Wednesday, March 30, 2011

Austerity and Household Debt

Economics as a discipline has a lot of problems owing to its relative newness, but one thing that's nice about it is that it's backed by another discipline where all the science is known - accounting.

Dig deep enough into the accounting side of a bad economic policy and you'll always find something alarming. In the case of the UK's disastrous plan to cut government deficits during a deep recession, the accounting problem comes in the form of household debt projections, which Krugman brings us today via Yves Smith (whose charts are always awesome).


Because the only way the economy can avoid taking a hit from government cuts is if private spending rises to fill the gap — and although you rarely hear the austerians admitting this, the only way that can happen is if people take on more debt.


Why is that? Can't households theoretically make more money? No. Since US deficit spending is the only source of net US dollars, households as a class cannot gain dollars unless the government provides them via deficit spending. The only way they can increase their spending power in the face of falling deficits is to borrow.

We don't need more consumer debt - we need less.

3 comments:

  1. I think you and Krugman are both wrong here. You seem to be confusing stocks and flows, and Krugman seems to be ignoring the possibility of liquidating assets. "US deficit spending is the only source of net US dollars," but the number of times those dollars change hands in a given time period is not a fixed quantity. "Spending" is a flow, and "dollars" are a stock, and the relationship between the two can change. Suppose the confidence fairy touches me with her magic wand and makes me decide to buy a new TV. Since I already have money in the bank, I can withdraw money to make the purchase. That is money that I didn't have to borrow, and it's money that would have existed whether or not I decided to make the purchase. Granted, Krugman is probably right to deny the existence of the confidence fairy, but as a matter of accounting, I don't see why greater spending requires greater debt.

    ReplyDelete
  2. I'd love to engage with you as you clearly have a good background in banking operations but you need to be more explicit about what you're disagreeing with.

    I don't disagree with anything you wrote, but it isn't clear to me what you think you're refuting.

    ReplyDelete
  3. OK.

    "The only way [households] can increase their spending power in the face of falling deficits is to borrow."

    I'm not sure what you mean by "spending power." You seem to imply that borrowing is the only way that households can spend more. That is only true for households without disposable assets. For the many households that still have disposable assets, they can spend more simply by deciding to spend more and then selling assets. And the asset that they sell might just be a bank balance or even cash under a mattress. And if a household has net positive cash flow after expenses, it doesn't even need to sell assets to increase its flow rate of purchases.

    So when Krugman says

    "private spending rises to fill the gap — and...the only way that can happen is if people take on more debt"

    it is just not true. There are two other ways that private spending can rise: people with assets can sell those assets, and people with positive cash flow can reduce their positive cash flow. And when and if they do so, it will improve the balance sheets of other households, so other households could potentially spend more without increasing their debt.

    ReplyDelete