Tag Archives: Government Spending

We need to balance the Budget over the Business cycle as Keynes suggested, right?

(This article first appeared in Liberal Democrat Voice)

Firstly, we do need to ask if Keynes did suggest that. There are arguments either way on this point.  Keynes’ view unfolded and developed starting in the bleak 1920’s in Britain. There was no “roaring twenties” for the UK economy as the government deflated the economy to try to fit the Pound back on to its pre war Gold  Standard. Keynes then did argue that governments should run deficits if private spending declined and reduce those deficits when future growth was strong enough. This has been interpreted by many that his intent was that the budget was to be more or less balanced over the business cycle. If anyone is keen to research into his thinking they might like to start with his 1924 publication “A Tract on Monetary Reform”.

A better approach might be to try to understand why Keynes should made a break from tradition and start to advocate that budgets should at times be unbalanced. If we consider an economy which is neither a net exporter nor a net importer and in which everyone spends what they earn within the economy, Government spending and taxation must balance. This is true regardless of the level of taxation imposed (providing it is finite) and so regardless of the level of inflation within the economy. It has to, according to the principle of sectoral balances originally developed in the 60’s and 70’s by the late Prof Wynne Godley at Cambridge University.

If the participants of the economy don’t spend all they earn, ie when private spending declines,  we can have a tendency to recession. Keynesian economists would point out that prices and wages tend to be “sticky” and so don’t respond quickly to changing circumstances as more classically minded economists suggest they should. Therefore, Keynes was quite right to suggest that the Government should spend  more, or tax less,  to prevent recession from occurring. The government needs to borrow money from the savers and spend it on their behalf. Later, when the savers withdraw their money from the bank, or empty their piggy banks, and spend it, the Government needs to run a surplus in its budget to prevent the economy from overheating and inflation occurring. So the budget does indeed end up balanced over the cycle. It ends up being an approximately symmetrical pattern when expressed graphically.

This relatively simple model may have been adequate for the UK economy in the 1920s. However in recent times the extent of saving and desaving hasn’t been symmetrical over the business cycle. When times are good people may borrow and spend more but equally they may put more aside for their retirement. So if the spending/saving/borrowing pattern of the population isn’t symmetric over the business cycle, neither can we  expect the government to run a balanced budget over the business cycle. Instead of imports and exports balancing,  our economy has something like an annual  5% of GDP deficit in its current account. Our trading partners seem happy to supply more real things to us than we supply to them. They take our IOUs in the form of treasury bonds or gilts to make up the difference. In effect they are like a big net saver within the economy. As Keynes pointed out,  if people are saving more, and that includes our trading partners, the Government has to be spending more or taxing less.

The ‘balanced budget over the cycle’ is really just a special case which does not apply to our own 21st century economy. If we try to force the Government budget into balance, at the same time ignoring the trading position and the willingness or otherwise of the economy’s participants to net save then we are courting economic disaster. The budget will not balance, no matter how hard we try, and we will end up like a dog chasing its own tail as the economy spirals ever deeper into recession.


Where does the Money come from in a Monopoly game?

It has been some time since I last played Monopoly. The Board Game.  As I remember we have several players and a banker who assumes a similar role to government in our economy. He hands out money at the start of the game. Whenever we pass GO, or draw a lucky card from the community chest we get a bit more. He charges us tax,  super-tax, and might put us in jail from time to time.

We don’t like it when that happens, but where does the money come from in a Monopoly game? The more right wing players might argue it comes from other players when they land on the their Mayfair or Park Lane properties which have houses and hotels on them! They like to think that wealth creates money rather than the reverse. But those of us who take a wider view know it all comes from the banker originally.

The government/banker is always in debt. He has to be. His debts are the players’ monetary assets. Penny for penny. Would the game work at all if he insisted on always balancing his budget?

PS Apologies if this is a statement of the bleeding obvious! But, many of our highly educated (over-educated?)  politicians still seem to be in need of such.

Want to reduce your deficit, Mr Osborne? Stop your boys burning those £50 notes* !

* Or at least ask them to tell you about it!

The Oxford University based Bullingdon club has attracted controversy of late, in large part  due to certain unsavoury practices  indulged in by its young, privileged, elitist but poorly behaved members. Their current initiation ceremony is reported to include the burning of a  £50 note in front of a beggar or homeless person.


Former members of the club are now a well ensconced part of the UK political establishment. These include the current Prime Minister Mr David Cameron (In photo, second from the left standing) , the Chancellor of the Exchequer Mr George Osborne, and the Mayor of London Mr Boris Johnson (far right sitting)

A key source of worry for our worthy politicians is the UK’s government budget deficit which now runs at approximately 4% of GDP. This is the gap between what the government spends into the economy and what it receives back in taxation.  The budget deficit is often referenced in support of their argument that we are all “living beyond our means”,  that our “credit card is maxed out”, and that cutbacks in spending  and increases in taxes are unfortunately necessary to “cut our coat according to our cloth” etc etc.

