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Hawks, Doves and Owls: Budget Policy Goes to the Zoo

There are three ways to look at budget deficits: as a hawk, a dove, or an owl.

A deficit hawk insists that there must be spending cuts and revenue increases to halt the growing deficit. Most Republicans and many conservative Democrats in Congress are deficit hawks—and so are European authorities who are imposing drastic austerity measures on Greece to get its fiscal house in order. A deficit dove, on the other hand, believes that concerns about short-term deficits are less important and attempts to shrink them should not override temporary efforts to foster economic growth. President Obama is a deficit dove. He believes that long-term deficits pose a problem for our country, but believes it is more important to focus on reviving the economy through short-term spending increases and tax cuts.

Then there is the deficit owl. Owls believe that concerns over budget deficits are misplaced and don’t think we ever need to balance the budget. They argue that any government spending that leads to deficits boosts demand and therefore economic growth. This is the basis for Modern Monetary Theory (MMT) and the subject of a Washington Post article by Dylan Matthews on Sunday that featured Levy Institute scholars James K. Galbraith and L. Randall Wray. Titled “Modern Monetary Theory, an unconventional take on economic strategy,” the article lays out the history and arguments for such an approach, and responses by its critics.

The MMT movement believes that governments that control their own currency should never default. Because governments can create money by printing it and putting it into circulation, there should never be an instance when a government runs out of money and fails to pay its debts. Thus, MMTers are not concerned with growing deficits. In fact, they believe that the government should be spending more and cutting taxes further during recessions like the current one.

The idea has predictably been considered outside the mainstream. The Washington Post article describes how James K. Galbraith, public policy professor at the University of Texas and former head economist for the Joint Economic Committee—and son of legendary author, Harvard professor and Kennedy advisor John Kenneth Galbraith—was laughed at by the Clinton White House when he advocated for it.

The story goes that in 2000, the government was running a surplus, and there were questions of how to use the extra money. While many conventional economists argued that it should be used to pay down the national debt or shore up entitlement programs, Galbraith warned policymakers not to do so. He insisted that directing money to the government instead of to individuals and private business—who would spend it and help the economy—was not the best approach.

Still, MMT has yet to be widely embraced. The main argument in opposition to MMT is that it could lead to hyperinflation. The reasoning is that when the government deficit spends, it issues bonds in the form of Treasuries. Ordinarily, when bond investors become worried that a debtor is borrowing too much, they require higher interest rates on the bonds to counteract the additional risks that the borrower has taken on. Such an approach would normally decrease the amount of debt that the borrower takes on, but the government is unlike other debtors. The Federal Reserve can continue to buy its outstanding debt by purchasing large amounts of Treasuries or other bonds, which increases the supply of money.

MMTers acknowledge that this progression could in theory lead to inflation, but they are confident that it will not do so. This is because the Fed’s actions amount to a computer keystroke, which floods banks’ reserves with cash but does little to move money throughout the economy. They argue that only by targeting demand will money start flowing. MMTers believe that inflation is a legitimate concern only when there is full employment and demand, which is clearly not the current case.

We can only guess whether the principles that underlie MMT will stand the test of time, but for now, the conversation about its potential benefits is heating up. Economists Dean Baker, Jared Bernstein and Paul Krugman are debating MMT’s merits, and it is spreading around respected blogs like Naked Capitalism and Firedoglake.

Hawk, dove or owl: which one are you?