Sunday, 14 August 2016

Kenneth Rogoff is still clueless on government debt.

Rogoff for some bizarre reason is a professor of economics at Harvard, and he has the dubious distinction of having given a huge amount of academic credibility to austerity – arguably more than anyone else in the world. At least he has campaigned against fiscal stimulus and the increased government debt that accompanies it. He’s not the only pro-austerity numptie at Harvard. For example there’s Alberto Alesina with his “expansionary austerity” theory. But I’ll concentrate on Rogoff.

Rogoff’s basic reasons for limiting fiscal stimulus seem to be much the same as the reason given by your average economically illiterate politician and the average member of the public. It’s the simple minded idea that government debt is much the same as the debt of a household, and hence that the debt (or at least much of it) has to be paid back and pain is involved in the paying back process.

That is nicely illustrated in a recent article by Rogoff entitled “America’s Looming Debt Decision”. One of the key passages reads:

“Suppose, for example, that US voters elect as their president an unpredictable and incompetent businessman, who views bankruptcy as just business as usual. Alternatively, it is not difficult to imagine a sequence of highly populist leaders who embrace the quack idea that the level of government debt is basically irrelevant and should never be an obstacle to maximizing public spending. Unfortunately, if the US ever did face an abrupt normalization of interest rates, it could require significant tax and spending adjustments. And the overall burden, including unemployment, would almost surely fall disproportionately on the poor, a fact that populists who believe that debt is a free lunch conveniently ignore.”

OK, let’s run thru this V-E-R-Y  V-E-R-Y  S-L-O-W-L-Y. So slowly that hopefully even Harvard economics professors can understand it, though I’m not optimistic on that score.

First, Rogoff’s claim that there are people who think “the level of government debt is basically irrelevant” is of course complete nonsense. The average mentally retarded ten year old has worked out that increasing the debt has results. The big question is: when is that a problem?

Next there is Rogoff’s claim that there would be problems (unemployment in particular) if interest rates rose after a government had incurred a larger than normal amount of debt.

Well let’s suppose the Worldwide and gradual decline in interest rates over the last twenty years or so goes into reverse. That would be no problem because it’s easy to adjust to any sort of GRADUAL change.

A sudden rise in interest rates.

Alternatively suppose there is a relatively sudden and large increase in interest rates. Well initially there’d be none of the “tax and spending adjustments” to which Rogoff refers. That’s for the simple reason that 99% of the time, interest on debt issued by governments is fixed at the time such debt is issued. That is, if the interest demanded by potential holders of US government debt doubled tomorrow, there’d be essentially no effect on interest payments made by  government next week.

However, over a longer period, an increasing proportion of the total debt would become due for rollover, and the question would then arise as to whether to pay the new higher rate of interest, or simply print money, pay off relevant creditors and tell them to go away.

Now whenever the words “print” and “money” appear the in same sentence, a host of economic illiterates appear from the woodwork chanting the word “inflation”. But apparently unbeknown to the latter numpties, we’ve actually BEEN printing money and buying back government debt like there’s no tomorrow for several years, and under the guise of what’s known as Q-U-A-N-T-I-T-A-T-I-V-E   E-A-S-I-N-G. You’ll have heard of QE, but whether Rogoff has, I’m not so sure.

And where’s the inflation? Nowhere to be seen – just as many of us predicted before QE was implemented.

QE raises demand.

But to be fair, it’s quite possible that more QE could raise demand too much and hence raise inflation too much. So what then? Well that excess demand is easily curtailed by cutting the deficit, i.e. by raising taxes and/or cutting public spending.

Now you might think that tax increases and public spending cuts would raise unemployment, as indeed Rogoff suggests.

But hang on: the only purpose of those tax increases / public spending cuts, as intimated just above, is to keep inflation within bounds, i.e. to keep inflation at the target 2% level.

I.e. it’s only the above mentioned “excess demand” that needs to be curtailed. Thus given competent management of the economy, all that happens is that government keeps demand at the full employment / 2% inflation level, and nothing much else happens. In other words the “unemployment” to which Rogoff refers is a complete myth.

Interest rates rise in just one country.

It was assumed above that an interest rate rise is more or less Worldwide. Another possibility is that potential buyers of a particular government’s debt take a dislike to that government IN PARTICULAR and to the relevant country in particular, and increase the rate of interest demanded for holding that government’s debt, or indeed to keeping money in the country at all.

Well in that case, again, there is still no excuse for a rise in unemployment. Former debt holders on receiving cash when their debt was due for rollover would in some cases place the money elsewhere in the world which would depress the value of the relevant country’s currency on foreign exchange markets. And that would depress living standards in that country.

But then if a household or individual person repays debts, that is a painful experience: it involves a temporary decline in consumption, i.e. a decline in living standards.

The unemployment to which Rogoff refers is still a myth.

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