The Claims of the American Deficit Debate: Exploring Disagreement Among Deficit Hawks, Deficit Doves, and Functional Finance Peter Hurford (Male) D01479213 Slayer Box 8192 Class of 2014 Supervised by Dr. Fadhel Kaboub
The Claims of the American Deficit Debate: Exploring Disagreement Among Deficit Hawks, Deficit Doves, and Functional Finance 1: Introduction After the 2009 American Recovery and Reinvestment Act spent roughly $787 billion dollars in an attempt to jumpstart an economy that was killed in a 2008 recession, a group of economists called Deficit Hawks saw this as just adding to the United States debt and not doing anything to solve the problem. On the other hand, a group called the Deficit Doves has countered by saying that the stimulus bill was not large enough, and the government should be spending even more to get us out of the recession, and only cut the deficit after full employment is restored. A last group, called Functional Finance, argues that given the government is financially sovereign (can print its own money), concerns over the deficit and the national debt are counterproductive. What matters is the function of the deficit (achieving full employment) rather than its level. The disagreement among these three positions comes up all the time among the television punditry, the newspaper editorials, and in the chambers of Congress. For those who want to ensure that America is productive as possible, it’s troubling that one view says we should focus on lowering the deficit and dramatically decrease government spending, yet another view says we should dramatically increase government spending, and it isn’t immediately clear which view is correct. Figuring out why disagreement exists and getting a consensus on which view is right is essential to solving the policy issue about what should be done with the US economy. This disagreement also has ramifications for economics as a discipline. Given that economics is a social science, it should be empirical, which means economists should be able to resolve their dispute by analyzing the existing data and making a conclusion as confidently as possible, or admitting that no position can be held confidently – yet they don’t. Instead sharp disagreement over the question of deficits has existed since the onset of the Great Depression in the 1930s. Given that each of the three economic views are logically consistent as a theoretical framework, yet differ dramatically based on the assumptions they make, how can we figure out which view is correct? Why do economists come to different assumptions in the first place, and why do they disagree?
2: Project Summary and Project Methodology In this research project, I hope to explain why there are differing views over the deficit and explore what this means for both policy debates in the United States and the field of economics as a discipline. I will (1) analyze the claims and assumptions made by each side of the deficit debate with an eye to explore why they are made and how reasonable they are given historical data, (2) explore how much economists really disagree and how their views get translated into the media and politics, (3) shed some light on why this disagreement has gone on for so long, and (4) come to a conclusion on how confident we can be, if at all, that any side of the debate is correct. 2.1: The Claims of The Three Sides There are three main sides to the deficit debate – the Deficit Hawks, the Deficit Doves, and Functional Finance. The Deficit Hawks follow a neoclassical view of economics and argue that the national deficit should be balanced every single year by slashing government spending. Most Hawks argue for this view by suggesting that deficits and printing money increases inflation and that the higher levels of borrowing will increase interest rates. Additionally, since Hawks view the government as competing with private corporations for a fixed amount of savings, this government borrowing will also crowd out private spending, thus decreasing the amount of money spent by private corporations and decreasing any stimulus effect (Mankiw 1995). Thus the Hawks argue that all the government is doing is placing a larger burden on future generations while making us worse off with higher inflation and interest rates, all while not doing much to improve the economy because of the crowding out effect (Mankiw 2006). Deficit Doves follow a textbook Keynesian view of economics and argue that instead it is appropriate for the government to borrow in periods of high unemployment. Deficit Doves see a vicious cycle – unemployment is caused by businesses not having money to hire people, businesses don’t have money because not enough people buy their products, and people don’t buy their products because they’re unemployed and don’t have enough disposable income (Krugman 1999). The Doves see that this cycle can only be broken by the intervention of the government, which has plenty of money to buy products or lower taxes that would put money in the hands of consumers to spend so that businesses are encouraged to hire again (Mankiw 2006). Thus Doves argue that while we definitely
should balance our budget in the long run, now is a terrible time to do it because we are in an economic slump, and withdrawing government support by lowering spending and/or raising taxes will only prolong this slump further, denying the government income and assets in the long-run (Krugman 2010). Functional Finance follow a Modern Money Theory based on ideas developed by Abba P. Lerner in the 1930s, which is a completely different conception of the role of taxation and government spending than in the theories of the Deficit Hawks and Deficit Doves (Matthew 1999). Instead of financing the government through taxation and borrowing (selling bonds), the government is financed directly by printing money. For a financially sovereign government, taxation exists to give value to the unbacked currency. The tax liability creates a demand for government money. When the government spends, it injects money into the economy, and when it taxes, it withdraws money from the system. Buying and selling bonds exists to control interest rates and inflation by controlling the quantity of money held by the public; by selling bonds, money is taken out and inflation and interest rates go down, vice versa for buying bonds (Bell 2000). Thus this view eliminates any reason to be concerned about the deficit (and the national debt), because the government will always be able to pay its debts by printing currency, will always be able to control interest rates and inflation by buying and selling bonds, and will always be able to control unemployment by buying assets with printed money or by lowering taxes (Friedman 1992). In my research, I will look at academic articles, books, and popular editorials to explore these three views, and deeply explore their foundations, justifications, models, and underlying assumptions to find out why each view was proposed, why each view continues to be defended, what proponents of each view have to say about the other two, and how reasonable each view is given the data we have. 2.2: How Much Disagreement among Economists Exists and Why Economists Disagree The kind of disagreement in economics is unlike any found in natural sciences. It isn’t like disagreement over the theory of evolution, in which more than 99% of all credentialed scientists accept the theory and there isn’t any legitimate academic debate. It also isn’t like disagreement over more modern scientific theories – while credentialed scientists may have differing views over the latest trend, this disagreement does not last
