Saturday, 14 December 2013

Should governments borrow?

Governments certainly shouldn’t borrow to fund current spending (as opposed to capital spending). That makes no more sense than a household borrowing to pay for food or fuel.
As to projects which are supposed to pay for themselves (e.g. a toll bridge) I don’t see what’s wrong with borrowing to fund that as long as the terms of the loan are exactly the same as if a private sector firm had built the bridge: in particular, if the bridge makes a loss, then lenders take a hair-cut.
As to government borrowing to fund a capital project which is not commercial (e.g. school buildings) the community as a whole benefits from that, so a simple and perfectly logical way to fund that is out of tax.
Borrowing is a possibility, but in effect that amounts to lenders lending to citizens who don’t buy government bonds. (I.e. the latter pay less tax as a result of others lending to government). But the problem there is how to gauge the right rate of interest. A fair market price is only reached where there is a genuine meeting of buyers and sellers and that “fair market” does not exist at the moment.
That is, at the moment, the effect of government borrowing to fund school building type investments is that each person who does NOT BUY government debt is FORCED to pay less tax and effectively borrow from those who do buy such debt.
To get a “fair market” we’d need to have government offer loans to “non government bond buyers” to match the bond buyers. That would constitute a genuine meeting of buyers and sellers. But citizens can borrow and lend to each other ANYWAY (perhaps via banks and perhaps not). So it’s hard to see any logical place for borrowing to fund school buildings. I.e. they might as well be funded out of tax.
And there is a definite problem with getting the interest rate in respect of loans to fund school buildings wrong: if the interest rate is too high, it will crowd out private lending and investment. Why lend to a private sector entity at X% of you can make an entirely safe loan to government and get X%?

Government borrowing to fund stimulus.

As Keynes said, stimulus can be funded out of borrowed or printed money. Quite what the point of borrowing money is when you can print the stuff is a mystery. I suspect the only reason Keynes put any emphasis on the borrow option is that whenever the words “money” and “print” appear in the same sentence, hoards of economic illiterates start hyperventilating, and chanting “Mugabwe” and “Weimar”.


The case for government borrowing is weak. There is some sort of argument for government borrowing to fund commercial projects like toll bridges, but in that case, the terms of the loan should be identical to those that would obtain with a bridge that is funded, built and operated by the private sector. So that’s not really “government”: it’s “government acting as entrepreneur”.


P.S. (16th Dec 2013). In contrast to my above claim that money creation by commcial banks artificially depresses interest rates, Messers Huber and Robertson claim that that money creation enables commercial banks to “cream off a special profit” (p.31). However, it’s generally accepted in economics that if competitive forces are working, firms cannot make “special” or “above normal” profits for any length of time. That is, competition reduces those profits to a standard return on capital sooner or later. So I’d argue that the benefit is passed on to the customer (i.e. the borrower) in the form of lower interest rates.


  1. From Abba Lerner: Functional Finance and the Federal Debt, 1943

    "The second law of Functional Finance is that the government should borrow money only if it is desirable that the public should have less money and more government bonds.... This might be desirable if otherwise the rate of interest would be reduce too low... and induce too much investment, thus bringing about inflation."

    Later in the same document Lerner indicates that the role of government borrowing/debt repayment is "to achieve a rate of interest which results in the most desirable level of investment".

    Did Lerner mean that borrowing should only be used when it is not possible to use government spending and taxes to achieve full employment and avoid inflation?
    Or did Lerner mean that government borrowing could be used to influence longer term interest rates, investment, economic growth and productivity?

    1. I’m a bit of a Lerner fan, but I don’t care for his idea that government is a good judge of the optimum rate of interest. Strikes me the market is the best determinant of interest rates.

      Re the first question in your last paragraph, my answer is “no”. Reason is that I don’t see how it’s possible for government net spending (i.e. the deficit) not to be a cure for excess unemployment. I.e. I agree with Mosler’s law: “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.”

      Re using borrowing by the government / central bank machine to rein in excess demand, that would do the job, but as I said above, I don’t like government borrowing. In my ideal world, such borrowing would just be used in emergencies. In fact Milton Friedman said the same: he said government borrowing might be justified in war-time, but that’s about it.

  2. Ralph,

    I often see you making statements about what MMT says which are not actually what MMT says, but rather what you say. Such as:

    "Nick asks, “We know the economy needs a bubble; but how big?” The answer is easy: “Big enough to raise employment as far as is possible without causing excess inflation, or put another way, big enough to cut unemployment to NAIRU” At least that’s the standard MMT answer".

    That is not the MMT answer at all, it is your answer. You should probably stop conflating the two. Just saying.

    1. There’s no hard and fast set of statements that sum up MMT any more than there is a set of statements that sum up monetarism, Austrianism or any other group. But in exactly what way does the above statement of mine clash with MMT?

      Re what Nick Rowe means by “bubble” on the post of his you refer to (link below), he himself says he uses it to mean the same as fiat money. See his comment at 7.05am. And on Mike Norman’s site, Roger Erickson is constantly going on about the need to create and spend fiat. So no clash there.

      Bill Mitchell, another leading MMTer is constantly going on about the need for a bigger deficit. No clash there.

      Scott Fullwiler and Stephanie Kelton recently published an article in which they argue for the abolition of government borrowing, and simply creating and spending fiat as required. In particular near the end they say “, there is no reason for the government to sell bonds at all. We can stop today.” No clash there.

