Does the deficit matter? : Lavender Room: Slowtwitch Forums

Without breaking out a ton of graphs and getting way into theory or politics.... no, it does not at the moment.

Start from the premise of usual supply/demand dynamics and break the economy down into large chunks (factors) within which resources are somewhat fungible: labor, housing, manufacturing, natural resources (and break them down into constituent categories if you wish). Within each of those factors if the quantity supplied is greater than the quantity demanded the tendency will be for prices to fall (or at the very least remain "sticky" at the current level).

So if you look at U.S. production factors, what do you see in terms of supply and demand?

Labor: high unemployment, more labor supply than labor demand. Prices (wages) in a broad sense will remain subdued for a long time short of a policy shock (minimum wage).
Housing: broadly balanced, some imbalances by type and region. Prices will adjust accordingly but will remain broadly flat.
Manufacturing: other than the odd product category here and there, abundant slack. Prices likely to remain subdued.
Natural resources: plenty of slack in energy and agricultural commodities. Broad price measures likely to remain subdued.

Keep in mind that with a category like manufacturing if capacity utilization is ~70%, increased demand (whatever the genesis) to ~80% will not appreciably impact prices. You really don't start to see any effect on pricing until utilization gets above 90% for most production factors.

You'll note that I'm speaking from the perspective of monetary policy (e.g. inflation) whereas your question pertained more to fiscal policy but the reality is that the two are inseparably intertwined. On this point, Kelton and the MMT school is correct (though it should be noted that this has been stated explicitly by both Keynesians and Neo-Keynesians for a long, long time... they just realize that fiscal policy involves politics and most technocratic economists don't like the idea of getting into the political weeds).

From a solvency standpoint, deficits don't matter for a country whose debt is in its own currency: it can always just print the currency to pay its debts. However I would like to point out that this is where Kelton and the MMT gang go off the rails. Kelton claims that *every* bout of hyperinflation has occurred in a country that owed a debt in a currency other than its own.

That's bullshit. It's a hollow narrative that can be easily disproved and one which is recursive to their statement about solvency so as to avoid further investigation.

Let's say that hyperinflation is *started* by owing a debt in a currency other than your own. The natural cause-effect would be to print your own currency so as to buy the foreign currency to repay the foreign debt. Essentially your demand for foreign currency determines your domestic currency supply. Problematic. Here's the thing: under this framework the inflationary pressures should cease once external debt service has stopped. However if you look at Venezuela, Argentina, Nigeria, etc, the hyperinflation continues long, long, long after all external debt service has ceased.

In those countries the true cause in inflation is a severe imbalance in supply and demand for goods and services.

Venezuela is a prime example here. The oil boom afforded Venezuela the financial capacity for a generous welfare state. Oil was exported and virtually everything else was imported with a pseudo-luxury service economy arising. Venezuela has (and always has) ample arable land but people stopped farming thirty years ago. Why farm when you can move to the city and live comfortably performing an easier job or simply doing shit-all? Industrial food supply chains similarly dwindled... and their demise was further accelerated by government takeovers and management from incompetent government bureaucrats. So when the oil stopped flowing out and the dollars stopped rolling in, what happened? Well, the dollars to buy food and basically everything else stopped rolling in. The government printed its own currency and stopped servicing its external debt (killing the Kelton/MMT argument) but the reality is that without imports there wasn't enough food (or gasoline, or various other things) produced domestically and nobody in the world wanted to be paid in Bolivars.

Compare the Venezuelan experience to Japan: Japan has been printing its currency aggressively for thirty years. Inflation? Hardly. The difference with Venezuela is two-fold: a domestic industrial policy with an emphasis on producing basically everything (except natural resources which they're kind of SOL) and an aging demographic and shrinking population with the attendant decline in demand.

So, to summarize as best as I can, deficits don't matter so long as you have significant productive capacity and productive slack.

Another interesting place where Kelton/MMT goes off the rails is on taxation. They claim that taxes "drive" the currency. Nice corporate powerpoint buzz word. This is another flawed premise. "Drive" is the buzz word that the MMT crowd is using to say "hey you have to use our currency." Basically the premise is that if you have to pay taxes in USD you will demand USD in your other transactions because, hey, you have to pay taxes. The reality is that you can accomplish the same thing with banking laws. The real slip with Kelton is, in a recent interview, where she said "taxing the rich is right and good". It's a social goal masquerading as economic necessity. Under the MMT framework taxes only exist to prevent the private sector from competing with the public sector for resources. Period. In fact, taxing anyone when there's productive slack reduces your economic output (the whole MMT framework starts with the premise of maximizing output!).

An interesting quirk with MMT is it actually argues for regressive taxation (assuming you start with their base premise of maximizing output). To see how this work, consider the current condition of the aluminum can shortage in the U.S: Americans as recently as January were eating over 65% of their meals outside of the home and you can extrapolate that to everything they consume: burgers, fries, soft drinks.... ah, soft drinks. Normally served in a paper or plastic cup. Well Americans are still drinking soft drinks but now they're drinking them at home out of an aluminum can. As such, can supply is less than can demand. Times are good if you're an aluminum can manufacturer. Lots of revenue and lots of profit. What to do? Kelton would say that those rich aluminum can manufacturers should be taxed. Look at all the money they have! Does that solve the supply problem? No. In reality the profit motive should incentivize the can manufacturers to bring more can production online (new factory, new tools, more aluminum ordered, etc.) and taxing them would simply strip them of the resources to do so. Classic supply-side setup.

Taxation under MMT is really about controlling productive slack. Home prices heating up? Tax homes based on square footage and tax secondary residences. Broad-based wage push inflation running too hot resulting from a tight labor market? Tax everyone.

Touching on something another poster said, the U.S. might have started a demographic decline. Europe is already in demographic decline. China is certainly experiencing demographic decline. Japan, South Korea, Taiwan, Russia, and others are already in advanced demographic decline. However this is not inflationary. This is deflationary and necessitates significant deficit monetization in order to keep the financial system solvent. The "QE" that the respective central banks will have to quietly and boringly undertake to keep the system running will largely cancel each other out from an FX standpoint with little to no FX influence on domestic inflation anywhere resulting. The reason that demographic decline is deflationary is that production and consumption of non-durable goods tends to fall in lock-step whereas things like housing tend to be oversupplied and this is partially offset by greater overhead from maintaining infrastructure (though the Japanese have simply abandoned certain roads and towns wholesale).

Economics is complicated, monetary theory can get weird, incentives matter, and you cannot promise that which you cannot produce but, symmetrically, you cannot sell to a buyer that does not exist.

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