profile.

Similarly, a country has three ways in which it can meet its debt commitments denominated in foreign currency: i) by obtaining foreign exchange through current account surpluses; ii) by using the stock of international reserves (obtained through previous current account surpluses); and iii) by obtaining access to foreign savings, i.e. borrowing. The first characterizes a hedge financial profile in which the cash inflows are sufficient to pay the foreign currency denominated liabilities. Any mismatch between inflows and outflows can be covered by reserves (its cushion of safety) or by borrowing; while the former can still characterize a hedge profile – as long as the cushion of safety is big enough to cover the shortfall for the necessary period of time – the latter is said to be speculative. In other words, the country borrows to cover a mismatch with the expectation that future revenues will be used to meet those debt obligations.

A situation in which further rounds of borrowing are necessary to meet those commitments is by definition a Ponzi scheme. It can only be sustained over time if it manages to keep fooling investors to continue to lend. Once a greater fool is not found and financial flows are reversed, the economy collapses in a Fisher-type debt deflation: as assets are liquidated to meet those financial obligations, their prices fall and the debt burden becomes increasingly heavier. The case of a country is different from a company, where outflows are often accurately expected, and it commonly leads to massive capital flight, currency devaluation, fall in public bond prices and increase in its premiums (i.e. interest rate payments). This last point illustrates the implications of accumulating foreign liabilities – reserves included – and implies the growth of negative net financial flows from borrowers to creditors through debt servicing. In general, from developing to developed countries.

The adjustment process punishes the borrower much harder than the lender. Greece presents a clear example. For the borrowing country, the standard imposed remedy is austerity: curtail of imports and public expenditure in order to forcefully meet those debts. Or, more often, to stir up enough confidence and access additional financial resources from private investors; in other words, continuing the Ponzi financing. Even in a case where interest payments on the borrowed funds are lower than the rate of capital inflow, the stock of debt would still expand, increasing financial fragility. A development strategy dependable on increasing usage of foreign savings is thus not feasible.

Of course, economic development is an extremely broad subject and we sure don’t want to commit the mistake of suggesting a “one-size-fits-it-all” policy a la neoliberal disciples. Nonetheless, a common issue for many developing economies is the lack of complexity and variety of its production structure – heavily dependent on primary goods – and the low price-elasticity of demand for its exports, which means that shifts in prices (exchange rate) do not do much to stimulate exports (increasing demand). As such, price adjustments might not always work as expected. This is one of the rationales behind the familiar “import substitution industrialization” strategy that tragically seems to have become the case for the UK and US.

These common characteristics affect the ability of emerging economies to face both up- and downswings of the international economy with countercyclical policies. While international liquidity is abundant in booming periods, it becomes extremely scarce during the slumps. Both capital floods and flights can be domestically disruptive for a developing economy, affecting its employment and output level, solvency, and – ultimately, its sovereign power. With scarce demand and international liquidity, the indebted economy falls into the debt-deflation spiral: it has to incur in a recession big enough to collapse imports at a faster rate than exports thus generating surpluses to clear off debt.

It should be clear that besides being completely inefficient – as opposed to the argument commonly used by “free-the-capital” defenders – the current economic system does little to stimulate demand. It is quite the contrary. Notwithstanding, after almost 10 years after the financial crisis, the world economy is still suffering the consequences of economic “freedom,” and the fighting tool has focused excessively on monetary rather than fiscal policy. Instead of cooperation, we are prone to have currency wars, protectionism, “beggar-thy-neighbor” policies and chronic debt accumulation.

These points of criticism are not novel, but they do deserve more of our attention. The same applies to their solutions, which are the focus of Part 2 of this article.

In the Spotlight: Pavlina Tcherneva

If I ask you to picture an economist, chances are you’ll visualize an older white male who makes you feel bad for failing to understand mysterious diagrams. Those certainly exist. But so does Pavlina Tcherneva. Chair and Associate Professor of the Economics Department at Bard College, Pavlina spearheads the group of faculty that convinced me (daughter of graphic-designer-dad and dancer-mom) to get a degree in Economics, and then another.