      At the top of Warren Mosler’s site, you will find “Mosler’s law” which says “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.” I.e. he is saying that however deep a recession, it can be dealt with simply by running a deficit. And as to whether the deficit should be funded by borrowing or new money, Warren advocates in a Huffington article that governments shouldn’t borrow. See second last paragraph here:

      No clash there.

      The relevant Nick Rowe article is here BTW:

    2. "in exactly what way does the above statement of mine clash with MMT?"

      "raise employment as far as is possible without causing excess inflation, or put another way, big enough to cut unemployment to NAIRU"

      That's not MMT at all, that's your own view.

    3. So you're saying that MMTers don't want to raise employment? Absolutely hilarious. If there is one that that everyone agrees on, whether they are MMTers or not, is that we want to reduce unemployment in as far as that's possible without exacerbating inflation too much.

    4. Hmmm. I too thought MMTers *were* saying that. (So am I, and a lot of other non-MMTers too, but that doesn't make it wrong.)

      Maybe y is objecting to your saying MMTers want a bubble to do that. OK. but as Ralph notes, that is in a context where I was using the word "bubble" in a slightly different sense, so that, for example, fiat money is a "bubble" in my sense. And government bonds *may* be a "bubble" too, in my sense.

      I think Ralph's OK there. (He gets a load of other stuff wrong, but not that ;-) )

    5. "raise employment as far as is possible without causing excess inflation, or put another way, big enough to cut unemployment to NAIRU"

      ever heard of the JG or ELR?

      ever read MMT critiques of the NAIRU?

    6. Re have I heard of JG/ELR? Yes I have. In fact the Economic Research Council published a work by me on that subject 33 years ago. For my most recent work on that subject, see:

      Re criticisms of NAIRU, Bill Mitchell is far and way the most vociferous critic of the idea. In contrast some MMTers are quite happy with the idea. And a big problem with Bill’s criticism is that he has produced his own term for the same idea. He calls it the “inflation barrier”. That’s the idea that there is some level of unemployment at which inflation becomes excessive (assuming one doesn’t have a JG scheme in place).

      Actually I made that “assuming no JG scheme” assumption above, which was doubtless why you asked if I had ever heard of JG. I should have made that explicit. I often make that assumption to keep things simple.


  3. Ralph:
    You say "the market is the best determinant of interest rates". (Your reply to KingKong's comment at top above).
    So does Ralphonomics advocate zero central bank/government intervention in the financial markets?
    No short-term interest rate target?
    (c.f. the importance of this for endogenous money theory and MMT)
    No CB stabilisation of financial crises (which is bound to affect both short and long term interest rates?

    I can see the case for such an extreme free market/ultra-libertarian view.
    As you note, this conflicts with Lerner's 2nd law of Functional Finance.
    It also conflicts with MMT which sees a role for the CG/government in setting interest rates.

    1. Re “zero central bank/government intervention in the financial markets”, yes I’d favour that (though perhaps having central banks adjust / interfere with interest rates could be used as an emergency measure).

      Re “stabilisation of the financial crisis”, I’d favor a system (as do most people I think) in which banks never tip us into a financial crisis in the first place. As to how to do that, I agree with Martin Wolf and Anat Admati who favor a quadrupling of bank capital requirements to about 20% of bank assets/liabilities. Plus Sir John Vickers (chairman of the Vickers commission) recently doubled his estimate as to what bank capital should be. Personally I’d take that further and go for the system advocated by Lawrence Kotlikoff, Richard Werner, Positive Money and others under which the ratio is effectively 100%.

      Re the idea that MMT “sees a role for the CG/government in setting interest rates”, I don’t think MMTers (apart from me) are very clear on that. Warren Mosler, Stephanie Kelton and Scott Fulwiller have arged for zero government borrowing. But as far as I know they haven’t spelled out loud and clear that that implies little or no interference with interest rates by CBs.

    2. Some MMTers believe that an upper limit for short term interest rates should be set by paying interest on excess bank reserves instead of open market operations. However, this is also government interference in the financial markets, contrary to Ralphanomics.

    3. I doubt it. Which MMTers were you thinking of?

    4. You are right, my error.
      I should have written:
      Some MMTers believe that a LOWER limit for short term interest rates can be set by paying interest on bank reserves.

      For example: Mitchell & Wray's draft MMT textbook Chapter 9 says:
      "In countries in which the central bank pays interest on reserves, bond sales are unnecessary because interest-paying reserves can serve the same purpose".
      Similarly L.R. Wray (2003): "Treasury debt could be eliminated entirely if the central bank were to simply pay interest on reserves"

      The point I am trying to make is that Ralphanomics is very radical. Abba Lerner and others, and more recently MMT writers, consider that setting interest rates is an important role of government.

    5. Thanks for pointing me in the direction of Ch9 of M&W’s new book. I word seached for “interest”, and couldn’t find a passage where they said that interest rate adjustment should DEFINITELY be used to regulate demand. The two passages you quote simply make the point that ASSUMING government has an interest rate policy, that can be implemented in a zero government debt environment by adjusting the interest paid on reserves.

      Re me being “radical”, obviously I’m being more assertive about the merits of a zero interest rate policy than Wray and Mitchell. In contrast, I think I’m saying much the same as Warren Mosler in his Huffington article. He says “I would make the current zero interest rate policy permanent.”


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