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.

 

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.

 

Is a Happy New Year Possible for 2016?

In April 2014 I wrote:   Stand by for the next UK crash! ETA 2016

I didn’t use my crystal ball which has never proved very reliable, in any case, when it comes to forecasting football scores or racing results. The reasoning was based  on the rate of fall in the financial position of the UK private domestic sector. It was obvious, then, that serious private sector debt problems would start to arise in mid to late 2015 if government policies carried on as they were.

Two recent articles by Owen Jones in the Guardian and Nigel Morris in the Independent  bear this out. Government policies have indeed been carried on as they were.

There is a very real danger of an economic crash as Owen Jones argues although he doesn’t have quite the right explanation. It’s really not much to do with the need for increased industrial productivity. The productivity of  UK and European industry is higher than it has ever been. Yet the economic problems are worse than they have been since the 30’s. Clearly Owen Jones, much as we might admire his political stance,  is barking up the wrong tree.

Simply, if the UK wants to run a 5% of GDP deficit in its Current Account Balance of Payments, someone has to fund that by borrowing. Usually it is government which has assumed that role but increasingly the burden is being shifted onto the Private Domestic sector.

It may work in the short term but soon the private sector will be increasingly unable to raise the necessary loans especially if there is a fear of higher interest rates, and a general credit crunch in the economy. The words ‘credit crunch’ started to become a cliche of all 2008 financial commentary  just prior to the GFC. We are starting to hear them again on a more regular basis.

It’s not looking good!

PS/Edit

The graphical basis of my concern. A modified screen shot from Neil Wilson’s blog “3poken”.

A Simple Spreadsheet Model of Government Spending

There is no intention on my part to provide Steve Keen any competition for  his excellent Minsky program but I thought I would have a  try to explain some of the economic ideas of this blog in figures rather than just in the usual words, so I put together this spreadsheet. Which you can download  here. (Just make sure that it doesn’t get renamed when downloading. It needs to be called econ.xls for the macros to work). It is quite easy to use.

As spending has to come before taxation we first have to spend some money into the economy. I’ve chosen $500. Just consider the $ symbol to represent whatever currency you like of course.

The recipients of this money are three users of the currency (A, B and C) who receive the above amounts for services rendered. Just to keep it simple we only have these three users in the economy. The payments are decided in a quasi random way in the program so you won’t see the same figures but they should add up to the total spend by the government. Press the RESET button and you’ll see this.

Next, with the Tax level set at 0%, press the second macro button. You’ll see that user A uses his money to buy from user B. Then user B buys from user C and user C buys from user A.

As the tax level is set at 0% the goverment isn’t receiving any revenue so we now need to change this to 20%. Press the RESET.

Press the second macro and each time we’ll see the effect of a single transaction. ( meaning that all three users are buying and selling from each other). Notice that cash assets are equal to the government’s deficit and as the revenue rises the cash assets fall and the deficit falls too. Eventually the deficit falls to zero. We can raise tax rates to 30% or whatever and though the deficit falls faster it doesn’t go into surplus even with high tax rate. Press the RESET.

We’ll next allow our users to put some cash away in a savings account. We’ll allow them $5. As there are three users , pressing Macro button 3# should show $15. We repeat the exercise and surprise, surprise, no matter how many transactions we have, we end up with a deficit of $15.

Of course if I were George Osborne I’d shriek in horror at this $15 deficit
🙂 and call in the Office of Budget Responsibility. They would no doubt advise that the way to restore the spreadsheet to showing a surplus was to cut spending and raise taxes. So we cut spending to $450 and raise taxes to 25% and give the program another go. “That’s odd” George would be thinking “I’ve done what the OBR has advised but still my deficit is persistent!”

Next George could try Nigel Lawson. He knows a thing or two about producing a surplus. He managed it in the late 80’s by encouraging lots of borrowing. That’s what he’d suggest again. So George would type -$20 (minus $20) in the savings account for each user. Press macro #3 and try again. A few taps later on the second macro and Hey Presto! We have, or rather George now has his surplus. If we are one of those users, we are the ones in deficit!

If this wasn’t so serious and wasn’t ruining the lives of our young people this might be all rather amusing.  How is it possible that such a cretin can be paid over £130,000 pa for f***ing up the economy?
………………….
Edit:
“Stuey” (below) asked an important question which might just bear repeating here with my answer.

Q: When I create a debt for the users, government runs a surplus. But isn’t that because the loan would have come from the government in the spreadsheet? Loans usually come from private banks. Doesn’t that make a difference?

