Wednesday, 16 July 2014
Simon Wren-Lewis versus MMT.
Simon Wren-Lewis claims we should try stabilise the debt at some proportion of GDP, whereas MMT says we shouldn't aim for any specific amount of debt: that is, the debt should be whatever level is need to bring full employment. Let’s examine that question.
Examples of SW-L’s claim are for example here, where he says “fiscal policy should be all about debt stabilisation”. And here he says, “….maintaining a 3% deficit would stabilise the debt to GDP ratio at 75% of GDP. I think that is still too high, and for various reasons it is good to plan for a steady fall in the debt to GDP ratio over the next few decades.”
Now the big problem with that idea is as follows. The private sector, as MMTers keep pointing out, desires some amount of savings in the form of base money and in the form of national debt (which is simply base money that pays interest). Plus it’s highly unlikely that the desired level of that form of saving will remain constant (or remain “stable”) over time. That is, it’s beyond dispute that the private sector has outbursts of Alan Greenspan’s “irrational exuberance” from time to time.
So what happens when the desired level of savings RISES? Well Keynes gave the obvious and simple answer to that: we get so called paradox of thrift unemployment. That is, if people desist from spending (an activity that results in jobs being created or maintained), and instead switch to saving, then unemployment rises.
Now in that situation it’s completely fatuous to stick to some pre-determined amount of base money and debt. All that will happen is that unemployment rises.
To summarise, if the objective is to maximise numbers employed within the constraints posed by inflation, then government is JUST FORCED to adjust the total amount of base money and debt. In other words it’s plain fatuous to try to stick to some pre-determined level of base money and debt.
Interest on the debt.
And as to the debt-phobes who worry about the interest that government (i.e. taxpayers) pay on the debt, the answer to that little problem is that a government that issues its own currency can pay any rate of interest it likes on it’s debt, as various MMTers have pointed out. Puzzled? You don’t know how to cut the interest paid on the debt? Well it’s easily done: just put into reverse the process whereby the debt arose in the first place. It goes like this.
Governments are always tempted to spend more than they collect in tax. So to counterbalance the inflationary effect of that “policy” (to give it an unduly flattering name), governments induce the private sector to abstain from spending that excess stock of base money by attracting the money back into government coffers, and the “inducement” is of course the interest offered on that money.
So to reverse the process, the state just needs to print money and buy back the debt (i.e. implement QE), and as to any inflationary effects, deal with that by raising taxes.
Why pay interest on the debt at all?
Given that the state can pay any rate of interest on its debt that it likes, you might be wondering what the point is of paying any interest at all. That is, why not reduce the rate to zero?
Well that’s exactly what’s advocated by a leading MMTer, Warren Mosler – see 2nd last paragraph of his Huffington article "Proposals for the banking system" here. And Milton Friedman advocated the same “zero interest rate” policy. See paragraph starting “Under the proposal..”in his paper "A Monetary and Fiscal Framework for Economic Stability", American Economic Review, 1948. See here.
In fact the whole process of incurring debt is raving bonkers (not to put too fine a point on it). The “debt incurring” process in practice consists of the following. The state spends an excessive amount of its money into the private sector (net of taxes) and thus has to bribe the private sector not to spend that money, which is nice for those with cash to spare, but not so nice for taxpayers who in practice pay for the above “bribe” (i.e. interest).
Instead of spending an excessive amount net of taxes, wouldn’t it be simpler to simply raise taxes? Well yes it would. So why don’t governments do that? Well the reason was explained very succinctly by David Hume over 200 years ago. As he put it, “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government.”