I’ve been looking at criticisms of MMT by Austrian economists like Robert Murphy. Murphy complains that MMTers take basic accounting identities and then illegitimately extract economic consequences from them.
Murphy’s complaint seems to be that while MMTers do the correct accounting for the whole economy, they illegitimately conclude that their explanations of why the accounting comes right are also correct. This is an interesting philosophical question: what can you learn from a mere accounting identity? Not as much as MMT thinks, says Murphy. I’ll give one example, from this post.
Opponents of government deficit spending sometimes complain that it crowds out private investment by taking away savings that could have been used by private investors. If, in the UK, you ask either David Cameron or Ed Miliband why they agree that the government deficit must be reduced, they or their advisors will tell you something like this. MMT argues that this cannot be true, since government deficit spending adds to the savings available for investment. To show this, they use a bit of accounting. I’ll quote the same source Murphy quotes to explain it:
The national accounts concept underpins the basic income-expenditure model that is at the heart of introductory macroeconomics. We can view this model in two ways: (a) from the perspective of the sources of spending; and (b) from the perspective of the uses of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.
So from the sources perspective we write:
GDP = C + I + G + (X — M)
which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X — M) [i.e., exports minus imports].
From the uses perspective, national income (GDP) can be used for:
GDP = C + S + T
which says that GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.
So if we equate these two perspectives of GDP, we get:
C + S + T = C + I + G + (X — M)
This can be simplified by cancelling out the C from both sides and re-arranging (shifting things around but still satisfying the rules of algebra) into what we call the sectoral balances view of the national accounts.
(I — S) + (G — T) + (X — M) = 0
That is the three balances have to sum to zero. The sectoral balances derived are:
- The private domestic balance (I — S) …
- The Budget Deficit (G — T) …
- The Current Account balance (X — M) …
Let’s take the simpler case, where the current account is balanced: the economy exports exactly as much as it imports, so that X = M and hence X – M = 0. So now we can take X – M out of the equation altogether, and we get:
(I – S) + (G – T) = 0, from which we can easily get:
G – T = S – I.
This last identity is the key to the MMT argument. What it tells you is that the government deficit (or surplus) must equal the private sector’s surplus (or deficit). Now suppose the government increases its deficit by keeping taxes level and increasing its spending. G – T goes up. Thus S – I has to go up, which means that the private sector’s net savings – its excess of savings over investment – have gone up. From this MMTers conclude that increasing the government deficit adds to private sector savings. Far from ‘crowding out’ private investment, the government adds to the savings available for investment.
Murphy, however, argues that the ‘crowding out’ story is perfectly consistent with the identity:
…if government spending (G) goes up while tax revenue (T) remains the same, then the left-hand side of the equation gets bigger as the government budget deficit grows. So the accounting tells us that the right-hand side must get bigger too. It may happen partially because people cut down on consumption and save more (due to higher interest rates and their expectation of higher tax burdens in the future), but it may also happen because private-sector investment goes down. In other words, as the government borrows and spends more, the equation tells us we might see lower private consumption, rising interest rates, and real resources being siphoned out of private investment into pork-barrel spending projects. I can tell my “story” of the dangers of government deficit spending with that equation just fine.
So look again at the equation:
G – T = S – I.
If G – T increases, because the government deficit spends, then S – I has to increase as well. But there are different ways for S – I to increase: S can increase or I can decrease (or both). Since I is investment, the italicized possibility amounts to a decrease in private investment: in that case public deficit spending has resulted in reduced private investment.
Suppose, for example, that government spending is £12 per year, total tax revenues are £5 per year, savings are £10 a year, and investment is £3 a year. (Why are the numbers so small? Maybe there’s been a lot of deflation. Maybe the Austrian economists have gotten into power.) Putting these values into the formula we get:
(Year 1) 12 – 5 = 10 – 3, which balances.
Now suppose that in the next year the government increases its spending to 13 and leaves taxes at 5. Savings might go up to 11, in which case investment can stay at 3. But what if, instead, savings fall to 9 and investment falls to 1? Then we have:
(Year 2) 13 – 5 = 9 – 1.
That still balances. But that means that government deficit spending has reduced private investment. Accounting hasn’t ruled out the crowding out effect, says Murphy.
He’s missed the point of the accounting insight, which concerns flows rather than stocks. Even if the private sector reacts to government spending by reducing its investments, it’s still true that it is net saving: it is accumulating financial assets, which are flowing to it from the government sector (even if only from ‘pork-barrel spending projects’). Thus if the flows stay as they are in Year 2, the private sector will build up its stock of financial assets, which it can then invest later. So the standard ‘crowding out’ argument – that when the government spends it takes away savings that could be used for investment – is still the opposite of the truth. When the government deficit-spends it provides the private sector with financial assets – money and bonds – that it can invest later. Cameron is wrong; Miliband is wrong; and all it takes to show how they are wrong is a bit of simple accounting.
One could perhaps construct a new crowding out argument, by saying something like the following: If the government can somehow lock itself into deficit spending, then (again assuming that the foreign sector is in balance) the private sector will be locked into surplus. It will be forced to accumulate savings rather than spending or investing them. I’ve never heard that as an explanation for crowding out, and it doesn’t seem to make any sense. How can the government prevent the private sector from spending its savings (does it issue only infinite-year securities)? Surely once the private sector has accumulated enough savings (or paid down enough debt – debt repayments count as savings in national accounting) people will start to spend and invest them, moving the private sector back towards deficit. The government will then move towards surplus: tax revenues will increase, and as firms use their new income to hire more workers fewer unemployment benefits will be paid out. How exactly this happens will depend on political choices. But what doesn’t depend on political choices is that the accounting identity must hold: if the private sector reduces its surplus, the government deficit must come down.
There is an alternative neoclassical argument, to the effect that the private sector simply can’t be out of balance; in the long term S = I. Presumably if markets are so perfect as to guarantee no imbalance in the private sector then the same must apply to the foreign sector. But if the other two sectors are in balance, and if the accounting identity holds, then the government sector can’t be out of balance. Deficit spending is not imprudent; it’s impossible. Thus if, say, the government prints money to increase G, it will just create inflation, increasing all the nominal values proportionately and not changing any of the flows. If it ‘borrows’ money it will have to raise taxes later, so that over the long term G has to be equal to T. Murphy says some things later in the piece that lean towards this neoclassical idea, that the government sector must, over the long term, be in balance.
To refute those sorts of arguments requires data and not simply accounting. The long-run trend in the US, according to Randall Wray’s Modern Money Theory (p.30) is decidedly not for all sectors to be in balance; it’s for the private sector balance to be around -2% of GDP (surplus), the government balance around 5% (deficit), and the foreign sector balance around -3% (surplus – i.e., foreigners saving US assets).*
Data is, of course, a more slippery customer than accounting. So it’s worth reemphasizing how much the accounting does show, which is that it is mathematical nonsense to propose that government deficit spending takes away opportunities for private investment. Unless there is a large enough trade surplus, government deficit spending is the only source of savings for the private sector to stock up for future investment.
So do any accounting courses have some places open for Austrian economists? How about for politicians?
* Sector surpluses are represented by negative numbers and deficits by positive numbers, in line with the quoted passage above, which represents the sectoral balances as (G – T), (I – S) and (X – M).