James Galbraith on the Deficit

by Shihang

We all learnt in H2 economics that a budget deficit has its advantages but Galbraith’s argument is totally different. He seems to commit an ad hoc fallacy arguing that a deficit causes stable bond rates, especially since Greece etc. seem to be direct counterexamples.

“Since the 1790s, how often has the federal government not run a deficit? Six short periods, all leading to recession. Why? Because the government needs to run a deficit, it’s the only way to inject financial resources into the economy. If you’re not running a deficit, it’s draining the pockets of the private sector. I was at a meeting in Cambridge last month where the managing director of the IMF said he was against deficits but in favor of saving, but they’re exactly the same thing! A government deficit means more money in private pockets.” Straight from Mr. Reeves’s lectures, although I suspect he would not be so equivocally in favour of deficits. I hope Mr. Galbraith understands the whole world cannot be in deficit, however desirable that might be. There will be losers and winners.

“The way people suggest they can cut spending without cutting activity is completely fallacious. This is appalling in Europe right now. The Greeks are being asked to cut 10 percent from spending in a few years. And the assumption is that this won’t affect GDP. But of course it will! It will cut at least 10 percent! And so they won’t have the tax collections to fund the new lower level of spending. Spain was forced to make the same announcement yesterday. So the Eurozone is going down the tubes.

On the other hand, look at Japan. They’ve had enormous deficits ever since the crash in 1988. What’s been the interest rate on government bonds ever since? It’s zero! They’ve had no problem funding themselves. The best asset to own in Japan is cash, because the price level is falling. It gets you 4 percent return. The idea that funding difficulties are driven by deficits is an argument backed by a very powerful metaphor, but not much in the way of fact, theory or current experience.”

Galbraith of course runs a rather impassioned Keynesian argument here, but seems to equivocate the ability of a nation to fund itself with financial stability. The problem I suspect with government debt is to do with consumer confidence, and that depends on investors’ assessment of risk. Perhaps it is more acceptable for the US to run a deficit because no one expects the US to default (given their centrality in the world economy), but investors can quickly decide that Greece (without such “too big to fail” backing) will default, and raise their bond yields.

Or perhaps I’m misunderstanding his argument.