American Monetary Institute

Review of “BUDGET – SMUDGET Why balance what, how, and when?” a paper by William Vickrey

Copyright 1996 by American Monetary Institute.

* The original paper is available at $8 per copy from : Columbia University, Office of Public Affairs, N.Y.,NY, 10027 (full address)

An American tragedy occurred on the night of October 9, 1996 on the Hutchinson Parkway, about an hour from here, when William Vickrey died of a heart attack three days after being awarded the Nobel Prize in Economics. Where is the tragedy in the death of an honored 82 year old gentleman? It is in American society missing the crucial and completely unique contribution he was determined to make to the current political and economic debate, or one could say stampede, toward requiring a balanced Federal budget. You see, under present conditions, Prof. Vickrey was strongly opposed to balancing the budget.

As recently as October 5th (see “final warning” on AMI home page) he issued a press release titled “Deficit Reduction Costs Jobs”, warning that each $10 billion of deficit reduction causes a drop of $8 billion in sales and production which translates into 100,000 people losing their jobs.

In 1988, Vickrey wrote BUDGET – SMUDGET, a 15 page paper notable for some frank descriptions of those pushing the balanced budget agenda. The paper examined and refuted the supposed rationale for balancing the budget, described the real effects of such a balancing, and outlined some better alternatives for the economy.

Strangely, while every unthinking exhortation in favor of curtailing the federal budget seems to receive network attention (I have personally seen in 1993, or 94 an unfortunate adolescent suffering from Downe’s Syndrome featured on a network TV documentary saying that when he grew up, he wanted to help the federal government balance the budget!); yet the counsel and wisdom of William Vickrey on this crucial question is being ignored.

Therefore AMI has made a special effort to present his views here. I was fortunate to hear Professor Vickrey present some of those viewpoints to a group of 20 economists attending a prestigious seminar at a local conservative think tank, two years ago. Most who reacted to his budget views disagreed with him, without presenting good reasons for doing so. The minority, possibly in agreement with him, were noticeably quiet about it.

After his talk, everyone else had left the room for lunch or dinner and I told professor Vickrey that I strongly agreed with his views on the budget, but that I was almost the only one in the room without a PHD in economics.(I also discussed with him the reason I’d challenged him earlier on the question of the government creating its money directly rather than borrowing money created by the Federal Reserve System- that an unbiased and careful analysis of monetary history (presently unavailable in any of the nation’s universities) demonstrated a superior record of monetary management by the U.S. government than by private banks).

Incidentally Professor Vickrey did one of his famous “startled out of an apparently deep sleep directly into a heart of the matter question” feats. Seeing this for the first time without having heard the legend, was a real treat!


(all italics and emphasis have been added)

On The Budget Process

In “Budget Smudget”, Vickrey begins by pointing out the basic flaw in the federal budgeting process itself – the failure to distinguish between capital and current account items, “(making) the nominal budget a poor indicator of the impact of government outlays and revenues.” Pressure to balance such a budget “results in inefficient decisions to lease rather than own office space, vehicles, computers and other types of equipment, as well as a reluctance to install labor-saving capital throughout government agencies.”

Rational decision making, he points out “generally requires a full balance sheet approach that would include not only tangible assets such as buildings and highways, but on the other side the unfunded liabilities for military and civil service pensions, as well as social security.”

On Education

Of direct relevance to current debates on funding education is Vickrey’s view that “Nearly all educational expenditure should be considered a capital outlay, whether it provides a future return in the form of enhanced taxable income or in terms of an enhanced quality of life.”

On The Balanced Budget Stampede

Vickrey uses some of the strongest language seen in economic writing to describe balanced budget advocates:
“… an insistence on a balanced budget, however properly defined, can have no justification except as a means of providing a procrustean bed into which the operations of a government conceived of as an adversary can be confined.” and
“…there is no real justification for a requirement that a budget of any sort should be balanced, except as a rallying point for those who seek to hamstring government.” and
“… a mystical faith in the propriety of a balanced budget, based on an unreasoned belief that deficits necessary produce inflation…”.

On Inflation

“But deficits do not in themselves produce inflation, nor does a balanced budget assure a stable price level.” he wrote.

Vickrey’s examination of the cause of inflation (“the overall result of individual prices being independently increased”) notes that “…Increasingly prices are set by sellers, …(able)… to raise their prices without a loss of sales sufficient to wipe out the gain.” This ability to raise prices he says stems from “the increasing sophistication of goods and product differentiation, both inherent and contrived. At the retail level, consumers are increasingly bamboozled by specious advertising and frivolous variety so that comparison of the products of various sellers is increasingly difficult…” and the demand for the products is inelastic.

