Why "Deficit" is a Four-letter Word

Paul Krugman has an interesting column in today’s NY Times. It reiterates a point that he’s made oh, maybe, three hundred or so times in the past couple of years. Heck … maybe more. It’s the classic Keynesian position that, despite the random howlings of the few deluded austerity hawks remaining, just happens to be right. In a recession, deficits be damned; throw money at the economy.

What’s interesting from the psychologist’s perspective isn’t the truth of this principle. It’s like an earlier column on the Libertarian approach to economics, why it is so hard to get certain ideas across to people, especially those with a rightward political tilt? So let’s take a look at what there is about human thinking that makes Keynes hard to grasp.

First, there is a principle in the field of “behavioral economics” that is far more important than most realize: the ± asymmetry of money. One reason why this principle goes unheralded is because most don’t even realize that it exists let alone grasp its import. When we say money is ± asymmetrical we mean that, psychologically speaking, losses tend to be more meaningful than equivalent gains. Losing $1,000 feels more negative than winning $1,000 feels positive. And this principle operates in the abstract. That is, merely contemplating these kinds of losses and gains produces these emotional reactions — though, of course, they are much more dramatic when real money is involved.

This principle tends to make people risk-averse. That is, they get twitchy when confronted with the possibility of a significant financial move in the negative direction — and this “twitchiness” is greater than the pleasure felt when contemplating the possibility of significant gain.

When the government throws money at the economy to stimulate growth the immediate impact is an increase in the deficit and an increase in total government debt. Keynes showed, unambiguously, that the long-term impact of a “stimulus package” is positive because the money put into the economy is spent and goods are purchased which results in manufacturers needing to produce more which results in hiring which gives more people money to spend which results in …. The economy grows, personal income increases, corporate profits go up. The result is an increase in tax revenue which eliminates the deficits. But, because of the asymmetry principle, the emotional negative experience of the immediate loss overwhelms the contemplation of ultimate improvement in the economy. Hence, Keynes’s approach makes people feel uncomfortable and they tend to dismiss the theory without thinking it through.

Second, timing counts — which, of course, is implied in the above. When you increase the size of the deficit it has an immediate negative impact. The government has to borrow which increases debt. That long-term gain that Keynes’s model predicts is long-term; it’s going to occur in the future. The further off, temporally speaking, an outcome is the less tangible it is and the less influence it has on current beliefs and actions. So people have this sense that if government spends it goes into debt now, immediately. And even if Keynes is correct and things will be better later, there’s that lingering feeling that well …. hmmm … like maybe it won’t because the ineffable future is harder to grasp than the current reality.

Third, Keynesian economics has counter-intuitive elements largely because people confuse personal finances with government finances. They are made unhappy when they see their government not balancing the budget. They point out that they can’t do this. They can’t spend more than they make because to do so would invite financial ruin. So, the argument goes, the same holds (or should hold) for governments.

This line of thought is wrong on several counts. For one, the average family doesn’t act this way at all. They routinely spend more than they make. Credit card debt is at an all-time high. They take out mortgages on homes, buy cars on time and run up debt in manifold ways. What counts here isn’t the absolute size of the debt but the debt relative to income or, in the case of government, the GDP. The psychological element here is an old one. Most folks have rather poor sense of themselves and a feeble grasp on what they actually do. As behavioral economists continue to point out, most decision-making isn’t rational and it often is made without regard to self-interest.

And there’s another big difference: governments can print money. They have to take care not to print too much or it will encourage inflation but they sure as hell can print it. They also can control the value of the currency, set interest rates and modulate the cost of borrowing. In fact, when they are prevented from doing these things or have these kinds of flexible financial moves restricted it can be catastrophic. If Greece (and to a lesser extent Italy and Spain) weren’t tied to the Euro and able to modify their currency they would not be in anywhere near the economic mess they’re currently in. Canada has, in just the last few weeks, been devaluing the Canadian dollar. The weaker dollar is making it easier for Canadian goods to be exported, discouraging Canadians from going into the US to make purchases and encouraging Americans to visit — all of which will increase Canadian productivity and give the economy a kick. It’s worth noting that these moves are being made by a Conservative government.

What’s the answer here? I don’t know. I spent a half-century trying to get complex, subtle ideas across to college students. One of the more effective ways, I discovered, was to keep saying the same thing over and over. So Professor Krugman, keep it up. We can use another 300 or so repetitions of the classic Keynesian principles and maybe, just maybe, they’ll get through to the austerity crowd.