Some economic fallacies
Recently we have seen the Textor-Crosby machine kick into overdrive. Howard is making the absurd argument that State borrowing levels are causing “upward pressure” on interest rates.
You can read some commentary at LP. I also commented in an earlier post that the entire proposition is delusional.
In the interests of informing people about some common economic fallacies, I have tracked down a link to William Vickrey’s “Fifteen Fatal Fallacies Of Financial Fundamentalism”, which I think is mostly intelligible for the layperson.
Fallacy 1:
Deficits are considered to represent sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital.
Current reality is almost the exact opposite. Deficits add to the net disposable income of individuals, to the extent that government disbursements that constitute income to recipients exceed that abstracted from disposable income in taxes, fees, and other charges. This added purchasing power, when spent, provides markets for private production, inducing producers to invest in additional plant capacity, which will form part of the real heritage left to the future. This is in addition to whatever public investment takes place in infrastructure, education, research, and the like. Larger deficits, sufficient to recycle savings out of a growing gross domestic product (GDP) in excess of what can be recycled by profit-seeking private investment, are not an economic sin but an economic necessity. Deficits in excess of a gap growing as a result of the maximum feasible growth in real output might indeed cause problems, but we are nowhere near that level.
Fallacy 3:
Government borrowing is supposed to “crowd out” private investment.
The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment.
Fallacy 4:
Inflation is called the “cruelest tax.” The perception seems to be that if only prices would stop rising, one’s income would go further, disregarding the consequences for income.
…
The main difficulty with inflation, indeed, is not with the effects of inflation itself, but the unemployment produced by inappropriate attempts to control the inflation. Actually, unanticipated acceleration of inflation can reduce the real deficit relative to the nominal deficit by reducing the real value of the outstanding long-term debt.
Fallacy 14:Government debt is thought of as a burden handed on from one generation to its children and grandchildren.
Reality: Quite the contrary, in generational terms, (as distinct from time slices) the debt is the means whereby the present working cohorts are enabled to earn more by fuller employment and invest in the increased supply of assets, of which the debt is a part, so as to provide for their own old age.
…
This fallacy is another example of zero-sum thinking that ignores the possibility of increased employment and expanded output. While it is still true that the goods consumed by retirees will have to be produced by the contemporary working population, the increased government debt will enable more of these goods to be exchanged for assets rather than transferred through the tax-benefit mechanism.
emmeline wrote:
I agree that it’s just bad economics to argue that increased borrowing by the states will always and everywhere result in upward pressure on interest rates.
But I do worry that - as with many Howard arguments - the plausibility comes from a grain of truth.
There’s an important qualification in Fallacy 3 above:
If all of the states are expanding their spending on infrastructure, at the same time that the economy is generally considered to be operating close to full capacity, it could be argued that that investment puts upward pressure on interest rates.
dibo wrote:
emmeline - i’m not an economist, but am i wrong to imagine that if the infrastructure investment is going to boost the productive capacity of the economy then the benefit at least cancels out the short-term inflation risk?
alex white wrote:
Idle resources lying around means things like budget surpluses not being put to productive use during a boom period. (Such as the Federal Government’s surpluses and tax cuts at the expense of infrastructure and economic capacity building, during a the resources boom).
dibo wrote:
this raises a further point - is it more beneficial to the economy to put money out into the economy through tax cuts which will boost consumption or spending on skills and infrastructure that boosts capacity?
which one will sustainably generate jobs, growth and wages?
emmeline wrote:
dibo - investment to expand productive capacity does makes sense; I was just playing devil’s advocate and making an argument based on the timing of that investment. I seem to remember seeing graphs - like this one - which show that a big increase in state government spending is in prospect. If all the states are trying to increase spending on infrastructure at the same time, with a construction sector already stretched by the resources boom, you could argue that that might just bid up prices in that sector, adding to inflationary pressures in the near term. Perhaps state governments should just have been spending more on infrastructure all along, rather than obsessing about running surpluses and being deemed ‘fiscally responsible’.
Graeme Bird wrote:
“Deficits are considered to represent sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital.”
Deficits ARE just that. Lets bring Keynesian macromancy to a close. The fact is that any government spending eats up REAL RESOURCES. And there is no trickery in the real world that can conjure real resources out of thin air. Therefore government spending crowding out BEGINS at 100% and goes up from there.
How government deficit spending exhibits this crowding out is not always totally predictible but it will depend largely on how its financed. If it is financed from money creation it will primarily increase prices, not necessarily consumer goods prices. If it is financed by local borrowing it will primarily effect interest rates. And if it is financed by overseas borrowing it will primarily increase our trade deficit. But more then likely it will increase all three in some sort of compromise between the three.
We see the evidence for price increases in the cost overuns and we see the evidence for interest rate increases directly. As we do with the trade balance which remains in deficit although our terms of trade has never been so good.
But it doesn’t matter how it pans out in any given time period in that nothing can be done to reduce the crowding out below 100% since the resources consumed are real resources. And the government must OUTBID the private sector for these resources.
Since the resources must outbid the private sector the crowding out starts at 100%
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