How Real Is the Federal Deficit?
by Robert Eisner
New York: The Free Press, 1986, pp. xiv, 240

This provocative treatment of the measure and meaning of the federal deficit has as its intended audience "economists and non-economists of all schools and political persuasions" [p. xiii]. Portions of the book of interest to economists consist largely of an updated presentation of the material that initially appeared in a 1984 article co-authored with Paul J. Pieper [1]. The remaining portions are devoted to instructing the layreader about the macroeconomic relationships that characterize the Keynesian model and about the role of wealth in that model.
        In an almost-incidental discussion near the end of the book [p. 166], Eisner explains how Robert Lucas came to question and then reject the Keynesian model. The discussion provides an interesting perspective on both Lucas's rejection and Eisner's reaffirmation of Keynesianism. During the decade of the 1970s, Lucas saw a substantial amount of involuntary unemployment co-existing with high budgetary deficits—a state of affairs that did not square well with Keynes's view of macroeconomic relationships. Abandoning Keynes's mode of analysis, Lucas constructed a theory in which markets always clear. The involuntary unemployment he thought he had seen was conceived to be voluntary unemployment. Eisner, who has been watching the same statistics, is now claiming that Lucas really did see involuntary unemployment, but the high deficits he thought he saw were really surpluses.
        If the wealth effect associated with privately held government debt is to be properly incorporated into the Keynesian model, Eisner makes clear, the debt and the deficit must be measured in real terms. Though committed both analytically and ideologically to Keynesianism, Eisner preaches repeatedly—in the present book and elsewhere—against the "cardinal economic sin of money illusion." Failure to measure deficits appropriately has caused economists and policy makers to fail in their diagnoses and hence in their policy prescriptions. More specifically, the years 1977-81 were misperceived as a period of fiscal stimulation. Conversion from officially reported deficits to Eisnerian deficits reveals that this period was characterized by budgetary surpluses and thus by fiscal stringency [pp. 86-88].
        The needed adjustments in the officially-reported deficit are dictated by the role that debt plays in the Keynesian model. Distinctions must be made between federal borrowing to make capital expenditures, which does not have a direct net wealth effect in the private sector, and federal borrowing to make current expenditures, which does; and between cyclical deficits, which are income-induced, and structural deficits, which are income-inducing. Beyond these distinctions, adjustments must be made for changes in the price level and in the rate of interest. Inflation erodes the real value of outstanding debt; movements in interest rates cause countermovements in the debt's market value. Making these adjustments, dubbed by Eisner the nominal-to-real adjustment and the par-to-market adjustment [p. 23], is equivalent to redefining the federal deficit as the change in the real market value of the privately held federal debt.
        Eisner's objective is clear and explicit. What he calls the "anti-Keynesian" counterrevolution of the 1970s" [p. 76] was based, he contends, on a false reckoning of the deficit—and hence a faulty evaluation of the efficacy of fiscal policy. Exposing this false reckoning and making the appropriate corrections is a prelude to and the basis for a major rewriting of recent economic history [pp. 4 and 87]. Clearly, Eisner has a vision of launching what might be called the "pro-Keynesian countercounterrevolution of the 1980s." The spirit of revanchism pervades much of the book but is most evident in the penultimate chapter, which explores the "Implications for the Disarray in Macroeconomics." In this Keynesian collage, macroeconomic maladies are to be attributed to the existence of saving: "The problem of insufficient demand develops because we do not generally spend all of our income on current consumption" [p. 168]. When individuals save, entrepreneurs have no way of knowing what consumption goods they will eventually want or when they might want them. Saving is brought in line with sagging investment demand through changes in income. If profit expectations are unduly pessimistic, the economy will experience economic stagnation.