A: It doesn’t make any real difference. We can easily put our three currency users into debt by clicking on the third macro.

Say we give them $100 worth of debt and the cash to match. That could be an overdraft at a private bank. So they’d have the debt but an extra $100 of cash ie spending money to start with. We click away on the second macro and the govt has a $100 surplus. Everything looks good – superficially.

If all the users banked at the same private bank the transactions would be recorded in the IOUs of that bank. Except, the tax bill on the transactions would have to be paid from the private bank’s reserves – in real central bank money.

So, at the end of the process, the users are collectively in debt to the tune of $100. The private bank has an asset of those debts but it has also lost assets of $100 from its reserve account. So the PB ends up all square. The debts in the economy remain, however, until they are repaid – unlike in the spreadsheet when they are extinguished by the reset button.

It is this accumulation of private debt in the economy which is the basis of Steve Keen’s debt deflation concept. The problem of increasing private debt levels can only be temporarily fixed by encouraging the creation of yet more private debt. But that’s a bit like a junkie needing a bigger and bigger fix. He needs at some point to choose a healthier lifestyle.
…………………….
PS I do this kind of database (usually Access) and spreadsheet programming in my day job too, usually in an engineering context. If you have any requirements send me an email:   peter_martin_2001@hotmail.com

 

 

 

 

The Job Guarantee, MMT and the Redistribution of Wealth

One important component of MMT is known as the Job Guarantee (JG) or sometimes the Employer of Last Resort (ELR) . The idea is an unemployed worker would be offered a job by the Government instead of unemployment welfare benefit. The job would be for public purpose and pay a basic wage. This would effectively define a minimum wage for other workers too.  There’d be no point working for less than the JG wage somewhere else for example. The government would possibly pay out slightly more than it would in welfare benefits to support these jobs, but it would not be paying out money for nothing. It would be receiving something in return, for the benefit of society as a whole,  and would prevent useful resources, the labour power of millions of workers, from going to waste.

Instead of there being a pool of unemployed there would be a pool of JG workers. Instead of an unemployment rate there would be a JG rate. Whereas government now uses unemployment as a means of inflation control,  a future government would use the JG and the JG pay rate as a means of inflation control. Bill Mitchell likens the JG scheme to one previously used by the Australian government to stabilise the price of wool. It used to buy up wool, which might otherwise have been unsold,  at sales auctions to guarantee a floor price. Then, later as the price of wool might have risen, stocks were sold from the buffer supply to reduce wool prices.

One potential problem is with the rights of JG workers. If they feel they are being asked to work for a lower level of pay than they might consider to be socially acceptable, and also under conditions which might be less than acceptable, do they have a right to join a union and demand higher pay and better conditions? The scheme cannot work too well if that is the case because the minimum wage will then potentially be a source of inflation.

So, the question arises: can we really compare human workers with bales of wool?  Should workers be ‘sold’ from a buffer stock to lower the wages of other workers?  This does not sound, to my admittedly socialist ears,  like an appealing idea!  Trade unions have to have an input into the level of the minimum wage whether or not it is defined by the wage of a JG. Governments may be fair and just in defining a reasonable living wage or they may not be!

It is potentially only a problem if  unemployment is brought down to something like 4% and efforts to reduce it below this figure create inflationary tendencies in the economy. Some of those 4% will be people between jobs but some will be, for as variety of reasons, hard-to-place workers. They shouldn’t just be abandoned but neither should we be too hasty to introduce compulsory work. The meaning of ‘compulsory’ being that there would be no social benefits otherwise.

MMT doesn’t, IMO,  make this point at all clear in its theorising. Bill Mitchell has expressed his view as:

“The existing unemployment benefits scheme could be maintained alongside the JG program, depending on the government’s preference and conception of mutual responsibility.
My personal preference is to abandon the unemployment benefits scheme and free the associated administrative infrastructure for JG operations.
The concept of mutual obligation from the workers’ side would become straightforward because the receipt of income by the unemployed worker would be conditional on taking a JG job…..
I would also allow a person a short-period – perhaps two weeks – in between losing their job and starting a JG job – to sort out their affairs. This period would be covered by full JG pay.”

We can all have our ‘personal preferences’ . Mine would certainly NOT be to “abandon the unemployment benefits scheme ” until such time as we have a genuine socialist society and not just a so-called socialist government in charge of an essentially capitalist society or economy. No economic theory, including MMT, has much if anything to say about the desirability of wealth redistribution. The argument to concentrate on economic growth rather than redistribution, is I would argue, a neoliberal argument in itself. GDP per capita now in the UK is twice what it was in 1979 when Mrs Thatcher first won a general election. It is a similar ratio in most advanced countries too, so Mrs Thatcher cannot have been at all responsible for the UK growth!

