Budget deficits forever?


Below is a helpful quote from post-Keynesians Wynne Godley and Marc Lavoie on fiscal deficits and full employment. I am sceptical, based on economic history, that full employment can be sustained for lengthy periods under capitalism, which Keynesians claim is possible given the right policies. However it usefully makes a nonsense of the oft-found obsession many governments have with austerity and ‘balancing the books’, as if the public finances are akin to those of a prudent household.

This quote applies to an economy closed to foreign trade and investment flows, or alternatively to the world economy as a whole, which can be considered a closed system in economic terms.

For open economies, or those in which we actually live, the model needs to be different. The work of Michael Pettis is a great help in this regard. In particular, given the behaviour of the private sector in an economy, a current account surplus will make it ‘easier’ for the government to run a budget surplus while the economy continues to grow. For countries running a current account deficit, this will be more difficult, and if satisfactory growth and employment are to be achieved, a government deficit will be hard to avoid, unless growth is sustained by rising private sector debt.

All this follows from Godley’s ‘three balances’ or ‘sectoral financial balances‘ approach. The three balances are the public, private and foreign sectors of the economy.

“…the government’s budget is equal, by identity, to personal saving plus firms’ net saving (undistributed profits less investment in fixed and working capital) which we call ‘private net saving’. There is no way in which the government can change private net saving at full employment, which will normally be positive. It necessarily follows that the steady state budget deficit is determined by private net saving, rather than the other way round, and that the budget balance must normally be in deficit. This is in accordance (or at least consistent) with one of Minsky‘s major contentions, but it is quite inconsistent with the ignorant assumption often made by politicians that the budget balance should be zero; it is also inconsistent with the Maastricht fiscal rules. It is a major anomaly that governments’ fiscal policies, throughout the world, are judged by their budget deficits, measured ex post, over which they have little more control than the money supply…” (my emphasis)

Wynne Godley and Marc Lavoie (2012), Monetary Economics, Ch.11, p.444


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