Tape 179 - Crowding out effect of Deficit?

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-	Welcome once again as MIT professor Paul Samuelson	0:02
	discusses the current economic scene.	0:05
	This series is produced	0:07
	by Instructional Dynamics Incorporated.	0:08
	Professor Samuelson a lot has been said and a lot	0:11
	has been written about the fears	0:13
	that the federal deficit will crowd out	0:16
	private capital from the market,	0:19
	what are your views on this?	0:21
-	We have the interesting spectacle	0:25
	of a Secretary of Treasury who instead of	0:28
	going around the country trying to talk up	0:31
	the market for government bonds has been	0:35
	giving dire warnings	0:39
	that the deficit may well be too large,	0:42
	and that this will	0:46
	be very difficult to finance and that government bonds	0:48
	may therefore be falling in price.	0:51
	This is not the first time, many of us will remember	0:56
	that George Humphrey who, during the Eisenhower years	0:59
	was Secretary of Treasury and being a forceful,	1:04
	retired business man	1:07
	from Ohio	1:10
	he often carried the ball in the budget briefings	1:11
	even though it's ordinarily	1:15
	not the Secretary of Treasury's function to do that.	1:16
	And we then had the spectacle of George Humphrey	1:19
	often undercutting the	1:23
	Presidential, that is the Eisenhower decisions	1:26
	and the cabinet decisions on the size	1:30
	of the expenditure budget	1:32
	and the deficit.	1:35
	He once spoke about deficits that would curl your hair,	1:38
	well Secretary of Treasury Simon	1:42
	seems to be engaged in somewhat the same type of behavior.	1:46
	Why is this?	1:53
	Well it could be	1:54
	that we live in a pluralistic administration	1:56
	and the Secretary Simon	2:00
	has different views from other members of the administration	2:01
	and he's just exercising his civil liberties.	2:03
	A more cynical interpretation is that	2:09
	Secretary Simon is going to return	2:13
	to the New York community and he wishes to return	2:16
	with his reputation	2:20
	intact	2:23
	and that he therefore	2:24
	is saying the things that he's doing.	2:27
	I think the more realistic interpretation is the third one	2:30
	namely, that he keeps saying these things in order	2:35
	to put pressure on congress and not to spend more money	2:40
	than	2:45
	the President has recommended.	2:47
	That of course is not feasible they already	2:50
	have voted to spend more money that the President	2:55
	has recommended but Secretary Simon would like	2:57
	to hold down	3:01
	the excess.	3:02
	And so we have always kept alive	3:05
	the question	3:09
	of crowding out	3:10
	effects of the federal deficit.	3:13
	I believe I've had occasion to	3:17
	remark on this problem.	3:20
	Where shall one begin?	3:24
	Shall one begin at the most naive	3:25
	level of sophistication?	3:30
	Namely is the deficit too large so that	3:33
	the government bonds just won't sell?	3:35
	I think it would have to be a very large deficit indeed	3:38
	for that to be the case, that the government bonds	3:43
	could not sell at	3:46
	any price.	3:49
	Some economists might argue that that's really impossible	3:51
	to happen, we could rephrase it,	3:54
	the government bonds won't sell at any feasible price	3:57
	that does not boggle the mind.	4:02
	I don't think that is the problem certainly not	4:05
	for the deficits that we're talking about,	4:08
	I think that there's some reason to think	4:11
	that the next fiscal year deficit,	4:13
	that's the fiscal year coming up from	4:15
	the middle of 1975 to the middle of 1976	4:17
	will be in the neighborhood of 70 billion dollars	4:22
	but let's suppose that it's in the neighborhood	4:26
	of eight billion which is 6% of the GNP,	4:28
	or even	4:32
	100 billion,	4:35
	the	4:37
	inability of the	4:38
	Federal Treasury to sell those bonds	4:41
	I don't think is a realistic apprehension	4:44
	at that level of deficit spending.	4:48
	The	4:52
	second	4:53
	degree of sophistication rewords the problem.	4:54
	In order to sell	5:01
	the bonds	5:03
	will the Federal Reserve have to buy them?	5:04
	Will the Federal Reserve have to create	5:09
	and undo expansion	5:11
	of the money supply	5:14
	in order to support the government bond market	5:16
	when there are deficits of this size?	5:20
	Now of course the Federal Reserve doesn't	5:23
	have to do anything if we have answered	5:25
	the first question that the government	5:28
	can't sell the bonds one way or another	5:30
	even though it means some increase in the interest rates	5:33
	and if the Federal Reserve thought that that	5:35
	were the desirable thing to happen to interest rates	5:37
	then it could refuse to	5:42
	finance the bonds.	5:45
	I don't wish to deny that	5:47
	there are certain political pressures	5:49
