William Vickrey wrote the Fifteen Fatal Fallacies of Financial Fundamentalism in 1996 in what appears to have been at least in part a warning about the dangers of Clinton’s drive to erase the deficit (see particularly the last paragraphs of Fallacy 7). While that may seem ironic considering the economic boom of the 1990s, the bust of the following decade gives his warnings a lot more credibility than they likely received at the time.
In particular, I find his conclusion (and most of the rest of the paper, “NIARU” aside) to be enormously relevant to our current situation, especially given the drastically weaker state of the economy now relative to that of the mid 1990s:
If a budget balancing program should actually be carried through, the above analysis indicates that sooner or later a crash comparable to that of 1929 would almost certainly result. To be sure, it would probably be less severe than the depression of the 1930’s by reason of the many cushioning factors that have been introduced since, and enthusiasm for the quest of the Holy Grail of a balanced budget may wane in the face of a deepening recession, but the consequences of the aborted attempt would still be serious. To assure against such a disaster and start on the road to real prosperity it is necessary to relinquish our unreasoned ideological obsession with reducing government deficits, recognize that it is the economy and not the government budget that needs balancing in terms of the demand for and supply of assets, and proceed to recycle attempted savings into the income stream at an adequate rate, so that they will not simply vanish in reduced income, sales, output and employment. There is too a free lunch out there, indeed a very substantial one. But it will require getting free from the dogmas of the apostles of austerity, most of whom would not share in the sacrifices they recommend for others. Failing this we will all be skating on very thin ice.
A brief summary of the 15 fallacies, each of which he demolishes in detail:
1. Deficits are considered to represent sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital. This fallacy seems to stem from a false analogy to borrowing by individuals.
2. Urging or providing incentives for individuals to try to save more is said to stimulate investment and economic growth. This seems to derive from an assumption of an unchanged aggregate output so that what is not used for consumption will necessarily and automatically be devoted to capital formation.
3. Government borrowing is supposed to “crowd out” private investment.
4. Inflation is called the “cruelest tax.” The perception seems to be that if only prices would stop rising, one’s income would go further, disregarding the consequences for income.
5. “A chronic trend towards inflation is a reflection of living beyond our means.” Alfred Kahn, quoted in Cornell ’93, summer issue.
6. It is thought necessary to keep unemployment at a “non-inflation-accelerating” level (“NIARU”) in the range of 4% to 6% if inflation is to be kept from increasing unacceptably.
7. Many profess a faith that if only governments would stop meddling, and balance their budgets, free capital markets would in their own good time bring about prosperity, possibly with the aid of “sound” monetary policy. It is assumed that there is a market mechanism by which interest rates adjust promptly and automatically to equate planned saving and investment in a manner analogous to the market by which the price of potatoes balances supply and demand. In reality no such market mechanism exists; if a prosperous equilibrium is to be achieved it will require deliberate intervention on the part of monetary authorities.
8. If deficits continue, the debt service would eventually swamp the fisc.
9. The negative effect of considering the overhanging burden of the increased debt would, it is claimed, cancel the stimulative effect of the deficit. This sweeping claim depends on a failure to analyze the situation in detail.
10. The value of the national currency in terms of foreign exchange (or gold) is held to be a measure of economic health, and steps to maintain that value are thought to contribute to this health. In some quarters a kind of jingoistic pride is taken in the value of one’s currency, or satisfaction may be derived from the greater purchasing power of the domestic currency in terms of foreign travel.
11. It is claimed that exemption of capital gains from income tax will promote investment and growth.
12. Debt would, it is held, eventually reach levels that cause lenders to balk with taxpayers threatening rebellion and default.
13. Authorizing income-generating budget deficits results in larger and possibly more extravagant, wasteful and oppressive government expenditures.
14. Government debt is thought of as a burden handed on from one generation to its children and grandchildren.
15. Unemployment is not due to lack of effective demand, reducible by demand-increasing deficits, but is either “structural,” resulting from a mismatch between the skills of the unemployed and the requirements of jobs, or “regulatory”, resulting from minimum wage laws, restrictions on the employment of classes of individuals in certain occupations, requirements for medical coverage, or burdensome dismissal constraints, or is “voluntary,” in part the result of excessively generous and poorly designed social insurance and relief provisions.
h/t commenter stunney at Economist’s View