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Rethinking public budget

from Lars Syll

The balanced budget paradox is probably one of the most devastating phenomena haunting our economies. The harder politicians — usually on the advice of establishment economists — try to achieve balanced budgets for the public sector, the less likely they are to succeed in their endeavour. And the more the citizens have to pay for the concomitant austerity policies these wrong-headed politicians and economists recommend as “the sole solution.”

One of the most effective ways of clearing up this most serious of all semantic confusions is to point out that private debt differs from national debt in being external … A variant of the false analogy is the declaration that national debt puts an unfair burden on our children, who are thereby made to pay for our extravagances. Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our children or grandchildren and to nobody else. Taking them altogether they will no more be impoverished by making the repayments than they will be enriched by receiving them.

Abba Lerner The Burden of the National Debt (1948)

Few issues in politics and economics are nowadays more discussed — and less understood — than public debt. Many raise their voices to urge for reducing the debt, but few explain why and in what way reducing the debt would be conducive to a better economy or a fairer society. And there are no limits to all the — especially macroeconomic — calamities and evils a large public debt is supposed to result in — unemployment, inflation, higher interest rates, lower productivity growth, increased burdens for subsequent generations, etc., etc.

Through history public debts have gone up and down, often expanding in periods of war or large changes in basic infrastructure and technologies, and then going down in periods when things have settled down.

The pros and cons of public debt have been put forward for as long as the phenomenon itself has existed, but it has, notwithstanding that, not been possible to reach anything close to consensus on the issue — at least not in a long time-horizon perspective.

In classical economics — following in the footsteps of David Hume — Adam Smith, David Ricardo, and Jean-Baptiste Say put forward views on public debt that was mostly negative. Later on, 20th-century economists like John Maynard Keynes and Abba Lerner would hold a more positive view on public debt. Public debt was normally nothing to fear, especially if it was financed within the country itself (but even foreign loans could be beneficent for the economy if invested in the right way). Some members of society would hold bonds and earn interest on them, while others would have to pay the taxes that ultimately paid the interest on the debt. But the debt was not considered a net burden for society as a whole since the debt cancelled itself out between the two groups. If the state could issue bonds at a low-interest rate, unemployment could be reduced without necessarily resulting in strong inflationary pressure. And the inter-generational burden was no real burden according to this group of economists, since — if used in a suitable way — the debt would, through its effects on investments and employment, actually make future generations net winners. There could, of course, be unwanted negative distributional side effects for the future generation, but that was mostly considered a minor problem since when our children and grandchildren repay the national debt these payments will be made to our children and grandchildren.

Central to the Keynesian influenced view is the fundamental difference between private and public debt. Conflating the one with the other is an example of the ‘atomistic fallacy,’ which is basically a variation on Keynes’ savings paradox. If an individual tries to save and cut down on debts, that may be fine and rational, but if everyone tries to do it, the result would be lower aggregate demand and increasing unemployment for the economy as a whole.

To both Keynes and Lerner, it was evident that the state had the ability to promote full employment and a stable price level – and that it should use its powers to do so. If that meant that it had to take on a debt and (more or less temporarily) underbalance its budget – so let it be! Public debt is neither good nor bad. It is a means to achieve two over-arching macroeconomic goals – full employment and price stability. What is sacred is not to have a balanced budget or running down public debt per se, regardless of the effects on the macroeconomic goals. If ‘sound finance,’ austerity and balanced budgets means increased unemployment and destabilizing prices, they have to be abandoned.

Now against this reasoning, exponents of the thesis of Ricardian equivalence, have maintained that whether the public sector finances its expenditures through taxes or by issuing bonds is inconsequential, since bonds must sooner or later be repaid by raising taxes in the future.

Robert Barro attempted to give the proposition a firm theoretical foundation, arguing that the substitution of a budget deficit for current taxes has no impact on aggregate demand and so budget deficits and taxation have equivalent effects on the economy.

The Ricardo-Barro hypothesis, with its view of public debt incurring a burden for future generations, is the dominant view among mainstream economists and politicians today. The rational people making up the actors in the model are assumed to know that today’s debts are tomorrow’s taxes. But — the main problem with this standard mainstream theory is that it simply does not fit the facts.