	from the administration possibly and certainly	5:51
	from the congress,	5:55
	but,	5:57
	many people would think	5:59
	that the more likely scenario	6:00
	is that the Federal Reserve will be motivated	6:03
	to expand the money supply to help finance the deficit	6:07
	or an even larger deficit than we're talking about	6:12
	at interest rates lower than the natural,	6:14
	spontaneous market would create them.	6:18
	Now it's not clear why this expansion	6:23
	of the money supply should crowd anything out,	6:25
	the argument at this point often branches off into saying	6:29
	well that would be inflationary because	6:31
	there is supposed to be some special connection	6:34
	in one run or another,	6:39
	let me for the moment talk about the short run,	6:43
	between the increase in the money supply	6:45
	and the price level.	6:48
	Now I don't think that there is in the short run,	6:50
	a special connection	6:53
	between an increase in the money supply	6:57
	and the price level.	7:01
	Which is different from	7:04
	an increase in total spending	7:07
	of equivalent amount however brought about	7:11
	other than by a Federal Reserve operation	7:14
	of increasing the money supply.	7:18
	An increase in aggregate demand and aggregate spending	7:21
	is likely in the short run to be distributed between both	7:26
	an expansion of real output and	7:32
	some	7:35
	expansion of the	7:37
	rate of price increase over	7:41
	what the rate of price increase would otherwise have been.	7:43
	And when we're operating in an economy with a good	7:48
	winter wheat crop coming up with many industries	7:54
	operating now at about 70% of capacity	7:59
	when the unemployment rate is 8.9%	8:03
	going on lets say,	8:08
	9 and a third percent before we're finished	8:10
	and with some deceleration	8:15
	already going on	8:19
	in the rate of inflation	8:20
	then I think	8:24
	one would be rash to	8:26
	expect the partition	8:29
	of an increase in nominal or money GNP	8:32
	between real output increase and price increase	8:35
	to be	8:39
	very much in the	8:41
	price direction.	8:43
	Now it could be that when we come to discuss	8:46
	the intermediate run and the long run	8:49
	we'll have to make some modification	8:52
	in that judgment,	8:54
	but let's stick with	8:56
	how things are likely to be	8:59
	for the next fiscal year.	9:01
	Remember the steady state deficit	9:04
	is not as large as the 70 or 80 billion dollars	9:08
	of the fiscal	9:12
	year	9:14
	or not to play games	9:16
	with the	9:18
	actual months	9:20
	of the next fiscal year	9:22
	let's just take from the present moment,	9:23
	talking in May of course to	9:26
	May of next year	9:29
	we're getting rebates	9:32
	on last years taxes perhaps some of my listeners	9:34
	have gotten their $100	9:37
	if you have $200	9:41
	you probably don't have enough money to spend	9:42
	on this	9:45
	subscription series,	9:47
	that is a one shot operation and it's not going	9:51
	to run into long run deficits of the same magnitude although	9:53
	Mr Simon may fear	9:59
	that having gone to the pump	10:01
	and found it so satisfactory	10:04
	this year there will be a move in congress	10:07
	to have another tax rebate	10:10
	next year.	10:14
	Well	10:16
	the	10:18
	issue has shifted you see	10:20
	from a crowding out effect to an inflation effect	10:22
	now to the degree that an inflation effect	10:24
	is	10:28
	a	10:29
	too much money spending,	10:32
	chasing too little expansible supply of goods	10:35
	that might, I guess	10:39
	be legitimately deemed	10:41
	to be be one aspect of a crowding out effect.	10:44
	To return though to the crowding out effect as such,	10:49
	it's usually what's crowded out	10:52
	is private capital formation	10:55
	so it is argued.	10:57
	Now to the degree	10:59
	that	11:02
	the Federal Reserve	11:04
	is doing its job,	11:05
	an increase in the deficit	11:09
	other things being equal, should	11:12
	be met by the Federal Reserve with some increase	11:17
	in the money supply probably,	11:21
	but it should not increase the money supply	11:23
	so much if it was already doing its job about right	11:26
	that there will be no increase in the rate of interest.	11:31
	There will therefore be some	11:35
	crowding out of the availability of credit	11:40
	to private	11:44
	investment spenders.	11:47
	This by the way is what would happen from any expansion	11:51
	of the economy brought about	11:57
	for example	12:01
	by an increase in consumption spending	12:02
	as I understand it and as I monitor the statements	12:05
	that come out of administration economists	12:08
	to say nothing of non-governmental economists,	12:12
	people like	12:15
	Mr Alan Greenspan	12:17
	want consumption spending to increase,	12:20
	they look with hope	12:24
	towards a rebound	12:26
	in	12:28
	automobile expenditures,	12:30