        Adjustments of the interest-rate are limited by the liquidity trap; adjustments of the real wage are prevented by the spiraling of nominal wages and output prices. The Pigou effect, which may as a matter of logic eventually curb the fall in demand, is too little too late. To avoid creating havoc in labor relations and otherwise putting the economy through an impossible wringer, the central bank should provide a direct stimulant. Eisner is true both in letter and in spirit to Keynes's Chapter 19 [2, p. 267] when he concludes that "Increasing the real quantity of money is something better left to the Chairman of the Federal Reserve than to the President of the AFL-CIO" [p. 171].
        A careful reading of Eisner's treatment of the deficit reveals that there are actually two purposes for making adjustments. One purpose, as indicated above, is to provide a basis for assessing the sign and magnitude of the wealth effect. People have a marginal propensity to consume out of net wealth. In the model that Eisner presents, the marginal propensity is 0.10 [p. 65]. But some people also have a propensity to worry about the federal deficit. Eisner's second purpose for making adjustments, though less explicit than the first, is to allay fears about the (insufficiently adjusted) deficit. The most significant such adjustment is based upon a revaluation of the Treasury's gold. "Real net debt" is measured net of the market value of the gold held by the Treasury. But a propensity to worry that is a function of the real net debt would give rise to some unusual dynamics and perverse incentives that Eisner overlooks. A high real net debt may cause worrywarts to buy gold as a hedge against the expected inflation which would result from real-net-debt monetization. But the bidding up of the price of gold would, purely as a matter of definition, reduce the real net debt thus allaying the worrywarts' fears and hence decreasing the demand for gold. The possibility of this process resulting in a stable equilibrium is in doubt. Further, if fiscal responsibility were to be gauged by movements in the real net debt, government officials could take advantage of the gold-based adjustment simply by creating inflationary expectations.
        The provocative and controversial nature of the book and the attention that it has received in the financial and popular press is largely attributable to Eisner's reluctance to acknowledge that there are a multiplicity of reasons to be concerned about government borrowing and that different reasons suggest different measures of the deficit. If the only concern were the wealth effect that relates government debt holdings to spending propensities, then Eisner's analysis would be unexceptionable. But there is also the concern that heavy government borrowing puts excessive burdens on credit markets, which suggests a conventional rather than Eisnerian reckoning of the deficit. There is concern about intra- and intergenerational transfers of wealth, which suggests that not only federal deficits but also taxes and transfer payments associated with Social Security and other such programs should be the appropriate focus of analysis. (Eisner excludes from consideration all such unfunded and contingent obligations.)
         There is concern about the uncertainty inevitably created by a high (conventionally measured) deficit. Will the government simply continue to roll-over the ever-increasing debt? Will foreign-trade imbalances caused by heavy government borrowing persist into the indefinite future? Will the government resort to debt monetization? If so, when and to what extent? Will taxes be increased? If so, when and whose? These questions and the absence of definite or even probabilistic answers are enough to dim the spirits of most all investors, Keynesian and otherwise. But Eisner is silent on this issue. And finally, there is concern about the possibility that ultimately the government will default on its debt. For those who are so concerned, the realization that the government is pursuing a default-as-you-go policy through inflation is no consolation.
         In sum, Eisner has distilled from the budgetary statistics that magnitude which corresponds most closely to the wealth effect of deficit financing in a Keynesian model. All other concerns about government borrowing he either talks away or ignores. The book would undoubtedly enjoy a more friendly reception both inside and outside the economics profession had the limited significance of the Eisnerian deficit been emphasized. But it would also be less provocative and would cause less controversy.
         In the context of the battle of ideas, Eisner's book has a claim on our attention not because of its contribution to our understanding of federal deficits but because of its potential strategic significance for the future of Keynesianism.

Roger W. Garrison
Auburn University

 1. Eisner, Robert and Pieper, Paul J., "A New View of the Federal Debt and Budget Deficits." American Economic Review, March, 1984, 11-29.

 2. Keynes, John M., The General Theory of Employment, Interest, and Money. New York: Harcourt, Brace and World, Inc., 1964 [1936].