Pavlina’s Work in a Nutshell
Pavlina is comfortable in many unconventional territories of economics. She can tell you why the government should be your backup employer, why the federal budget really need not balance, and what money really is. Besides the US and her native Bulgaria, she’s consulted policy makers in Argentina, China, Canada, and the UK. Her work has been recognized by a wide range of people; most recently by Bernie Sanders, who used her graph to illustrate his point on inequality.

Current Research
Pavlina’s current research focuses on the “Job Guarantee” policy, which recommends the government acts like an employer of last resort by directly employing those people looking for work during economic slowdowns. In 2006, she spent her summer in the libraries of Cambridge, examining the original writings of Keynes. She offered a fresh interpretation of his approach to fiscal policy, and got a prize for it, too. Today, she investigates what the policy can do for economic growth, the unemployed, and in particular: women and youth.

Path to the Present
If you’re feeling inspired, take note: Being like Pavlina doesn’t happen overnight. In her case, it began with winning a competition that sent her to the US as an exchange student. She then earned a BA in math and economics from Gettysburg College, and a PhD in Economics from the University of Missouri-Kansas City. Her undergraduate honors thesis was a math model of how a monopoly currency issuer can use its price setting powers to produce long-run full employment with stable prices.

As a college student, she helped organize a conference in Bretton Woods around this idea, which became the inaugural event of what has become known as Modern Monetary Theory. Then, there were a few years of teaching at UMKC and Franklin and Marshall, and a subsequent move to the Levy Economics Institute and Bard College several years ago. In the midst of all that, she was a two-time grantee from the Institute for New Economic Thinking (INET) in New York. Today, Pavlina lives in the Hudson Valley, together with her husband and daughter.

Eager for more?
If you’re curious about the Job Guarantee policy, here is both a 15 minute video, and a 150 page book. To understand Pavlina’s take on the Federal Budget, this article goes a long way. And to figure out what’s the deal with money, read this chapter of her book. Her work on inequality was featured in the New York Times, NPR, and other major media outlets. She has articles published by INET, Huffington Post, and over a dozen works on the SSRN.

Behind Optimism in the Economy, the Fed Fears the Next Recession

After a two-day meeting concluding on Wednesday, Federal Reserve officials voted to keep interest rate unchanged at a target rate of 0.25 to 0.50 percent. According to Chairwoman Janet L. Yellen’s press conference, members of the Federal Open Market Committee (FOMC) feel they are closing-in on the Fed’s statutory mandate—to foster maximum employment and price stability—and they consider that the case for a rate increase before the end of the year is still strong.

Their optimistic view of the economy is based on economic growth picking up its pace in the second half of the year, mainly supported by household spending and what Ms Yellen described as “solid increases in household income.” Meanwhile, the labor market has been tightening and some Fed officials consider the low unemployment rate to be at its full employment value, or at least “pretty close to most FOMC participants’ estimates of its longer-run equilibrium value,” to use Ms Yellen’s words. Even though inflation remains below the Fed’s target, given current economic growth and an improving labor market, we will see a pick up soon after “transitory influences holding down inflation fade.”

“We’re generally pleased with how the U.S. economy is doing,” expressed Ms. Yellen.

However, after presenting such an optimistic economic outlook, it seems at odds that Fed officials lowered their projections of GDP growth for 2016. The median growth projection for the year is now 1.8 percent, down from 2.0 percent in June. In short, it seems contradictory that policymakers believe the case for an interest rate increase has “strengthened”, while at the same time revising down their growth projections, for the third time this year.

Sending a strong signal in August that a possible interest rate hike was coming and then pulling back, made market participants question the Fed’s and Ms. Yellen’s credibility. But again, during the press conference following the meeting, Ms. Yellen said that an interest rate increase is due before the end of the year, if “we simply stay in the current course.” So which one is it? Is the economy strong enough to operate with higher rates, or not?

I think the conflicting message can be somewhat explained by noting two things. First, Chair Yellen’s remarks at Jackson Hole, last month. This speech was about the monetary policy toolkit the Fed has at its disposal to respond to future economic downturns. Among the tools, however, Ms. Yellen didn’t include the alternative of negative interest rates. Whether or not negative rates are a good idea is not the point. The point is that she declared that “doing so was impossible,” sending a strong message that the Fed is very much constrained by the zero lower bound on nominal rates. Then this past Wednesday Ms. Yellen reiterated that the zero lower bound is a “concern,” saying that monetary policy action has “less scope than [she] would like to see or expect [them] to have in the long run.”

