Wednesday, April 13, 2011

The deficit.

The political right wants the deficit cut. The political left says the public spending cuts and/or tax increases needed to do this will hinder the recovery.

So the big question is how to cut the deficit while not reducing demand. Or put another way, how do we increase the demand increasing characteristics of each dollar of deficit?

The first part of the answer is to let the deficit accumulate as cash rather than bonds (as I pointed out here, sort of, a year ago). Cash is more liquid than government bonds. The stimulatory effect dollar for dollar of cash is more than that of bonds (that’s why QE, while it is not the best thing since sliced bread, does have a finite stimulatory effect).

Second, given an increase in household income and/or assets, the poor spend more than the rich. Put another way, the multiplier is larger in the case of the former than the latter. So deficit money needs to be channelled to Main Street not Wall Street.

But the rich / political right don’t like either of these solutions.

As to the first solution, the political right tends to think that printing extra money brings inflation. They don’t get the point that the quantity of money is irrelevant: it’s the rate at which it is spent that influences demand, and hence inflation.

As to the second solution, it’s a bit hard to see why the rich would object to channelling deficit money to ordinary households if this raises GDP and employment. Presumably the rich prefer being surrounded by paupers, to being equally rich (or even richer) and surrounded by people with enough money to buy food. Or in the words of Marie Antoinette, “Let them eat cake”.

Certainly the thrill gained from wealth is no so much the absolute level of wealth: if everyone has a ten bedroom house, there is not much of a kick to be had from owning a ten bedroom house. The real thrill comes from having stuff that others don't have. Charming creatures we human beings!


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