How to Balance the Government Budget. The MMT way! (Part 2)

To fix the UK economy requires that aggregate demand be increased. Nearly all politicians understand that. Except, the favoured way, and some might say the only way, for those on the right of the political spectrum is to create a credit bubble to encourage more private spending through more private borrowing. That’s not an option for the foreseeable future as the private sector is now saturated in debt. So saturated , in fact, that we’ll have another crash in the next couple of years unless the next government acts quickly to prevent it. That will require them to spend in a sensible fashion but nevertheless spend big time. Realistically, it is going to be a difficult sell electorally. The problem, for those politicians wishing to advocate this line, will be questions such as “where’s the money going to come from?”  and comments such as we “can’t afford” to do that.

Of course, the money comes from where all money comes from in the first instance, and as Keynes said, if something can be done it can be afforded. The only danger of too much spending is too much inflation. The danger of too little spending is the recession we have now, both in the UK and, even worse, in the Eurozone.

The problem is that the electorate, and most politicians, don’t understand economics. That’s not surprising. The mainstream media don’t explain it at all correctly. To most people, the government is like a company or a household. To spend money it has first to acquire money. That’s true for a user but not at all the case with an issuer of currency.

It’s rather like living in society where everyone thinks the world is flat. If we insist the world is really round then they might not like that and vote for someone else. We, in turn,  wouldn’t like that so the best approach may be to pretend we think the world is flat too, and work our way around the problem as best we can!

One way is to redefine what we mean by ‘government deficit’. As Neil Wilson has recently noticed, Ed Balls has been astute enough to use the term ‘current deficit’.

http://www.3spoken.co.uk/2014/12/how-to-eliminate-uk-deficit-trick.html

I think we all missed the inclusion of the extra word for slightly too long, so full marks to Neil for spotting that. Maybe, we gave Ed slightly more criticism than he may have deserved over his advocacy of ‘balancing the books’.

So what could be the plan? The idea is simply that we shouldn’t count capital spending, just current spending. On a personal level,  current spending is our going down to the pub and drinking a few pints. We’ve nothing to show for it the morning after. Capital , or investment spending, would be on building a house or investing in a viable business. The value of that would, if we drew one up,  appear on our personal balance sheet, so even if we went into the red financially we would still be in the black overall once the value of the physical assets was counted.

So how’s it going to work for government?  Current spending is, amongst other things, paying out unemployment benefits. Capital spending includes electrifying all railways and building houses.  The government is in a very advantageous position when it comes to doing anything in the economy. Unlike you or I, it doesn’t have to borrow money at high interest rates. It can either just create the money or borrow it via the sale of gilts at very low interest payments. Also unlike a private developer which has to pay taxes to government during the course of the development, government actually receives taxes. Therefore if a private developer can build at a profit, then government can do the same thing and make an even bigger ‘profit’.

So say it decides to build a £100 million residential development. It classes that as investment spending or capital spending so it doesn’t appear on the books as a ‘current deficit’.  It hands out contracts to builders in the private sector and most of that money gets spent on wages. Either directly, on the wages and salaries of building workers, architects etc, or in the process of the labour that goes into making bricks, concrete, timber, tiles etc. So straightway some £30 million or so comes back as taxes and NI payments. The bricks, concrete etc attract VAT when they are purchased. So that’s probably another £10 million or so going back into government coffers. That revenue is classed as current revenue so it reduces the ‘current deficit’.

Then that remaining £60 million gets spent and respent in the economy. At every stage taxes are levied. 20% VAT, corporation tax, capital gains tax, fuel taxes, alcohol and tobacco taxes, yet more income tax and NI, plus lots more taxes too that we can all think of. The end result is that nearly all that £100 million goes back to government. At the same time building workers who were unemployed have now found jobs so don’t need to be paid dole money any longer.

Then government can take delivery of those £100 million worth of flats or houses , say about 400 of them at £250k each.  It then sells them to a housing association or  co-operative and gets all its money back. But it’s already got it back anyway! Alternatively it can rent out the residences directly, or via a lease arrangement with the co-operative, and collect the lease or rents, which at present day prices, especially in London, will pay off any interest multiple times. That way it still owns the properties and their value appears as an asset on the government’s balance sheet.

In other words it makes a tidy profit on the deal. And no it’s not necessarily inflationary, when there are unused resources available.  Government will have created something extra for sale in the economy. Inflation has to be about more money chasing the same amount of goods not more money chasing extra goods.

It can repeat the same idea in lots of other ways too. For example, it can extend and modernise the Underground in London. It can start to construct Underground railways in other major cities like Manchester, Birmingham  and Liverpool. The spending is classed as ‘investment’ or ‘capital.’ The revenue from the spending is classed as ‘current’.  The price tag  is not important, providing that the resources are available and unused, and providing  we create useful jobs paying living wages, we can  always afford to pay for them. By creating jobs we are not just investing in infrastructure, but we are also investing in people, enhancing their participation in  society and providing them with the means to support themselves and  their dependents. We can always afford that.