Ms. Yellen’s remarks at Jackson Hole made it clear that the Fed trusts that, whenever the next downturn hits, “conventional interest rate reductions” will be their first line of defense. However, in order to make those reductions, rates cannot be down to where they are right now; they need some room for maneuver. For example, during the past nine recessions the FOMC cut the fed funds rate by an average 5-1/2 percentage points. Meaning that right now the Fed is 5 percentage points short of what they would need to reduce rates, if an average recession hits the economy.

Second, as Ms. Yellen noted during the Q&A, monetary policy operates with long and variable lags—in other words, that the implementation and effects of new monetary policies would normally take some time. For this reason, she argued, the principle of forward looking is so important. That is, acting ahead of time, and based on projections and forecasts, before a threat materializes. In this regard Ms. Yellen stated, “I’m not in favor of the whites of their eyes rights sort of approach. We need to operate based on forecasts.” Moreover, the Chairwoman has repeatedly stated that any adjustments in the stance of monetary policy will be “gradual,” in a succession of small increases. Thus, it would be inconsistent to keep rates unchanged when the Fed forecasts of inflation are pretty much on target for 2017 and 2018 and when monetary adjustments will be gradual and needing some time to be implemented and have effect.

It seems as if the Fed fears its ability—or lack of—to respond to the next crisis, and those fears could be weighing heavily in their considerations of a rate hike. If that is the case then the good news, for them, is that they have their favorable outlook of the economy and the principle of forward looking to justify the hike.

So, if there are no negative surprises, it’s very likely that before the end of the year the fed funds rate will increase from its current target range of 0.25-0.50 percent to the 0.50-0.75 percent range. The next Fed meeting will take place just a week before the election. Even though the Fed is not supposed to play politics, policymakers will not want to rattle the markets right before polls open. So November’s meeting is not likely to be the one, all bets are on December.

Illustration by Heske van Doornen

The Brazilian Burden

On August 29th Dilma Rousseff, the democratically elected Brazilian ex-president, defended herself at the Senate against accusations of fiscal fraud, the so called “pedaladas fiscais.” Despite her defense, two days later, the president was formally impeached, putting an end to a process that has been carried on since May, when she first left office to face trial. The crime accusations were mainly accompanied by harsh criticisms of how the Workers’ Party (Partido dos Trabalhadores, PT) fiscal irresponsibility led to the poor economic condition that the country finds itself. Among the economic meltdown and several scandals of corruption, her approval rate and the popularity of her party collapsed in recent years. After 13 years of the leftist PT administration, the presidency is now occupied by the then vice-president Michel Temer, member of the centrist Brazilian Democratic Movement Party (Partido do Movimento Democrático Brasileiro, PMDB), a party also involved in corruption scandals, and whose popularity is as bad as his predecessor.

Political matters “apart,” the Brazilian economic situation is indeed dire. GDP is expected to contract 3.18% in 2016, a second year of contraction, following the 3.85% in 2015. Unemployment increased more than four percentage points from the beginning of last year, reaching 11.3% in June 2016. Despite the poor economic performance, inflation is still above the 6.5% target roof, being expected to accumulate 7.4% this year. The inflationary pressure comes mainly as an effect of the rapid exchange rate nominal devaluation of almost 54% within the years of 2015 and 2016, reaching now R$ 3.29 per dollar. As an attempt to control inflation and attract foreign capital, the Brazilian Central Bank – going in the opposite direction of the major Central Banks – sharply rose the short-term interest rate (Selic), sustaining it at 14.25% (!!!) since mid-2015. This also had a feedback effect on the government’s total deficit. (*)

Two questions remain open: what are the real roots of the economic crisis and will the new administration be able to tackle it? To understand the roots of the bust, it might be easier to refer to the very causes of the boom that preceded it.

The boom and bust

From 2002 to 2008, the Brazilian economy performed really well, growing at an average of 4% per year. This was possible mainly by a combination of policies aimed to reduce poverty and income inequality along with the positive international scenario.

