Monday, 11 February 2013
The national debt and deficit are total and complete non-problems.
Keynes said “Look after unemployment and the budget looks after itself”. Unfortunately the massed ranks of economic illiterates in high places continue to have no inkling of what that means: that is, they continue to witter on about the debt and deficit.
What Keynes meant was: “concentrate on unemployment – and as to the deficit, or surplus, or debt that results from that, well just forget about them”.
Now for a more detailed explanation.
A microeconomic entity, like a household or firm, certainly has to watch its debts, plus if is suffers a constant outflow of funds, i.e. a deficit, clearly that cannot go on for ever. However, the government of a country which issues its own currency, like Britain, is an entirely different kettle of fish. (I.e. microeconomics is completely different to macroeconomics).
Given a recession, it is desirable for government to spend more than it collects in tax. Recessions occur because of inadequate spending by the private sector. So if government makes up for that lack of spending by spending more (and/or collecting less tax so as to encourage private sector spending), that reduces unemployment.
As to whether that deficit accumulates as extra government debt or simply as extra money in the hands of the private sector, well that really doesn’t matter, as Keynes pointed out in a letter to Roosevelt in the 1930s (1). Personally I favour the print option and for numerous reasons. One reason is that it is senseless for government to borrow something which it can itself produce in limitless quantities at no real cost.
Those dreaded bond vigilantes.
But assuming the debt DOES RISE, the deficit and debt-phobes then start worrying about what happens if a country’s creditors lose faith in the country and start demanding a higher rate of interest on its bonds (as has happened for various European countries which DON’T issue their own currencies: the Euro periphery countries).
Well if those interest rates DO RISE, there is NO IMMEDIATE effect on interest paid by the debtor country because rates of interest on bonds are fixed when bonds are first issued. However, as bonds mature, then clearly the question arises as to whether to roll them over and pay the new higher rate of interest, or simply print money and repay the relevant creditors.
Now there might seem to be a problem with the latter “print” option, namely that it could be inflationary. Well you have to wonder what planet anyone who thinks that has been living on for the last three years. During that time we’ve printed money like there’s no tomorrow and bought back debt and in the guise of quantitative easing. And where is the hyperinflation?
However, its perfectly possible (in particular, absent a recession) that money printing could be inflationary. But that’s no problem: that inflationary effect can be countered with a very simple DEFLATIOINARY measure, namely raising taxes (and/or cutting public spending). And assuming the latter inflationary and deflationary effects cancel out, there is no effect on anything: no effect on demand, numbers employed and so on.
See what I mean? This is all a total non-problem!!
Well very nearly: there is actually one very minor problem which has to do with the amount of debt held by foreigners.
If a foreign debt holder is given cash in exchange for their bonds, they are likely to move their money to elsewhere in the world in search of better yield. And that would hit the value of the pound, which in turn would hit living standards in the UK.
But that’s simply a reflection of the fact that borrowing from an external source gives one a temporary standard of living boost (just like when you run up debt on your credit card). And that temporary boost is reversed when you pay back the debt. No big mystery there.
Moreover, the latter “borrowing from abroad” phenomenon is another reason for governments not to borrow at all. That is, if, as suggested above, deficits just accumulate as extra money, then the above “borrow from abroad” problem just doesn’t arise! And numerous economists have suggested that governments just shouldn’t borrow: e.g. Milton Freidman (3), Warren Mosler (4) and Claude Hillinger (5). I also wrote a paper arguing that government borrowing makes little sense (6).
Reverting to Keyes, “looking after unemployment” will on occasion result in a rapidly rising national debt (and/or monetary base). And on other occasions (i.e. given Alan Greenspan’s “irrational exuberance”) the result will be a budget SURPLUS and a declining national debt (and/or monetary base).
But which of the two latter outcomes happens to occur – deficit or surplus - and how large they are are, is a complete irrelevance.
The debt and deficit are not a constraint when it comes to dealing with unemployment. The REAL CONSTRAINT is inflation.
1. See 5th paragraph of letter from Keynes to Roosevelt where he says “public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money.”
2. I’ve always suspected that Keynes also preferred the “print” option. However he was politically very astute and realised by 99% of the population foam at the mouth on hearing the words “print” and “money” in the same sentence. I suspect that was why he kept rather quite about the print option.
3. Milton Friedman. See article entitled “A Monetary and Fiscal Framework for Economic Stability” in the American Economic Review, June 1948. See in particular under the sub heading “The Proposal” (p.250).
4. See 2nd last paragraph of article by Warren Mosler here:
5. Claude Hillinger. See p.3, para starting “An aspect of…”:
6. Paper entitled “Government borrowing is near pointless” here.