Supposedly august economics institutions continue to repeat a popular bit of nonsense on the subject of fiscal consolidation.
The nonsense is nicely encapsulated by a passage written by John Plender in the Financial Times. He refers to “The unbearable tension between the short-term requirement to lift the economy and the longer-term need for fiscal consolidation..”
If you don’t immediately see the nonsense there, then I suggest you’re not up to speed on deficits, national debts, consolidation, etc.
Much the same nonsense appears in the National Institute Economic Review. They say, “…it is clearly the case that over the medium to long term fiscal consolidation is essential for debt sustainability . . . . In this paper we assess the impact of the scale and timing of this fiscal consolidation programme on output and unemployment in the UK.” (That publication is produced by the National Institute of Economic and Social Research (NIESR)).
You’ll have no trouble finding other articles and papers that repeat the “Plender / NIESR consolidation” nonsense. E.g. see the passage starting, “The calculations do not take into account…” in this OECD paper.
The flaw in the above quotes is thus. (Incidentally it’s just monetarily sovereign countries like the U.S., Japan or the U.K. considered here. Individual Eurozone countries have a very different set of problems.)
The above quotes imply that a country with a national debt that is expanding relative to GDP as a result of its deficit must at some point put the process into reverse, or at least bring the debt expansion to a halt. But – shock horror – reversing the process will hit the recovery, or at least be deflationary.
And that gives rise the $64k allegedly difficult question as to WHEN TO REVERSE the process and by how much, a question which keeps hundreds of so called economists employed at the taxpayers’ expense.
Deficits no not necessitate rising debts.
The first bit of nonsense in the Plender / NIESR idea is the assumption that a deficit means an expanding debt. As both Keynes and Milton Friedman (and numerous other economists) have pointed out:
DEFICITS CAN ACCUMULATE AS EXTRA MONETARY BASE RATHER THAN AS EXTRA DEBT.
Thought I’d put that in capitals and in colour for the benefit of NIESR and OECD staff have never heard of Keynes or Friedman.
Oooh la la, but money printing is inflationary, isn’t it?
A possible response from the above is that having a deficit accumulate as monetary base equals money printing or “monetising the debt”, the effect of which is inflationary.
Well David Hume answered the latter point 250 years ago. As he pointed out, a money supply increase only has an effect on inflation to the extent that it is SPENT.
To be more accurate, given significant spare capacity, a money supply increase, EVEN IF IT IS SPENT, will initially just affect demand rather than inflation. And that’s exactly the effect required! Raising demand gets us out of the recession.
(Provisional conclusion: the NIESR, the OECD etc are 250 years behind the times.)
Why monetisation makes sense.
To repeat, Keyes and Friedman pointed out that a deficit can accumulate as DEBT OR BASE. When it accumulates as debt, the effect (surprise surprise) is to expand the amount of debt held by traditional holders of debt: wealthy individuals, pension funds, etc.
However, the continued recession is being caused to a far greater extent by reluctance by households, particularly underwater households to spend rather than by reluctance of wealthy individuals or pension funds to spend. Thus we’d probably get a lot more “bang per buck” for what that’s worth from having the deficit accumulate as base, and channelling that extra base into the pockets of ordinary households rather than channelling extra debt into the pockets of the wealthy and pension funds.
Let’s assume no monetisation.
However, let’s assume no monetisation, i.e. let’s assume the standard “deficit expands the debt” scenario.
The Plender / NIESR / OECD argument, to repeat, is that the expansion of the debt must come to a halt or be reversed at some stage, therefor we might as well start thinking about how and when to “halt / reverse” even if the effect hits economic growth a bit.
The REALITY is that national debt is an ASSET as viewed by the private sector entities holding that debt, and those entities will not continue expanding their holding of said assets indefinitely. That is, a point must come at which they start trying to spend or divest themselves of those assets. In particular, debt holders receiving cash for debt that reaches maturity will not re-invest the cash in new government debt: they’ll try to spend the cash. And when that happens, demand rises: the recession comes to an end.
I’ll put that in more graphic form for the benefit of the NIESR, OECD, etc. If you steadily increase the bank balance of a household, what's the household likely to do? Just continue to let the balance increase ad infinitum?
Anyone with a grain of common sense appreciates that the effect is to increase the household’s spending. What do people or households do when they get a tax rebate or win money on a lottery?
Difficult one that, isnt’t it? Um . . . er . . . THEY SPEND SOME OF THE RELEVANT MONEY!!!!! Doh.
In short, the fact that at some point the expansion of the debt will have to be stopped is not an argument for stopping it BEFORE it looks like the recession has ended. That is, the point at which to stop the debt expanding is when the private sector starts spending at a rate that brings full employment.
And taking the point even further, the point at which to run a surplus and contract the debt is when the private sector gets too confident, or goes into “irrational exuberance” mode, and starts spending at a rate that looks likely to exacerbate inflation in a serious way.
The NIESR gets it right in the end.
But credit where credit is due: the NIESR article does come to the right conclusion in the end (after spending probably tens of thousands of taxpayers’ money in the process). But they needn’t have bothered. The conclusion is intuitively obvious to anyone with a grasp of economics.
To put the above point in “Modern Monetary Theory speak”, a monetarily sovereign government does not need to tax or borrow because it can print money anytime. Therefor tax and borrowing must have some other purpose.
The purpose of tax is to counteract the inflationary effect that would arise from a simple “print and spend” operation. And the purpose of borrowing is to provide the private sector with a stock of net financial assets such that the private sector spends at a rate that brings full employment (though quite what the point of issuing INTEREST PAYING debt is, rather than NON-INTEREST PAYING DEBT (i.e. cash) is, is a mystery). Milton Friedman advocated the abolition of interest paying debt.