The Fiscal Debate Continues

|Peter Boettke|

As a public debate over austerity in the Eurozone and the US continues a significant side of the debate continues to assert that what is needed is Keynesian economics 101.  Another side of the debate, which isn't really paid attention to beyond lip-service, argues that all we have had for the past 60+ years is Keynesian policies and the legacy of which is what we must confront now.  The democratic states of the west since WWII have simply oscilated between liberal Keynesianism and conservative Keynesianism, and we have never moved in the actually implementation of public policy into an "After Keynesian macroeconomics" world, let alone returned to the more orthodox teachings of pre-Keynesian macroeconomics.  Instead, we have lived in an age of "economic illusion" where common sense economics was denied, and governments used the tools of monetary and fiscal policy to distort market signals, disrupt the coordination of economic plans, and deceive an unorganized and ill-informed public.

The reason why the situation isn't worse is because of the great gains achieved during that 60+ year period due to technological innovations, and the opening up of trading opportunities throughout the globe.  As Adam Smith argued long ago, the power of self interest enables a market economy to overcome any number of impertinent obstructions that human folly may thrust upon it.  But a market cannot overcome an infinite number of obstructions; there is a tipping point.  There also is a question of arithmetic -- which is very often unpleasant for current generation polticians as they strive to spend more, and pass the payment to others.  Sooner or later the bill comes due, and in the case of many public expenditures there is no connection whatsoever to "investment" that paid off through time.  Instead, the fiscal commons just produced an overspending in the "here and now" and a promise to pay a "big bill" down the road.  That big bill has accumulated over those 60+ years, and policy makers now the Eurozone and the US are grappling with that reality.  Like their predecessors, they would like nothing better than a justification to send this bill down the road to future generations so they can continue to spend.

Unless we as economists, economic policy makers, and the interested layman focus our intellectual attention on the political and economic consequences of Keynesianism we will not make progress. The problem goes to the root of the Keynesian prescription in macroeconomic policy, and further in macroeconomic thinking in general.  But the debate among economist about public policy focuses primarily of late on the effectiveness of austerity.  Robert Skildelsky has challenged the austerity arguments and calls for a Keynesian solution to be followed which will boast aggregate demand and relieve the Eurozone and the US from its current state of an "unemployment equilibrium".  He claims that the current policy path of fiscal austerity measures has produced a predictable failure.  Ken Rogoff argues that while there is no magic Keynesian bullet to fix the problem, inflation may be the key (or at least the lesser of evils).  He repeats that he is  not an advocate of extreme austerity measures.

In debating these issues, one should start with examining what we know from natural experiments with austerity and whether tax increases or spending cuts are more effective at getting the economy back on track.  In a study for Mercatus, Veronique deRugy and Alberto Alesina argue that spending cuts and more competitive environment is the key to regaining fiscal responsibility and generating renewed economic growth.

Since 2008, I have been arguing that for economists wanting to comment on our contemporary problems the best places to start are Buchanan and Wagner's Democracy in Deficit, and Hayek's A Tiger By The Tail.  Critical to that reading, is to ultimately see the connection between the two and the deficit, debt, debasement cycle that Keynesian policies have unleashed throughout the democratic west.  Governments, ancient as well as modern, Adam Smith told us want to engage in this juggling trick of deficit spending, accumulating public debt, and then debasing the currency to pay the debts off cheaply.  The task was to constrain the juggling as such a policy leads to the ruin of nations and in some instances the collapse of civilization.  Orthodox economics from Smith to Hayek taught the dangers of this juggling.  Keynes argued we need to embrace the juggling.  We haven't stopped juggling ever since.

Comments

[Harrison Searles]

At times it has seen to me as if most discussion of this issue has been corrupted by physics-mimicking equilibrium thinking rather than a concern about institutional evolution over time. Most Keynesians seem to be concerned simply about maintaining the juggling trick now rather than a concern about what the consequences of that juggling will have on society in the years, and generations, to come. Concerns, about the consequences of the juggling trick on coordination within society are tossed to the side. All that matters is maintaining their full-employment equilibrium, damn the consequences.

[Daniel Kuehn]

A comment of mine seems to be lost (or didn't get through the new system), but the gist of it applies equally well to Harrison's comment so I'll restate it.

