Thursday, 28 April 2016

We need more government debt.

The world is awash with deluded individuals who think that government debt is comparable to the debt of a household or firm: something that is bad, bad, bad. And allegedly that government debt needs to be reduced or paid off as soon as possible.

Reason for that delusion is that the word “debt” has negative overtones, and the overtones of a word are all that most people consider: that is, considering the ACTUAL NATURE of government debt is too much like hard work.

To be more exact, government debt is an asset as viewed by those who hold that debt (i.e. private sector entities like households). I.e. government debt is a form of saving. Thus we might as well scrub the phrase “national debt” and rename it “national savings”. If we did that, the above people would immediately conclude that the more “national savings” there are the better.

So where does the truth lie on that “savings – debt” scale? Well the answer is that “national debt / savings” is neither good nor bad: the reality is that for any given situation (level of inflation, unemployment, etc) there is an OPTIMUM amount of “debt / savings”, as advocates of Modern Monetary Theory (MMT) have been trying to point out for a long time.

It’s thus good to see Narayana Kocherlakota publish a Bloomberg article recently advocating more government debt – in flat contradiction of the conventional view that the debt should be reduced. (Incidentally, Kocherlakota is former president of the Minneapolis Fed and is an economics prof at the University of Rochester.) However, not even Kocherlakota’s analysis is without flaws, so I’ll run thru it.

In his 3rd para (starting “How is the US government..”) Kocherlakota argues that because interest on US national debt is lower than it was ten years ago, that therefor that rate of interest must be too low.

To put it politely, that’s not a brilliant piece of logic: if the speed of your car is less than it was two minutes ago, does that prove the speed is now too low?

Put another way, the fact that something is less now than it was recently is completely irrelevant. The IMPORTANT point is this: what’s the OPTIMUM amount of any variable (debt, car speed, etc)? Unfortunately as I’ve pointed out over and over, the concept “optimum”, simple as it is, is way beyond the comprehension of about 99% of the population.

Well according to MMT, which I agree with, the optimum amount of national debt is not too difficult to determine, at least in theory. It goes like this.

Debt as viewed by debt holders is an ASSET. In fact national debt is simply a form of term account: it’s a chunck of money on which government pays interest (as distinct from physical cash, on which government pays NO INTEREST).

And the bigger the stock of those paper assets (debt and base money) held by the private sector, the more the private sector will spend, all else equal. Thus the OPTIMUM amount of that stock is simply the amount that induces the private sector to spend at a rate that brings full employment. Easy.


Another related question (mentioned above) is this: what exactly is the OPTIMUM rate of interest to pay on the debt? (Apologies for using that word “optimum” again!)

Well there’s no real reason to pay any interest at all! Milton Friedman advocated an abolition of government debt: i.e. he advocated that the only liability of the state should be base money. To be more exact, there’s no reason for government AS CURRENCY ISSUER to pay any interest. In contrast, there might be a reason for government AS OPERATOR OF INFRASTRUCTURE investments to pay interest, but even the arguments there are not good, as I’ve explained elsewhere.

Having said that, I wouldn’t rule out the use of interest rate adjustments altogether: obviously they’re a useful tool to use in emergencies. But basically, and to repeat, there aren’t any BRILLIANT arguments for paying interest on government liabilities year in year out.

Later in the above mentioned 3rd paragraph, Kocherlakota says (in reference to the fact that interest on government debt is at record lows) “This means that the price is near record highs, suggesting that the U.S. government's supply of such safe investments is falling far short of demand.”

Well demand for anything (revelation of the century this) depends on the price. All Kocherlakota is saying is that if interest on the debt was higher, there’d be more demand for it. You don’t say?

That ignores the more important and more basic question dealt with above, namely: what’s the OPTIMUM level of interest on the debt? Like I said, the concept “optimum” is beyond the comprehension of 99% of the population.

Kocherlakota continues, “In other words, we're starving the world of desperately needed financial safety.”

No we’re not: households and other entities are free to stock up on whatever amount of US dollars they want. At least they’d certainly have that freedom in an MMT regime. However, they WOULDN’T necessarily get any or much interest on that stock. And why should they? That is, why should one lot of people (primarily the less well off) have to pay taxes to fund interest for those who choose to amass a big pile of government debt or cash?


Given the number of errors in the opening hundred words or so of Kocherlakota’s article, I can’t be bothered with the rest of it. It just isn't too clever.

P.S. David Andolfatto published an article on the same topic on the same days. He seems to more or less agree:


  1. 1. You fail to define the optimum government debt. Your proposed principle (if valid, which it isn't) would merely determine the optimum amount of net private financial assets (debt plus base money.

    2. Your mentions of MMT appear to muddle the stock of "debt" with the flow concept "deficit".
    According to Abba Lerner's seminal paper 'Functional Finance And The Federal Debt', Social Research, Vol 10, 1943, page 47:

    The first law of functional finance is that fiscal policy (and hence the fiscal DEFICIT) should target full employment. It should NOT target any particular government DEBT.
    The Debt is merely the consequence of historical fiscal deficits.
    According to Lerner and MMT there is no such thing as an "optimum" debt, nor is there an "optimum" money supply.

    1. “You fail to define the optimum amount of government debt”. Try re-reading the above. I said, “Thus the OPTIMUM amount of that stock is simply the amount that induces the private sector to spend at a rate that brings full employment.” Admittedly I used the word “stock” to refer to the sum of debt and base money, but since the two are virtually the same thing (as pointed out by Martin Wolf and others), that’s not too much of a faux pas.

      “Your proposed principle (if valid, which it isn')”. Care to produce some reasons for my principle not being valid?

      “Your proposed principle would merely determine the optimum amount of net private financial assets (debt plus base money). Quite. I’m referring to what MMTers call “Private Sector Net Financial Assets”. That quantity or concept is fundamental because it’s that that gives the private sector an inducement to spend: when people come by a large chunk of PSNFA (e.g. when they win a lottery, their weekly spending rises) – a point which is obvious to the average street sweeper, but which many professional economists have a problem with. That’s because professional economists spend half their time looking for unnecessary complexity with a view to keeping themselves employed at the taxpayers’ expense.

      “2. Your mentions of MMT appear to muddle the stock of "debt" with the flow concept "deficit".” OK: exactly where do I “muddle” those two very simple concepts?

      Next, and re that passage from Lerner, he is quite clearly not saying (as you seem to suggest) that there’s a significant difference between base money and debt. He is saying much the same as me, namely that the size of the debt does not matter for the reasons normally given by those who think that government debt is similar to a household debt and should preferably be paid down as quickly as possible.

      Re your last two paras (starting “The first law..”), if you look at the top of Lerner’s p.49 you’ll see he makes exactly the point I make, namely that government debt is a private sector asset, hence the larger the debt, the higher will private sector spending be, all else equal.

      As to whether Lerner ever said there’s such a thing as an “optimum” amount of base money and debt, I’ve no idea, but he clearly IMPLIES that idea. After all, the optimum amount of spending is whatever brings full employment, and since the size of PSNFA influences spending, there must be some optimum amount of PSNFA.


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