Her accusation then,  and from her supporters too,  was  the left was being reactionary in its demands for redistribution and that all economic problems would be solved by having a more productive economy. This might be described as the ‘rising tide raises all boats’ theory. Experience should have taught us that the rising tide may well have raised luxury yachts but not necessarily “all boats”. We have more unemployment now than we had in 1979, more underemployment, more homeless, more people relying on food banks, and the NHS is in very poor shape. Clearly all problems have not been solved and will not be solved, regardless of the level of past and future economic growth, until the question of wealth redistribution is back on the political agenda.

By all means let us establish a  Job Guarantee but let us make it very clear we mean a Voluntary Job Guarantee. We should make sure the benefits of that extra production, that extra economic growth,  are used to equalise wealth distribution rather than those benefits ending up in the possession of the already ultra wealthy as has happened with previous economic growth.  Let’s see how that works out before even thinking about any compulsion.

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.

“We need deficits because people want to buy gilts” – Richard Murphy

Richard Murphy published an interesting  article “On budget surpluses and the economic illiteracy of the Fiscal Charter”  yesterday in which he made several important points such as “we need deficits because people want to buy gilts” and “if the government runs a surplus someone else has to run a deficit”.

Absolutely right and well said, Richard! I hope everyone who’s even the slightest bit worried about our deficit and so-called “national debt” reads this very important piece of what will be ‘news’ to them. Maybe John McDonnell has finally seen the light? There’s nothing wrong with a a change of mind when new evidence and new arguments compel that. Intelligent people change their views all the time as more information becomes avaialble.

The question to be resolved, and I must admit I’m not totally clear on the answer, is if we should sell gilts. Is the fact that people want to buy them a good enough reason to sell them? Why can’t we just allow people to put their money on deposit. Offer the a fixed interest rate, say 2%, and tell them “That’s it. Take it or leave it”.

Some would say 2% was way too high. We should pay 0%. So what will happen then? If we discourage people saving, deliberately creating enough inflation to make 0% , or even 2% very unattractive, we’ll theoretically have no deficits at all.

Because Government Deficit = Savings of the Non-Government

Is that what people really want? Is George Osborne aware that what he needs to do to achieve his surplus is create more inflation and stop selling gilts?

“All of the economic research that allegedly supported the austerity push has been discredited”

I’m not sure if it will help anyone decide how to vote in the British election tomorrow, but I’d say this article by Paul Krugman was essential reading for anyone trying to make some sense of it all.

The main parties are busily engaged in a stupidity competition!

http://www.theguardian.com/business/ng-interactive/2015/apr/29/the-austerity-delusion

Are Government Bonds Just Another Form of Money?

Most mainstream economists would argue they are not. They would say  cash and bonds are not economic equivalents.  They would argue that issued money wasn’t debt but issued bonds were. A common counter argument would run as follows:

“This idea  falls apart at the local gas station…  you can’t go shopping, bar-hopping, or on vacation to Miami with a bunch of T-bills and not notice the difference compared to cash…therefore, they are NOT ECONOMIC SUBSTITUTES. Let’s be very clear here: nominal financial *value* DOES NOT EQUAL purchasing power.”

I’ve quoted here from an on-line discussion I’ve just had on this same topic.

The argument on whether bonds are, or can be considered to be money, has perhaps to be considered on several levels. Of course if we need to pay a £9 grocery bill a (genuine) £10 note will be very acceptable  to the cashier. A £10 bond, were it to exist in paper form wouldn’t be. Neither of us would know exactly what it was worth at the time. If it was close to maturity it could well be worth something close to £10 but if not, it might not be enough to cover the £9 bill. That’s the only difficulty.

The acceptability argument, though, would also fail €500 notes in Europe. They aren’t easy to spend! No-one wants them.  Does that mean they aren’t cash or even money? The best way to get rid of them is to take them into a bank where you have an account and pay them in. The cashier will probably take a note of the serial number in case there is any problem. In that respect a €500 note is no more useful than a paper bond. We’d be able to pay that into our bank account too.

To answer the question we need to consider what money is and why it has a value. To fit in with the concept of financial sector balances, money has to be classed as a liability or a debt to the issuer and an asset to the holder.