Is this what Ed Balls has in mind?  His Bloomberg speech shows  he knows enough about economics to suggest that he does.

http://www.edballs.co.uk/blog/?p=907

 

Advertisements

11 responses to “How to Balance the Government Budget. The MMT way! (Part 2)

  1. Thank you, Peter, for an excellent article very lucidly explained. If only New Zealand’s Minister of Finance could read it and understand it: “The government is in a very advantageous position when it comes to doing anything in the economy. Unlike you or I, it doesn’t have to borrow money at high interest rates. It can either just create the money or borrow it via the sale of gilts at very low interest payments.”
    Money created ex nihilo by government is called Sovereign Money, and has been well described by Prof. Joseph Huber and also by Positive Money. As long as it’s spent bringing into use labour and physical resources otherwise under-utilised, it’s not inflationary.

  2. There’s a big flaw in the Balls deficit trick, which is that where any entity borrows to fund investment, normal practice is to repay the debt as the relevant asset depreciates, or when the asset is worn out and is scrapped. Indeed, if the debt CAN’T be repaid as the asset depreciates, that’s good evidence that the investment is not viable.

    Thus if government is to fund investment via borrowing, then it can’t borrow an amount equal to each year’s NEW investment: it can only borrow an amount equal to “new investment less depreciation on existing investments”. And at a rough guess that means the NET INCREASE in government borrowing will to limited to 10% or less of each year’s new investments.

    Next: does it really matter whether government funds investment from borrowing or from tax? Personally I don’t think it does. Milton Friedman and Warren Mosler advocate/d that government should borrow NOTHING. I.e. they argue/d that the only liability the state should issue should be base money. I’d be happy with that arrangement.

    However, given that there are two ways of funding public investments, i.e. borrowing and tax, presumably one must be better than the other. Personally I can’t work out which. Inspiring ideas on that topic will be welcome.

  3. It’s a good plan, but aren’t you missing the fact that flat earthers will recognize this as SOCIALISM, an evil they hate even more than MMT.

  4. Ralph.

    The shift in the auto-stabilisers will cover the additional depreciation charged to the current budget. The hope is that the shift in the auto-stabilisers will be enough to match the current expenditure/spending difference, with the saving differential allocated to capital.

    Nobody will be looking at the reduction in asset value in the second year.

    The mediamacro people are interested in the current deficit. Once that is combined with the debt they lose interest. (Guffaw).

    Remember that they are hard of accounting in the first place otherwise they wouldn’t be banging on about the deficit like their lives depended upon it.

  5. Unfortunate title to the blog.

    Capital budgeting isn’t the MMT way at all. Under MMT you’d match the capital budget and let the current budget float – via a Job Guarantee once you’d set the tax/spend at the right level.

    Direct capital spending is more akin to the ‘pump priming’ of Old Keynesians and is very likely to create supply side issues long before we get to full employment.

    Because of course the problem is a lack of ‘effective demand’, not just aggregate demand.

    • Yes that’s a fair point. From a purely MMT POV the deficit, in absolute terms, isn’t important. It just needs to be whatever it needs to be to achieve full employment, or as close to it as possible consistent with having low inflation. In addition, there would be the JG you mention.

      If we ever get there it is unlikely to be in one go, so MMT should have something to say about the intermediate stages. The previous attempt at running the world’s economies along Keynesian/Lernerist lines foundered on the supply side issues you mention leading to higher than acceptable levels of inflation. Although with the world’s political situation as it was in the 70’s it wouldn’t be correct to blame it all on K/L economics.

      If that process repeats itself we’d be in a better position to argue for a modification of K/L principles to include the JG, rather than allowing the neoliberals to have their way again as they started to under Thatcherism.

  6. I should point out that when I talk about the capital budget, I’m talking about structural investment. The type of investment that needs to be done regardless of the current stage of the cycle. That (probably) needs to be taxation matched to make sure the real resources are always free.

    MMT then floats the budget alongside that to offset net-saving requirements in the non-government sector. Whether that spend ends up classified as consumption or investment is less important than whether there is full employment.

    This Labour proposal is just ‘back to the 70s’ pump priming Krugman style. They’ll be back to jiggling interest rates around like JuJu sticks just as soon as possible.

    It’s just not Lernerist at all IMV.

  7. “Whether that spend ends up classified as consumption or investment is less important than whether there is full employment.”

    I agree. There is some validity in trying to separate different types of spending but it is overemphasised .Some economists make too much of the difference. IMO. The most wasteful type of government spending would be on unemployment benefits. It would be better, for all concerned, if government spent a little more in the short term and got something in return in the longer term by creating a job, than spend less and get nothing in return at all.

    Often, though it simply is a matter of opinion as to how spending should be classified. Is spending on education, health, defence, transport, energy… consumption or investment? Ultimately, economically, it doesn’t really matter. All income, for anyone, derives from someone else spending money. Less spending means less income.

    But politically it does matter. So, if the electorate are happier spending on what they consider to be investment, let’s just argue that more types of spending should be classed as investment.

  8. “The most wasteful type of government spending would be on unemployment benefits. ”

    Not really. People will spend the unemployment benefits and do something with their day. Something is always done, but not necessarily something that others would consider ‘work’.

    I think Bill Mitchell suggested in his framing article that it should all just be called ‘investment’.

    • Yes OK! I’ll go along with that.

      PS I was going to ask you about the difference between “aggregate demand” and “effective demand”. I’d always considered the two terms to be synonymous.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s