Saturday, 5 December 2020

The Resolution Foundation falls for the nonsensical “fiscal space” idea.



The Resolution Foundation is a UK economics think tank, and the their ideas on “fiscal space” are set out in recently published work entitled “Unhealthy Finances”, which at about 70,000 words is about the length of an average book.

I demolished the whole fiscal space idea in an MPRA article about ten years ago, and another MMTer, Bill Mitchell, took the idea apart in an article entitled “The ‘Fiscal Space’ Charade” in 2015.  

Plus I explained the flaw in an article on this blog in 2012.

Anyway, there’s nothing like repetition for getting ideas across. So I’ll briefly explain the flaw in the fiscal space idea yet again in the paragraphs below.

Fiscal space is the idea that if a country’s debt/GDP ratio is on the high side, relative to where it’s been in recent decades, it will have to pay a relatively high rate of interest on that debt and/or if it wishes to implement more stimulus, it will have to borrow yet more and pay an even higher rate of interest on its debt, thus in that situation, it does not allegedly have “space” for implementing stimulus.

And if you want an alternative definition, the IMF definition is set out near the start of the above mentioned article by Bill Mitchell.

The first and very obvious flaw in that FS idea is that any country which issues its own currency does not need to borrow in order to fund stimulus: it can fund stimulus by simply printing money, which in effect is what most of the World’s larger countries have done over the last five years or so. You have to wonder what planet Resolution Foundation authors live on.

The second flaw in the fiscal space idea is the assumption that because the debt has been at let’s say 50% of GDP for the last two decades, that therefor it is not sustainable for it to remain at 100% for the next one or two decades. That assumption is particularly questionable given that the Japanese debt/GDP ratio is around 250% with few obvious problems, and given that the UK ratio was at a similar level just after WWII.

Moreover, it is plain impossible to predict where we will be in three or five years’ time. For example it could be that in five years’ time, the big increase in the desire to save that happened over the last twenty years or so goes into reverse. That is, the private sector could go into “spendthrift mode”, or if you like, Alan Greenspan irrational exuberance mode. In that case it would certainly be desirable to raise taxes so as to rein in the additional demand that stemmed from the latter exuberance, and hence cut the debt, as suggested by the Resolution Foundation.  

But equally, it could be that the private sector’s desire to save CONTINUES to increase, and we become another Japan.  In that case government HAS ABSOLUTELY NO OPTION but to meet those “savings desires” (to use an MMT phrase). If government DOES NOT supply the private sector with the savings it desires, the private sector will try to save so as to acquire those savings, and Keynesian “paradox of thrift” unemployment will ensue. In that case (unless government wants to see unemployment rise to unnecessarily high levels) government and central bank will just have to let the debt (and/or the stock of base money) rise even further.

The moral is: “play it by ear”. In other words the basic MMT idea is quite right: that’s the idea that the deficit (or surplus) simply need to be whatever results in unemployment being as low as is consistent with hitting the inflation target while keeping interest on the debt at or near zero.  In contrast, all attempts to PREDICT (a la Resolution Foundation) what tax rises will be needed in three or five years’ time are futile.

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