Friday, 17 February 2012

The deficit: Martin Wolf struggles manfully with problems solved long ago by Modern Monetary Theory.

In this Financial Times article, Martin Wolf claims that deficit reduction will have to come about mainly by “lower desired savings”.

Incidentally Martin Wolf rather glosses over the distinction between flows (deficit) and stocks (debt). But that over-simplification does not of itself weaken his argument too much, and I’ll continue with the over-simplification.

Anyway, Wolf’s basic point is a classic piece of the nonsensical “conventional wisdom” that plagues discussions about the debt and deficit. That is, he assumes that deficit or debt reduction are some sort of end in themselves. He puts the cart before the horse.

The reality is that the private sector’s savings desires vary over time, and if those desires RISE, then government just has to accommodate them, else we get paradox of thrift unemployment. And if those desires STAY HIGH, then government will just have to leave the debt at a higher level than would otherwise be the case. (By the way, “savings desires” are normally referred to in Modern Monetary Theory literature as “private sector net financial assets”).

As to exactly what is wrong with a relatively high debt, Martin Wolf does not tell us. But presumably it’s the interest rate burden that worries him. Well the first answer to that is the Britain (like some other countries) is currently paying a near zero real rate of interest on money borrowed (i.e. after adjusting for inflation).

Second, and regarding the possibility that the real rate might rise significantly, that is not a problem. A rise in interest rates indicates an unwillingness by the private sector to hold as much debt. Well the solution to that problem is easy: stop borrowing until the interest on debt falls again to the near zero level.

Of course the latter wheeze involves printing money and paying back debt as it matures, that could easily be too stimulatory or inflationary. But that’s not a problem: just raise taxes by whatever amount is needed to counteract the above stimulatory / inflationary effect.



  1. " then government just has to accommodate them, else we get paradox of thrift unemployment. "

    There is another option, which is to confiscate (tax) excess savings over investment so that (S-I) is always zero and the government budget always balances.

    Which sounds great in theory. Then you try and design a mechanism to do that and you run into all sorts of distributional and ethical issues.

    In the end accommodation is easier, and you can get around to taxing it away when it comes back into the flow in an excessive fashion.

    And in the meantime people feel wealthier for very little cost on the part of the state.

  2. Two many rich people on TV and radio preaching austerity for the little guy and not willing to pay for it by raising taxes on themselves.

    Bush showed what happens to an economy when you cut taxes during a boom. Everyone piles on to the pyramid and overextends the system through unproductive speculation.


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