Friday, 12 June 2015

Deficits funded by new money – is withdrawing that money difficult?

With a view to dealing with recessions, government can fund a budget deficit either by borrowing money or printing money, as pointed out by Keynes. The “print” option is favored by several economists and groups. E.g. MMTers tend to favor that option (far as I can see). Simon Wren-Lewis (Oxford economics prof) has been toying with the idea recently, and Positive Money favors the idea.

An obvious potential problem with “print” is that the money may need to be subsequently withdrawn and that can be politically difficult: that is, raising taxes can be politically difficult.

In order to work out whether the “withdraw” problem is any worse under “print” than under “borrow”, lets first run thru the print and borrow processes.

The print option is simple enough: the government / central bank machine just prints $X and spends it and / or cuts taxes.  The result is that private sector paper assets (base money / cash to be exact) rises by $X which induces the private sector to spend more. Also the ACTUAL PROCESS of spending that money raises demand: e.g. if government spends more on road repairs, then more people are employed repairing roads.

As to “borrow”, government borrows $X, spends it, and gives $X of bonds to those it has borrowed from. The net effect is that private sector paper assets rise by $X as above, but in this case the rise in private sector paper assets takes the form of bonds instead of cash / base money.

The big problem with “print” (to repeat) is that the private sector then has more base money than before which means that when the recession is over, private sector spending may be excessive.

Obviously if the latter excess is not too much, that isn't a problem: the excess demand can be dealt with by standard deflationary measures: interest rate hikes or a budget surplus (or smaller deficit).

On the other hand if the excess spending is TOO MUCH there might be a problem. But is the problem any more under “print” than under “borrow”?

It might seem that the problem is indeed bigger under “print” and because base money is more liquid than bonds, thus when the private sector is in possession of an extra $X of money, spending will rise by more than when in possession of extra assets in the form of $X of bonds.

However, that’s not a fair comparison because to get a given amount of stimulus under the two options, fewer pounds or dollars need to be printed under “print” than the number of pounds or dollars that need to be borrowed under “borrow”. Reason is that money is more liquid than bonds, thus presumably the stimulatory effect of money (per dollar) is more than the stimulatory effect (per dollar) under “borrow”.

Also note that under “borrow”, extra cash ends up in the pockets of the less well off section of the population just as it does under “print”. That is, under “borrow”, cash is taken from the rich and spent on the population in general, so cash in the hands of the less well off will rise just as it does under “print”. And that section of the population has a higher tendency to spend extra cash it comes by than the rich. So to that extent the need to withdraw cash from the population in general might be just as much under “borrow” as under “print”.


After a bout of stimulus, there may well be a need to rein in some of that stimulus, e.g. raise taxes. But it’s not clear that the problem is any worse under the “print and spend” option than under the “borrow and spend” option.


Afterthought. (Same day). Another point which tends to reduce the political difficulty in withdrawing money after a bout of stimulus (in both the case of "print" and "borrow") is that the only point in that withdrawal is to reduce excess demand: i.e. the purpose and the effect is NOT TO cut living standards to below the level that obtains at full employment. Put another way, the effect of the extra taxes involved in withdrawal does not cut living standards, which might seem strange. Indeed, one could argue that the effect is to INCREASE living standards. Reason is that excess demand and excess inflation involve very real costs. If those costs are removed, then living standards will rise.

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