Sunday, 11 October 2020

Tribune, the left wing publication publishes pro-austerity article.

As Bill Mitchell (co-founder of MMT) pointed out ten years ago, the political left is so incompetent that its economic policies often amount to little more than aping the economic policies of the political right.

Roll forward nearly ten years and nothing much has changed, at least if this article by James Meadway in Tribune is any guide. Title of the article is “Against MMT”.

Essentially Meadway apes George Osborne’s never ending but futile promises to balance the budget: not a clever policy. (George Osborne is a former UK finance minister and Meadway is a former economic adviser to the head of the Labour Party.)

Specifically Meadway says “Labour has adopted a strict set of rules for how a future government will manage its finances. The ‘Fiscal Credibility Rule’ says, first, that Labour will commit to removing the deficit on day-to-day government spending at the end of a five-year period.” And “Labour will commit to seeing the level of government debt relative to the size of the economy lower at the end of five years than at the start.”

I’ve explained the reasons why that is a recipe for austerity several times over the years on this blog, but I’ll run thru it again. Here goes.

Government debt is a safe asset as viewed by the private sector, which holds that debt. And a not unreasonable assumption is that the amount of that debt that the private sector will want to hold will remain more or less constant over the very long term.

Of course there will be significant rises and falls in the debt/GDP ratio: over the last three hundred years the ratio rose substantially after the Napoleonic wars and after the two World wars in the 1900s. But the average ratio in the 1700s, 1800s and 1900s was very roughly 75%. It never fell below around 25% or went above say 300%.

Let’s start with the clearly over simple, but no totally unreasonable assumption that nothing dramatic, like a World war, pandemic or a big rise or fall in consumer confidence is taking place. In that case it might seem that since the debt/GDP ratio needs to stay constant, a balanced budget is suitable.

But that’s not the case because inflation in a typical year eats away at the real value of the debt, ergo in a typical year the debt will need to be topped up, and that can only be done via a deficit! So if the debt is to stay constant at say 75% of GDP and inflation is at the 2% target, then the deficit needs to be 75% times 2% which equals 1.5% of GDP. Plus assuming growth of say 1% in real terms, that would mean another .75% is needed to take account of growth, making 2.25% in all.

Meadway makes no mention of the latter “inflation and growth” points.

But as intimated above, the above “debt will stay at a constant 75% of GDP” assumption is over simple. So what happens if the private sector has a bout of lack of confidence and decides to cut spending and save instead? Well as Keynes explained in his “paradox of thrift” point, the result is excess unemployment. Ergo the deficit would need to be larger than the above 2.25%.

And given a pandemic or war, it would need to be even bigger. But of course things could go the other way: i.e. there might be an outbreak of “irrational exuberance” in the private sector and no pandemic or war, in which case a surplus rather than a deficit would be suitable.

All in all, having a balanced budget or deficit reduction as an objective is nonsense if a government is aiming to minimise unemployment in as far as that is consistent with hitting the inflation target. Indeed in a typical year that is simply a recipe for austerity in the form of excess unemployment.

In short, MMT is right and Meadway is wrong. That is, the deficit and debt, as advocated by MMT, need to be whatever minimises unemployment while hitting the inflation target and keeping the rate of interest on government debt near or at zero.

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