Harvard’s incompetent economics professors.

There’s a bunch of economics profs at Harvard who clearly do not understand economics and who were pushing for restrictions on stimulus during the recent crisis: i.e. in effect they were advocating austerity. That bunch includes Kenneth Rogoff and Carmen Reinhart.

Rogoff’s objection to stimulus is the same as the objection often heard from those who have not worked through a basic introductory economics text book: i.e. that stimulus involves an increase in government debt, plus that debt must be repaid at some time, which will allegedly be a burden on the population in future years. Indeed, Rogoff has his own emotionally charged term for debt: he calls it the “debt overhang”, e.g. see here.

Well the first blunder there is that stimulus does not require more debt: as Keynes pointed out in the early 1930s, stimulus can be funded via more debt or simply by having the state (i.e. government and central bank) print money and spend it (and/or cut taxes). Indeed the latter “print and spend” policy is actually what many states have done over the last five years. That is they’ve implemented what might be called traditional fiscal stimulus (i.e. government borrows $X and spends $X while giving $X of bonds to lenders), plus that has been followed by QE (i.e. the central bank prints money and buys back those bonds), and that all nets out to “the state prints money and spends it”.

As regards the emotionally charged phrase “debt overhang”,  normally when people employ emotion, that’s because they have problem making their case using logic or reason.

But the emotion is not limited to “debt overhang”: another emotionally charged phrase used by Rogoff is “financial repression” (see the above linked to article by Rogoff and others). That’s the idea (alluded to above) that repaying the debt incurred to effect stimulus is some sort of burden on households.

Well the first problem there is that government debt (you may be amazed to hear) is almost never repaid. For example the UK’s national debt decline from around 250% of GDP just after WWII to around 50% in the 1990s. But scarcely any of that debt was repaid in the normal sense of the phrase “repay a debt”.

That dramatic decline in the debt / GDP ratio took place almost entirely because of two factors: first, the fact that inflation continually erodes the real value of the debt. Second, there’s the fact that given real economic growth, GDP expands in real terms, which means that even if there’s no inflation, the size of the debt relative to GDP will decline.

But let’s try to help Rogoff with his strange idea: i.e. let’s assume no inflation and no growth. Surely in that case the national debt would need to be repaid, which would be a burden on households? Well the answer is “nope”, and for the following reasons.

The national debt (and the stock of base money) are assets as viewed by the private sector. Thus the more of those assets that the private sector holds, all else equal, the more the private sector will spend, i.e. the higher will demand be. (Incidentally national debt and base money are pretty much the same thing, as explained by Martin Wolf, chief economics correspondent at the Financial Times (see his para starting “The purchases of…”).

So….if after a dose of stimulus (i.e. an increase in the stock of base money and/or national debt) and the economy remains at full employment, what on Earth is the point if “repaying the debt”, i.e. raising taxes and grabbing base money / national debt off the private sector? There is no point in doing that: the effect will be to cut demand and cause a recession!

Alternatively, if demand is too high, and inflation looms, then clearly it’s necessary to damp down demand, and that can be done by raising taxes and grabbing some of that base money / national debt off the private sector. And clearly that will be a burden as viewed by some individual households.

But notice that there is no effect whatever on the real incomes of households as a whole: reason is that the sole purpose of the latter “grabbing” is to keep demand down to the level at which the economy is as near capacity as possible without causing excess inflation.

So we have a slight semantic difficulty here, namely that increased taxes are certainly viewed as a burden by some households. On the other hand there is no burden on the population as a whole in the sense that real incomes do not decline. So is that “grabbing” a burden or not?

Well I suggest that since the basic net effect is to keep households’ incomes at the maximum possible level, there is no burden or “financial repression” as Rogoff calls it. However, I should say that I’ve ignored the effect of foreigners buying national debt, so as to keep things simple.  But even if that complicating factor is taken into account it does not change the basic conclusion here all that much.

And finally, a possible objection to the above argument is the idea that a higher than normal debt can mean a higher than normal amount of interest to be paid on the debt, which is a burden on taxpayers. Well the simple answer to that interest on the debt should never be allowed to rise significantly above zero.

For example, if interest on the debt actually is well above zero, and stimulus is needed, the first thing to do is cut interest rates, and keep cutting them till they are at or near zero. If more stimulus is still needed, then run a deficit (funded, as Keynes suggested, either by more debt or fresh base money). But any debt increase there should not be taken so far that it starts to push up interest rates to any significant extent.

Indeed the latter policy of keeping interest on the debt at or near zero is pretty much what the UK Labour Party’s new “fiscal rule” consists of. For more on that, see this article by Simon Wren-Lewis, who is a former Oxford economics prof, and co-author of the fiscal rule.

And Milton Friedman and Warren Mosler (founder of Modern Monetary Theory) advocated an even more extreme version of the “fiscal rule”: they advocated a permanent zero interest rate. E.g. see Mosler’s second last paragraph here.