very long, and no one tries to make policy decisions based on the theory until it gains majority support (Chase 1977). Instead, economists seem evenly split among the three theories of deficit, and this disagreement has existed for over eighty years, starting as a decision on how to respond to the Great Depression in the 1930s (Krugman 1999). Yet political pundits remain as confident as ever, and economists who promote one of the three views often do so by claiming that his or her view is justified as obviously more correct than the others – the lack of strong data doesn’t seem to phase any economist who decides to do public advocacy. It is notable that astronomers and historians do not face the same problems in their field while being at the same disadvantage (Chase 1977), nor do disagreements among any other social science play out so strongly in the media. Another explanation is that the disagreement is fundamentally ideological or normative, which could explain why people argue so passionately for their view even if they lack the requisite confidence. As Thomas Kuhn argues in The Structure of Scientific Revolutions (1970), scientists occasionally talk past each other and develop their own “scientific paradigms” based on what essentially amounts to wishful thinking. This does seem to play out in the economic debate: Deficit Hawks often state that maintaining a deficit is irresponsible, that passing on debt for our children to inherit is deeply immoral, and that the government should be smaller and stay out of the affairs of its citizens and businesses as much as possible (Eisner 1984). Deficit Doves often state that governments are not analogous to households or corporations and thus should be allowed to maintain deficits when convenient to maximize employment, seeing government as having an obligation to protect citizens from the business cycle (Krugman 2012). Lastly, Functional Finance supporters proclaim that the government has an even bigger responsibility than the Deficit Doves proclaim, arguing that the government should see to it that a job is given to every person who is ready, willing, and able to work (Matthew 1999). As Kuhn argues, if it is difficult to figure out which assumptions are most reasonable given the economic data, it becomes easy to just pick whichever assumptions lead to the theory you prefer given your ideological stance. To test how much economists disagree, I will follow up on the research in the previous section and look at the implications of economic assumptions made by each of the sides as well as the arguments and counterarguments given in literature, looking for mutually exclusive claims or disagreements on factual matters. To explore why this
disagreement exists, I will look to see if disputes are factual or normative, and then see how these disputes could be resolved through an examination of economic conditions, or if there just is no basis to make this test. 3: Preliminary Paper Outline Section 1: Introduction Section 2: Deficit Hawks Section 3: Deficit Doves Section 4: Functional Finance Section 5: Why is There Disagreement About the Deficit? Section 6: Conclusion 4: Project Schedule I plan on meeting with my advisor, Dr. Fadhel Kaboub, Tuesday and Thursday of each week. Week 1-2: Focus on Deficit Hawks •
Read articles, books, and editorials advocating a Hawk point of view
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Understand the basic assumptions the Hawk view proposes
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Analyze economic arguments in support of the Hawk view
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Read about what the Hawks have to say about the Doves and Functional Finance
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I will finish drafting Section 2 of the paper and turn it in to Dr. Kaboub for feedback
Week 3-4: Focus on Deficit Doves •
Read articles, books, and editorials advocating a Dove point of view
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Understand the basic assumptions the Dove view proposes
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Analyze economic arguments in support of the Dove view
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Read about what the Hawks have to say about the Hawks and Functional Finance
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I will finish drafting Section 3 of the paper and turn it in to Dr. Kaboub for feedback
Week 5-6: Focus on Functional Finance •
Read articles, books, and editorials advocating a Functional Finance point of view
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Understand the basic assumptions the Functional Finance view proposes
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Analyze economic arguments in support of the Functional Finance view
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Read about what the Hawks have to say about the Hawks and Doves
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I will finish drafting Section 4 of the paper and turn it in to Dr. Kaboub for feedback
Week 7-8: Explore Disagreement Among the Three Views •
Look at debates between members of the three views to explore specific disagreements
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Look at underlying assumptions of the three views and explore where they come into conflict
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Look at ways the conflict could be resolved and explore how economists have attempted to resolve this conflict
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Explore claims made by politicians and see if they accurately reflect the views as advocated by economists
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Explore how much economists disagree versus how much politicians disagree
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Test to see if disagreement is sharper among those who are especially ideological and partisan
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I will finish drafting Section 5 of the paper and turn it in to Dr. Kaboub for feedback
Week 9: Come to Conclusions •
Based on conclusions from Weeks 1-6, explore how confident we can be in the assumptions of the three views
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Based on conclusions from Week 7 and 8, figure out to what degree economic disagreement is driven by ideology and to what degree it is driven by empirical claims or other factors
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I will finish drafting Section 1 and Section 6 of the paper and turn it in to Dr. Kaboub for feedback
Week 10: Focus on finalizing paper •
Work with Dr. Kaboub to explore the implications of findings for public policy and for the economic discipline
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Finalize the paper based on Dr. Kaboub’s feedback
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Compose poster for presentation
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