Sunday, 8 April 2018

The IMF is still away with the pixies…:-)


Bill Mitchell (Australian economics prof) published an article in 2013 entitled “IMF still away with the pixies”, which claimed the IMF had a poor grasp of macroeconomics. Unfortunately things have not improved much if a recent article published by the IMF is any guide. It’s entitled “Climbing out of debt.”

The argument in the article runs as follows.

National debts are relatively high right now, and given that interest rates may return to their pre-crisis levels in the near future, that means a high interest payment burden on taxpayers unless something is done to cut debts. And that in turn means taxes need to be raised or public spending cut. Thus the question arises as to which of those two options is the better: raising taxes or cutting public spending – in particular, which has the bigger effect so far as reducing GDP goes.

The IMF authors claim that public spending cuts are in fact the better option. Their concluding paragraph reads:

“The bottom line is that reducing the debt-to-GDP ratio depends a lot on how the budget deficit is corrected…….Deficit reduction policies based on spending cuts, however, typically have almost no effect on output, so they are a sure bet for a reduction in debt to GDP.”

That whole argument is actually nonsense on stilts, basically because there is no need for government to borrow at all. The bulk of public spending is already funded via tax, and it would be easy to fund ALL public spending via tax (plus a bit of good old money printing – of which, more below).

But let’s examine that point in more detail.

First, far from there being any particularly good reasons for funding public spending via borrowing, politicians’ motive for doing so is in fact suspect: one of politicians’ main motives is to ingratiate themselves with voters by imposing the burden of today’s public spending on future generations. As David Hume writing over 200 years ago put it:

“It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker's shop in London, than to impower a statesman to draw bills, in this manner, upon posterity.”

Next, the IMF authors’ toying with different effects on GDP coming from public spending cuts as compared to tax increases is nonsense because GDP should ideally always be kept at the “capacity” level: the level where unemployment is minimised in as far as that’s compatible with avoiding excessive inflation. And indeed that is more or less where the economy is right now: unemployment is at near record low levels.

Now if the economy is at or near capacity with inflation not a serious problem, why are IMF people even contemplating reducing GDP just so as to reduce the amount of interest paid on the national debt? If it’s desirable to cut that interest rate burden that’s very easily done without there being any effect on GDP at all: just have the central bank print money and buy up government debt! Or if you like, continue with QE.

Of course that might have too much of a stimulatory or inflationary effect, but that effect is easily countered by raising taxes and “unprinting” the money collected. Indeed Milton Friedman and Warren Mosler argued that governments should never incur any debt at all: i.e. they argued that all public spending should be funded via tax. Thus the above “continue with QE and raise taxes as necessary” is simply a movement towards the set up advocated by Friedman and Mosler (FM).

Incidentally, note that while raised taxes normally make households worse off, that’s not the case here because the sole purpose of the latter tax is to cut demand to a level that the economy can meet without excess inflation. I.e. in that that tax deals with excess inflation, it probably makes households BETTER OFF.

There are absolutely no strictly economic or technical problems involved in the latter “buy up government debt and raise taxes” ploy. The big problem is POLITICAL: that is, politicians, 90% of whom do not have even the most basic qualification in economics, think they are qualified to decide how much debt government should incur and how large the deficit should be.

Another apparent problem with adopting or moving towards the FM “no borrowing” scenario, is that if there is no government debt, then it is more difficult for central banks to control interest rates (central banks normally control interest rates by buying and selling government debt).

I.e. stimulus would be effected mainly or exclusively by creating more money and spending it (and/or cutting taxes), and given the snail’s pace at which politicians decide how to spend extra money, things would need to be speeded up there. But there are no strictly technical or economic difficulties there.

For example in the UK, it is common for the finance minister to announce changes to the sales tax, VAT, and the tax on alcohol and fuel, and to effect those changes within 24 hours. That is not particularly democratic, but it is quick, plus there is nothing to stop other democratically elected politicians, in particular UK House of Commons debating the matter at their leisure, and pushing for a change to how taxes are collected over the long term: e.g. more coming from income tax and less from VAT.

Ben Bernanke actually gave his blessing to a system of that sort, i.e. a system where the Fed decided the SIZE OF the deficit (i.e. how much new money to create) while politicians decided EXACTLY HOW to spend that money (more on education versus more on infrastructure versus more on tax cuts, etc). See para starting “A possible arrangement…” in his Fortune article entitled “Here's How Ben Bernanke's "Helicopter Money" Plan Might Work”.

And finally, even if there is no government debt, there is nothing to stop a central bank raising interest rates if it wants to simply by wading into the market and borrowing at above the going rate. Various central banks may not be allowed to do that under the existing legislation in various countries. But there is not good reason for central banks not being allowed to do that. Thus the law can easily be changed.


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