The orthodox dogma about deficits is that they are “always very bad witness Greece”. This is the claim of the austerity obsessed fiscal conservatives. But what a lot of the advocates of this position seem to ignore is that this austerity free market approach is identical to what was foolishly followed during the great depression of the 1930s and which led to a much worse depression, the rise of fascism and eventually to world war.It is remarkable how little the establishment has learned from history. There is a scientific rebuttal of this argument available in the literature going back to Abba Lerner and John Maynard Keynes. More recently economists like myself, Robert Eisner, Ruben Bellan and other Keynesians have tried to explain this logic to both professional economists and  the general public. But apparently to no avail. So I am republishing below a post from 2011 on exactly this subject. Much misery can be avoided by the use of reason instead of ideologically driven ignorance in solving our economic problems. But it takes courage to do so.

One of the best Keynesian economists in the U.S. was the late Robert Eisner who taught for many years at Northwestern University and who was at one time president of the American Economics Association. I had the pleasure of spending a day with Eisner when he came to Montreal at my invitation in the late 1980s to speak to my students about Keynes and macro policy. His book How Real is the Federal Deficit (1986)is still an essential text in understanding this theoretical and policy question.

Around the same time a much less well known Canadian economist who taught for most of his career at the University of Manitoba Ruben Bellan had published in Canada a work on lowering unemployment through stimulus and appropriate monetary and fiscal policy with the apt title The Unnecessary Evil:An Answer to Canada’s High Unemployment(1986). Bellan also approached the issue from a Keynesian perspective and grounded his argument in the success of the wartime policies of full employment through investment and government expenditure that had successfully ended the great depression in Canada. I had published my monograph The Deficit and Debt Management :An Alternative to Monetarism in 1984 that made quite similar arguments to both Bellan and Eisner but Eisner because of his prominence received considerable attention from both the New York Times and the Wall Street Journal as I recall but after a brief flurry of interest his argument was forgotten.

Bellan was subject to several nasty dismissive reviews in the conservative business press and my own work received some attention most of it critical and like the others relegated to obscurity. The fact was and remains so all three of us were largely correct in what we had argued. It is now 25 years later and the time long overdue to reconsider the arguments in detail so as to help perhaps prevent another great depression from coming about due to the triumph of ignorance and ideological bias over rational inquiry.

Bellan put the issue rather well in the opening paragraphs of his book.

” for the entire decade of the 1930s the Canadian economy wallowed in the worst depression in history. the unemployment rate averaged about 15 %; in 1932 it was a catastrophic 22%. World War II…brought a dramatic transformation. By 1941, once the war effort had reached high gear, severe unemployment was replaced by a critical labour shortage…This galvanization of the Canadian economy from sluggishness to hyperactivity was achieved by the federal government’s enormous spending…The government could have spent money on this scale previously; war did not provide it with financial capability that it had not possessed in peacetime. It had refrained, however, forbidden by an economic orthodoxy that warned both that it was impossible and that the results would be catastrophic. first declared the experts, Canada simply didn’t have the money; it would have to be obtained from foreign sources-and they would no doubt refuse to supply it. secondly, a large addition to the country’s monetary circulation would inevitably cause a ruinous inflation. finally, the burden of debt assumed by the government in borrowing the money would oppress the country ever after.” (pp 9-10)

Bellan goes on to detail how the experts of the day insisted that only private sector activity and new investment could do the job and how it would be” ruinous folly” for the government to undertake public spending to accomplish the task.

It is quite simply amazing how all of these discredited arguments have come back in contemporary times. Bellan concluded the opening chapter of his book with a plea for a ”more humane -and less wasteful-economic policy” and pointed out that he had ”greater respect for the free enterprise system than did those champions of free enterprise who insist it is incapable of providing useful employment for all …who seek it.” (p.11)

Eisner would not have disagreed with the thrust of Bellan’s argument . Because he was much more of an econometrician and macro theorist he established his argument in a different more theoretical fashion. One of the key tools in his approach to crunching the data to prove his case was the concept of the high employment budgetary deficit(or surplus) which he defined as follows;

”it is calculated from a budget that presents estimates of what expenditures and receipts and hence the deficit would be if the economy were at a level of activity independent of cyclical variations in employment, output and income. Since the cyclical variations in output and income are closely associated with those of employment and unemployment the budget has usually been defined for a constant rate of unemployment.” (p.83)

That rate of high employment was originally defined as 4 % unemployment but was raised over time in stages to 5.1 % by 1975.(See Eisner, appendix C, section E p 215). Once one makes this adjustment in the data Eisner shows that deficits have a strong positive impact on the economy. What this approach also shows is that nominal deficits once adjusted for the cyclical component often turn into surpluses which explains the mystery of why a cyclically induced deficit not sufficiently treated with stimulative fiscal policy can accompany high unemployment and not appear to work to cure the problem. This is so because the apparent deficit is actually a contractionary high employment surplus or a much smaller deficit than is necessary to overcome the cyclical downturn’s impact on employment and growth.

To use deficit finance properly you need to have a high employment deficit when you are suffering from excessive unemployment.

All too often the deficit that prevails is the consequence of the rise in unemployment rather than deliberate counter cyclical spending. This cannot correct the problem ,particularly if most of the automatic stabilizers have been damaged or diminished by years of neo-con policy.

Bibliography:

Ruben Bellan, The Unnecessary Evil:An Answer to Canada’s High Unemployment, Toronto:McClelland & Stewart, 1986.

Harold Chorney, The Deficit and Debt Management:An Alternative to Monetarism, Ottawa:The Canadian Centre for Policy Alternatives, 1984.

Robert Eisner, How Real is the Federal Deficit,New York: Free Press ,Macmillan, 1986.