Wednesday, 24 July 2019
The IMF’s bizarre “fiscal space” idea.
If you’re looking for incompetence in high places, nothing quite beats the “fiscal space” idea, much favoured by the IMF, OECD and similar organisations. Google “IMF” and “fiscal space” and you’ll find twenty or thirty IMF articles on the subject and an equal number by the OECD, UN, WHO, World Bank, etc.
I actually had a go at demolishing the fiscal space idea several years ago in a short article here. (Title of article: “Fiscal space is hogwash.”) But the IMF continues to spew out articles about fiscal space. So it’s time for another article on this subject. This present article is a bit longer and more detailed. (Incidentally, for another article which mocks the fiscal space idea, see this article by Bill Mitchell entitled “The ‘fiscal space’ charade – IMF becomes Moody’s advertising agency.”)
Fiscal space is the idea that in order to implement stimulus, governments have to borrow and spend, and that allegedly raises the rate of interest government has to pay on its debt, which in turn places a limit on the amount of stimulus. Thus fiscal space, so the story goes, is the amount of stimulus that can be implemented before serious problems kick in in the form of increased interest rates etc.
This IMF work for example defines fiscal space thus: “Fiscal space is a multi-dimensional concept reflecting whether a government can raise spending or lower taxes without endangering market access and debt sustainability.”
There’s no need to borrow!
One big flaw in the whole fiscal space idea is that governments and their central banks do not need to borrow in order to impart stimulus! As Keynes pointed out in the early 1930s, governments and their central banks can simply print money and spend it in order to impart stimulus. Indeed, that’s exactly what several large countries have done over the last five years or so via QE! (At least that certainly applies to countries which issue their own currencies, or to groups of countries which issue a common currency, like the Eurozone. Individual countries within in the Eurozone which do not have their own currency are entirely different, of course.)
Let's expand a bit on exactly what QE is. In reaction to the recent recession, governments have borrowed and spent more than usual (say $X) while central banks have printed around $X of money and bought back that debt. That nets out to the same as “government and its central bank print and spend $X”. Indeed, governments do not even need central banks in order to print and spend: the UK Treasury printed or “created” money at the start of World War I.
Of course advocates of the fiscal space idea might answer that by claiming that the sight of a government (with or without the help of its central bank) going for “print and spend” might induce government’s creditors to doubt the responsibility of such a government and thus demand extra interest on its debt. (Though I know of no instances of the IMF or other advocates of fiscal space being bright enough to actually make the latter objection.)
Anyway, one answer to that is that as long as the amount printed is enough to cut unemployment to the minimum feasible level without causing excess inflation, money printing is a perfectly responsible course of action. Indeed, the latter form of responsibility is exactly what the larger developed countries have displayed in recent years: that is, they have printed larger than normal amounts of money so as to implement QE, and lo and behold, the amount printed has been enough to take unemployment down to record lows without exacerbating inflation. But those governments have not printed completely ludicrous “Robert Mugabe” amounts of money and given us hyperinflation.
You really have to wonder whether the IMF has ever heard of QE or whether it is aware of the relevance of QE to this debate. Indeed the above mentioned IMF work from which the IMF definition of fiscal space was quoted is around thirty thousand words in length (longer than many books), but QE is not mentioned so much as once!
Can IMF ignorance be excused?
In defence of the IMF, it could perhaps be argued that prior to QE, the IMF did not have the experience of QE to confirm that money printing when done responsibly is no problem. Unfortunately that excuse won’t wash.
First, as pointed out above, Keynes explained in the 1930s that money printing was a perfectly viable way out of recessions. Second, since QE, IMF enthusiasm for fiscal space and the number of articles they turn out per year on the subject has continued unabated. In short the IMF and similar international organisations which enthuse about fiscal space do not seem to have learned much from QE.
A second flaw in the fiscal space idea, which is actually very close to the above one, is that as soon as interest on government debt rises significantly above zero, stimulus can then be imparted by cutting interest rates: and that’s done by among other things, having the central bank print money and buy back government debt.
Indeed there’s little difference between QE and cutting interest rates: that is, QE consists of printing money and buying back debt when interest rates are at or near zero, whereas conventional interest rate cutting consists mainly of printing money and buying back government debt when interest rates are significantly above zero.
In fact Simon Wren-Lewis (former Oxford economics prof) specifically advocates using interest rate cuts when rates are above zero, and fiscal stimulus when rates are at or near zero.
To summarize so far, fiscal space looks like one big irrelevance.
Does “borrow and spend” have particular merits?
It could perhaps be argued that fiscal space would be relevant if “borrow and spend” was a much better way of imparting stimulus than interest rate cuts or QE. Unfortunately though, there’s a monster flaw at the heart of “borrow and spend” as follows.
Clearly the effect of extra public spending (or tax cuts) is to stimulate demand. But the effect of borrowing, considered in isolation, is the opposite. That is, if government or central bank borrow $Y and just sit on the money, that CUTS demand. Now if you’re aiming to raise demand, it’s a bit of a nonsense to do something that has the opposite of the desired effect! That’s like throwing dirt over your car before washing it!
To summarize, Keynes was right to say in the 1930s that the way out of a recession is for government to borrow or print money and spend it (and/ or cut taxes), but the print option clearly makes more sense than the borrow option.
As the German economist Claude Hillinger put it in 2010, “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.”
Is “unprinting” money difficult?
Another possible argument against “print and spend”, and hence an argument in favour of fiscal space, is that if stimulus is imparted by “borrow and spend”, then when stimulus needs to be reversed, government bonds can be sold to mop up any excess supply of money in private hands.
Well the answer to that is that stimulus can always be reversed simply by raising taxes and/or cutting public spending. But if that’s politically difficult, government or central bank can simply wade into the market and offer to borrow at above the going rate of interest.
Central banks in some countries may not be allowed by law to do that at the moment, but there’s no good reason to stop them: i.e. the law can be changed.
The moral (to be cynical) is that if you can produce an important technical sounding phrase, like “fiscal space”, “secular stagnation” or “austerity”, your fortune is made: everyone likes to sound technical and important, so all and sundry will repeat your important sounding phrase for years to come. The fact that the important sounding phrase is in some cases no more than emperor’s clothes won’t worry anyone.