Precisely what do you mean by "juggling trick"? I think one of the problems that Pete faces in these discussions is that it's never clear precisely what he means. I think people do think a lot about this, Harrison. The example I mentioned earlier of someone who DOES talk about this precisely that I'm familiar with is Michael Wickens, and it's very clear what is and is not a good debt accumulation stance. DeLong and Summers' BPEA paper does this too. I don't know how you can be sincere when you say that "most Keynesians" are not concerned about the consequences of the juggling trick.

But that all comes back to the fact that it's not clear exactly what the juggling trick even is.

[Harrison Searles]

It's very clear what Pete means and what Adam Smith meant before him. Very. The juggling trick is how nations have paid for war both before and after Smith. The juggling trick had been held in many nations by democracy and classical liberal governing practices. Just look at the differences between how the United Kingdom paid for its war against Napoleon and its wars against Kaiser Wilhelm II.

However,as Buchanan and Tullock showed in the prophetic _Democracy in Deficit_, now those rules of governance no longer apply even to peacetime. Now governments continue to accumulate debt. Of course, differing parties and those aligned to those differing parties will point the finger at the other party. But that ignores the point, who did it doesn't matter (and who did it was when push came to shove either a conservative or a liberal Keynesian), that it was even able to happen has shown that there's are no longer any constraints, either legal or moral like the Gladestonian ethos of public spending, on the juggler. And when the juggler isn't constrained, he will juggle.

You say that the Keynesians are concerned about debt accumulation, sure. However, that is not what I'm getting at. What I'm getting at is that Keynesians show no concern about the institutional consequences of debt accumulation. When a Keynesian points out that the United States and other nations have been faced similar levels of debt in the past like following the Second World War, they reveal this blind spot. The problems of debt faced by a nation after a war and after a generation of peacetime deficits are two completely different problems because of the differing institutional natures of the problems. Especially problematic is the emergence of peacetime patterns of behavior that are now dependent on the government deficit spending of the type that this article touches on, but fails to recognize <http://www.nytimes.com/2013/05/13/opinion/how-austerity-kills.html?pagewanted=all&_r=0>. Decreases in government spending don't kill, the expectation that the government will maintain promises that it cannot keep kill.

“I don't know how you can be sincere when you say that 'most Keynesians' are not concerned about the consequences of the juggling trick.”
Keynesians have a lot of promises of smart people working on the problems of the debt, but when it actually comes to what those solutions are, they're all about getting the right people in control rather than about setting up binding rules. That is simply not taking the problem of Smith's juggling trick seriously because the most important lesson that can be taken from it is that the juggler's hands need to be bound, not that the juggler has to come from a certain political persuasion.

[Daniel Kuehn]

re: "What I'm getting at is that Keynesians show no concern about the institutional consequences of debt accumulation. When a Keynesian points out that the United States and other nations have been faced similar levels of debt in the past like following the Second World War, they reveal this blind spot. The problems of debt faced by a nation after a war and after a generation of peacetime deficits are two completely different problems because of the differing institutional natures of the problems."

But who do you imagine is disagreeing with you on this!

[Harrison Searles]

If everyone is agreeing with me on it, then why is that such a popular thing, among Keynesians like Brad DeLong and Paul Krugman, to point out that the advocates of austerity are overreacting because Western nations were in a similar level of debt after WWII. The consequence of my statement is that this analogy is entirely improper and yet Keynesians like DeLong and Krugman continue to make it. Nor do I see other Keynesians pointing their error out.

And where are the Keynesians pointing out the systematic problems of patterns of expectations of public services that cannot be fulfilled in debt-laden nations? The last time I checked, the only mention this gets is a sob story of how austerity is ruining lives like here <http://www.salon.com/2013/05/19/paul_krugmans_right_austerity_kills/>.

Or the problem is completely ignored to say that less government spending creates less income and therefore depresses the economy rather than thinking about whether government spending is creating, to use Arnold Kling's term, patterns of sustainable specialization and trade. Paul Krugman does that: "In an economy where we’re all in the same boat, one person’s spending is another person’s income. So when the government cuts spending, it reduces people’s income, leading to less business, more unemployment, and a vicious spiral of slowing down the economy."

Where's everyone who agrees with me going against Krugman on this point? After all, my statement that everyone supposedly agrees with me on means that we cannot look at simply the amount of spending in the economy, we have to look at what institutions have coevolved with that spending. Where's that concern among the Keynesians? All I've seen from them in a concern about the amount of spending in society.