So in this context, we might ask just what macroeconomic impact the burning of our currency might have? It is course illegal to deface or destroy currency. Why should that be?

It does have an effect. If these wealthy young men had chosen to give £50 to a homeless person that money would no doubt have been quickly spent. It would have been a stimulus to the economy.  The destruction of £50 has the opposite effect. It is exactly the same as if we had handed that £50 note over to the government in taxation, where the government routinely puts old notes through the shredder.  If Mr Osborne knows of specific instances where currency has been deliberately destroyed he is quite entitled to count that as voluntary taxation. His deficit would be reduced commensurately.

As he can’t know just what happens to our currency he has to assume it still exists and that it is just being saved somewhere. The net effect is still the same. To keep the economy functioning,  at full capacity,  any money which has been taken out of circulation either by its destruction or because it is being stored in a safe or bank account has to be respent back into the economy by government on our behalf. It’s neither here nor there  whether the budget is in deficit or in surplus.

We don’t need to know how much is being burnt and how much is just being stored. If any government overdoes the spending, relative to the levels of taxation, we’ll have too much inflation, but if it underdoes it , like now, we’ll have deflation and high levels of unemployment and underemployment.

The British left needs to discuss more than the UK’s membership of the EU.

As the EU debate swings into life in the UK we’ve so far heard the most from the business sector who have been most pro in their advocacy of the UK’s continued membership. It is perhaps quite natural that big business would like the EU to remain as it is. Those on the traditional left would say that’s because they want to have a large pool of unemployed workers to keep wages down and maintain worker discipline!

Are they correct in saying that? As things are at the moment it is hard to say they aren’t. It is hard for big business to argue that they only want the EU for its expanded, but much depressed, market.

The modern supposedly progressive left has been seduced by the powers-that-be in the EU into thinking the EU to be a socially progressive organisation too. Recent events in Greece, for example, are shaking that view. That needs  to be shaken  some more. A first step would be to get them to actually discuss the problem. We might well think the election of Syriza in Greece, with its band of ex-Maoists, ex- Trotskyites, ex-Communists would be a topic of interest for them. Not so. They are shell-shocked into silence at the moment. The main Labour websites have nothing at all to say on that.

Anyone believing in a united Europe, as many of our EU advocates clearly do, should feel as passionately about unemployed young people in Spain or poverty in Greece as they do about it in the UK. The progressive left  say they like everything about the current level of EU integration, and like the EU as it is. If they ever remember to make a critical comment, it is not because they wish to change anything or intend to vote against any of its measures.

If the UK today had ultra high levels of youth unemployment as the south of the EU currently suffers,  the progressives would never let anyone hear the end of it. Rightly so. There would be marches  from the most depressed areas to London to demand some action.

If the UK had Greek levels of unemployment, and a Greek cost of living crisis which has depressed average real incomes by almost a quarter since 2007, again we would not hear the end of it, as the ‘progressives’ would rightly think it completely unacceptable. If the unemployment in Greece or Spain had been brought about by a right wing military coup, again there would be uproar. So why is it that these people who believe in pan European solidarity have nothing to say about the scandal of poverty and joblessness in large areas of Euroland? Why are they not insisting on new policies for the EU?

Now’s a good time to be saying something about that in connection with the EU referendum. The British left needs to discuss more than the UK’s membership of the EU. It needs to discuss the EU itself too.

Why not give control of the fiscal deficit to the Bank of England?

In a democratic society, I would argue that decisions regarding interest rates, both long and short term, should be made by the elected government. They used to be. However, for nearly 20 years, short term rates in the UK have been set by the BoE. The level of short term interest rates is important and it can be adjusted to stimulate a slowing economy or slow an overstimulated economy. But there are other adjustments that can be made too.

Just as a pilot has all the control levers at his disposal when he’s flying a plane (if he, or she, does hand over to the co-pilot it would be all the controls not just one) then all the controls need to be either in the hands of government or the hands of the central bank.

But just who has the controls when it comes to controversial policy decisions like QE? Does an  independent Bank of England decide, all on its own, to buy up £375 billion of government securities from the private financial sector? I don’t think so!

QE is no big deal. That’s not a common view, I’ll agree, but from a scientific perspective, there seems to be no reason why the issue of government , or the BoE if you prefer, IOUs in the form of cash should be any more or less inflationary to the economic system than the issue of IOUs in the form of gilts (treasury bonds). If it is necessary to buy back gilts from the private sector to control longer term interest rates then that’s what needs to happen.

So why not give control of the fiscal deficit to the BoE too? The BoE could calculate the best combination of fiscal and monetary policy, including whatever level of QE is needed, and tell the government what it needs to do. Arguably the government could decide to raise income tax a bit here or reduce VAT a bit there , etc, but it would not have complete control of fiscal policy as it now does.

This is not my favoured option BTW. But, if the pilot is going to hand over the (macroeconomic) controls to his or her co-pilot it should be all the controls and not just one.