Increasing worker’s real wages and government cash transfers to poor households – channeled mainly through social security and the famous Bolsa Família – established a virtuous cycle of increasing private consumption. Another important factor was the promotion of policies towards labor-market formalization, which guaranteed not only access to social security but also the availability of poor households to private lines of credit. Note, however, that not only poor households benefited from “cash transfers”: the historically high short-term interest rate guaranteed that rich households too enjoyed the fruits of the boom. The government managed to attend then both extremes of the income distribution.

International conditions also played a major role in boosting the domestic economy. High international liquidity and the commodity-price super cycle guaranteed appreciation of the exchange rate, which beyond positively impacting domestic real wages, also helped to keep inflationary pressures under control by making foreign goods more accessible.

The Brazilian economy suffered its first hit with the 2008 financial crisis. Despite the GDP growth of 7.5% already in 2010, the fast economic recovery was mainly a result of aggressive counter-cyclical expansionary policies by the government, who acted through state-controlled enterprises (as the oil and energy companies, Petrobras and Eletrobras) and programs of investment in economic and social infrastructure. From 2011 on, GDP returned to low levels, making it necessary for the government to adopt a new set of policies that can be summarized in tax exemptions and subsidized credit expansion to private companies from public banks. As it happens, this attempt to increase private investment had the only effect of deteriorating the public fiscal situation.

The budget, the budget!!!

The change in orientation of government policies – from an expansion of public investment in 2008-10 to a provision of fiscal stimulus to private companies in 2012-14 – happened at the same time as the commodity boom ended. Already in 2011, commodity prices stagnated and, along with Brazilian terms of trade, started its downward path in 2014. The end of the commodity cycle had a harsh impact not only in economy’s aggregate demand but also on the fiscal budget.

Before we get to the fiscal issue though, please, don’t get me wrong. The cause of the Brazilian economic crisis is less a result of the end of the commodity boom in itself than by the productive structure that such cycle reinforced. Brazil’s external sector is highly dependent on the exports of primary goods, and this dependence only deepened in the past decade. In 2015, roughly 50% of Brazilian total exports were composed by primary products, a number that increased 4.5% per year since 2002, when it accounted for less than 30%. If we include natural resource-based manufactures on the calculus, it reaches nearly 70% of total exports! Furthermore, while labor productivity increased 5.3% per year from 2000 to 2013 in the agriculture sector, it decreased 0.6% per year in the manufacturing industry.

No wonder when commodity prices reverted trend the economy took a strong hit. Instead of setting the ground for the eventual bust, Brazil placed all its coins on booming commodities. Despite all the public investment programs and fiscal exonerations to the private sector, the PT administration did not manage to increase investment as share of GDP, which remained stagnant around the 18% level throughout 2002-2015 – with public investment accounting for less than 3% of GDP. Lack of investment in infrastructure and manufacturing industry perpetuated an anemic economy with low productivity and dependent on economic cycles.

Public consumption and investment decreased even further after 2014 when the rapid deterioration of the fiscal budget turned the 3%-of-GDP government fiscal surpluses to almost 3%-of-GDP deficits. It is interesting to notice that the decreasing surpluses started in 2011, not accidentally when commodity prices stagnated. We can look at the three institutional balances for the Brazilian economy, representing the government, private, and foreign sectors, as follows below in order to see these trends more clearly.

We already know from previous posts on this blog (see here and here) that the government sector has a “crowding-in” effect on the private sector, meaning that government expenditure will, by an account identity, revert in private sector savings. Of course, in an open economy, this is only true as long as we assume the foreign sector to remain “stable”. Both the private and government sectors can only simultaneously run a surplus if the foreign sector generates a surplus that is big enough to account for both. (The intention of the figure presented is not to show that the balances sum to zero – which could be demonstrated by inverting the sign of the private sector and using a bar graph – but to show the movements of the financial assets and liabilities between the three sectors).

In the case of the Brazilian economy, the improvement of the foreign sector in 2001 allowed an increase in the private sector savings and a decrease in government total deficits. Once the financial crisis struck at the end of 2007, despite the counter-cyclical policies, the deterioration of the current account was mainly absorbed by a decrease in savings of the private sector, with government persisting to run primary surpluses and to sustain its total deficit level – even decreasing it until late 2012. On that year, we observe a sharp deleveraging of the private sector which, given the steady trend of the current account, was completely mirrored by the public sector.