[Daniel Kuehn]

re: "And where are the Keynesians pointing out the systematic problems of patterns of expectations of public services that cannot be fulfilled in debt-laden nations? The last time I checked, the only mention this gets is a sob story of how austerity is ruining lives like here"

Have you missed the health reform debate? Not all macroeconomists have participated but those two have. You're in the area - have ever seen the long term entitlement picture discussed? I feel like we're observing completely different things here.

[Barkley Rosser]

Harrison,

What is your point about how UK financed its various wars? It financed the one against Napoleon by borrowing from Dutch banks so heavily that by 1815 the debt/GDP ratio was at 300%, far beyond the silly and now discredited 90% threshold pushed by Reinhart and Rogoff. A century of British economic, political, and military dominance of the world followed that awful event.

Of course, for WW II Keynes was opposed to what he viewed as excessive borrowing in his "How to Pay for the War." This was the period when he was most sympathetic to Hayek, eventually writing a praising letter to him on the publication of The Road to Serfdom. Were you supporting this latter approach of Keynes or the former "Keynesian" one of the Napoleonic wars?

[Harrison Searles]

Barkley,

My point is that how the UK financed its wars is the basic form of Adam Smith's juggling trick that I would say is now peacetime practice across the West. I said nothing about either the magnitudes of the debt nor the 90% figure, which I think no one should have paid attention to in the first place (point predictions should not be taken seriously in the study of society). My statement was about the historical form, and the general concatenation of events.

Nor did I make Keynes a target. Honestly, from my own reading of him, I would not consider him as someone who supports the peacetime juggling trick.

That being said, I don't think any one person would say that they support the juggling trick, either in Smith's day or today. I would say the juggling trick is itself spontaneous order, and the product of action across a multitude of decision-makers all trying to make the best of their situation. However, without institutions and rules to limit their set of decisions to prevent the (for the most part) unintentional emergence of the juggler.

[Harrison Searles]

Errata: "Nor did I make Keynes a target. Honestly, from my own reading of him, I would not consider him as someone who supports the juggling trick."

[Barkley Rosser]

Harrison,

I think the real issue here is the one Daniel asked that you never answered and is the substance of my earlier inquiry: what is this "juggling trick" that you are so worked up aboout? You have never said. You elided the issue by bringing up how UK finances its wars, which led to my pointing out that there is a very far from clear message there.

Let us call them "sensible Keynesians," who may not be all that far from Hayekians, who would say that you finance a war with borrowing that you pay back (or at least lower the debt/GDP ratio) after the war ends, with a similar view holding vis a vis recessions, when budget deficits tend to emarge anyway due to reduced tax collections for a given fiscal policy. I do not know if this view is what you agree with, think UK followed for one war or another or what.

[Barkley Rosser]

To clarify further, this "sensible Keynesian," which long predates Keynes, is that one runs deficits during wars and recessions and surpluses during peace and prosperity, although I know that some Austrians disagree with this, although I am unaware of Hayek or any other demanding every year balanced budgets, and while Buchanan supported a balanced budget amendment, the last time I checked it did allow for loopholes for at least war, if not recession.

[Daniel Kuehn]

re: "To clarify further, this "sensible Keynesian," which long predates Keynes, is that one runs deficits during wars and recessions and surpluses during peace and prosperity"

Or not necessarily surpluses but debt-stabilizing deficits. This is precisely why I wish Pete or Harrison would make their case more formally. If you define it formally, like Wickens, its clear that almost all Keynesians are on Smith's side of the juggling trick (by that definition). And if Pete doesn't like that definition he has to offer an alternative but more importantly why his alternative is better (I don't think there's a good case).

But by keeping it vague, he skirts by with lumping debt-stabilizing-regular-deficit-Keynesians with some imaginary anti-Smithian yahoo.

If details were actually laid out, I think Pete could get a much wider audience for these questions. As it stands, when people get bashed over the head with being told they're not Smithian and not mainline they're not going to just hang around and endure the abuse.

[Daniel Kuehn]

Two questions I posed to Harrison over facebook on this:

"1. Do you think Keynesians would agree with the characterization of their views in this post [i.e. - Pete's post here]?
2. If not, is that a problem?

