Monday, 21 August 2017

Government borrowing is near pointless.

Milton Friedman in his 1948 paper “A Monetary and Fiscal Framework…” claimed government borrowing made no sense apart possibly during war-time - see section II: “Operation of the proposal”, 2nd para.  However, he did not give very convincing reasons. Here are my attempts at a reason.

Any government can fund itself just via tax: i.e. not engage in any borrowing, as indeed Friedman said. As to borrowing, what that does is to enable some citizens to make more than the normal contribution to government spending and get paid interest on that “more than normal” chunk of money, meanwhile another lot of people can make less than their fair contribution to government spending, but they have to pay taxes to fund interest on their “less than fair share”.

So in effect, all government borrowing does is to enable the former lot of people to lend to the latter lot. But people are free to borrow from and lend to each other anyway! People lend for example when they put money into a bank term account, and people borrow when they get a mortgage for example. So does government borrowing achieve anything that is not taking place anyway, or couldn’t take place anyway?

Well government certainly seems to be an EFFICIENT intermediary between lender and borrower. Governments have draconian powers when it comes to extracting interest: that is, if you’re one of the above mentioned people who pays less than their fair share of tax and has to pay extra tax to fund interest on what you have effectively borrowed, then government can simply demand payment from you and send you to prison if you don’t pay. And in the case of a government which issues its own currency, it always has the option of printing the money needed to pay those it has borrowed from.

Those draconian powers of government explain why government debt, at least in the case of any moderately responsible government, yields such a low rate of interest: lend to government, and your money is safer than when lending to anyone else.

However, those draconian powers of government are not a normal free market phenomenon: commercial banks, non-bank corporations, and individual people when lending or borrowing do not have those powers. And if GDP is to be maximised, the only loans taking place should be loans done in accordance with normal commercial criteria.

Ergo there is no case for government borrowing. QED.

However, I wouldn’t rule out government borrowing (or borrowing by the central bank) altogether in an emergency. Indeed, to repeat, Friedman cited one “emergency” namely war. However another possible emergency is a sudden and excessive rise in demand caused for example by an outbreak of Greenspan’s “irrational exuberance”. In that case it might be difficult to effect enough deflation just via fiscal means, so having government (maybe in the form of the central bank) wade into the market and borrow at above the going rate of interest might make sense.

But to repeat, the case for government borrowing in normal circumstances seems thoroughly weak.


Endnote.  I have actually argued against government borrowing before, e.g. on this blog, but I think the above is a “clincher” argument I haven’t set out before.


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