Wednesday, 24 September 2014

Cutting the deficit is an absurd objective.

If aggregate demand declines for whatever reason (e.g. less spending by households or a drop in demand for exports) then the deficit should be increased else unemployment rises. And excess unemployment makes no sense. Ergo the deficit needs to be varied, and indeed will occasionally turn into a surplus given higher than usual consumer and business confidence.

Thus to have a target for deficit reduction in a given number of years’ time is absurd because no one knows what households will do or what will happen to exports and other variables in the future.

So what objectives DO MAKE sense?

Well inflation is already accepted as an objective, and quite right. There are arguments for zero inflation, but 2% is a more widely accepted target. If inflation is above target, the deficit needs to be cut (unless the inflation is cost push). If inflation is below target, the deficit needs to rise. But note that the deficit  ITSELF is not an objective in the latter scenario.

Interest on the debt.
Another valid target is interest paid on the debt. As numerous MMTers have pointed out a government that issues its own currency can pay any rate of interest on its debt it likes. An argument for a zero real or “zero after adjustment for inflation” rate is that the relevant country at that rate can get interest free loans from foreigners. An argument for a NEGATIVE real rate is that the relevant country or government can actually PROFIT FROM its creditors. In the latter scenario, the relevant country is simply acting as a bank: supplying safe and fairly liquid assets to those who want same and charging for the service. That makes sense.

It can also be well argued that the NOMINAL interest rate on the debt should be permanently held at zero. In effect that means the only liability the government / central bank machine issues is base money: base money and so called debt that yields no interest are the same thing. E.g. $100 bills yield no interest. Milton Friedman argued the case for a permanent zero rate, I think rightly.

However, AIMING FOR a permanent zero rate and actually ACHIEVING it are not the same thing. That is, if the objective is a permanent zero nominal rate, that can in theory be achieved simply by varying the amount of base money created and spent into the economy (as advocated by Positive Money). However, letting the central bank borrow base money back from the private sector so as to damp down a boom might not be a bad supplementary tool.

As to a positive REAL rate on the debt, there are no good arguments for that. What’s the point in government borrowing money and paying any significant interest when it can print the stuff? That’s pointless. Moreover, a positive real rate increases inequalities. Reason is that interest is paid for by the average taxpayer, and ends up in the pockets of the rich.

So . . . if the real rate on the debt / base money looks like rising too far, the relevant country needs to cut that rate, and that’s easily done by printing base money, buying back debt or ceasing to roll it over, and that amounts to QE. And as to any inflationary consequences, that can be dealt with by raised taxes and/or reduced public spending. But note that there needn’t be any effect on numbers employed as long as the latter deflationary effect exactly cancels out the inflationary effect of printing more base money (easy in theory, but obviously less easy in practice).
The latter mixture of inflationary and deflationary effects MAY CUT the deficit. In fact it will do, if the inflationary effect of the above QE is significant.

But that deficit reduction effect is COMPLETELY IRRELEVANT.  It’s by the bye. It is not in itself an objective. It’s a number that comes out in the wash. To repeat, making deficit reduction ITSELF an objective makes no sense.

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