It's one thing to all agree on what everyone thinks and then disagree on whether it''s right or not. But if you are arguing against a viewpoint nobody has that seems like a non-starter. Too many of Pete's writings on Keynesians lately have, I fear, been complete non-starters. They read like people who say that the problem with libertarians is that they don't concern themselves with poor people. Where would you go with that?"

Similarly, what does Pete expect us to do with this? It's a "do you still beat your wife?" kind of post.

[Daniel Kuehn]

It goes without saying, but all excellent points Barkley.

[Harrison Searles]

The juggling trick is, to quote Pete, the process of "deficit spending, accumulating public debt, and then debasing the currency to pay the debts off cheaply." War spending, especially before the liberal era, has been the classic example of the trick. Adam Smith's own elucidation of the juggling trick in _The Wealth of Nations_ (especially pgs. 929-931 of the second volume of the Liberty Fund edition) focused on war spending with a much longer historical exposition of the practice.

Do either you or Daniel deny that the policies of governments in the past, whether Roman or British, have lead to the creation of such a juggling trick in the past? To me, this is a rather obvious historical description of events.

The reason I for one am so “worked up” about this problem is that in the long run we aren't all dead, in the long run the world controls us or our descendents, who are still very much alive. The problems of the contemporary, peacetime juggling trick will solve themselves, but they will solve themselves in a manner that will be destructive to society, the rule of law, and advanced forms of social cooperation. Of course, everyone is going to say we need a “long term” plan, but the problem is that a long term plan that doesn't start today isn't a plan, it's an excuse, and the long run is always quicker to come than we'd like.

Onto sensible Keynesianism.

"To clarify further, this 'sensible Keynesian,' which long predates Keynes, is that one runs deficits during wars and recessions and surpluses during peace and prosperity..."
The "sensible Keynesian" position is simply bad political economy, though. It doesn't take seriously the challenge of the liberal tradition, which all sensible Keynesians would certainly call themselves members of, of establishing the rule of law, not men.

To take the problem seriously means moving beyond hoping that the right sensible Keynesian is in charge, and to instead start to think about what institutions are necessary to ensure a “sensible Keynesian” outcome. No one likes being nailed to a mast and forced to obey the rule of law, but that's what's necessary to take the political economy of governance and politics seriously.

Sensible Keyneianism boils down to saying things, but giving no credible commitment in the form of legal rules. Words are wind.

And, just as I don't see anyone here discussing R&R's 90% threshold, I see no one here saying that what is necessary to prevent the juggling trick is a rule binding the government to balance the budget every single fiscal year.

[Daniel Kuehn]

re: "To take the problem seriously means moving beyond hoping that the right sensible Keynesian is in charge, and to instead start to think about what institutions are necessary to ensure a “sensible Keynesian” outcome."

Right. Agreed. This is just plain being a sensible economist, though - not just a sensible Keynesian.

In fact it's not even just being a sensible economist - it's being a sensible liberal.

[Barkley Rosser]

Ah, Harrison, I confess that I did not read Pete's post closely enough to see his use of this phrase, "juggling trick," that you have turned into such a big deal. So, yes, let us agree that there have been many nations that have indulged in excessive deficit spending, more likely to be dangerous if not tied to wars or recessions, that have also engaged in super stimulative monetary policy when there is peace and prosperity, and have ended up with hyperinflation. Duh.

But you have not remotely begun to deal with the example I gave above, UK in 1815 with a debt/GDP ratio far above any nation currently on the planet, and not suffering at all the inflation or "debasement of currency," that Pete and you seem to see as the inevitable outcome of this badly labeled "juggling trick." Clearly it only becomes meaningful once some other conditions are in place, none of which have been laid out by either of you.

The obvious such conditions are those I laid out as "sensible Keynesianism," although given that this is a term that many here simply knee jerk reject for ideological reasons, let us call it "common sense mainline economics," to use a term Pete uses. And Buchanan's amendment in fact made exceptions for both main contingencies.

[Barkley Rosser]

Harrison,

What do you think people should be saying about the 90% threshold? Do you think that the rules you advocate should somehow incorporate it? As it is, it has become clear that there is no threshold at 90% debt/GDP ratio. The correlation is a negative straight line above about 20%, so nothing at all happens at 90%. It is a meaningless crock.

