Big national debt justifies a small deficit?

Martin Wolf (chief economics commentator at the Financial Times) seems to have fallen for the above popular mantra in a recent article. He said: “It makes sense to run a still smaller deficit when debt is high..”. Every MMTer knows the flaw in that statement and I’ve explained the flaw in that idea a dozen times on this blog. But I’d do it again. Here goes.

First, while the UK debt / GDP ratio is high compared to RECENT decades it is SMALL compared to what it was in the 1950s. Plus it is small compared to Japan’s debt / GDP ratio. So is the UK debt too large or too small? It’s clear that simply comparing it to recent decades or a few decades earlier tells us ABSOLUTELY NOTHING!!

A more intelligent question is: what basic principles should determine the size of the debt? Well here’s a few ideas on “basic principles”.

The government of a country which issues its own currency does not have a huge amount of freedom of choice when it comes to deciding how much liability to issue in the form of base money and national debt, or “safe assets” as the latter two are sometimes called.

If the private sector has less than its preferred stock of safe assets, it will try to save in order to accumulate the stock it wants, and that is deflationary: it tends to result in Keynes’s “paradox of thrift” unemployment.

Alternatively, if the private sector has MORE THAN its preferred stock of safe assets, it will try to spend away the excess, which is likely to result in excess demand and inflation.

Ergo, if government does not provide the private sector with approximately the stock of safe assets it wants, there’ll be trouble.

But governments do have SOME ROOM for manoeuvre as regards that stock: that is, they can issue or incur a relatively large stock without the private sector being tempted to spend away the excess if the interest paid on that stock is relatively high.

As MMTers keep pointing out, the government of a country which issues its own currency has complete control over the rate of interest it pays on its debt, so an important question is: what’s the best rate to pay? The answer given by Milton Friedman and Warren Mosler (founder of MMT) was “zero”. I.e. they argued that there was no point in government paying anyone just to hoard an excessive stock of money.

Friedman and Moser were right or least nearly right: that is it could be argued there’s a case for paying SOME interest on the  debt, but a sufficiently small rate that the REAL or inflation adjusted rate is less than zero. That way government profits at the expense of its so called creditors. I don’t see much wrong with that.

So…to get back to Martin Wolf’s above claim, the important question is not whether the debt is high compared to recent decades, but whether an excessive rate of interest is being paid to those holding the current stock of debt. Well in the case of the UK and most other developed economies the rate is within the bounds suggested above: i.e. above zero but below the rate of inflation. However, the rate is a bit nearer to the rate of inflation than zero, so for that reason I suggest the debt should be reduced a bit. And that is easily done by printing money and buying back some of the debt, while dealing with any inflationary consequences of that by raising taxes and/or cutting public spending.