Wednesday, 1 November 2017

Shock, horror: UK finance minister may abandon “fiscal targets” (yet again).

That’s according to this Financial Times article entitled “Philip Hammond ‘between a rock and a hard place’…”.

Given that UK finance ministers have abandoned fiscal targets about ten times in as many years recently, you’d think that by now some of those in high places (e.g. at the FT and the Treasury) would have tumbled to the fact that there’s something a bit wrong with “fiscal targets”. But seems they just don’t get it.

Incidentally Ann Pettifor recently penned an article criticizing the above “target” nonsense entitled “The Deficit and the IFS….”.     .  You may prefer her article, though the paragraphs below cover a few points which she doesn’t, and vice-versa.

I’ve been thru this target nonsense before, but I’ll go thru it again. After all, constant repetition is a much better form of persuasion than logic or reason.

The deficit, as explained by Keynes, needs to be whatever keeps unemployment as low as is consistent with not too much inflation. As he put it, “Look after unemployment and the budget will look after itself.” And that’s very much how MMTers see things. So the “target” for the deficit should simply be whatever deals with excess unemployment.

But that raises an obvious question, at least in the minds of debt and deficit-phobes, namely what happens if the national debt and deficit are higher than normal? Should we worry?

Well a POSSIBLE problem with a higher than normal debt is the debt holders will demand a higher than normal rate of interest for holding that debt. But if they AREN’T demanding that elevated rate of interest (as is the case at the moment) or put another way, as long as the real or “inflation adjusted” rate of interest is near zero, then why worry? Darned if I know.

And if debt holders DO START to demand a higher rate of interest, the solution is easy: tell them to shove off. Or to be more exact, print money and pay off debt as it matures, and tell those who have been paid off that if they want to buy more UK government debt, then they can’t.

The latter strategy of course amounts to QE which is mildly stimulatory and hence possibly inflationary. But that’s easily countered by raising taxes and “unprinting” the money collected. In that debt is held by native UK people and institutions, there won’t be any effect on aggregate demand or average living standards, though there will be re-distributive effects.

In contrast, and in as far as UK debt is held by foreigners or other internationally mobile investors, those investors when they find they can’t buy UK debt, will tend to sell Sterling and seek investments elsewhere in the World, and that will result in Sterling falling a bit on foreign exchange markets, which in turn means a finite drop in UK living standards. On the other hand if the debtor country manages to get a loan at a zero or near zero real rate of interest for several years, why complain?

The correct “targets”.

If some sort of randomly chosen figure for the deficit and debt as a percentage of GDP is not the right “target”, what is? Well one was set out above: that’s Keynes’s point that the deficit needs to be whatever brings full employment.

As to the debt, it is important to realize that government debt and base money are virtually the same thing, as Martin Wolf once explained. Thus the basic question here is: what should the total of debt plus base be? Incidentally MMTers have tumbled to the importance of the latter quantity “debt plus base” and sometimes refer to it as “Private Sector Net Financial Assets”.

As to the debt, i.e. the interest yielding part of PSNFA, it is debatable as to whether there should be any at all. Milton Friedman and Warren Mosler argued for zero debt. I pretty much agree with them, one reason being this: if the state can print money or grab any amount of money from the citizenry via tax, why borrow the stuff and pay interest on it?

Put another way, as Keynes said, a deficit can be funded by printed or borrowed money, and no one, far as I know has explained the reasons for borrowing. The idea that because the state invests in infrastructure and similar is not a reason to borrow: if a taxi driver needs a new taxi and happens to have enough cash to buy one, why would he want to borrow money? He wouldn’t: because taxi drivers have more sense than economists. I’ve been through the possible arguments for borrowing before on this blog, and none of the arguments are impressive.

Thus borrowing makes sense only if there’s no other way of coming by cash.

Returning now to the subject of targets, what’s the ideal size of PSNFA, or put another way, what should the “target PSNFA” be? Well the more PSNFA there is, all else equal, the more the private sector will spend. After all, there is a limit to the amount of state liabilities (PSNFA) that households and businesses will want to hold. And how do we know what that ideal PSNFA size is?

Well we don’t need to know. If the state simply prints and spends base money when unemployment is too high, and does the opposite, i.e. raises taxes and “unprints” money when inflation is too high, then PSNFA always tend towards its ideal size. Whether that is 10%, 60% or 260% of GDP, well that’s wholly irrelevant.

To summarize.

We should forget about arbitrarily chosen and wholly illogical numbers for the debt and deficit and simply follow Keynes’s above prescription, namely print and spend money, and/or cut taxes when unemployment is excessive.

That’s beautifully simple isn't it? And anyone with a grasp of, or interest in science knows that science attaches importance to simple equations or rules which seem to explain a lot. Why is Einstein’s equation E equals MC squared held to be importance? Reason is first that it is simple, and second it seems to explain a lot: it explains things about the movement of plants round the sun and things about sub-atomic particles. That is unlikely to be a coincident: it’s more likely that Einstein’s equation is a fundamental property of the universe.

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