Government borrowing is pointless.

I actually addressed this issue on this blog in November last year, but on re-reading that article, it struck me as leaving room for improvement. So I’ve scrubbed it and re-written it in the paragraphs below. Here goes.

Both Milton Friedman and Warren Mosler (founder of Modern Monetary Theory) claimed that government borrowing is pointless, though they did not give any very detailed reasons. To be more accurate, Friedman claimed government borrowing served no useful purpose except in an emergency like war time, while Mosler simply said he opposed government borrowing.

For Friedman see under his heading “Operation of the proposal” in this paper of his entitled “A Monetary and Fiscal Framework for Economic Stability” published by the American Economic Review.

For Mosler, see the second last para of his Huffington article, “Proposals for the Banking System”.

In view of Friedman and Mosler’s lack of detailed reasons, I’m having a go at setting out some detailed reasons.

First, it’s important to distinguish between government borrowing as traditionally understood and another possible form of borrowing, which is to have government (or central bank) borrow with a view to damping down demand given an outbreak of irrational exuberance: i.e. excess demand. That form of borrowing would involve borrowing money and then doing nothing with that money.  I’m not advocating the latter form of borrowing as a particularly good way of dealing with excess demand, but clearly it’s a useful tool to have in reserve.

Second it’s important to distinguish between borrowing to fund current spending, and in contrast, borrowing to fund spending of a capital nature, i.e. investment spending. It is widely accepted by borrowing to fund current spending (both in the case of a household and in the case of government) does not make much sense. So that leaves capital spending.

For the naïve, that’s people who think government budgets can be treated the same way as household budgets, the purpose of government borrowing seems obvious: government borrows $Xbn instead of grabbing $Xbn off taxpayers. That borrowing appears to provide government with money to spend without any immediate costs for taxpayers or citizens generally.

There is however a problem, which is that the laws of macro-economics are very different to micro-economics: in particular, for every billion a year of extra spending by government (macro), private sector spending must be cut by a billion a year, assuming to keep things simple, that aggregate demand is to remain constant.  In contrast, when a household (micro) goes on a spending spree (e.g. buys a new house) as a result of having borrowed a large sum, there is no immediate need for it to cut down all that much on spending in other areas, e.g. on clothes, holidays, though of course over the very long term (decades rather than years) it will have to cut spending so as to repay the loan, or at the very least pay interest in the case of an interest only mortgage.

But does having government borrow a billion actually cut private spending by a billion? Certainly not! In fact it might not cut it at all. After all, those who lend to government, i.e. the well off, don’t invest in government bonds (or anything else) unless they think it makes them better off in the long run. So the net effect could easily be to increase spending by the private sector!

Of course raising taxes so as to fund interest on the sum borrowed will cut household spending, but that cut won’t be nearly enough: the cut required is the full amount of the capital sum borrowed, not just the amount of the interest thereon for a year or two.

Bill Mitchell draws attention to this nonsense, or at least implicitly draws attention to it in this video clip, where he says government bonds do not cut inflation.

And to add insult to injury, the above farce is even worse in the case of government bonds bought by foreigners. To illustrate, if someone in Switzerland buys UK government bonds, that might depress private sector spending in Switzerland (though for reasons given above, even that is doubtful). But it certainly won’t depress private sector spending in the UK!

Next, there is the problem of funding interest on the sums government borrows. If government simply raises taxes on the rich and poor in the same ratio as already obtains (which of course will involve, at least hopefully, taxing the rich more than the poor) then that still means the after tax income of the typical rich person has risen relative to the after tax income of the typical poor person. And that’s presumably not what government or the electorate would want, thus government will need to load some extra tax on the rich while reducing taxes on the poor so as to get back to, or near to the after tax income distribution that government and the electorate wants. In fact to get back to the “after tax income of the rich relative to the after tax income of the poor ratio” that existed prior to the above bout of capital spending, government will need to rob the rich of ALL OF the interest the rich get from lending to government, far as I can see.

Even if that latter point of mine is not quite right, it still looks like it would be much simpler to fund the capital spending by raising taxes on the rich and poor in a way that leaves after tax income distribution as between rich and poor at about the level that government and the electorate desires, and forget all about borrowing. That would be a lot simpler wouldn’t it?


Profligate politicians.

Another problem with borrowing is the temptation for politicians to borrow too much. Simon Wren-Lewis (former Oxford economics prof) refers to this problem as the “deficit bias”.

And David Hume writing three hundred years ago made exactly the same point when he said, “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt, will almost infallibly be abused in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills, in this manner, upon posterity.”

Conclusion. Given the tendency of politicians to borrow too much and given that government borrowing achieves nothing or almost nothing, it looks like the best course of action is to simply abolish government debt!


The future generations myth.

And finally, there is the popular myth that since sums borrowed by government this year must be paid back in several decades time, that will enable to cost of capital projects to be loaded onto the future generations which benefit from such capital projects (bridges etc).

The flaw in that idea is that future generations inherit not just a liability, that is, the obligation to repay the latter government debt, but also an asset, namely relevant government bonds!

In fact the latter point stems more from the laws of physics rather than the laws of economics. That is, it just isn't physically possible to build a bridge in 2020 using steel and concrete produced in 2030 or 2040 etc. I.e. the blood sweat and tears required to build a bridge in 2020 absolutely must be expended in 2020 (or a year or two earlier).

Incidentally I'm well aware of "overlapping generations" idea proposed by Nick Rowe which claims to make the latter "load costs onto future generations" idea work. I'm not impressed by that idea, but the reasons are too involved to deal with here.