Thursday, 28 July 2011

Does the Financial Times understand the debt and deficit?

This leading article (4th para) poses a dilemma which the FT (along with 95% of economists) can’t solve. It’s a dilemma that lies at the heart of the current shenanigans in Washington over the debt and deficit, and it’s as follows.

Britain could arguably do with more stimulus, i.e. more deficit. But that will increase the debt. And since the latter is already too large, it would be irresponsible to enlarge the deficit (or slow the pace of consolidation). Well for the benefit the massed ranks of economic illiterates posing as economists. I’ve spelled out the solution to this problem a dozen times. I’ll put the solution in bold coloured letters.


The various knee jerk objections that economic illiterates come up with in reaction to the above idea are predictable to the point of tedium. But I’ll run through them.

Objection No 1. More monetary base equals more bank reserves, so banks would go on a lending spree which would be inflationary.

Answer: Bank reserves has increased by an astronomic and unprecedented amounts over the last two years and the result? Banks are reluctant to lend!!! So the above objection flies in the face of the evidence. As for the theoretical reasons as to why bank reserves have little to do with bank lending, see here.

Objection No 2. More monetary base increases the private sector’s net financial assets which means the private sector will go on a spending spree and cause inflation.

Answer: There has already been a massive and unprecedented increase in the monetary base. Where is this spending spree? I don’t see it. Of course the amount of money in the hands of the private sector is ONE FACTOR that determines demand. But consumer and business confidence also play a part. The private sector is in cautious mode just at the moment: e.g. it is deleveraging. So if we are going to make up for this caution, increasing the amount of money in the private sector’s hands would be a good idea.

That may well result in excess demand in the future. But in that case, we just need to rein in the above money and “unprint” it, or extinguish it.

3. Inflation is already too high, so we can’t raise demand.

Answer: If that’s the case, then the constraint on stimulus is inflation, not the above “debt is too large” point.

Moreover, if the debt-phobes think the debt is such a problem, it can perfectly well be reduced while maintaining a neutral stance on the stimulus / deflation scale. In other words it would be perfectly possible to stop the debt growing as from tomorrow morning by simply letting the entire deficit accumulate as base instead of debt. It is quite likely that that would be more simulatory / inflationary pound for pound than having the deficit accumulate as base. But so what? The solution to that little problem is to have a smaller deficit, which is what the debt/deficit phobes want, isn’t it?



  1. If inflation is too high, it is unlikely to be because of "too much money". Too much demand might be a reason, but we're hardly there atm. The world needs demand and if Britain goes first, good for them as they're the ones getting a socially healthy market and cheap imports.

  2. Read up about interest on excess reserves and then re-read what you've said about the monetary base.

    Why print money when you can just get the Fed to stop artificially boosting the value of base money?

  3. We live in unusual times. Individuals and govts are servicing high debt loads. Folks are not optimistic about the future. Many probably expect a double-dip recession. Isn't this why an increase in banks reserves haven't caused excessive lending? Under more normal circumstances it could present a bigger problem.

    One thing that's hard to understand is: where is all the price inflation coming from? If the money supply in the UK is stable (or at least not being lent out). I guess one thing is that the GBP has lost a lot of value over the last few years. That could be said to be in large part due to monetary policy of the BoE (i.e super low cash rate). However, IIRC, Mervyn King denies that the increase in consumer prices is due to monetary policy and is instead some sort of "one off" VAT increase problem only. Would you agree that the BoE is trying to keep the credit bubble inflated?


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