Once again, the mistake – to name one – of the PT administration is that instead of increasing fiscal stimulus through direct government expenditure and investment in infrastructure it bet on providing credit and fiscal exonerations to the private sector as an attempt to increase private investment. In a scenario in which – to use Minsky’s terminology – the demand price of capital decreases at a faster rate than the supply price of capital, investment will not take place. In other words, despite the stimuli reducing the cost of new investment, expectations of profits were falling at a faster rate. In a situation of lack of aggregate demand, the government has to directly spend in order to create the necessary stimulus to the private sector through the generation of profits. Its avoidance led to the deterioration of the fiscal budget through the revenue side, surpassing now 10% of GDP, a result of the economic meltdown.

Instead of stimulating the economic activity by driving aggregate demand and adjusting the economy by sustaining the levels of output and employment, the government opted, mainly after 2014, for a “building confidence” strategy in which it compromises to reducing inflation, generating primary surpluses by increasing interest rates, and cutting government deficits, an adjustment that comes, in such case, through deepening the economic recession. All of it with the intention to attract market’s attention and foreign capital inflows. It, in fact, has a huge potential to generate financial fragility – but this is subject for another post.

And what now?

To address the second question posed at the beginning of this text, it is hard to believe that the new administration will be able to revert the dire scenario. It is still unsure if Temer will have the political leverage to pass important fiscal structural reforms in Congress, such as pension reform. Temer’s pledge to sharply reduce the government deficit can be summarized in the attempt to pass a law that will impose a limit to government expenditure indexed to the inflation level of the previous year. Besides reducing the ability of the government to invest, it also means cutting spending on areas such as education and public health, thus reducing the welfare state that was established in the previous decade, a major element in the virtuous cycle.

Whether or not promising to reduce inflation and the public deficit will be miraculously enough to stimulate agents confidence in the future, it will for sure hurt the economy and lead to a further decrease in demand price of investment in the short-run. In a situation of deleveraging private sector and slow global trade, it is unlikely that private investment will rise anytime soon. Until then, workers will be the ones to suffer from the increasing unemployment levels. The interest rate, beyond undermining any conceivable investment effort that could come from private agents, also carries a feedback effect to government budget and a distributive matter, as mentioned in the beginning of this text. When the pressure to cut government spending increases, “attend both extremes of the income distribution” becomes a hard job. We already know which side was chosen. Unfortunately, very often the adjustment burden comes from the weaker side.

(*) All the data presented in the text are extracted from the Brazilian Central Bank (BCB) and the Brazilian Institute of Geography and Statistics (IBGE).

The Job Guarantee: The Coolest Economic Policy You’ve Never Heard Of

When you think of economic issues what are the first things that come to mind? Poverty, inequality, unemployment, inflation, and crisis are all common answers to the question. Wouldn’t it be great if there was a policy that could address all of those issues (and more) in a cost-effective manner? In this piece I will give a very brief introduction to Job Guarantee (JG) schemes, the proverbial economic silver bullet.

Hyperboles aside, Job Guarantee proposals (which may come in many different names such as Employer of Last Resort, or Public Service Employment) are a remarkably good way to address many of the social economic problems current faced by populations all over the world. Ideas about JG programs date back to as early as the 1600s, they have been implemented in many nations during a variety of different stages of the business cycle – and usually to a great deal of success.

Simply put, JG is a direct public employment policy where all of those people who are willing and able to work are guaranteed a job given that these individuals meet some basic employability requirements. Most proponents of JG establish that these jobs should pay a basic, fixed, uniform wage plus full medical coverage and free child care (the latter can be provided by JG workers themselves). The goal of the program should be to ensure that all full-time JG workers are able to obtain a living standard that is above a reasonable poverty threshold. Thus, this sort of program go a long way in addressing poverty. Furthermore, it would also target another major economic problem, the stagnation of real wages and the currently low minimum wage granted to US workers. The JG wage would instantly become the minimum wage for the entire economy: workers in other sectors that are receiving less than the JG wage would be very compelled to take one of those guaranteed jobs, and employers would have to raise their salary offers in order to keep their workforce. Finally, the wages would also act as price anchor, which improves upon the stability of the economy.