Today there seems to be a rather widespread consensus of public debt being acceptable as long as it doesn’t increase too much and too fast. If the public debt-GDP ratio becomes higher than X % the likelihood of debt crisis and/or lower growth increases.

But in discussing within which margins public debt is feasible, the focus, however, is solely on the upper limit of indebtedness, and very few ask the question if maybe there is also a problem if public debt becomes too low.

The government’s ability to conduct an ‘optimal’ public debt policy may be negatively affected if public debt becomes too small. To guarantee a well-functioning secondary market in bonds it is essential that the government has access to a functioning market. If turnover and liquidity in the secondary market become too small, increased volatility and uncertainty will, in the long run, lead to an increase in borrowing costs. Ultimately there’s even a risk that market makers would disappear, leaving bond market trading to be operated solely through brokered deals. As a kind of precautionary measure against this eventuality, it may be argued – especially in times of financial turmoil and crises — that it is necessary to increase government borrowing and debt to ensure – in a longer run – good borrowing preparedness and a sustained (government) bond market.

To view government debts in terms of the ‘functional finance’ concept introduced by Abba Lerner, is to consider their role in the macroeconomic balance of the economy. In simple, bare bones terms, the function of government debts that is significant for the macroeconomic health of an economy is that they provide the assets into which individuals can put whatever accumulated savings they attempt to set aside in excess of what can be wisely invested in privately owned real assets. A debt that is smaller than this will cause the attempted excess savings, by being reflected in a reduced level of consumption outlays, to be lost in reduced real income and increased unemployment.

William Vickrey

  1. Prof Dr James Beckman, Germany
    August 8, 2018 at 1:08 pm

    Lars, I have been left cold by much of this discussion. Witness WWII borrowing, followed by the great American expansion of nearly 30 years. My point: sometimes a government must borrow, as for national defense or other national disaster. Other times a govenment is advised for borrow as for VA & other -insured home loans, a national road system, better health care/education, all of which were a part of my growing up post WWII in California.
    To those who note the US had lots of national private savings, the biggest post WWII thrust was to complete education & build a family. My father moved from Minnesota to California to do just that. There were lots of others. Global savings & the Federal Reserve COULD made this happen even without most of those war-accumulated savings, it seems to me. Crazy advertising to motivate buying was largely unnecessary I think. I recall Trump-type performers such as “Mad Man Muntz” who sold autos & electronics in the 1960’s on. Moreever, he had an engineering sense that perhaps benefited electronics’ merchandising: 4-track stereo for one.

    • Calgacus
      August 8, 2018 at 7:41 pm

      Lerner, Keynes, MMT, Vickrey are not criticizing public debt. They’re criticizing people who criticize public debt, and who understand it incorrectly, by making false, insane distinctions and producing stupendous quantities of nonsense based on them. Public debt and public money are the same thing. Bonds are dollars, dollars are bonds.

      To those who note the US had lots of national private savings,
      After the war. Not before the war, not in 1929. The national private savings was the (internal) public debt, to the penny.

      Global savings & the Federal Reserve COULD made this happen even without most of those war-accumulated savings, it seems to me.

      No. There were no global savings after the war. Everybody owed the US. Again, the war-accumulated savings was the public debt. The Federal Reserve has no such power to make such things happen. It is far, far less powerful than the propaganda makes it out to be. All the Fed can do and did especially back then is exchange one form of money for another by bond trading, by discounting, by monkeying with interest rates. It does NOT really create money. Congress and Treasury spending is what really creates the money = public debt, which was necessary for the stable worldwide expansion.

  2. lobdillj
    August 8, 2018 at 7:27 pm

    Lars, I am so pleased that you included a link to Stephanie Kelton’s YouTube, The Public Purse. I highly recommend that everyone watch it. There are serious misconceptions that are universally accepted by mainstream macroeconomists today in the text of your comment above. It is not clear to whom they are attributable (yourself, Abba Lerner, or William Vickrey). I list these misconceptions here:

    1. A sovereign government, issuer of the currency, must pay for its spending with taxes or debt or both.
    2. Bonds are a means of financing government expenditures.
    3. Bonds are a means to achieve two over-arching macroeconomic goals – full employment and price stability.
    4. In simple, bare bones terms, the function of government debts that is significant for the macroeconomic health of an economy is that they provide the assets into which individuals can put whatever accumulated savings they attempt to set aside in excess of what can be wisely invested in privately owned real assets.
    5. Public debt incurs a burden for future generations.