	for that matter,	12:33
	they look with hope for a rebound on housing expenditures.	12:34
	These are what are called spontaneous expansions	12:42
	they are not engineered by wicked deficit financers,	12:48
	by fine tuners,	12:52
	but they certainly have the effect other things being equal,	12:54
	of increasing interest rates	12:58
	and therefore making	13:02
	it more difficult for a private investor	13:03
	to get the credit	13:07
	to build a new machine tool	13:10
	which he otherwise would not have built.	13:12
	I picked machine tool because to the vulgar mind	13:14
	that's the kind of capital formation which constitutes	13:17
	the only really legitimate,	13:20
	genuine kind of capital formation.	13:22
	If you	13:24
	stockpile inventories	13:27
	that's kind of unnecessary or speculation	13:28
	to the vulgar mind.	13:32
	As a matter of fact to many vulgar minds housing	13:34
	is just kind of a regretful	13:38
	expenditure, housing construction expenditure	13:42
	and is not legitimate capital formation	13:44
	it doesn't, they say enable us to compete	13:47
	with the enterprising west Germans and the Japanese	13:50
	only machines tools are really productive,	13:54
	now I wouldn't want to give my blessing	13:58
	to such interpretation.	14:00
	But the point is, and this is where	14:01
	I think one should focus.	14:05
	The only legitimate way to describe	14:09
	the crowding out effect is to ask yourself	14:12
	whether you think as a result of the deficit	14:17
	there is too much consumption spending.	14:21
	If there is so much consumption spending	14:25
	that it takes us to full employment	14:27
	and you have even more consumption spending than that	14:30
	obviously it must come at the expense of private investment.	14:34
	If	14:40
	If one puts the matter incorrectly	14:43
	one says something like the following	14:46
	I couldn't even begin to sort out the number	14:49
	of fallacies that are involved in an argument like this	14:51
	but let me try to state it,	14:54
	if you run too big a deficit that will make	14:56
	the problem of financing the federal debt	15:00
	so unmanageable and so difficult that	15:04
	that will increase interest rates	15:07
	and that will abort the boom.	15:09
	Well,	15:14
	if it is the	15:18
	expansion	15:20
	of the economy	15:21
	which is creating the transaction demand for money	15:23
	which pushes up the interest rates,	15:26
	then all you really have to do	15:29
	is to have an even bigger deficit.	15:31
	And then the boom will not be aborted although	15:34
	if the logic of the proposition	15:37
	I stated the first time had been correct	15:39
	I suppose by the same	15:41
	logic or illogic	15:44
	the more you expand the economy the less	15:46
	you expand the economy.	15:48
	So all you really have to ask yourself I think is	15:52
	whether you think	15:55
	that the fiscal stimulus	15:59
	is creating too much	16:00
	consumption spending.	16:03
	We are	16:06
	very near,	16:08
	the experts think, to the trough of the business cycle.	16:09
	We are as people say	16:15
	very near to the end of the recession.	16:18
	It's a very bad terminology one must say,	16:22
	that we've all fallen into	16:26
	because the word recession	16:30
	as defined by the national bureau	16:32
	is used	16:36
	to	16:38
	describe the decline	16:39
	in the real GNP.	16:44
	When you get to the end of the decline	16:50
	you come to the end of the recession.	16:53
	That's the language which is used.	16:55
	The person who is not a tactical economist	16:59
	could be forgiven for breathing a sigh of relief	17:01
	and saying thank God the recession is over.	17:04
	Well what it is that's over is the period	17:08
	of active sliding.	17:11
	The moment just before the dawn	17:16
	is the darkest moment of the night.	17:18
	The moment just after the dawn	17:22
	is still very, very dark indeed,	17:25
	according to the principle of continuity.	17:29
	Now if	17:30
	you don't	17:32
	like a moment make it a	17:35
	micro moment.	17:37
	When we are at the end of the recession	17:40
	we are at the trough at the very nature of prosperity	17:45
	indeed with respect to the amount of unemployment	17:50
	if you use that as a measure of the amount	17:53
	of suffering,	17:55
	or if you use as a measure	17:57
	of the amount of cost of the business cycle,	17:59
	the shortfall from what it is we could be producing	18:03
	our high employment real income	18:08
	production potential then it is sometime	18:11
	after the recession ends	18:15
	that the situation is still worsening.	18:18
	You're not at the end of the problem,	18:22
	you're not at the beginning of the end of the problem	18:27
	to use the expression of Churchill and Roosevelt	18:32
	during the dark days of World War II,	18:35
	when the first	18:41
	ray of dawn	18:43
	was our successful invasion of North Africa,	18:45
