The flip side to the fact that deficit spending in a recession is responsible is that the story of the 1990s, the story of prosperity through surpluses, was actually deeply irresponsible, laying the conditions for the current crisis. Joe Weisenthal has a masterful article out, drawing on the work of UMKC professor and MMT theorist Stephanie Kelton, explaining how Clinton’s balanced budgets created trouble for the economy. I’m not certain I buy all of it, but it’s too important not to share.
Weisenthal lays out the makeup of GDP with this standard equation.
C represents consumption from individuals, I represents investment spending, G represents government, and X-M represents exports minus imports.
In our current predicament, we have low consumption, little or no investment, and a trade deficit. Government has to fill the hole. In the 1990s under Clinton, government was in surplus, meaning that it was dragging on growth. In addition, the trade deficit surged under Clinton in the late 1990s. So while investment was decent, the only sector that really made up the gap in GDP was private consumption. Household savings completely dissipated in the Clinton years, and household debt rose precipitously. Weisenthal shows this all in charts.
Then Stephanie Kelton lays the hammer blow:
Now, you might ask, “What’s the matter with a negative private sector balance?”. We had that during the Clinton boom, and we had low inflation, decent growth and very low unemployment. The Goldilocks economy, as it was known. The great moderation. Again, few economists saw what was happening with any degree of clarity. My colleagues at the Levy Institute were not fooled. Wynne Godley wrote brilliant stuff during this period. While the CBO was predicting surpluses “as far as the eye can see” (15+ years in their forecasts), Wynne said it would never happen. He knew it couldn’t because the government could only run surpluses for 15+ years if the domestic private sector ran deficits for 15+ years. The CBO had it all wrong, and they had it wrong because they did not understand the implications of their forecast for the rest of the economy. The private sector cannot survive in negative territory. It cannot go on, year after year, spending more than its income. It is not like the US government. It cannot support rising indebtedness in perpetuity. It is not a currency issuer. Eventually, something will give. And when it does, the private sector will retrench, the economy will contract, and the government’s budget will move back into deficit.
This is precisely what happened. It fueled an expansion of bubbles, first from tech stocks, then from housing, as private actors had to keep borrowing to satisfy consumption. And this could not hold out, and a crash resulted.
There’s a separate thread, based on some conservative thought about the blame of Fannie and Freddie in the crisis, that concerns the lack of Treasury debt and the need for something to replace it, which quickly became Fannie and Freddie-issued mortgage backed securities. I think there’s more to this story, as it was the private-label MBS that really took off relative to the GSEs. And what you must add to the critique of the Clinton years is deregulation, which allowed for the leveraging up of banks and the explosion of risky derivatives trading which turned a more manageable crisis into something disastrous.
And that brings up a broader question that people who advocate balanced budgets must answer.
What’s the point of it?
Despite the budget surplus, interest rates were higher. And the surplus provided no protection of the coming slump. And if anything, it just weakened the most brittle part of the economy: households.
That may not be a bug, but a feature. If it’s only households who suffer, elites don’t have to care. That sounds stupid but it’s actually true. The fortress balance sheets are in the hands of those wealthy enough to have walled themselves off from an economic downturn. They’re happy to see balanced budgets, because it constrains governments from taking steps to help the less fortunate, usually with progressive taxation.
So let’s not fall all over ourselves praising Bill Clinton tonight. His economic program laid the foundation for the current crisis.