Why do they lie to you?

“When President Obama tells you we are running out of money, that the piggy bank is empty, that is just not true. All economists know that is not true so the question is why do they lie to you?”

Professor L Randall Wray (Sept 2012) (time =3.40)

Of course President Obama is far from alone in giving out the same false message. We hear these kind of comments all the time from politicians, even supposedly liberal and socialist politicians.

Not just in America, but in the UK and other countries too. “Running out of money” is a justification for austerity economics. The UK, Australia, NZ , Japan etc all have sovereign currencies so they can’t run out of money either.

Is it possible that politicians themselves, are not actually lying, but they don’t understand the economic systems they are supposed to be in charge of? Or is it more likely that they do understand them but prefer not to explain them?

Which would be worse?

PS The only justification for not spending more would be if employment was as high as it could possibly be. If all industrial plant and machinery was working at full capacity. In that case spending more could generate  inflation. If that’s their worry then the politicians and their economist advisors should say so

A Simple Four Sector Model of an Economy

MMT incorporates sector models, which date back to Keynes and play a role in neo- and post-Keynesianism, of the economy which gives, IMO, a key insight into the way a typical sovereign economy may function. The  model usually used is one of a three-sector model, government, the private sector and a foreign sector as ‘rest of world’.

There is an aggregation of individual accounts into overall national accounts. According to the principles of double-entry bookkeeping, all financial assets are another’s financial liabilities. All accounts together – private, public, foreign – sum to be  zero. In a three sector model at least one of the three has run a net surplus, while at least one of the other two has to run a deficit.

In principle the division can be of any number from two upwards. This model divides the private sector into the active economy where the money supplied to it changes hands at least once in the course of an arbitrary time period, say a month, and stored private money where money doesn’t change hands, or  if it does, moves from one account to another in a way that does not affect the active economy.

The active economy is where people earn their living, by selling their labour power, and buy  commodities which are the necessities of life. It is the one that matters to most people but  of course does not exist in isolation.
Stored private money would normally be tied up in savings accounts, long term investments such as government bonds, but equally it could be stored as cash under a proverbial mattress or even in a child’s piggy bank. Active money is the sort normally held in our current, or checking, accounts, and in our purses and wallets.

economy2The model shows that Government Spending, Withdrawals and Loans and Exports payments all will add currency units CUs to the active economy and can be considered inflationary

Taxation, Savings, and Import payments will remove money and can be considered to be deflationary.

For illustrative purposes only, the left side table show CU levels at time period t. The right side table shows CU movements.
Starting at time t=0 we can assume zero levels. Further we assume a’ready to go’ economy.
At time t=1 we can conceptualise the ‘kick-starting’ of the economy by a government expenditure of 13 CUs. Simultaneously taxation (3 CUs) is required to establish the value of these CUs. This leaves 10 CUs of fast moving money in the active economy. 10 CUs is the set target.
At time t=2 Government spends an extra 6 CUs, taxes 3 CUs. The private sector saves 2 CUs. There are 1 Cus of exports and 2 Cus of imports.
The position  is still 10 CUs of active money in the economy.
At t=3 Government spends 5 CUs and taxes at 3 CUs. Savings andwithdrawals are both 1 CUs. Exports are 2 and Imports are 3,
This leaves 11 CU’s in the economy. One higher than the target. This can be corrected later or left as is of course.

There are several important things to note from this simple model:

  • Government has a strong influence on the workings of an economy but it is not in total control. Except in special times  like wartime, it would not be able or willing to sufficiently control the savings and desire for loans of the private sector.
  • As stores of money are built up by the private  and overseas sectors,  so too does the level of Government debt. One is the inverse of the other.
  • Wealthier  members of the private sector, and the thrifty members too,  contribute more to Government debt than the less wealthy and less thrifty .
  • Running a continuous trade deficit  increases levels of government debt and/or reduces the stored money of the private sector.
  • Government debt is necessary to create private wealth.

Implications for Real economies
1) The USA

The USA has a total government debt of around $17 trillion.

Of this ~$5 trillion was owned by the overseas sector. ~$5 trillion is owned by intragovernmental organisations ~$7 trillion by the US private sector.

The argument is often made in MMT circles that no matter  what the size of any government deficit, or debt, the government can never involuntarily default. It is the ‘government checks never bounce’ argument’ which is now  well established.

But, if the US doesn’t have a debts problem, could it have an assets problem? Could the size of assets (stored money)  held by the private and overseas sectors ever become so large they threaten to destabilise the US economy? The owners of these assets are could well consider that what we argue are necessary fiscal measures to reduce unemployment levels,  to be highly inflationary. They may well be wrong in thinking that, but is it possible they could bring about that inflation by spending wildly, on anything and everything,  outside of government control, before the $ lost too much of its purchasing power?

A little extra inflation would probably be a good thing but could it get out of hand?

To be continued.