[K Sralla]

I am not necessarily defending Reinhardt and Rogoff, but I do not recall that they presented the 90% debt/GDP rule in the way Barkley and Daniel claim. In my reading, they are simply making the point that countries with a long history of multiple defaults have a lower credit worthiness than developed countries with a better historical track record of public finance.

For example, the United States gets to carry a bigger debt load than Greece before the bond markets say the game is up. Japan probably is able to sustain a much larger debt load for much longer than Brazil, and so on. However, big country or small, when debt/GDP begins passing 90%, certain events *have the potential* to trigger a sovereign debt crisis.

That is how I read their point.

As a final editorial rant, may I point out that some in your camp (ie Daniel) seem to hold that since the term "juggling trick" conveys no quantitative meaning, they therefore will not even stoop so low as to engage in a discussion about public finance or political economy with anyone who uses the term qualitatively.

Who are you guys trying to convince with this type of "gottcha" lawyer technicality? All of us know exactly the "concept" conveyed by this term, and the fact that you fail to subtanitively engage the point is telling.

Why don't you just come out put all us simpletons right? Just remind us that based on the "mainstream" model of public finance, a nation can perpetually accumulate an ever expanding public debt, then continue to roll it over indefinately by taxing more, borrowing more, and printing more (robbing Peter to pay Paul), and all this with very little if any risk of *ever* experiencing a sovereign debt crisis if only some rational political discourse prevails. The bill simply never ever comes due in the future, and the burden of public debt is never passed on to folks living in the future.

Likewise, please impress us simpletons out here by stating the mainstream public finance theorems straight up using numbers and a formal mathematical model. Wow us with some nice partial differential equations (some real hum dingers), and teach us what proper modern scholarly discourse looks like.

Thanks for taking the time to educate us!

[Daniel Kuehn]

K Sralla -
You're sensationalizing what we said. Nobody's calling anyone a simpleton and Barkley and I gave two different, entirely qualitative potential interpretations (although quantitative would be great too).

Clearly there's a lack of clarity in the statement, and wanting clarity is absolutely not the same thing as wanting a lot of math.

I think people stay vague on this count because it gets awkward explaining what's wrong with a debt-stabilizing level of deficit spending. If you complain about that then you start to belie prior claims that what you care about is burdens on future generations.

[Daniel Kuehn]

re: "therefore will not even stoop so low as to engage in a discussion about public finance or political economy with anyone who uses the term qualitatively."

And this is uncalled for. I'm in the discussion after all - obviously I don't see things this way. I'm just saying it gets frustrating. I'm not the one here who has tarred a swath of my colleagues as promoting "economics of illusion". I'm still in the conversation without making any kind of denigrations like that. Don't fling this at me.

[Socialdemocracy21stcentury.blogspot.com]

"Another side of the debate, which isn't really paid attention to beyond lip-service, argues that all we have had for the past 60+ years is Keynesian policies "

An incredible travesty of history.

Keynesian full employment macro-management was largely abandoned from the late 1970s and early 1980s.

Over the past 30 years we have had a revived neoclassical approach to macro, generally with its emphasis on monetary policy and inflation targeting, and rejection of older fiscal activism.

[Barkley Rosser]

Harrison,

Based on what you are saying, I think you are referring to R&R's excellent book, _This Time is Different_. They do not talk about the 90% threshold there. That came in a paper in the AER P&P in 2010, which has now been shown to have a lot of problems. Pete's citing Rogoff's comment on inflation is yet another issue.

I would also say that Buchanan and Wagner's point that a problem with discretionary fiscal policy is the asymmetry involved that tends to lead to permanent deficits, as it is politically easy for legislatures to increase spending and cut taxes but to resist undoing either of those.

K. Sralla,

The hard fact is that whether the debt/GDP ratio is rising or falling, most of the time we pay off old debt by issuing new debt, aka "rolling it over." There is nothing wrong with that, and it is the way things work.

If you think we should just pay off all the debt, I note that the one time in US history that we did so was in 1836. This was immediately followed by the Panic of 1837, one of the worst downturns in our history, with tax revenues falling so sharply that, well, we were back to borrowing money once again, never to stop since.

[Roger McKinney]

Barkley, didn't the panic of 1837 have something to do with the government requiring banks to hold government debt as reserves? Or am I thinking of a later crisis? If so, the reduction in government debt would shrink the money supply. Without such a requirement a state with no debt would be no problem.