Thursday, 30 April 2020

Adam Tooze says a high post Corvid debt is not a reason for austerity.

Adam Tooze got a degree in economics at Cambridge and is now a history prof at Columbia University. His recent article in the Guardian arguing that a high post Corvid debt is not an excuse for austerity has gained general approval, and rightly so. (Article title: “Should we be scared of the Coronavirus debt mountain.”)

However he rather goes off the rails towards the end of the article on a few technical points. Details on that are in the paragraphs below.

His third and fourth last paras are as follows (which I’ve put in green italics).

“There is one mechanism through which we can ensure we truly owe the debts to ourselves. That mechanism is the central bank. Its principal job is to manage public debt – and at a moment of crisis central banks do what they must. They buy government debts or, in what amounts to the same thing, they open overdraft accounts for the government.

That has two effects that, acting together, have the potential to negate debt as a political issue. Central bank intervention lowers the interest rate. If interest rates are held down, debt service need not be an onerous burden. At the same time, the central bank purchases remove government IOUs from private portfolios and put them on the balance sheet of the central bank. There, they are literally claims by the public upon itself."

Contrary to Tooze’s suggestions, the fact of the central bank buying government debt has little effect on the extent to which “we owe the debt to ourselves”, and for the following reasons.

Where such debt is not bought by the central bank, that debt is a debt owed by the state (by which I mean government and central bank combined) to those who hold such debt: i.e. when that debt matures, government has to pay debt holders back with cash, with most of that cash being raised in the normal way, that is, grabbed the money from taxpayers. Though of course, government can (and normally does) roll over the debt, i.e. pay debt holders back with money raised from new debt holders (who to a significant extent will be the same lot of people).

But government or central bank can create limitless amounts of the latter cash (aka “base money”) either via pressing buttons on computer keyboards or by producing physical cash ($100 bills etc). Government, in the form of the Treasury, actually got into the money printing business in the UK during WWI.

Thus the stuff which is normally referred to as “government debt” (Gilts in the UK and Treasuries in the US) is only a debt in that the latter cash is also a debt. And indeed it is a debt to some extent: that is, anyone in possession of base money can get government to supply them with something of real value: goods or services offered by government, e.g. surplus public land or old military equipment which has been put up for sale.

Alternatively, the holder of the cash might use it to buy something from another private sector entity, with that entity choosing to demand real goods or services from government.

Thus having the central bank buyback government debt, contrary to Toose's suggestions, has no effect on the extent to which we "owe the debt to ourselves". Nor does it reduce the extent to which "government IOUs" are in "private portfolios".

Incidentally, the latter points are very much in line with the point long made by MMTers, namely that there is not much difference between government debt and zero interest yielding base money.

Interest rates.

Next, Tooze says “Central bank intervention lowers the interest rate”. Well the answer to that is that interest rates are already at record lows: only slightly above zero. So that point is of limited relevance.

Debt as a political issue.

Then he says that buying back the debt tends to “negate debt as a political issue” by which he means, to judge by the associated link, that while there may be a need to cut the debt, there would be no need to cut the stock of base money, if debt is swapped for base money (which is what the buy-back consists of).

Well that idea is flawed and for a reason already alluded to above, namely that there is little difference between debt and and base money. Indeed, in the World’s financial centers, short term government debt is accepted in lieu of money.

To expand on that, the reason the debt may need to be cut is that (as MMTers have explained) the debt is a private sector asset, or a “Private Sector Net Financial Asset” to use MMT phraseology. But so too is base money! And an excessive stock of either of those two in private sector hands will obviously tend to encourage spending by the private sector, which may go too far and stoke inflation.


Then in his second last para, Tooze says “….modest inflation would help us by taking a bite out of the real value of the debt.”

Well there’s a slight problem there, namely that if the state’s creditors (i.e. those who buy government debt) get the impression that the state will let inflation eat away at the real value of the debt to an excessive extent when the debt gets a bit high (or indeed when it’s not particularly high) then those creditors are going to charge a relatively high rate for lending to government.

Indeed, the 1970s inflationary episode resulted in rates remaining on the high side for most of the 1980s: relevant creditors had no intention of being robbed TWICE.

In short, excess inflation would not be a brilliant idea post Corvid any more than it’s a brilliant idea any other time.

To summarise, Tooze makes several mistakes.

High debt is no excuse for austerity.

However Tooze is quite right to say (to repeat) that a relatively high debt is no excuse for austerity (in the sense of deficient aggregate demand). The reason why a high debt is often SEEN AS a reason for austerity is the entirely fallacious idea that government budgets (macro-economics) can be compared to the budget of a MICRO-ECONOMIC entity like a household or firm.

That is, a household can obviously cut its debts by spending less while maintaining its income. Unfortunately if government does that, aggregate demand declines, which is not what’s wanted (unless demand and inflation are excessive). So how can the debt be cut WITHOUT affecting demand?

Well that’s a little problem to which I have long suspected rather a large number of economists (Tooze included) do not have the solution. The solution is as follows.

First, note that the debt can only be excessive if it leads to an excessively high rate of interest being paid on the debt. (And in the view of many MMTers, me included, “excessively high” means anything much above zero. Milton Friedman thought likewise)

So the solution is first to raise taxes and “unprint” the money collected at about the same rate as Gilts or Treasuries mature, while not rolling over that debt. That way government debt declines. And that of course has a demand reducing effect, as mentioned above.

But that is easily countered by cutting interest rates, which of course has the opposite effect: i.e. it has a stimulatory effect.

So, assuming things can be so arranged that the latter two effects cancel each other out, there is no net effect on demand. Hay presto: no austerity. Of course, getting the above two effects to exactly cancel each other out is not easy in practice, but certainly the latter “cancel out” strategy is the right one to go for.

I actually got the impression best part of ten years ago that most economists didn’t understand the above “unprint” point, so I wrote a paper explaining it, entitled “Consolidation causes little austerity”. 



  1. On your point about Tooze being wrong on letting inflation run to far and the ensuing markets deciding to raise interest rates to lend to government. I am not so sure this old paradigm still exists. For a start since 2008 interest rates on gov debt have been at historic lows. The markets cannot have not had a good return on gov debt on over a decade,in fact in some cass they are accepting negative debt, that is they are paying governments to hold their debt.

    That was before COVID-19. Now we are in a new wholey different world and my supsicion is that the so called "market" will be happy to be allowed to hold any gov debt at any price.Where else is as nearly safe in today's global economy. The governmnets are holding the markets together here.The direction of travel is now that (Sovereign)states are telling the markets what the rate is ,not the other way round.

    1. I certainly agree that debt holders are prepared to hold more of the stuff nowadays than twenty years ago at a given rate of interest. But there must surely be limits to the extent to which they are prepared to be robbed. E.g. and to take an extreme example, if governments offer to me was, "you can deposit £1,000 with us, and in a year's time you'll get £500 back in real terms (i.e. after inflation has eaten away half of it)", then my reaction would probably be to spend the £1,000 now (maybe on a real asset like a house or car), which would ensure that in a years time I still had £1,000 worth of real asset.

    2. That's a steep discount. But I take the point. However I think Tooze's answer would be that we can't be worrying about the markets right now,they aint the priority. The central bank can just buy that debt in any case for little or no interest(which it pays back in any case) and hold it forever if it wishes .What that means for the future is moot,we have probably hit a defining watershed moment in financial history.


Post a comment.