With U.S. government deficits increasing again and big spending plans coming from potential Democratic candidates for president, we thought it would be prudent to have a conversation with Stephanie Kelton. She’s a proponent of Modern Monetary Theory (MMT), the economic rational cited by rising political stars like Rep.
Kelton currently works as a professor of public policy and economics at Stony Brook University. Previously, she served as chief economist for the Democrats on the U.S. Senate Budget Committee and was a senior economic advisor to
‘ 2016 presidential campaign.
Below is the Q&A with Kelton, edited for time and clarity. She was being interviewed for a CNBC Digital video.
Jordan Malter, CNBC: You wrote an article in The New York Times. It was titled, “How we think about the deficit is mostly wrong.” What’s the conventional thinking and why is it wrong?
Stephanie Kelton: So the conventional thinking about budget deficits, I think, tends to be that people look at a deficit and they think that it’s evidence of overspending. They think it’s evidence the government is mismanaging its books. That it’s done something wrong. [But] evidence of overspending is inflation.
So what is the budget deficit? I like to do this by using an example. I think it helps people. If you think of the government deficit as the difference between what the government spends into the economy and what it taxes back out, then imagine a government that spends $100 into the U.S. economy but it only taxes $90 back out. We label that a government deficit and we record that on the government’s books. But what we forget to do, is pay attention to the fact that there’s now $10 somewhere in the economy that wouldn’t have been there otherwise, that is put there by the government’s deficit. In other words, their deficits become our surpluses. So when we talk about the government having all this red ink, we have to remind ourselves that their red ink becomes our black ink, and their deficits are our surpluses.
Malter: So, do deficits and aggregate debt matter at all? At some point can a country have too much debt?
Kelton: So the deficit definitely matters. It’s just that it matters in ways that we’re not normally taught to understand. Normally, I think people tend to hear deficit and think it’s something that we should strive to eliminate, that we shouldn’t be running budget deficits. That they’re evidence of fiscal irresponsibility. And the truth is the deficit can be too big. Evidence of a deficit that’s too big would be inflation.
But the deficit can also be too small. It can be too small to support demand in the economy and evidence of a deficit that is too small is unemployment. So, deficits can be too big, but they can also be too small. And the right level of the deficit is the one that gets you a balanced overall economy. The one that allows you to achieve high levels of employment and low inflation.
Malter: Where does growth play into this? You’re saying high unemployment means that the deficit might be too small. Is low growth also a sign of the deficit being too small?
Kelton: Well, it depends because you’ve got to balance the potential benefits from higher growth against the risks of higher inflation. And so you may see a slow-growing economy that has close to full employment and inflation at about 2 percent. The question is then: Should you expand fiscal policy? Should you run bigger budget deficits in order to boost growth? So what is the objective? What is the proper policy goal? I think the right policy goal is to maintain a balanced economy where you’re at full employment and you’re guarding against an acceleration in inflation risk.
Economists tend to understand that the kinds of things that you can do to boost longer-term growth are investments in things like education, infrastructure, R&D. Those are the sorts of things that tend to accelerate productivity growth so that longer-term real GDP growth can be higher. So there are ways in which the government can make investments today — that increase deficits today — that produce higher growth tomorrow and build in the extra capacity to absorb those higher deficits.
Malter: I want to talk a little bit more about the policy proposals a little bit later but before that, Modern Monetary Theory — MMT — can you explain that?
Kelton: MMT starts with a really simple observation and that is that the U.S. dollar is a simple public monopoly. In other words, the United States currency comes from the United States government. It can’t come from anywhere else. And therefore, it can never run out of money. It cannot face a solvency problem, bills coming due that it can’t afford to pay. It never has to worry about finding the money in order to be able to spend. It doesn’t need to go and raise taxes or borrow money before it is able to spend.
So what that means is that the federal government is nothing like a household. In order for households or private businesses to be able to spend, they’ve got to come up with the money, right? And the federal government doesn’t have to behave like a household. In fact, it becomes really destructive for the economy if the government tries to behave like a household. You and I are using the U.S. dollar. States and municipalities — the state of Kansas or Detroit — they’re also using the U.S. dollar. Private businesses are using the dollar. The federal government of the United States is issuing our currency, and so we have a very different relationship to the currency. That means that in order to spend, the government doesn’t have to do what a household or a private business has to do: find the money. The government can simply spend the money into the economy and when it does, the rest of us end up receiving that spending as part of our income.
Malter: How much is too much? The CBO estimates that if things remain unchanged, the debt will be 152 percent of GDP in 2048. That will be the highest in the nation’s history. Is that too much?
Kelton: Let’s remember what the national debt is. The national debt is nothing more than a historical record of all of the dollars that the government spent into the economy and didn’t tax back that are currently being held in the form of safe U.S. Treasurys. That’s what the national debt is. So the question about whether the debt is too big or too small (or whether it might get too big at some point in the future) is really a question about whether that’s too many safe assets for people to hold 10, 20, 50 years from now.
If you think about what happened after World War II, when the U.S. national debt went in excess of 100 percent, close to 125 percent of GDP. If we were talking about it the way we talk about it today as burdening future generations as posing a grave national security risk, we would have to scratch our heads and say, wait a minute. Do we think that our grandparents burdened the next generation with all of those bonds that were sold during World War II to win the war, build the strongest middle class, produce the longest period of peacetime prosperity, the golden age of capitalism, all of that followed in the wake of fighting World War II, increasing deficits, massively increasing the size of the national debt. And of course the next generation inherits those bonds. They don’t become burdens to the next generation. They become their assets.
So it’s impossible really to put a number, nobody can. How much debt is too much debt? If you look at Japan today you see a country where the debt-to-GDP ratio is something like 240 percent. Well above, orders of magnitude above, where the U.S. is today or even where the U.S. is forecast to be in the future. And so, the question is how is Japan able to sustain a debt of that size? Wouldn’t it have an inflation problem? Wouldn’t it lead to rising interest rates? Wouldn’t this be destructive in some way? And the answer to all of those questions, as Japan has demonstrated now for years is simply: No. Japan’s debt is close to 240 percent of GDP — almost a quadrillion, that’s a very big number, yen. Long-term interest rates are very close to zero, there’s no inflation problem. And so despite the size of the debt there are no negative consequences as a result and I think Japan teaches us a really important lesson.
Really, the only potential risk with the national debt increasing over time is inflation and to the extent that you don’t believe the U.S. has a long-term inflation problem you shouldn’t believe that the U.S. is facing a long-term debt problem.