    Point 1: There is no logical reason why the sovereign must borrow any money at all, and taxes do not pay for anything. The sovereign creates all money in circulation out of thin air by crediting the accounts of all payees with payment. No payment is made through taxes, and there is no need whatever to borrow money to pay. Whatever money is borrowed was originally created by the government (or in our ridiculous and unnecessary system, by Federal Reserve member banks through agreement of the government).
    Point 2: No! The government does not need to borrow. Bonds are paid off by simple creation of money through computer keystrokes.
    Point 3: If there is any benefit to bond issuance it is the security of private assets guaranteed by the full faith and credit of the US government.
    Point 4: See Point 3.
    Point 5: That is a useful lie. The liability account item labeled national debt is only a historical record of government spending (done exclusively through creation of money by computer keystroke entry into the accounts of payees.) There is no way that taxpayers will ever pay off a single penny of this. Taxes received are duly noted in taxpayers’ accounts and the receipts are then sent back into the thin air where they originated.

    The wrangling over the budget has the useful function of using austerity to spend on programs Wall Street and powerful corporations want and to defund programs that benefit Main Street. It is kabuki theater. And as for the claim that the national “debt” must and will be paid, there is no feasible payment schedule by which this can happen. As Prof. Michael Hudson has noted, “Debts that can’t be paid won’t be paid.” (See, for example, his book, Killing the Host.)
    Additionally, if the national debt account contains payment entries labeled “Revenue” it is fraudulent accounting that hides the source of all government spending.

  3. Helen Sakho
    August 9, 2018 at 1:56 am

    Dear Lars, I can tell that you have been at it again! You made me happy temporarily this morning when I watched the video you had posted, but like Prof. James, and further to my comment earlier today, my joy was momentary. I must admit that I have often been warned by a very close friend, a genuine mathematical jewel that insomnia is not good for my health when I do send him pieces of writing to read as “compulsory” in the early hours of the morning. When he and I occasionally “hook up” from Mars, I do ask him if he could kindly disentangle for me mathematical models that I have formulated decades ago and forgotten all about. And he does always oblige promptly and accurately.

    As, I am sure we are all aware, whole concepts such as the nation-state, nationalism, national identities, and all related issues to public versus private domains and markets are being reshaped. A whole host of borders, alliances, threats and counter-threats are being cross fired at key moments in key geographies and non-geographies by leading actors, their agents and their marketing experts. In the absence of states, unions, enduring alliances, and the rest of it, who is going to create the Newest of the new Brave New World? Or, should it be Worlds? I will, once again, make a naïve guestimate. I reckon it is going to be a “Belliwood” this time. In a large, borderless world connected by simple and cheap devices, we can all relax and enjoy the fun really. After all, humour is healing to the body and the soul. But, on this one, I am with Prof. James. I, too, got utterly confused by this discussion and had to re-read through the last comment’s very useful disentangling of the various “misconceptions”.

    The derailment of Economic disputes from main issues that remain unprecedented polarisation – on all fronts, in all geographies remains my key concern. Please do note that I am not including the non-geographies that do not even come into the equation. As I have repeatedly argued, we urgently need a new curriculum. Admittedly, I am now absolutely convinced that apart from perfectly legitimate mathematical formulations, we need two basic components we could test in a mock exam:
    1) What competitive advantage would your village offer to which technological giant to give each family unit a free device and in return for what? Choose from the following options: a big smile on everyone’s face documented in a photograph; a photograph showing the village chiefs distributing free devices to smiling children; or strong bandits fighting over newly arrived boxes of beautiful gadgets that had been delivered to your village of choice free of charge. You do not need to justify your answer.
    2) Do explain, in as much detail as you can, your reasons for your choice of the village. It will help the examiners to determine how up-to-date you are with the latest developments in the field. (Older students are strongly advised to not choose this question and to stick to reading and writing books.) A pass mark is, however, guaranteed for all.

    • Prof Dr James Beckman, Germany
      August 9, 2018 at 2:17 pm

      Bravo, Helen, as I could give this exam in a course in Economic Anthropology, where of course the students generally like/know anthro more than econ. I really, really feel sorry for econ students who want to comprehend “the way things work” in whatever part of the world they live–unless they use their eyes.

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