Thursday, 14 May 2020

Covid has blown Rogoff’s fiscal rule out of the water, while MMT’s remains totally unfazed.

Kenneth Rogoff is a Harvard economics prof. Over the last ten years he has been one of the world’s leading advocates of austerity. In particular his big idea has been that debt/GDP ratios should be limited to 90%. Apart from the technical flaws in his research which others have highlighted, his 90% idea has been blown out of the water by the massive deficits being used to counteract the effects of Covid. I.e. limiting the debt and deficit just at the moment would be absurd.

Incidentally, as MMTers have long tried to explain, government debt and base money are much the same thing. That is, a tranche of government debt is simply base money lodged with government for a period of time on which government pays interest. As Warren Mosler (founder of MMT) put it, government debt is essentially a term account at a bank called “government”.

Thus the important quantity here is not, strictly speaking GOVERNMENT DEBT: it’s government debt plus the stock of base money, which is sometimes referred to by MMTers as “Private Sector Net Financial Assets” (PSNFA). But I’ll use the more traditional and inaccurate phrase “government debt” or just “debt” below. 

As for what the optimum amount of deficit and debt is, the MMT view is simply that it needs to be whatever brings full employment (or something as near full employment as is possible in a Covid scenario), while keeping to the inflation target. The actual AMOUNT of debt that results from that policy is wholly irrelevant.

Indeed that is very much what Simon Wren-Lewis (former Oxford economics prof) claims. As he put it in the first sentence of a recent article, “Do you want to know why fiscal rules should never involve targets for the debt/GDP ratio, or debt interest, or any stock measure, and why public investment should not be part of a fiscal rule?”

Of course the debt-phobes worry about what happens if, given a relatively high debt, government’s creditors start demanding a higher rate of interest. Well I’ve been thru this all before on this blog a dozen times, but I’ll run thru it again.

First, a rise in the interest demanded by creditors, i.e. debt holders, does not result in any significant immediate rise in the interest paid by government because (certainly in the case of the UK): the average term of government debt is several years (about ten years in the case of the UK).

Second, as regards debt due to mature this week or this month, creditors can simply be paid off and told to get lost. Of course the resulting increased stock of cash in the hands of the private sector could stoke inflation (though the increase in the stock of cash in private sector hands as a result of QE did not appear to stoke inflation). At any rate if it does look like stoking inflation, that inflation can be reined in simply by raising taxes and/or cutting public spending.

Note that has no effect WHATEVER on aggregate demand, and hence no effect on living standards. All that happens is that demand is held down to the level where it does not cause excess inflation: the level which maximises GDP.

And if the latter “reining in” exercise does not do the trick, interest rates can always be temporarily raised, though as suggested above, they need to be cut back to near zero as soon as possible.

To summarise, the “MMT/SW-L” fiscal rule works just fine in a Covid scenario, just as much as it does in a more normal scenario. And people who think up rules or equations which work in in a variety of different circumstances, i.e which are of very GENERAL application, like E=MC2, often earn Nobel prizes.


Game set and match to MMT / SW-L. As for Rogoff, why on Earth anyone still listens to him is a mystery.

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