Sunday, 23 June 2019
OMG: “fiscal space” rears its ugly head again.
The IMF has for years backed the “fiscal space” idea: the idea that government should not borrow too much in good times, the idea being that abstaining from such borrowing leaves room to borrow when a recession hits.That idea has an obvious appeal. Unfortunately the idea makes no sense at all. I’ve demolished that idea before on this blog, e.g. here.
Unfortunately the fiscal space idea continues to rear its ugly head: e.g. in this recent Vox article by two Lund University people. (Article title: "Fiscal Policy is No Free Lunch....")
Specifically, they say, “…governments should stabilise the debt-ratio in normal times at a level that allows for ample borrowing and spending if and only if the economy suffers from a major crisis”.
That idea is based on the argument that the larger the debt the higher the rate of interest that creditors will charge for holding debt, all else equal (which is a truism). Thus it would seem that if the debt is on the high side and a recession hits, government will have to pay over the odds to borrow money so as to implement stimulus.
The flaw in that argument is as follows.
If interest on the debt is on the high side, that means there is plenty of scope for using interest rate cuts to impart stimulus! Indeed, the latter policy, i.e. using interest rate cuts to impart stimulus when rates are significantly above zero, is the central idea behind the UK Labour Party’s so called “fiscal rule”: at least according to Simon Wren-Lewis. (Title of SW-L’s article is “Is Labour’s Fiscal Rule Neoliberal.”) See in particular SW-L’s para starting “It is now received wisdom…”.
Also, if the authorities do want to go for fiscal stimulus rather than interest rate cuts, the mere fact that aggregate demand is lower than it should be is (by definition) proof that the private sector is in “money hoarding” mode rather than “spendthrift” mode. I.e. the private sector is not spending enough to bring about full employment.
In that scenario, i.e. given that the private sector is willing to hoard money or government debt, the private sector is not going to demand much of an increase in interest rates or indeed any increase at all for holding more debt!
Incidentally, government debt and money (base money in particular) are virtually the same thing (as pointed out by Martin Wolf, Warren Mosler and others): the only difference is that base money normally pays no interest, whereas government debt is simply base money which yields interest.