Paul Krugman on Monday delivered an excellent primer on basic economics and the importance of what economists call accounting identities.
His key point is that just as 2+2=4, for economies as a whole spending=income.
“If everyone tries to slash spending at the same time, incomes will fall—and unemployment will soar,” Krugman noted, as it did in the Great Recession.
News reports often liken government finance to family budgets, but Krugman reminds us “an economy is not like a household.” Among other things, the federal government can create money, while households can only earn more or spend less.
That America remains in the economic doldrums makes it “tempting to argue that the economic failures of recent years prove that economists don’t have the answers,” Krugman wrote, adding, “the truth is actually worse: in reality, standard economics offered good answers, but political leaders—and all too many economists—chose to forget or ignore what they should have known.”
Central to understanding standard economics are accounting identities, which regardless of ideology or viewpoint are, and must be, true.
Economist Dean Baker, who blogs about economic coverage, has long made the same point—that journalists covering the economy and public finance should check their work against standard accounting identities to avoid conceptual error. As he wrote for the British newspaper The Guardian in 2010:
There are few areas of economics more boring than accounting identities. This is really unfortunate, since it is virtually impossible to have a clear understanding of economic policy without a solid knowledge of the underlying identities.
Most of the people in Washington policy debates were apparently overcome by boredom before they could get this knowledge. As a result, we see some really silly policy debates.
Baker sometimes uses accounting identities to show factual problems in news reports and opinion columns, though the algebra is not always so simple as spending=income.
Peter Dorman, who teaches economics at Evergreen State in Washington, has also cautioned about commenting on reducing fiscal deficits “without regard to fundamental accounting identities.”
Dorman points out that private and government debt cannot be simultaneously reduced (except through infusions of foreign earnings), because “one person’s debt is another’s asset.”
Matthew Yglesias has also shown the relevance of accounting identities, noting that they are not causal theories, but equations that must be true.
My own explanation of these economic basics is available in text
and video.
"“If everyone tries to slash spending at the same time, incomes will fall—and unemployment will soar,” Krugman noted, as it did in the Great Recession."
It's good to note that when Krugman mentions this, he's talking about Richard Koo's work on the 'balance sheet recession' and the Japan experience during the nineties - something which journalists who seek to be knowledgable about this recession should be looking at carefully because of the many parallels between them.
When assets collapse in value, and the value of debt used to purchase assets remains stable, people prioritize the payoff of debt over the opportunity of new investment. In that environment it doesn't matter how low your interest rate is, no one is going to risk borrowing more when they still have to pay off the last round of bad borrowing. Monetary policy loses it's ability to grow an economy when this reality sets in. The private sector isn't going to pick up the ball and run with it, even when the defenders are benched and the field is clear, when it's blown out its knee. The government has to pick up the ball.
But that's exactly the moment when the some of the worst people in the world cry about 'DEFICITS! INfLATION! OMG!'
When it comes to the government policy helping people pick up their balance sheets and making life normal again, we hear the scolders bellyache about finances and government spending and how we need to cut the entitlements we have, not make new ones.
You know when these folks are silent? When the most awful people in the world come looking for handouts. Suddenly, there's no limit to the creativity and the funds that can be committed to
rat bastard bailouts'saving the economy'.And here's where accounting identity analysis can really come in handy, I think, because when it comes to giving infinite tax payer support and money to few individuals and institutions; turning every big institution on wallstreet into ruthless versions of Freddy Mac and Fannie Mae, you have to ask where's the tax payer / societal benefit? Where's the benefit in giving tax cuts to the rich?
Because if the money given doesn't translate into someone else's income down the road, if it just gets hoarded amongst the rich and the luxury makers who service them, then there is no growth relative to the amount of resources handed over. The resources get trapped and stop circulating in the economy, they lost to the economy.
This is the problem with inequality, it traps resources which would otherwise be productive and forces those on the bottom tiers to rely on credit, instead of income, to sustain a household. The priority of government policy is to save parasitic institutions from themselves instead of the people whom they've harmed. Why?
Perhaps that's what's achievable? We see what happens when the government tries to help us instead of the vampires "DEFICITS! INFLATION! SPENDING! OMG!" As journalists, we really shouldn't contibute our voices to this chorus.
#1 Posted by Thimbles, CJR on Thu 10 Jan 2013 at 12:59 PM
" As journalists, we really shouldn't contibute our voices to this chorus."
And yet many still do...
for a variety of reasons (the quality of the catering is much superior at an OMG THE DEFICIT event).
Ps. Nice addition to the CJR neighborhood, David. Hope to see more of you about.
#2 Posted by Thimbles, CJR on Thu 10 Jan 2013 at 01:15 PM
Accounting identities? Please define. It sounds like jargon for accounting 101.
#3 Posted by Dave, CJR on Sat 12 Jan 2013 at 03:14 PM
It's important jargon because we are talking not just about descriptions of reality but relationships between its parts.
What is savings for one person is a liability for another (your savings = bank's owing). One person's spending is another person's income (your salary = your employer's cost). When people discuss actions which affect one entity, they cannot grasp the full picture of the action's effect until they understand the relationships tied to that entity.
And this is why discussions of cutting government spending and reducing costs of programs need to be done with care (lacking in today's climate) because you're not talking about costs alone, you're talking about the incomes of teachers, fire fighters, and the elderly - for instance. And by contracting those incomes, you contract the economy as a whole while reducing the value once provided by those services.
Hope that kinda helps.
#4 Posted by Thimbles, CJR on Sun 13 Jan 2013 at 12:57 PM