Adair
Turner in today’s Financial Times argues
for “money-financed deficits”. I.e. he argues that when stimulus is needed, the
state should simply create new base money and spend it, and/or cut taxes.
However,
he also argues for a return to the higher interest rates that prevailed prior
the crisis. He even refers to the current low rates as a “dangerous subsidy”.
His arguments there do not stand inspection.
He does
cite a few very obvious advantages of higher rates, like the fact that higher
rates would reduce indebtedness. But I can dream up half a dozen advantages and
disadvantages of a warmer or colder climate in the space of ten seconds. That proves nothing.
In
contrast, the IMPORTANT question in relation to interest rates, is: what’s the
OPTIMUM level of interest rates. As I’ve pointed out before here, 95% of the
population, the intelligentsia included, does not seem to understand the
concept “optimum”.
So
how do we arrive at the optimum rate of interest? Well I suggest adopting a
principle widely accepted in economics, namely to assume that market forces
bring about the optimum price for anything, unless it’s obvious that the market
is ignoring some social consideration.
A
free market.
So let’s
start with a very simple free market scenario: government spending is a minute proportion
of GDP, but government does issue a currency. Now the logical AMOUNT OF
CURRENCY to issue is whatever keeps the economy ticking over at full employment.
I.e. it’s the amount of currency / money that keeps unemployment as low as is
consistent with acceptable inflation (i.e. NAIRU).
But
why should government issue SO MUCH currency that there is excess demand and
inflation, and government has to borrow some of that money back (i.e. issue
government debt) with a view to preventing excess demand? There’s no logic
there.
Ergo
the state should simply issue enough currency to give us full employment. As to
government debt: forget it. And what do you know? That’s exactly what Milton
Friedman and Warren Mosler advocate. That is, they argued that the only
liability the state should issue should be money, i.e. that the state should
not issue debt.
Public
investments.
Moving
on from the above scenario where public spending is a minute proportion of GDP
to a more realistic scenario, namely where a significant amount is spent on
public investments, should the state borrow so as to fund those investments?
Obviously if the state does borrow, that will push up interest rates.
Well
the naïve often think that because an investment is made, money should be
borrowed so as to fund the investment. But that’s actually nonsense: if a taxi
driver wants a new taxi and happens to have enough cash to buy it, then he or
she won’t borrow. (Moral: taxi drivers know more about economics than some
economists).
In
the case of public investments, the state is never short of cash because it can
grab as much cash as it wants from the private sector via tax (or just print
the stuff). Ergo government borrowing
makes no sense (or so I’m claiming).
And
if anyone cites the argument that borrowing spreads the burden across
generations, I’ll demolish that one.
Conclusion.
The
question as to whether interest rates should be bumped up as a consequence of
government debt issued so as to fund public investments is complicated. Turner
does not appreciate that point or the complexity.
As
to whether the state should borrow so as to fund public investments and thus
bump up interest rates, my answer is “no”: and Milton Friedman and Warren
Mosler agree with me.
But
I’m open to other views.
________
P.S. One
argument for above zero interest rates on state liabilities is that that
enables government to adjust demand by adjusting interest rates. That argument
would hold if interest rate adjustments were a much better method of fine
tuning than fiscal adjustments, but I doubt they are.
Moreover,
the mere fact of having the state issue “debt” or “interest yielding
liabilities” increases inequalities. That’s because it’s the rich who tend to
hold or own government debt, while it’s the average taxpayer that funds the interest
payments.
In normal times I agree. But during the war it was necessary to suppress private demand. High tax rates played apart, but when you are asking people to work extra long hours to produce the weapons needed.
ReplyDeleteKeynes favored an income tax which would be refunded after the war. But people don't trust government to do that. Allowing them to earn money with which they buy bonds to be paid back when war demand is ended has a similar impact and gives contract security.
This is a very limited exemption to your rule.
Milton Friedman agreed with you! Word search for "war" here:
Deletehttp://0055d26.netsolhost.com/friedman/pdfs/aea/AEA-AER.06.01.1948.pdf