Wednesday, 24 February 2021

The Tony Blair Institute proposes a fiscal rule.


That’s in a work published yesterday and entitled “Fiscal Rules, OK?

There’s a good summary of the failures of various fiscal rules between 1997 and the present on pages 6 to 11 of this work.  

The fiscal rule proposed in this work, as one of its authors admitted during the associated webinar yesterday, is complicated. By comparison, my preferred rule (which I think is pretty much MMT compliant) is ultra simple. It simply consists of: “The deficit should be whatever keeps unemployment as low as is consistent with hitting the inflation target, while interest on the debt is held at or near zero”. And that in turn is in effect close to the Simon Wren-Lewis / Jonathan Portes rule which says that stimulus should be implemented via interest rate cuts except where interest on the debt is near zero, in which case fiscal stimulus should be implemented.

The Tony Blair Institute (TBI) rule consists of four elements. The heading for the first is “1. A Long-term Government Debt Objective and Implied Deficit Ceiling.” And that involves declaring what the ideal debt / GDP ratio to aim for in ten or twenty years is.

Well there’s a big problem with a long term debt / GDP ratio objective, which is that the size of the debt itself influences demand, and it is plain impossible to say years in advance what sort of assistance from deficits and debts the economy will need in ten or twenty years time. I’ll expand on that.

Government debt is essentially money that private sector entitites have deposited at a bank called “government”: i.e. that debt is an asset as viewed by the private sector. Thus the higher the debt, all else equal, the more the private sector will tend to spend. Plus of course, the deficit itself stimulates demand.

But if say there’s an increased desire to save or hoard money in ten years time, the appropriate debt will be higher than absent that desire to save or hoard! Or if consumer and/or business confidence is much higher in ten years time than it is now, then all else equal, a LOWER debt would be suitable. Conclusion: aiming for a specific amount of debt in ten or twenty years time is a questionable objective.

The truth is that government does not have much choice about the size of the debt and the stock of zero interst yielding base money (and the sum of those two is sometimes referred to by MMTers as “Private Sector Net Financial Assets (PSNFA)). For example if PSNFA is lower than the stock of PSNFA that the private sector wants to hold, then the private sector will save in order to acquire its desired stock and we get Keynsian “paradox of thrift” unemployment.


The second element.

The second element of the TBI fiscal rule is headed: “2. A Real-Time Affordability Test.” And the first paragraph under that heading reads, “The deficit limit would then be adjusted to reflect the affordability of additional borrowing. The adjustment would be calculated based on the difference between the real interest rate on government debt and the long-run growth rate, such that the government’s scope to borrow is expanded when borrowing is cheaper and reduced when it is more burdensome.

The flaw in that idea is that it assumes governments and central banks have no control over interest on the debt. As MMTers have explained over and over, interest on the debt is what MMTers often call a “policy variable”: i.e. governments can pay any rate of interest they want. To illustrate, if a governments wants to pay nothing at all, it can: it just needs to implement stimulus by creating and spending zero interest yielding base money into the economy in whatever amount is needed to bring full employment, and not offer to pay any interest to anyone.


The third element.

This consists of a so called “escape clause” similar to the Wren-Lewis / Portes idea, namely that fiscal stimulus kicks in where interest rates are near zero and stimulus is definitely needed. Well doesn’t that rather clash with the “aim for a specific debt / GDP ratio in ten or twenty years time” objective? If fiscal stimulus continues to prove necessary, then the debt is simply going to rise and rise, perhaps to somewhere near Japanese levels.


I favour the ultra simple MMT type rule.

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