	I believe that Churchill	18:49
	and Roosevelt said this is not the beginning of the end	18:50
	it's the end of the beginning.	18:53
	Well the end of the recession, when it comes,	18:55
	is only the end of the beginning of our troubles.	18:59
	So we should not	19:03
	now in the	19:06
	economic winter of our discontent,	19:08
	which is still to be with us,	19:11
	as I have explained it even if the optimistic consensus	19:14
	forecasters are correct we should not be losing	19:18
	our sense of balance between	19:22
	what is too much stimulus and what is too little stimulus.	19:25
	Any increase in the interest rates	19:32
	which causes	19:36
	there to be too little rate of expansion	19:40
	of overall real demand	19:44
	can be	19:47
	countered and offset	19:49
	by greater deficit spending and or	19:51
	greater increase in the rate of growth of the money supply.	19:56
	Well those are the terms	20:02
	in which the crowding out effect should be analyzed.	20:04
	We're still left of course, with a problem	20:08
	that few people	20:12
	seriously discuss	20:14
	and that is whether	20:18
	we have a special scarcity	20:20
	of capital goods and capital formation at this time.	20:23
	That issue is always begged,	20:29
	it is taken for granted that for a variety	20:32
	of reasons the rapid capital formation abroad	20:35
	the	20:40
	pollution demands upon the	20:43
	system,	20:47
	the ravages of inflation as it is put,	20:48
	that America is especially capital short now.	20:52
	What exactly is being said there?	20:57
	Surely not that,	21:01
	if we had more capital we would be somewhat better off,	21:03
	that is always true.	21:07
	The only time that wouldn't be true	21:10
	would be if the	21:12
	stationary economy	21:15
	had brought the rate of interest down to zero,	21:16
	and then any further deepening of capital any extension	21:19
	of the degree of roundaboutness of production	21:25
	would no longer pay.	21:28
	It's a nice academic debate,	21:31
	whether one could get to that state.	21:34
	You can get philosophers to argue on both sides	21:39
	of the proposition, and neither one can convince	21:42
	the others because it's an argument about asymptotes	21:46
	and about the horizon and just beyond the horizon.	21:49
	But there is nobody that I know, who thinks	21:53
	that we are already at that point	21:57
	where the American economy could not use more capital.	22:01
	But what else is new?	22:05
	What are you saying when you just say	22:07
	that well if you just had more capital	22:08
	then the productivity of labor would be a little bit higher,	22:10
	real wages would be a little bit higher	22:14
	also I may add that other things being equal	22:17
	the rate of profit would be a little bit lower	22:20
	if you had more capital.	22:25
	What is being argued by Secretary Simon	22:27
	for one by many trade association groups,	22:30
	in fact a whole chorus of administration economists	22:34
	is that there is some	22:38
	identifiable sense in which we are especially short	22:41
	of capital formation and of stock of capital.	22:45
	Now, I've reviewed this problem	22:49
	I suppose like Halley's Comet	22:52
	not at intervals of 75 years on these tapes	22:53
	but at intervals of maybe every six months	22:57
	and I want to assure you that if you do	23:02
	a very careful analysis, double entry bookkeeping	23:05
	on the one hand all the factors which can be discerned	23:10
	in the situation which suggests that capital	23:14
	is in some sense especially short,	23:17
	and you jot those down well, for example	23:20
	the five fold increase in the price of oil,	23:23
	much of it coming from the Persian Gulf	23:27
	obviously makes for great profit opportunities	23:30
	in the exploitation of new energy sources	23:36
	in North America.	23:40
	The Alaska Slope is just an example offshore drilling	23:42
	reactivation of	23:47
	coal mines and strip mining	23:50
	these are needs for capital formation.	23:53
	But a notice, every survey that we have,	23:58
	this is the other side of the balance sheet	24:02
	shows a diminution	24:04
	of the intended real	24:06
	capital formation plans	24:11
	of business.	24:14
	And this is something that I should have mentioned	24:16
	when I was talking about the crowding out effect,	24:19
	the, everything which expands consumption	24:23
	does it is true,	24:26
	tend to raise interest rates other things being equal,	24:30
	but that same expansion of consumption	24:32
	also increases the motivation for investment.	24:36
	It increases the degree of	24:41
	fullness of capacity operations	24:44
	the profitability at the margin of new capital	24:46
	and the SOE's economists have known,	24:50
	well since the time of Malthus and Ricardo	24:53
	but more particularly I recall in 1938	24:56
	a famous	25:00
