Tuesday, 8 July 2014

Why do governments borrow?

About 90% of economists, in common with 90% of the human race, seem unable to ask fundamental questions, in particular the following.
What’s the point of a government borrowing money and paying interest when it can print the stuff at no cost?

The economy is at capacity.
There is of course a moderately good reason for borrowing when the economy is at capacity / NAIRU. That is that if government simply printed money and spent it, that would be inflationary unless private sector demand was reined in by enough to counterbalance the increased government spending. And borrowing is one way of “reining in”.
But even there, why borrow rather than raise taxes?
As to where the economy is operating at BELOW capacity / NAIRU, what is required is STIMULUS. And that’s clearly achieved by printing and spending (and/or cutting taxes).
As to the other standard Keynsian form of stimulus, having government borrow and spend (rather than print and spend), that makes no sense, at least on the face of it. Reason is that borrowing (to repeat) is “anti-stimulatory”. Now what’s the point of doing anything ANTI-STIMULATORY when the objective is stimulus? Mad or what?
The only possible excuse for borrowing where the objective is stimulus is that that form of stimulus is easier to reverse than spending funded by taxes. But the evidence for that is unimpressive: that is, the lags involved in monetary policy (i.e. borrowing) don’t seem to be much different to those involved in fiscal policy (adjusting taxes and public spending).

Another excuse for borrowing is that taxes are allegedly distortionary. That’s a favourite one with Simon Wren-Lewis. E.g. see his 2nd paragraph here, and his 2nd paragraph here. And see here.
Well the answer to that is that clearly taxes CAN BE distortionary. E.g. a tax on red cars but not green or blue cars would be distortionary (and for no good reason). On the other hand a given percentage tax on EVERYONE’S income would be very distortion free.
Moreover, government borrowing has distortion written all over it. As regards where the economy is at capacity, borrowing reins in the spending of JUST those who lend to government and those who would have borrowed from said lenders had government not waded into the market for funds.
In contrast (to repeat) taxes can be very distortion free.
As to where the economy is NOT AT capacity, much the same applies. That is, borrowing reins in the spending of just those who lend to government, not those who don’t.

The excuse for government borrowing is weak in the extreme. And I’m not the first to say that. Milton Friedman and Warren Mosler said the same. In other words the form of stimulus advocated by Positive Money and (far as I can see) most MMTers, namely to simply create new money and spend it in a recession looks like it makes sense.   Plus as a German economist, Claude Hillinger put it, “An aspect of the crisis discussions that has irritated me the most is the implicit, or explicit claim that there is no alternative to governmental borrowing to finance the deficits incurred for stabilization purposes. It baffles me how such nonsense can be so universally accepted. Of course, there is a much better alternative: to finance the deficits with fresh money.”

David Hume nailed it.
The REAL REASON governments borrow was set out by David Hume over 200 years ago. As he put it, “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government.”
As to why today’s economists accept without question that government borrowing is desirable, the reason is that that’s what they were told in their graduate years, and most human beings, economists included, are robots: they believe almost anything they’re told. That is, if today’s so called professional economists had been told in their graduate years that GDP was related to the length of Oprah Winfrey’s toe nails, instead of being told that government borrowing was desirable, they’d have accepted that without question, and would not be writing learned papers, complete with the compulsory two pages of maths (to make it look scientific) on the relationship between GDP and Oprah Winfrey’s toe nails.
Of course I’m exaggerating there, but not by all that much.
As Edmund Burke put it, “Custom reconciles us to everything”.


  1. You might consider that by borrowing, government increases the value of money. If government never borrowed, always printed, then the supply of money could only increase. Eventually, the money government printed would become worthless.

    With endless government borrowing such as we see commonly today, the supply of money is steadily on the increase but the VALUE stays reasonable constant. This reasonably constant value is due to government borrowing, even though it be at near zero interest rates.

    1. But governments are already committed to money becoming near worthless in 50 or 100 years’ time (relative the current value of dollars, pounds, etc) as a result of the 2% inflation target. As long as money supply increases over the short term are not so large as to cause inflation to go above that 2% target by too much, then I have no objection to money supply increases.


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