The first question I usually get when telling someone about the Job Guarantee is “yeah but, how can we afford it?!” Questions about the deficit and national debt have been put to rest previously on this blog (see here), hence I shall focus on other questions regarding its affordability. For starters, it has been shown elsewhere that JG is remarkably cheaper and more effective than other proposals, such as Basic Income and Negative Income Tax, in achieving lower poverty and unemployment rates (see here, and in many pieces by Rutger’s Phillip Harvey). Secondly, the newly employed JG workers would bring in savings in many different ways: they would get out of unemployment insurance, food-stamps, and other such programs; they will pay income tax, medicare and social security tax, as well as more consumption related taxes; and the government would spend less on issues that are related to poverty, such as higher crime rates. In addition, employment multipliers would make it so the JG program would not have to employ the entire unemployed population. The extra consumption and production related to the JG will create indirect and induced jobs which will represent a significant portion of the job creation from the program. Finally, yours truly is among a number of economists who have modeled the implementation of a a JG for the US and found that eliminating unemployment at a living wage would cost just around 1% of the American GDP.

At this point many say something like “but employing everyone while raising the minimum wage has to be inflationary!” the answer to which is a simple “nope”. First, we have to bear in mind that in the current system the economy’s most precious resource – workers – is being wasted in unemployment, while under a JG program it will be put to use. Orthodox economic thought claims that millions of people need to be unemployed in order to contain inflation, that it is financially “sound” to a tenth of the population in idleness for an unknown period of time. It comes from the idea that the economy is always operating at full capacity, which then brings the inflation problem to being a matter of equilibrating the demand and supply forces of the economy. Both of these assertions are, to quote Keynes, “crazily improbable – the sort of thing that which no man could believe had not his head fuddled with nonsense for years and years.” Government expenditure is as inflationary as any other sector expenditure. Unemployed workers are spending in consumption either way, being sustained by welfare or, dangerously, by credit – and there’s nothing financially “sound” about that.

A JG program would in fact control for inflation by proving a minimum wage anchor for prices and by increasing the productive capacity of the economy through its projects. It would take off the pressure put on demand from the unemployed by increasing supply of goods and services by incorporating those idle workers in the productive structure. Furthermore, even if we assume it to be inflationary it would be a “one-time” increase in inflation, and not an accelerating type one, meaning that demand (and inflation) wouldn’t rise above the full employment level.

In that sense, the costs associated with a JG program (increasing budget deficit and inflation) are not more than ideological myths that obscure the true social costs of unemployment and poverty and curtails any innovative attempts to deal with them. Indeed, generating aggregate demand, employment and inflation is all what the US economy has tried to do since the 2008 financial crisis, but through the wrong ways. A JG program would be extremely more efficient and less costly than QE or negative interest rates. As the world crumbles in economic and political instability, guaranteeing jobs would surely deal with most of its problems. It is up to governments to load and shoot that silver bullet. I don’t think there’s a more appropriate time than now.

Written by Carlos Maciel & Vitor Mello
Illustrations by Heske van Doornen

Bloated Bodies & Starved Economies: Two harmful misconceptions

Over 35% of American adults are considered obese. These numbers are disproportionately higher in communities of color, whose access to healthy food is limited by time, money, and location. American Big Fast Food pushes “healthy” options which are laden with sugar, but advertised as “fat free”. The nutrition science community sold the idea that fat free meant free from creating fat, but the distinction is not quite true. Likewise, “low calorie” diets were sold on a similar idea that all calories are equal. The body in fact has different subsystems for digesting different types of calories. Carbohydrates go one place, proteins another, and fats themselves are digested separately. Carbohydrates are easily stored as glycogen and when present in the system the body prefers the quick use of them. When no carbohydrates are present, gluconeogenesis breaks down fats and proteins for use as energy. Looked at from this system perspective, the high carb low fat diet commonly advocated from the 1980s onward seems rather foolish if one wishes to burn fat stored on the body. In fact, the opposite should be advocated, a low-carbohydrate diet which starves the body of the fast glycogen deposits and forces it to switch into ketosis. The aphorism that “fat makes you fat” was wrongly sold to the public. While an understanding of the body system seems to clearly disprove the old ideas, the fact that the old paradigm pervaded common thought means communities continue to suffer from obesity without access to the new knowledge and healthy diets.