	article by Oscar Lange in which he showed that	25:01
	there is an optimal	25:04
	configuration of investment which involves	25:08
	not too much consumption spending as at full employment	25:11
	and on the other hand not too little as when	25:15
	there is practically no final consumption spending	25:18
	and that's undermining the demand	25:21
	for capital formation, this is not to deny	25:23
	that something which he overlooked,	25:25
	should not be overlooked namely	25:27
	that you can have new capital	25:29
	which	25:32
	is being built for the purpose of building new capital.	25:33
	People say a Ponzi game like that	25:36
	cannot continue indefinitely,	25:37
	well all of life is kind of	25:39
	a Ponzi game	25:42
	and there is no necessary	25:44
	limit to that process	25:47
	the overwhelming bulk of the evidence	25:55
	if you do this double entry bookkeeping	25:56
	is extremely mixed.	26:00
	I've quoted again and again studies like that	26:02
	of William Nordhaus of Yale	26:06
	that appeared in The Brookings Papers	26:08
	oh six months ago or nine months ago,	26:10
	showing that if you correct properly,	26:13
	profit figures, for under reporting of profits	26:17
	and for over reporting of profits	26:21
	you correct for example, for the fact	26:24
	that if the firm is not using a LIFO,	26:27
	the time of inflation,	26:31
	the tax upon so called reportable money earnings	26:33
	is really a depleting of capital kind of tax,	26:38
	and also that even if you allow fast appreciation	26:43
	in a time of inflation if you can only take	26:49
	into appreciation your historical cost	26:52
	which falls uniformly short of reproduction cost	26:55
	then there is an overstatement of reported profits.	26:59
	Well after somebody like Nordhaus or George Terborgh	27:03
	for the Machine Tool Trade Association	27:07
	make these computations you find	27:10
	that the share of profits,	27:13
	incorporate value added in particularly	27:16
	in manufacturing and mining,	27:19
	leave out the banks but there's no reason	27:23
	to leave them out.	27:25
	Has been a falling fractional share,	27:27
	some of the increase of course has been to government but	27:31
	there still is a discernible increase	27:36
	in the relative share of labor	27:38
	in the	27:41
	corporate value added.	27:43
	An even better measure of	27:48
	how valuable capital is,	27:52
	is to take its marginal yield	27:53
	which is the rate of interest or the rate of profit	27:56
	before or after taxes and whichever way you compute it	28:00
	Professor Nordhaus finds it to have fallen	28:06
	rather steadily these last ten,	28:09
	these last 20 years,	28:13
	moreover this is a world wide phenomenon	28:16
	it's a phenomenon that has been going on at a rapid pace	28:20
	even more rapid pace in the UK and in Italy,	28:25
	it's a phenomenon that's been going on	28:29
	In western Germany, it's a phenomenon that	28:32
	has been going on in Japan.	28:35
	People blame it on inflation but	28:37
	that's just one,	28:40
	new example of money illusion	28:43
	because to the degree that the inflation	28:46
	is unanticipated it's not likely	28:50
	to be prejudicial to profits	28:53
	to the degree I suppose I have to modify	28:58
	that to the degree that the inflation	29:01
	is due to wage push, it might be prejudicial profits	29:02
	but we haven't had an inflation primarily due	29:06
	to wage push, and in any case	29:09
	how do the	29:11
	workers successfully make their push	29:13
	without causing their employment to fall off?	29:17
	And	29:22
	so that	29:24
	it's	29:25
	unlikely that	29:27
	the situation with respect to the rate of profit	29:30
	would be very much different.	29:32
	I'm speaking of course of corrected profits,	29:34
	if there had been no	29:37
	inflation but a steady price level	29:40
	it is in the last analysis a question	29:43
	of how much capital there is around the world competing	29:46
	with capital around the world	29:48
	in conjunction with and against the background	29:51
	the amount of labor and the skills that work with it.	29:55
	And so I have to remain	29:58
	an agnostic	30:01
	on the need for capital,	30:03
	I won't go over to the other side	30:06
	and say that there is absolutely a capital glut	30:08
	because it could be that there has been a capital glut	30:13
	in the recent past, I mean the last decade	30:16
	but we're just moving into a epoch	30:18
	where the yields on capital are actually	30:20
	in process of rising.	30:23
	But it's when they rise and through their rising	30:24
	that we will know that pollution demands	30:27
	and other demands have caused capital to be short.	30:30
-	If you have any comments or questions	30:36
	for Professor Samuelson address them to	30:38
	Instructional Dynamics Incorporated	30:40
	450 East Ohio street,	30:42
	Chicago Illinois 60611.	30:44