So, if we have a closed system of say 100 currency users and their ‘government’ issues 10 currency units to each, the government then has a fiancial debt/liability of 1000 currency units and the users have total assets of 1000 currency units.

The users later switch half their assets to bonds. Say they each buy, at auction, 5 cu of bonds from their government (on the promise that they will be worth, say, 10 cu at some future time) their total assets are still 1000 cu as they can trade the bonds for exactly what they paid for them between each other or even sell them back to the government, if it should have a policy of QE!

The government still has total liabilities of 1000 cu. The fact that it created new IOUs (bonds) and swapped them for its previously issued IOUs (Cash) is of little signficance. If the effective interest rate on those bonds is zero, then zero significance.

The commonly held view that cash and bonds are somehow fundamentally different probably is a hangover from gold standard days. If the government had a policy of backing its cash IOUs but not its bond IOUs with gold,  it would make some significant difference. If gold held in bank reserves by government was counted as a financial asset, then issued money wouldn’t represent any net debt, providing it was always on a strict 1:1 basis.

Of course it is arguable that gold is just a commodity like all the other commodities owned by the government and shouldn’t be counted. But if the mindset is that MONEY=GOLD it’s possible to see the logic of the alternative argument.

Classical economists don’t understand real people or real economies.

There is at last some evidence that the political mainstream is coming around to the idea that  “places {in the same currency zone -PM}  in deficit have to be easily financed by places in surplus”. At least there is,  if we can consider John Redwood, a British Conservative MP,  to be representative of the mainstream. He, himself, may well question that assertion, but nevertheless this  recent quote  shows that it isn’t just Greece’s Syriza and the political left who are making the argument.

John Redwood is, of course, meaning Germany although the same argument would apply to Holland who run an even bigger surplus, as a percentage of GDP than Germany. The Germans were always happy to finance their customers when they used the DM. They’d buy up the treasury bonds of the deficit countries, like the UK and US, and that way their surpluses were recycled to their customers by the process of government deficit spending. So why the problem now? From their POV now, they should be even keener to do that. It would keep “their” trade zone healthy. They could impose conditions , of course, but there would be no reason to impose such stringent conditions as they do.

They seem wedded to the idea that internal devaluations are now needed in the peripheral countries of the Eurozone. General devaluations are no longer possible within the common currency zone. But can internal devaluations work? We know external, or general, devaluations can work. Recently the Canadian dollar has fallen by about 20% against the US dollar. This isn’t particularly noticeable to Canadians until they cross the border into the US. Then they realise that their wages and salaries are now worth 20% less, in terms of US$, than before. Canadian prices, at least the ones unaffected by import costs, such as rents, in are now 20% less too. Imports from the USA are now 100*(0.2)/(1-0.2) =25% more expensive.

This shift is necessary for the Canadian economy to adjust to changing world conditions. But what would have happened if Canadians used the US$? Theoretically,  if Canadians had reduced all prices and all wages by the same amount, and IF spending patterns were left unchanged,  the outcome would be the same. I’ve used the big IF because IF prices were falling fast then the real level of interest rates would be very high, even if they were nominally zero, and which would make it irrational for any individual to spend more than they had to.

But would that have really happened? If Canadian companies had faced falling demands for their products, they would do what all companies do. They’d cut back. But there wouldn’t be pay cuts and price cuts. Maybe just no pay rises and no price rises. They’d lay off some of their staff and stop recruiting others. They would adjust to being 20% (or close to it) smaller in this way. That would be repeated right through the Canadian economy which would end up 20% smaller too. Unemployment would skyrocket and the US media would no doubt be making negative comments about the Canadians, especially if they’d dared say it was even partially the USA’s fault.

That’s exactly what’s happened in Greece, Spain and elsewhere. Except of course it is the Euro not the US dollar which is causing the problem.  Economists, of the classical variety, will argue that this should not have happened.  Some will be in complete denial and will argue that it can’t have happened, or if it has, it must be due to some other factor. Lazy Greeks maybe? They can , of course, show nice mathematical models of how an ideal economy would be able to restore its competitiveness if only people would just behave rationally – according to their definition of rationality. But real people behave rationally as they themselves see it, not how anyone else might see it. That needs to be understood by real economists too. Including real German ordo-liberal economists!

So instead of imposing austerity on countries like Greece and Spain, to force internal devaluations, the Germans need to find some new economic advisers who can come up with some other way to equalise the money flows. Otherwise, their dream of a united Europe will become ever more nightmarish as time passes.