Wednesday, 22 May 2013

IMF continues to hyperventilate about sovereign debt.

This voluminous paper by the IMF is a waste of ink and paper. It’s entitled “Fiscal Adjustment in an Uncertain World”, and was published in April 2013.

Basically it argues that deficits and national debts are too high. But the paper itself says “in practice it is difficult to pinpoint what constitutes a prudent amount of public debt.” (p.vii).

Well forgive me stating the obvious, but if you don’t know what constitutes a “prudent” amount of debt, how do you know that any particular level of debt is too high or too low?

Anyway, their basic argument (surprise, surprise) is that too high a level of debt constrains economic growth. And with a view to bolstering the claim, they cite (you won’t believe this) Rogoff and Reinhart.

Now if the IMF had cited R&R before the recent uncovering of  flaws in R&R’s work, then OK. But this IMF work was published in April this year: that’s AFTER the flaws in R&R’s work was publicised. Taxpayers of the world are clearly getting brilliant value for money from the IMF, I don’t think.

Authors who back R & R.

Next, and with a view to bolstering their claim that excessive debt constrains growth they cite a number of other “authorities”. The first of these is another IMF paper.

The paper is “Fiscal Deficits, Public Debt, and Sovereign Bond Yields” by Messers Baldacci and Kumar. And basically all this paper shows is that there is a tendency for high debt to result in the relevant country having to pay a relatively high rate of interest on that debt.

Well of course!!!!  The average six year old has probably worked that out.

What both the above IMF papers completely miss is the following point, which has been fully grasped by most advocates of Modern Monetary Theory (MMT), and doubtless many others.

In a recession, governments need to run deficits and those deficits CAN ACCUMULATE as debt. Though as Keynes and Milton Friedman both pointed out, they can equally well accumulate as extra monetary base.

Now recessions are caused by a decline in private sector spending, i.e. by an increase in private sector saving. (That’s saving of money or something near money, like public debt, rather than saving in the form of accumulating physical assets, like houses.)

In short, recessions are caused by an increased desire for what MMTers tend to call “private sector net financial assets”. And if you have an “increased desire” for something, you aren’t going to demand a huge price holding an additional stock of that item, are you?

In other words, where a government runs up debt so as to deal with a recession, it won’t have to pay very much interest on that debt. Want some evidence for that? Well the “real” or “inflation adjusted” rate of interest on US, UK, German and Japanese debt has been around ZERO for the last few years!!!!!

Conclusion so far: in that a government runs up debt so as to deal with a recession, those increased rates of interest that the IMF worries about just won’t materialise.

But of course, governments don’t run up debts just to deal with recessions. Governments sometimes run up debts for unjustified reasons. A common reason is that voters tend to blame tax increases on politicians more than they blame politicians for the increased interest rates that result from irresponsible government borrowing. So politicians are always tempted to pay for government spending by borrowing rather than by raising taxes.

Thus the “discovery” by Baldacci and Kumar that there is a tendency for high debt to result in high interest rates is no discovery at all. It simply reflects the fact that governments are less than 100% responsible when it comes to running up debt.

The IMF paper does quote so called “authorities” other than R&R and Baldacci and Kumar. But the latter two pairs of authors are such a joke that I just cannot be bothered looking at the other so called authorities.


What the IMF SHOULD BE SAYING is something along the lines of: “present debt levels are perfectly OK because that debt is being used to counter the recession, but governments need to be prepared to raise taxes and/or cut public spending when the recovery comes. And if a government FAILS TO raise taxes or cut public spending come the recovery, then interest rates will rise.”

Instead, what the IMF is saying is more along the lines: “high debts PER SE are undesirable, and ANY reduction in deficits and/or debts is to be welcomed.”

And a final bit of advice for the IMF in connection with what constitutes a "prudent" level of debt. Keynes answered that one long ago when he said "Look after unemployment and the budget looks after itself".  In other words, keep unemployment as low as is consistent with acceptable inflation. As to the debt, if the private sector hankers for a big stock of private sector net financial assets, then the debt will be relatively high. If not, it won't. And trying (a la IMF) to somehow FORCE a lower level on debt onto the private sector than the private sector wants will simply lead to excess unemployment. Thus any preconceived ideas as to how big the debt should be are pure nonsense.


  1. Good post. Pretty clear explanation

  2. Ralph,

    I recently followed the link to Warren Mosler's site, which appears somewhere fairly prominently on your site and read with interest the "Seven Deadly Frauds of Economic Policy" paper, among others.

    Doesn't he say that the deficit can be basically as big as the government wants it to be, and not only does that not matter, it's actually a good thing, and indeed a budget surplus is a bad thing.
    (Obviously not so big that it causes inflation though).

    Quite interesting in any case, although I am not sure I go along with him in all respects.

    I imagine the IMF are not big Mosler fans.

    1. Hi Monty,

      Yes, I agree with most of what Warren Mosler says. He actually wrote an article about a hypothetical household consisting of parents and children in which they set up their own currency. He uses that mini-economy to illustrate very nicely some of the fundamental characteristics of money, national debts etc. See:

      I would have mentioned it if it had illustrated the points I made above, but I don’t think it does. It’s worth a read anyway.

      Another article (written by Paul Krugman) about an equally simple mini-economy which I think is also a “must read” is this:

  3. Thank you for the links Ralph. Very interesting.


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