Goldman’s Hatzius: “Peterson-ism” Can’t Win

Joe Weisenthal posted an incredible interview with Jan Hatzius yesterday. Hatzius is known for schooling fools on the economy, but he’s better known as Goldman’s economist. And Joe is…always working 10x as fast (and better) than everyone else in the world.

Also today, David Weigel wrote about the 20 years of failures of the Peterson Institute. The Peterson Institute has tried to make balanced budgets a political priority for over 20 years, and it has had almost zero success.

It seems like nobody is very interested in balancing the budget in the near term. This post will explain why so few people ever want to balance the budget.

The recent fiscal cliff debate is all about spending more money instead of cutting back enough to balance the budget. Jan Hatzius thinks going over the fiscal cliff would be a disaster:

“…I think the economy will be contracting, and potentially contracting pretty rapidly. It’d be a very unpleasant environment.”

But this does’t tell us why so few people are willing to cut the budget at any given point in time. Here is where it gets really interesting – we need to do a bit of detective work to figure why people hate balancing the budget.  Hatzius shows us this chart, and then explains:

“…every dollar of government deficits has to be offset with private sector surpluses purely from an accounting standpoint, because one sector’s income is another sector’s spending, so it all has to add up to zero. That’s the starting point. It’s a truism, basically. Where it goes from being a truism and an accounting identity to an economic relationship is once you recognize that cyclical impulses to the economy depend on desired changes in these sector’s financial balances.”

That’s pretty dry, but hold on. Think about what Hatzius is saying, in terms of Peterson’s desired policy outcome. Peterson is trying to reduce the government deficit. Peterson is trying to balance the government budget. 

Hatzuis is telling us Peterson’s policy approach to reduce the government deficit must force the private surplus lower, by definition. Peterson wants there to be less private surpluses for the United States.

“Private Surpluses” is a weird term, isn’t it? You might know it better by the words “Private Savings”. This phrasing makes it much more clear what Pete Peterson wants.

Pete Peterson wants Private Savings to be ZERO in any given year, and zero in total.  

Deficit reduction means savings reduction. Pete Peterson might think his cause is smart, and even noble. But he’s just a person doesn’t know what consequences of his desires would be. He would not want private sector savings to be zero – of course not. Who would? It’s a case of “be careful what you wish for – you just might get it!”

Now, we can and should investigate the meaning of money and the link between the real and nominal worlds ( and many other useful topics). This is a worthy and useful examination of a complex and difficult topic. I think this is one of the most important ideas in economics, and I am lucky to be working with such insanely talented people.

But this post is about how Jan Hatzius implies Peterson-ism can’t win. Hatzius shows us the most important chart in the world, and explains the math behind it. It’s 100% clear: Reducing the government deficit reduces private savings. Pete Peterson’s institute is constantly trying to convince people to reduce the amount of savings available to them.

Of course, reducing savings is a terrible sale, an awful pitch, and will be totally unpopular. “Come on – let us all have LESS savings! If we enact my scheme – you are all but guaranteed to be poorer in 20 years!” Yeah, that’s a hell of a sales pitch.

Deficit reduction means savings reduction. We know from Hatzius every time someone says “reduce the deficit”, they are really saying “reduce private savings”. Less Savings is what Peterson is trying to sell, even if he is changing the packaging to make it more attractive.

I suspect even though most people today do not know about Hatzius’s chart, the Sector Balances equation, many people intuitively suspect we need government spending. Hatzius takes this intuition and makes it a concrete relationship between government deficits, and private savings.

Nobody wants to have less savings, especially right now. In fact, it’s widely recognized there is a shortage of safe assets in the world. In general, nobody has wanted less savings…ever.

Pete Peterson is trying to convince people to do something that just feels wrong, and so he’s had almost zero success with his endless pitch to reduce private savings.
Of course, I hope Peterson fails entirely. It’s the only sane response once you know the relationship between government deficits and private savings. A balanced budget is (usually) a terrible idea, because it reduces the savings available to the private sector.

In the interview, Hatzius gives a shout out to Wynne Godley. We are big Godley fans around here at MR. I’d like to leave with a quote from the master himself, which should help to illuminate why Pete Peterson is doomed to failure:

 “It is thirty years since Carl Christ, of Johns Hopkins University, had the brilliant insight that should an economy ever reach stationary equilibrium, all stock variables as well as all flow variables would be constant; and that if all stock variables, including government debt, were constant, government receipts would have to equal government payments. It would then follow that if the economy were moving toward stock-flow equilibrium and if taxes were levied as a proportion of income, the GDP of a (closed) economy would always be tracking, perhaps with a long lag, government outlays divided by the average tax rate – the very same concept that we call fiscal stance. Therefore, a necessary condition for the expansion of the economy, at least in the long term, is that the fiscal stance should rise: Government expenditure must rise relative to the average tax rate. If the tax rate were held constant, government expenditure would have to rise absolutely for output to grow; if government expenditure were held constant, the tax rate would have to fall.” [Italics and Bold mine]

How can you fight against this basic fact? It is like fighting the moon. We need an increasing fiscal stance in order to have a growing economy. And once you know this relationship – why in the world would you want to balance the government budget? 

This is what Hatzius shows us with his chart. Pete Peterson’s success would mean the economy stops growing. And it’s why Peterson is doomed to lose the battle, and the war.


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3 years 4 months ago

So how is it possible that Germany had a budget surplus in the first half of 2012 – yet the German economy also grew?