Wynne Godley and the Fiscal Cliff

11 Dec, 2012 at 13:32 | Posted in Economics | 5 Comments

Looking at balance sheets from a macroeconomic perspective, it is of course important not to look at the different sectors in isolation. Assets and liabilities of households, banks and government have to be analyzed as interdependent parts in a cumulative process where one sector’s surplus is counterbalanced by another sector’s deficit.

 
To Wynne Godley – and those of us who have absorbed at least a rudiment of MMT – this was self-evident. A sectoral balance approach is a necessary ingredient in understanding financial crises – and that’s also one of the reasons why the Fiscal Cliffers are so wrong.

It was the bubble that banks and big companies created with a large private sector debt that led to the crash, and that dwarfed government tax revenues and a fortiori drew the government sector into the red and forced it to reduce spending and cut down on employment.

If the the government in such a situation tries to reduce its debt, there’s a real risk it triggers the private sector into a large deleveraging that inevitably will raise unemployment even further.

So, today’s problem is not that we’re not reducing the deficit of the government sector fast enough. On contrary. The risk is we’re reducing it too much and too fast. To follow the Fiscal Cliffers is repeating the mistakes of the 1930s. Cutting governmental spendings and raising taxes only prolong the recession. Bad idea!