fatisnotfat America has another problem caused by a common misconception. There is a pervasive view that the government should not have a deficit, and should in fact run a surplus and pay down all of its debt. Of course, any good American pays down their debts. The banking system is gracious enough to give us loans to buy houses, cars, and get educations. We pay them back for the opportunity, never wanting to default on payments and enter bankruptcy. It makes sense that we think that our government, which so well represents us, should similarly pay back its debts. It is not quite that simple. Much like the fat in food being different from the fat in our bodies, the idea that government debt is the same as household debt is a harmful misconception. Like not all calories are the same, not all debts are the same. When the government runs a deficit, and spends more than it collects in taxes, it is engaging in an act of money creation. When it runs a surplus, and spends less than it collects in taxes, it is engaging in an act of money deletion. Like understanding the subsystems of the body helped us understand how different calories are used, understanding the economic subsystem of money helps us understand how different debts are used and created.

The government determines what is used for money. Today, USD denominated deposits within the banking system are the main thing we use for money. They are widely accepted and we use them to pay taxes. Deposits enter into the system in two ways. The first is through the budget process which determines the amount of fiscal spending, most of it largely mandatory based on existing law. The budget has some discretionary spending which can be increased by Congress, which can go towards things like education, public jobs, and infrastructure. As the Treasury deficit spends deposits in bank accounts are created, and the Treasury issues a bond as the matching liability on its balance sheet (“the debt”). The other way deposits enter the system is through private banks making loans to households and firms. Banks can always extend loans if they think the venture will be profitable. They make the loan, which creates a deposit as a liability in another bank. After loans are created, the banking system needs to meet reserve requirements for the amount of deposits in the system. If they are not holding enough reserves they can sell assets to the Fed to get them. So banks make loans whenever they see profitable business ventures, and the government accommodates with enough reserves for them to do so. money creation3.jpg

After deposits are created, they circulate hopefully a few times within the banking system but ultimately are collected as taxes or used to pay down private debts. When taxes are collected the Treasury extinguishes some bonds as the debt is now paid. So running a surplus means the government is removing deposits from the system (“paying down the debt”). What happens if we rely on only the private sector to add deposits? Bill Clinton tried in the 1990s when he ran an unprecedented surplus for a couple years. It turns out however that Americans are stubborn and still wanted to buy houses, cars, and get educations. So as our real incomes fell rather than reduce our standards of living we graciously racked up debt with the banking sector. The banks saw us as profitable ventures and gave us loans as deposits, causing the central bank to create the reserves to accommodate this lending. This debt that households accumulated is fundamentally different than the debt pinned on the government as this process unfolds. This is because the government can never be forced to default. Looking at the net flows of financial balances yearly sheds some light into this process. Every year, the net amount spent by the government (red line) matches the net amount saved (or dissaved) by the rest of the world (blue is domestic, green is foreign). This exact mirroring is the result of accounting identities within the system.

sectoral_balances1

In the 1990s and 2000s you see the private sector as a whole taking on debt and dissaving for the first time in recent history, as the government ran a surplus and other countries bought up large amounts of US securities. Today many US households are still holding onto these debts. The misconception that government debt is the same as these private debts has starved our economy. Much like the mistake of the nutritional science community in prescribing low fat diets to reduce fat, it has been the mistake of the economic science community to prescribe low government debts in order to fix our household debts. debtisnotdebt3 In order for households to get enough deposits so they can pay back their debts, the government should run deficits that end up in their hands. The reliance on the private sector has taken priority over the public good, and most of the deposits have landed in the hands of the top 1%. They were supposed to “trickle-down” the wealth to the rest of us, but after forty years of trying this has not happened. The private sector only employs as many people as it finds profitable to do so, and if they can deploy their capital in financial casinos to make more profit than employing people to build stuff that enhances society, they will do just that. So how can we get money into the hands of the financially responsible Americans who just want to work and pay back their debts? A answer to this problem is to rely on direct government job creation, much like the New Deal after the Great Depression. This spending will cause the government to accumulate more debt in the short term, but if spent on education, infrastructure, public jobs, worker co-ops, and raising the minimum wage then these new deposits would funnel into the bottom of the income distribution, and American households could pay down their own debts. Maybe then we’ll realize: government debt, like a nice fatty avocado, is good for us.

Written by Bradley Voracek