Monthly Archives: April 2016

Governments should spend more and tax less to reduce their deficits.

There’s no mistake in the title! To understand economics as it works at the macroeconomic level means we cannot just assume that what works for us as individuals or households also works for currency issuing governments like the UK, the USA and Australia. At first look,  it’s almost as if we have gone down the rabbit hole and we really are in a parallel universe. It is tempting to quote Lewis Carroll’s Queen in “Through the Looking Glass”:

“Why, sometimes I’ve believed as many as six impossible things before breakfast.”

But Alice was quite right in saying:

 “one can’t believe impossible things.” 

We just need to look at the problem from the right perspective to make sense of it all. Any currency issuing government, such as the USA, the UK, or Australia  need never have a Greek type debt problem providing it understands how its own economy works.

The government deficit can be expressed as:

Govt Deficit = Savings of Everyone Else = Private Domestic Savings + International Savings

or

Govt Deficit = Private Domestic Savings + BOP deficit(trade)

In other words, if everyone else in the world wants to save in US dollars, UK Pounds or  Australian dollars which they must if want to sell these countries more stuff than they buy from them, then the governments, or the Private Domestic Sectors in these countries, have to run a deficit.

If the Governments try to reduce their deficits by cutting spending and raising taxes then all they will do is force their economies into recession or even depression.

If they do really want to reduce their deficits, they would have to discourage everyone else saving. In the UK, that would include overseas trading partners who sell to the UK more than they buy from the UK and save the difference.

The way to do that would be to keep interest rates low and engineer some inflation, just a few % should be enough,  into the system – by increasing government spending and reducing taxation. So, perhaps counter intuitively, the way to reduce the government’s deficit in the longer term is for it to spend more and tax less in the shorter term.

Note: I’m not arguing that governments should make deficit reduction a primary object of economic policy. The government’s fiscal policy should always be aimed at steering a sensible middle course between having too much inflation on the one hand and too much unemployment and too many business failures on the other.

But, inevitably, there will always be those neoliberal types  who focus on the government’s deficit. They always seem bewildered that it doesn’t change in the way what they expect it to, and this article is an attempt to explain why.

 

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A High Pound, a Healthy Economy, Low Deficits: Pick Any Two from Three!

We all might like to have: 1) A high pound 2) Close to full employment with a healthy growing economy 3) Low government and trade deficits or even surpluses. But, are all three even possible simultaneously? If we have to choose just two which one should we leave out? For most people, there is no simple answer but if we better understand the way our economy works we will at least know what the options are from all political perspectives. Including the second option, of a healthy economy, should be a “no-brainer” for politicians right across the political spectrum. Businesses need a buoyant economy to make profits just as workers need a buoyant economy to find decent and well paid jobs. But is it? The quest for a balanced government budget seems as distant a goal as ever, but the connection to that other largely forgotten deficit, in trade, is rarely made.

Previous generations understood, what we seem to have forgotten, that if any particular country, as a whole, has a net deficit trading position with the rest of the world then either the government of that country, or the inhabitants of that country, has to fund it by borrowing. In other words, the internal deficits run by governments, and the extent of the private sector debts which can accumulate in the economy, are directly related to the external deficits caused by a trade imbalance. We can see that countries such as Germany, Switzerland, Holland and Denmark which run large trading surpluses do not have any of the public or private sector debt problems* which we see in the UK or USA which run large trading deficits. Unfortunately, though, the solution to world debt problems cannot be for everyone to run a trading surplus!

If we do wish to ensure the third option, of low deficits, is included in our choice we need to understand that both government and trade deficits have to be kept low. Transferring the burden of debt, as seems to be the wish of George Osborne, necessary to sustain the current UK trading imbalance, from government to the private sector is going to do less than nothing to solve the economic problems of the country. If he wants to reduce his government’s deficit, without crashing the economy by imposing an unrealistic debt burden on everyone else, he has to acknowledge that this can only be done by reducing the trade deficit too. He has to start to tackle the problem from both ends by nudging down the value of the pound. Including the low deficit option means we have to then choose between having a high pound and a healthy economy.

We can see for ourselves what happens when a country like Greece is stuck with a currency which is too high to suit its economic capabilities and yet it is forced to attempt to balance its books. The economy crashes! Or, we can choose a high pound, a healthy economy and have a more relaxed attitude to the twin deficits. There are many economists who present a good case for selling as much debt (government gilts) as is possible and recycling the proceeds back into the economy with increased deficit spending. Some debt can also be sold to the central bank in what has come to be known as People’s Quantitative Easing. Providing inflation is kept under reasonable control there should be little or no problem.

We can also have a more relaxed attitude to the build up of private debt (if we know what we are doing!), but we should appreciate the difference. Government debt, unless it is in some foreign currency, doesn’t have to be repaid in the same way. The accumulation of too much private debt, though, can lead to economic busts to follow the initial boom created by the increase in bank lending. Tory chancellors starting with Tony Barber and later Nigel Lawson were fond of shifting the debt ‘burden’ from government to everyone else this way. We had the Barber boom, then the Lawson boom. The recession of the early 90’s should have been termed the Lawson bust. Later the supposedly more socialist Gordon Brown boasted of his economic prowess by delivering a government surplus around the turn of the millennium. Simply created by allowing too much private sector borrowing, unfortunately!

Most of this posting, so far, is entirely apolitical in nature. The same economic constraints apply whatever the political complexion of the society or economy involved. It is natural we might have different ideas and opinions over the ideal size of government. It is fair enough to argue for a more socialist approach to the distribution of available wealth and income or a more conservative approach. What is not fair enough, though, is for the political right or neoliberals (who are unfortunately not confined to the Tory Party) to wreck public services like our NHS, and our economy, for some nefarious purpose, or in some misguided attempt to reduce the government’s deficit, by cutting government spending and raising taxation without taking into account everything else that changes when they do that. All they’ll do is crash the economy – again! Judging by the economic storm that is brewing, the powers-that-be haven’t learned from past mistakes and it looks very likely we are seeing the start of yet another very severe financial crisis.

* A country with a large trading surplus is unlikely to have its Private Domestic Sector in overall net deficit. Although this is theoretically possible if Government insists on running an even larger surplus. But the net position can still hide localised high debt problems within the PDS.

Footnote: Some MMT supporters might argue that the tone of this article is more Keynesian than MMT. I accept that criticism but I originally wrote this with the promise from the editor of LabourList, Peter Edwards, that ‘sensible’ articles on economics would be accepted. He’s not explained why but he’s still managed to reject it! So I do accept that I attempted to temper the tone slightly!

Nevertheless I’m posting this up here as the start in a series of articles which are aimed at those who might be immediately turned off by a more strident MMT view  (such as the Govt can never run out of pounds etc) , but at the same time ensuring that the arguments are technically correct.