Friday, 13 April 2012

Fiscal space is hogwash.

The phrase “fiscal space” is popular with respectable members of the economics profession and particularly in IMF and OECD circles. E.g. see here, here, here or here. But you can easily find a hundred other examples of IMF and OECD staff and others wittering on about “fiscal space” by Googling. Unfortunately the whole concept “fiscal space” is nonsense: it is irrelevant.

A country with a low debt to GDP ratio allegedly has “fiscal space”: that is, come a recession, such a country allegedly has the option of running a deficit and in consequence running up its debt.

In contrast, a country which already has a high debt to GDP ratio, allegedly cannot implement the above policy, thus, so the argument goes, it cannot escape a recession or has more difficulty doing so. The reason given is that potential creditors are not impressed by entities that are already heavily in debt.

Unfortunately the above argument just doesn’t apply to a country which issues its own currency. Incidentally I’ll deal below just with such countries: Eurozone countries are another matter.

Where a government is already heavily indebted, it is perfectly true that potential creditors may well not lend other than at relatively high rates of interest. But there is a simple solution to that problem: don’t borrow money - just print the stuff and spend it (and/or cut taxes).

As long as the relevant country is in recession, i.e. has ample spare capacity, the additional demand will not be inflationary. Thus the lack of fiscal space is a complete irrelevance.

And there is a second reason for thinking that the whole concept “fiscal space” is irrelevant, as follows.

Where a country DOES HAVE fiscal space, why is that any help? Allegedly the reason is that the country can adopt the classic Keynsian “borrow and spend” method of escaping a recession. But what on Earth is the point of the “borrowing” part of “borrow and spend”?

The purpose of borrow and spend is to impart stimulus. But borrowing (i.e. withdrawing cash from the private sector) has THE OPPOSITE EFFECT!!!!!! That is, the effect of borrowing “anti-stimulatory” or “deflationary”.

The exact extent to which public sector borrowing crowds out and thus negates the intended effect of borrow and spend is of course disputed. But it beggars belief that borrowing has no deflationary effect at all.

As Keynes himself pointed out, “print and spend” is a perfectly viable alternative to “borrow and spend”.

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