Thursday, 7 March 2013
The national debt and deficit are total and complete non-problems.
You’ll have heard a thousand economics commentators, politicians and the like wittering on about the need to cut the debt and deficit. They all make the mistake of equating NATIONAL debts and deficits with the debts and deficits of MICROECONOMIC entities like households and firms.
Indeed one of the most common mistakes in economics is to apply microeconomic laws at the macroeconomic level. The reality is that micro and macro are almost separate subjects.
A microeconomic entity certainly has to watch its debts, plus if is suffers a constant outflow of funds, i.e. a deficit, clearly that cannot go on for ever. However, the government of a country which issues its own currency is an entirely different kettle of fish.
Given a recession, it’s positively beneficial for government to spend more than it collects in tax. Recessions occur because of inadequate spending by the private sector. So if government makes up for that lack of spending by spending more (and/or collecting less tax so as to encourage private sector spending), that raises demand and employment.
As to whether that deficit accumulates as extra government debt or simply as extra money in the hands of the private sector, that doesn’t matter, as Keynes pointed out in a letter to Roosevelt in the 1930s (1). Keynes in that particular letter was indifferent as between having government borrow and print money. Personally I favour the print option and for the following reason.
Governments can create money at will. Now what on earth is the point of BORROWING SOMETHING, which you your self can produce for free? It’s a bit like a dairy farmer buying milk in the supermarket. So unlike Keynes, I prefer the “print” option to the “borrow” option.(2.)
Those dreaded bond vigilantes.
But assuming the debt DOES RISE, the debt-phobes and deficit-phobes then start worrying about what happens if a country’s creditors lose faith in the country and start demanding a higher rate of interest on its bonds (as has happened for various European countries which DON’T issue their own currencies: the Euro periphery countries).
Well if those interest rates DO RISE, there is NO IMMEDIATE effect on interest paid by the debtor country because rates of interest on bonds are fixed when bonds are first issued. However, as bonds mature, then clearly the question arises as to whether to roll them over and pay the new higher rate of interest, or simply print money and repay the relevant creditors.
Now there might seem to be a problem with the latter “print” option, namely that it could be inflationary. Well you have to wonder what planet anyone who thinks that has been living on for the last three years. During that time we’ve printed money like there’s no tomorrow and bought back debt and in the guise of quantitative easing, and no hyperinflation has materialised.
However, its perfectly possible (in particular, absent a recession) that money printing could be inflationary. But that’s no problem: that inflationary effect can be countered with a very simple DEFLATIONARY measure, namely raising taxes (and/or cutting public spending). And assuming the latter inflationary and deflationary effects cancel out, there is no effect on anything: no effect on demand, no effect on GDP, no effect on numbers employed and so on. I.e. the increase in tax does not make anyone any worse off.
See what I mean? This is all a total non-problem!!
Debt owed to foreigners.
Well it’s very nearly a non-problem: there is actually one minor problem which has to do with the amount of debt held by foreigners.
If a foreign debt holder is given cash in exchange for their bonds, they are likely to move their money to elsewhere in the world in search of better yield. And that would hit the value of the relevant country’s currency.
But that’s simply a reflection of the fact that borrowing from an external source gives one a temporary standard of living boost (just like when you run up debt on your credit card). And that temporary boost is reversed when you pay back the debt. No big mystery there.
Moreover, the latter “borrowing from abroad” phenomenon is another reason for governments not to borrow at all. That is, if, as suggested above, deficits just accumulate as extra money, then the above “borrow from abroad” problem just doesn’t arise! And numerous economists have argued that governments shouldn’t borrow: e.g. Milton Freidman (3), Warren Mosler (4) and Claude Hillinger (5). I also wrote a paper arguing that government borrowing makes little sense (6).
And finally, let’s finish with a quote from Keynes. He said “look after unemployment, and the budget looks after itself”. Quite right. In other words one of the main duties of government is to ensure as far as is possible that there is work for those who want work. The fact of doing that will on occasion result in a rapidly rising national debt (and/or monetary base). And on other occasions (e.g. given “irrational exuberance”) the result will be a budget SURPLUS and a declining national debt (and/or monetary base).
But which of the two latter outcomes materialises – deficit or surplus - and how large they are, is a complete irrelevance. It’s non-problem.
1. See 5th paragraph of letter from Keynes to Roosevelt where he says “public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money.”
2. I’ve always suspected that Keynes also preferred the “print” option. However he was politically very astute and realised by 99% of the population foam at the mouth on hearing the words “print” and “money” in the same sentence. I suspect that was why he kept rather quite about the print option.
3. Milton Friedman. See article entitled “A Monetary and Fiscal Framework for Economic Stability” in the American Economic Review, June 1948. See in particular under the sub heading “The Proposal” (p.250).
4. See 2nd last paragraph of article by Warren Mosler here:
5. Claude Hillinger. See p.3, para starting “An aspect of…”:
6. Paper entitled “Government borrowing is near pointless".
P.S. (11th March 2013). Warren Mosler says much the same here.