The infamous debunker of most-things-classically-economic was recently asked to brief Congress on the fiscal cliff, and how the downturn of 1937 could be a foretaste of what will happen if the Cliff comes to pass. The paper, slides, and presentation – designed to be simple enough for Dennis Kucinich and his colleagues in Congress to comprehend – provide another glimpse as Steve Keen argues that an attempt by the government to reduce its debt now may trigger a renewed bout of deleveraging by the private sector – and this is what appeared to happen in 1937, when confidence that the worst of the Depression was over led to the government reducing its deficit.
Private sector deleveraging, which had stopped in 1934-35, began once more and unemployment rapidly rose from about 10 to almost 20 percent. The main danger with the Fiscal Cliff is therefore not what the reduction of government spending will do on its own, but that it might trigger a renewed bout of deleveraging from the $40 trillion overhang of private debt that Keen calls the “Rock of Damocles”.
Full briefing here:
Steve’s Takeaway Points:
- Private debt and government debt are independent, but affect each other.
- Both boost demand in the economy when they rise, and reduce it when they fall.
- Private debt is more important than public debt because it is so much larger, and it drives the economy whereas government debt reacts to it
- The crisis was caused by the growth of private debt collapsing.
- Government debt rose because the economy collapsed, and it reduced the severity of the crisis.
- A premature attempt to reduce government debt through the fiscal cliff could trigger a renewed bout of deleveraging by the private sector, which could push the economy back into a recession.
- For the foreseeable future, the main challenge of public policy will be not reducing government debt, but managing the impact of the much larger “Rock of Damocles” of private debt that hangs over the economy.
Keen’s paper here:
The slides can be access here.