For these and other reasons he concludes that “Monetary policy is inherently incapable of curbing this process (of inflation) except insofar as it goes to the extreme of idling resources” and causing unemployment.

Vickrey points out that this is rarely faced honestly: “While they generally avoid speaking or even thinking of the policy in terms of increasing unemployment, the main channel through which restrictive monetary policy will act to restrain the raising of prices by price setters is by cutting back on the demand for resources and adding to unemployment.”

“Currently a level of unemployment of 7% or more seems to be required to keep inflation from accelerating, a level quite unacceptable as a permanent situation.”

“The supply -side effect of a restrictive monetary policy, moreover, is likely to be perverse, in that high interest rates enter into costs and thus exert inflationary pressure, as well as inhibiting the expansion of capacity or the introduction of cost reducing capital improvements.”

“In such a context it should be clear that balancing a nominal budget will solve nothing, and attempting to achieve such a spurious balance will produce much mischief.”

On The Real Social Costs Of Unemployment

Again Vickrey tells it like it is:
“The effects of such a level of unemployment are particularly harmful when it is concentrated on a small percentage of the labor force, with consequent increases in crime and delinquency and disruptions of family life, rather than expressing itself as, say, an extra three weeks vacation for everybody. In the short run, at least, inflation is far preferrable to unemployment if the two are considered alternatives.”

A measure of how important increasing employment is in Prof. Vickreys view can be seen in how much inflation he thinks would be acceptable:

“If unemployment could be brought down to say 2% at the cost of an assured steady rate of inflation of 10%per year, or even 20%, this would be a good bargain.”

The reader should consider that these conclusions are those of a seasoned economic observer and theorist, with a lifetime of impressive practical achievement. Vickrey is concerned though that the inflation rate might not remain steady, at 10 or 20%, but might accelerate “eventually reaching levels that would be extremely disruptive of normal economic calculations”. What is needed, he says is “some new instrument for controlling inflation that does not involve massive unemployment.”

Proposing A New Instrument – An Excess Markups Penalty

“The achievement of a reasonably full degree of employment without accelerating inflation will require development of some additional tool.” As an example of the kind of instrument needed, Prof. Vickrey proposes a penalty tax on excess markups, as a means of containing inflation. Starting from a proposal by Prof. A. Lerner to develop “a market in rights to raise prices, with those wishing to raise prices being permitted to do so only by purchasing the right from others willing to lower theirs to a corresponding degree”, Vickrey concludes that to make it workable, instead of prices, gross markups should be the starting point: “Firms would be given initial entitlements to gross markup on the basis of past performance.”

These entitlements would be transferable and a market in them would be developed. The plan would operate “somewhat similar to an excess value added tax, comparable in some respects to the wartime excess profits tax except for the fact that the entitlements would be directly tradable.”

As to controlling the ultimate rate of inflation Vickrey thought it could be determined in how the program was structured. “The way in which the entitlements are established would determine the overall average degree of price increase … the resulting equilibrium price of entitlements would automatically adjust to provide the degree of restraining pressure to keep inflation at this predetermined level.”

A fascinating proposal which deserves full study sooner, rather than later, as so many of Vickrey’s proposals suffered a great time delay between his thinking them up, and their finally being generally accepted.

Budget Smudget should be read by all economists; government officials; labor union people; political aides and consultants; think tank personell; and news organization employees and personalities, who in any way are factors in the great balanced budget stampede – er debate.

Stephen Zarlenga
at Kinderhook, Nov. 21, 1996

One Afterthought

Under conditions where there is the political will to institute Vickrey’s proposed markups control system, it may also be possible to shift all or a part of the nation’s money creation process directly to the Federal Treasury, without the debt creating and interest costing intermediary of the Federal Reserve banking system.

Using such an interest free system of funding particularly the capital side of a properly drawn federal budget, would present an effective way of keeping interest rates very low, and the projects would directly provide the much needed employment: rebuilding bridges, roads, schools, and more, with probable benefits to all, except certain banking elements. (Remember the folks who brought us the savings and loan entertainment?).

For starters, just yesterday a small commuter plane collided with a private plane at the Quincy, Illinois airport, leaving 14 dead. In the reportage it was stated that thousands of such small airports have no control towers or radar “in these times of tight federal budgets”. It was estimated that $750 million would be needed to provide them. The project becomes feasible, where the government controls the money power for the public interest, instead of the bankers; who are so myopic they won’t even fund the crucially needed technology upgrades at the major airports they themselves use!

Your comments and views are appreciated.