Why the U.S. Is Nothing At All Like Greece
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For almost two years, we’ve been hearing a new battle cry in the war against government spending: unless the United States slashes deficits we will become Greece, Europe’s poster child for fiscal insolvency and economic crisis. The debt crisis in the eurozone, the 17 European countries that share the euro as their common currency, is held up as proof positive of the perils that await the United States if it continues its supposedly fiscally irresponsible ways.
Take the Heritage Foundation, the Washington-based think tank that specializes in providing red meat for anti-government pro-market arguments. Heritage introduces its 2011 chart on the rising level of government debt (to GDP) with this dire warning: “Countries like Greece and Portugal have suffered or are anticipating financial crises as a result of mounting debt. If the U.S. continues federal deficit spending on its current trajectory, it will face similar economic woes.”
Even for those who understand that cutting deficits right now will only weaken a still-fragile recovery, and that weakening the recovery will only increase deficits, getting past the argument that “a eurozone crisis is on its way” is no easy task.
What follows is a self-defense lesson on why the United States is not Greece—or Europe. The U.S. economy is far larger and more productive than Greece. The United States has many more tools in its macro-economic policy box than countries in the eurozone. And while calls for austerity have kept the United States from undertaking government spending and investment large enough to support a robust economic recovery, at least thus far, the United States hasn’t undertaken the same self-defeating austerity measures Europe has. If we learn the right lessons from what is happening in the eurozone now, we never will.
Central Banks and Deficit Spending
When economic activity plummeted during 2008 and 2009 in the United States, Europe, and throughout the world, coordinated stimulus spending of nations across the globe prevented the collapse of world output from becoming another Great Depression. Today, deficit spending remains critical as working people continue to struggle through an economic recovery that has done little to create jobs or to lift wages, but much to restore profits.
Governments finance deficit spending by borrowing. Governments sell bonds—promissory notes—to domestic and foreign investors as well as other government agencies, and then use the proceeds to pay for spending in excess of their tax revenues. In the United States, domestic investors, foreign investors, and government agencies hold near equal shares of government bonds issued by the Treasury and receive the interest paid on those bonds.
The Federal Reserve (“the Fed”), the U.S. central bank, can buy U.S. government bonds as well. The Fed can also create money (sometimes metaphorically called “printing money”) simply by entering an appropriate credit on its balance sheet and spending it. When the Fed uses this newly created money to purchase bonds directly from the government, it is financing the government deficit. Economists call the Fed’s direct purchase of government bonds “monetizing the deficit.” By such direct purchases of bonds that finance the deficit, the Fed can fund government spending in an emergency, should it choose to do so. Monetizing the deficit also significantly expands the money supply, which pushes down interest rates, which can also help stimulate the economy.
In the current crisis, the Fed did precisely that. By purchasing government bonds, the Fed financed public-sector spending, and by pushing down interest rates, it encouraged private-sector borrowing. In doing so, the Fed supported a market recovery, but also helped to keep unemployment from rising even higher than it did.