Simpletons think that cutting public spending will cut the deficit.

Preliminary note: if you’re an advocate of Modern Monetary Theory you’ll probably already understand the points made in this article, and thus won’t need to read it.

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Simple folk (and that includes many broadsheet newspaper economics commentators) see government the same way they see a microeconomic entity like a household or firm. If a micro entity has a deficit, i.e. expenditure exceeds income, then clearly cutting expenditure will reduce its deficit.

However if GOVERNMENT cuts its spending, and assuming aggregate demand (AD) is to be left untouched, then when spending is cut by £X, tax must be cut by £X as well. So, shock horror: the deficit remains unchanged. (I’ve assumed, incidentally, that when public spending is cut by £X the eventual effect on AD is equal and opposite to an £X cut in taxes. That’s not strictly true, but for the sake of simplicity I’ll stick with that over-simplification.)

So what on Earth do we do if we want to cut the deficit and/or debt while leaving AD untouched? We’re all soiling our pants over that, aren’t we?

The answer is that all announcements to the effect that the deficit/debt should be cut by some pre-ordained amount are total and complete nonsense. They’re raving lunatic. They’re a sign of mental deficiency.

The deficit is simply extra spending by government, not covered by tax, and aimed at making up for any AD deficiency. Thus if we are committed to full employment, then we’re committed to occasional deficits (well actually more or less permanent deficits for reasons I explained a few months ago on this blog).

But what if interest rates rise?

If the debt continues to rise relative to GDP, won’t creditors become increasing skeptical of a government’s willingness or ability to repay it?

Well the first answer to that is that (contrary to popular perception) deficits do not necessarily result in any rise in the debt. As Keynes pointed out nearly a century ago, a deficit can be funded by BORROWED MONEY OR PRINTED MONEY. Unfortunately half the world’s economists still haven’t grasped the latter very simple point. Certainly Kenneth Rogoff,  Harvard economics professor and former chief economist at the IMF doesn’t understand that point.

Indeed, what on Earth is the point of borrowing money when you can print the stuff? There’s no point . . . .unless you’re an academic economist or professional economics commentator looking for a way to keep yourself occupied, in which case you can write any number of articles and papers on the relative merits of borrowing versus printing. That will undoubtedly further your career and keep the salary cheques rolling in.

But assuming a government does go for the borrow option, and creditors get the jitters and raise interest rates? Well there’s a simple solution staring us all in the face: QE. That is, print money and buy back debt. (Or cease incurring debt and go for the print option).

That will have the effect of REDUCING the rate of interest paid on the debt. In fact a government that issues its own money can do just as much of the above QEing as it likes, and reduce the interest rate on its debt to any level it likes – a point which is widely accepted in Modern Monetary Theory circles.

Inflation.

Of course whenever the words “print” and “money” appear in the same sentence, hoards of Neanderthals appear from the woodwork chanting “inflation”. Now I have a message for Neanderthals, which is that the average ten year old has worked out that excessive money printing leads to excess inflation. The point is so obvious that it goes without saying.

Moving on to some slightly more subtle points (way beyond the comprehension of Neanderthals), funding a deficit with printed money will not result in excess inflation unless AD becomes excessive. Ergo . . . . roll of drums. . . . .if JUST THE RIGHT AMOUNT of money is printed and spent, then AD will rise by the right amount and employment will rise to the full employment level (or “NAIRU”, if you like acronyms).

It is of course just conceivable that inflation would rise ABSENT any rise in AD and because of inflation expectations: that is, it is possible that the average household and firm keeps an eye on the money supply figures and raises their wage demands / prices accordingly. But frankly the idea that the average household or firm keeps an eye on the money supply figures is an idea straight out of cloud cuckoo land.

But there again, expectations or “Ricardianism” is a great wheeze for keeping academic economists employed. If they could keep themselves employed counting angels on pin heads, I’m sure they’d go for that as well.

But so far as REALITY goes, I agree with Joseph Stiglitz who said “Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense.”

Conclusion.

Governments are FORCED TO implement deficits if they want to maintain full employment. There is nothing they can do about it. And as to the rise in the debt or expansion in the amount of base money that results from a deficit, there is NO PROBLEM there.