Absolutely the worst thing that Obama could do is become a deficit dove with an economy producing at 65% of capacity, unemployment in the double digits, savings rate increasing, and consumers deleveraging. This result is falling aggregate demand. The only way to head in the direction of closing the output gap and reducing unemployment is more government spending, not less.

A sovereign government that is the monopoly provider of a non-convertible currency within a flexible exchange rate regime is not revenue constrained. The government does not need to either borrow or to tax in order to "fund" spending. Government money (physical currency and bank reserves, called high-powered money or base money) is a public good that the government creates and manages in the public interest. It is a mistake to compare the government finances with household or firm finances, since both are revenue constrained whereas the government as monopoly currency provider is not. (Think of government money as Monopoly™ money provided to play the game.)

The government does not need to borrow to spend. Borrowing is simply was way of soaking up excess reserves and providing some interest on holldings instead. This interest is government spending injected into the economy, raising aggregate demand. The reduction in reserves allows the Fed to set an overnight interest rate above zero. This is straight national accounting, no complex economic theory based on models and assumptions. It's just how the monetary and fiscal system work in a modern economy without convertibility or fixed rates.

We will not have a double dip recession if the government acts to increase aggregate demand by spending to purchase existing and potential supply in order to close the output gap. If the government does not do this and reduces spending instead, conditions will just get worse rather than be helped. Let's not fall victim to the neoliberal monetarist myth of "fiscal responsibility." That all ended on August 15, 1971, when Nixon cut the dollar loose from convertibility with gold.

Of course, the other way to increase aggregate demand is to stop extracting money from the economy with taxes. Taxes don't "fund" spending. They decrease funds available for spending, which is desirable when the economy approaches full employment. Now it isn't.

So the government could also reduce taxes. Most taxes are paid by the wealthy and business, so reducing taxes is not as effective at stimulating demand quickly, because the wealth don't spend proportionately as much as the less well off, and business won't start spending until demand picks up. So reducing taxes in not as stimulative as spending.

What about inflation? The world is looking into the abyss of a deflationary spiral. Inflation is remote with an output gap of 35%, double digit employment, and raging debt deflation.

What about the falling dollar, or government "running out of money"? The later is ridiculous, since the government is the monopoly provider of its currency. It is never going to run out of money, become insolvent or default on its obligations. Falling dollar? Raising import prices constitute hidden tariffs that help US business, and lower prices externally for US goods increase exports. No problem (other than hurting our allies' exports).

Tim Hickey is one hundred percent right.

Paul Krugman wrote an article which described a very simple "one commodity" economy. This was a real "mini" economy in Washington D.C. It is a beautiful, simple expositon of the points that Tim makes.

See here: http://www.slate.com/id/1937

How's that working out for Japan, Tom?

Can't wait to come back to this comment in 5 years time. I'm bookmarking this one... LOL

Just wait until interest rates shoot the moon. We'll see how eager foreigners are to buy our debt then. Oh and if we print? I'm sure the Chinese and other treasury holders will be real happy to hear about that. Can you say "head for the exits"?

Best thing the feds can do is put a moratorium on the income tax and ramp up a fair tax over the next five years. Cut govt spending in half and pay down the debt. Eliminating the min wager and Bacon-Davis would put people back to work pronto as well. The best way to put productive $ into the economy to create lasting jobs and businesses is for people to make decisions with that money in their best interests. Decisions made with $ by politicians has only their interests in mind. The jobs that come from these $ are handouts and political favors.

Mike, how high are Japanese rates, and how high were they when when Japan was running really huge deficits some time ago? Remember how far the Japanese carry trade goes back? This experiment has already been conducted. Japan's problem was not its fiscal policy. It was its failure to force the banks into write off their bad loans and instead letting them operate as zombies. This sabotaged its recovery.

The US has been "printing" for some time, increasing its budget deficit, and adding to the national debt. The overnight rate is effectively at zero, the real interest rate a minus percent and the yield curve on Treasuries is flat all the way out. You are seeing ghosts, and your proposal (except the tax reduction) would exacerbate the situation by reducing net financial assets when the public want to increase saving, thereby further reducing aggregate demand when the outgap is already 65%.

Your argument is hypothetical. There is no empirical evidence backing up what you say (other than to reduce taxes, which is financially equivalent to increasing deficit through government spending). But as a matter of fact, the government does not need to borrow to spend, since it is not revenue constrained. In fact, Randy Wray posted to that effect today in Memo to Congress: Don’t Increase the Government’s Debt Limit!.

There is a load of evidence on the effect of the opposite of what you recommend (except reducing taxes). For example, Warren Mosler is an advocate of MMT who advocates reducing taxes instead of spending. The argument for spending is that it gets money into the system quickly in a targeted way. MMT is based on national accounting, not theory. Progressive use the same principles to recommend spending, while conservatives like Mosler use it recommend reducing taxes. Mosler, for example is for temporarily eliminating the payroll tax.

I don't blame anyone for not getting this first off. since MMT is hard to believe at first blush. I felt the same way most people do, until I investigated it.

Here's an excerpt from a comment by Marshall Auerback about the principles of MMT:

"You will also note from other things I have written on this blog that I don’t share the concerns about the budget deficit. The recognition of the national accounting relationships which underpin modern monetary theory are not matters of opinion. These include (but the list is not exhaustive) :

• That a government deficit (surplus) will be exactly equal ($-for-$) to a non-government surplus (deficit).

• That a deficiency of spending overall relative to full capacity output will cause output to contract and employment to fall.

• That government net spending funds the private desire to save while at the same ensuring output levels are high.

• That a national government which issues its own currency is not revenue-constrained in its own spending, irrespective of the voluntary (political) arrangements it puts in place which may constrain it in spending in any number of ways.

• That public debt issuance of a sovereign government is about interest-rate maintenance and has nothing to do with “funding” net government spending.

• That a sovereign government can buy whatever is for sale at any time but should only net spend up to the desire by the non-government sector to save otherwise nominal spending will outstrip the real capacity of the economy to respond in quantity terms and inflation will result.

As a matter of conceptual clarity it makes no sense to say the government can “save” in its own currency. It might spend and build assets (financial or otherwise). But running surpluses do not build up any store of “saving” that allows for higher spending capacity in the future. This is in contradistinction to the way a household, for example, functions. For them spending less on consumption than they earn amounts to saving which can then be stored to permit higher consumption than otherwise in the future.

Trying to draw an analogy between the national government which issues the currency and the household sector which uses the currency is flawed at the most elemental level. Of-course, it is a representation that lies at the heart of mainstream economics and is a powerful analogy for them to beguile the ignorant public."

Navigating the Jobs Crisis: Time to Try Government as Employer of Last Resort

I agree with you on the lack of debt destruction Tom, but let's ask a question. Whos pays for it all in the end? Directly or indirectly?

Japan is about to blow sky-high a la Iceland. We are on that path if we don't turn ourselves around...