Friday, 24 September 2010

Peter Peterson: economic genius.

Peter Peterson is a billionaire who spends a significant proportion of his wealth every year promoting the idea that the deficit and national debt must at all costs be reduced. So does he have any particularly bright ideas to back this claim?

The answer is “no”. The ideas put by the Peterson Foundation site are about as simple minded as it is possible to be. The ideas are set out in an article entitled “A Path to Balance”. (There is a link to the article from the Foundation’s site – see the “This paper” link in orange.)

This article is easily comprehensible to a ten year old: that’s how sophisticated it is.

The article starts with two charts, the first of which shows the deficit as a proportion of GDP rising from about zero in 1949 to an average of (shock horror) about 4% for 2001 to 2009. That of course is grossly misleading because in 1949 national debt was at a near record level as a result of WWII and was rapidly being paid back. You’d expect no deficit in those circumstances: indeed you’d expect the occasional surplus. Collecting tax and using the money to pay back the national debt is almost the definition of “surplus”.

Just under that chart is another, showing national debt as a proportion of GDP declining from around 80% in 1949 to roughly 40% in the seventies and eighties, and then rising again to roughly 60% in 2010. What this omits, because it would spoil the Peterson story, is that the debt was over 200% just after WWII. That is, Peterson wants us to think that a rise to much more than the 80% level is some kind of disaster. That’s a bit hard to reconcile with the fact that the debt was well over 200% just after WWII. So we just keep quiet about that, don’t we?

The Peterson master plan is to gradually reduce the debt: a stroke of genius! That sounds much like a household gradually paying off its mortgage. The latter, of course, is microeconomics: about as relevant to paying off a national debt as chalk is relevant to cheese, because national debts, deficits and so on are macroeconomics, whereas individual household mortgages are microeconomics.

The first big problem with gradually paying off national debt at some pre-determined rate over the next ten years or so is that it might be a totally inappropriate policy in say five years time. For example, if there was an outbreak of irrational exuberance and general all round confidence in five years time, with the economy booming and excess inflation just round the corner, then some form of deflationary policy would be needed: for example raising taxes and paying off the national debt much faster than under the above “ten year plan”!

The second big problem is that collecting extra tax (and/or reducing public spending) is deflationary. Thus the basic effect of the “ten year pay back” scheme is deflationary. That could be wholly in appropriate if the economy stays in the doldrums over that period. So what to do?

Well there is an amazingly simple solution. Indeed, this solution could, at least in theory, wipe out the debt in just one year. Here’s how.

First print money and buy the debt back. That on its own would doubtless be too stimulatory and inflationary. Solution: mix the latter policy with a deflationary method of paying the debt back, that is raise taxes (or reduce government spending) and use the money collected/saved to buy the debt back.

Mix the above deflationary and stimulatory/inflationary measures in the right proportion, and you have a neutral pay back arrangement: no excessive inflation or unemployment while paying back. Indeed, the elements of the above solution can be altered to produce any desired outcome. For example for a more stimulatory stance while effecting the pay back, implement a bit more money printing and a bit less tax increase / public spending reduction.

There is just one problem (and one only) with the latter “wipe the national out” system: it would probably involve too much dislocation if started and completed on just one year. That is, it would be difficult to effect without some abrupt changes in the tax paid by particular groups, and that would bring political problems.

But, essentially paying the entire national debt back in a few years, at the same time as adopting any amount of stimulus or deflation you like is not difficult: how to do it can be explained to an intelligent ten year old. For more on this, see here.


  1. There's a simpler solution to the national debt problem.

    Include currency issued in the figure and rename it 'national equity'.

    Plus I'm not at all convinced that 'paying back bonds' is stimulatory. Just because somebody has got cash for their bond doesn't mean they are going to turn that into a flow - particularly if the reserves have an interest rate on them.

  2. "The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

    The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A."

    Printing money is just a tax on holding money.

    So actually your solution is just the same thing everyone else proposed. Except less politically palatable because people now prefer overt tax to rampant inflation (it reminds them of the 70s).

  3. Neil: is your “national equity” some sort of equity share in “U.K. PLC”? The idea needs setting out in more detail before I or any else can comment, I think.

    I agree that “paying back bonds” (ie. Quantitative easing) is not all that stimulatory. But cash is a bit more liquid than bonds, so I assume there is a finite stimulatory effect.


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