January 12, 2019

Deficit spending, public debt, and macroeconomic profit/loss

Comment on Simon Wren-Lewis on ‘Should we worry about temporarily raising government debt?’


The curious thing about Simon Wren-Lewis’ argument is that it does not contain the word profit. It goes without saying that this omission makes the whole argument worthless.

Simon Wren-Lewis’ argument is based on the underlying standard model. This model is provably false and therefore has to be rectified first.#1

As the correct analytical starting point, the elementary production-consumption economy is defined with this set of macroeconomic axioms: (A0) The economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

Under the conditions of market-clearing X=O and budget-balancing C=Yw, the price is given by P=W/R, i.e. the market-clearing price is equal to unit wage costs. This translates into W/P=R, i.e. the real wage is equal to productivity.

Profit for the economy as a whole is defined as Q≡C−Yw and saving as S≡Yw−C. It always holds Q≡−S, i.e. the business sector’s profit is equal to the household sector’s dissaving, or, the business sector’s loss is equal to the household sector’s saving.

(i) Now, if the government runs a deficit in period 1, total expenditures are C+G, the market-clearing price rises, and the business sector makes a profit Q=G. The output O is redistributed between the household and the government sector. This amounts to taxation in real terms which is brought about by the price increase.

(ii) The banking system consists alone of the central bank. So, profit takes the form of deposits at the CB. The business sector’s deposits are equal to the government’s overdrafts. For a start, there is no interest on deposits/overdrafts.

There is no longer deficit spending. The price returns to its original level.

This intermediary time lasts from period 2 to t−1 and the government’s debt is simply rolled over. If employment and/or productivity increases, the economy grows.

(iii) In period t, the debt is redeemed. The government taxes the household sector, total expenditures reduce to C−T with T=G, the market-clearing price falls, and the business sector makes a loss of −G. After the government’s repayment, both overdrafts and deposits at the CB are again zero.

As a result, the grandchildren are hit by taxes T but get the whole output O. The business sector’s loss in period t is equal to its profit in t=1. The real taxation happened in t=1, but nominal taxation is deferred to period t.

If the interest rate on overdrafts is, for simplicity, equal to the interest rate on deposits, the government sector taxes the household sector, and the interest payments go to the business sector respectively the firms’ owners a.k.a one-percenters.

The taxation/redistribution over the indefinite intermediary time and the final taxation and redemption in period t could be avoided by immediate nominal taxation in period t=1. Immediate taxation settles ALL issues of intertemporal redistribution and is, from the perspective of the ninety-nine-percenters, preferable to deficit spending and deferred taxation.

From the government’s perspective, stealth taxation through deficit spending is preferable because nominal taxation vanishes behind the time horizon. From the business sector’s perspective, profits now and losses behind the time horizon are also preferable.

So, let the next administration worry about permanently growing public debt.#2

Egmont Kakarot-Handtke

#1 On the saying “We owe the debt to ourselves”
#2 Keynes, Lerner, MMT, Trump and exploding profit

REPLY to Simon Wren-Lewis on Jan 25

You sum up: “In policy terms I think it is the last nail in the coffin of what Paul Krugman calls the deficit scolds. Those who argued for austerity because of the burden on future generation, although on weak ground even if r > g, find their argument collapses if g > r.”

Paul Krugman (i) confuses some issues and (ii) lets some negative facts simply disappear by dividing them through infinity.

If the present government deficit-spends 100 on current output on behalf of the present generation then in some future period t the debt of 100 has to be redeemed. Now Krugman argues if GDP is currently x and in period t has grown to 1000x then the burden in terms of Debt-to-GDP is greatly reduced and in the course of time approaches zero. This is undoubtedly true but misses the point. The debt burden is not reduced by one penny but only optically by putting it in relation to an arbitrary denominator. If the economy shrinks instead, the relative debt burden increases. And this collapses the argument of Paul Krugman. 

Because nobody can say whether the economy is bigger or smaller in a future period t the whole argument degenerates to an exercise in pointless speculation.

The real problem with government deficit spending is the distributional effect. In crude terms: because of Public Deficit = Private Profit the Oligarchy gets a free lunch from the government. This, in turn, generates interest income for an indefinite time, i.e. the government taxes WeThePeople and hands the interest over to the Oligarchy. Finally, in some period t, it is NOT the future “generation” who redeems the debt. Instead, the government taxes the future WeThePeople and hands the money over to the future Oligarchy which has inherited the financial assets = public liabilities.

In sum: compared to immediate taxation, deficit-spending is a bad deal for WeThePeople and a good deal for the Oligarchy.

The, intentionally or unintentionally overlooked, distributional effect of public deficit-spending is the last nail in the coffin of the soapbox economist Paul Krugman.