Home > Uncategorized > Understanding government debts and deficits

Understanding government debts and deficits

from Lars Syll

The balanced budget paradox is probably one of the most devastating phenomena haunting our modern 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.

But the truth is that public debt is normally nothing to fear, especially if it is financed within the country itself (but even foreign loans can be beneficent for the economy if invested in the right way). Some members of society hold bonds and earn interest on them, while others have to pay the taxes that ultimately pay the interest on the debt. The debt is not a net burden for society as a whole since the debt cancel itself out between the two groups. If the state issues bonds at a low-interest rate, unemployment can be reduced without necessarily resulting in strong inflationary pressure. And the inter-generational burden is also not a real burden since — if used in a suitable way — the debt, through its effects on investments and employment, actually makes future generations net winners. There can, of course, be unwanted negative distributional side effects for the future generation, but that is mostly a minor problem since when our children and grandchildren repay the national debt these payments will be made to our children and grandchildren.

To both Keynes and Lerner, it was evident that the state has the ability to promote full employment and a stable price level – and that it should use its powers to do so. If that means that it has to take on 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.

Discussing within which margins public debt is feasible, the focus today 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.

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. February 10, 2019 at 9:09 pm

    We have a national debt because we have a central bank. That is the bottom line and the size of the debt must be in proportion to the quantity of money in the economy. The folks at the Fed will verify this but will not tell you what the proportion must be. Bookkeepers confuse an understanding of the nation’s monetary system with their budgetary approach. Unfortunately, bookkeepers are just not qualified to deal with an entity that creates money. Their techniques are designed for and work very well for entities that use money but they have not the slightest idea of how to incorporate money creation into their bookkeeping columns. From this incompetence of bookkeeping we get the truly big lie in the discussion; that taxes are revenue. By trying to fit the government into the “user of money” category rather than a creator of money, they, the bookkeepers must have revenue to support expenditures and they picked on taxes as revenue. Beardsley Ruml in 1946, who was then Chairman of the Federal Reserve Bank of New York, explained why taxes were not revenue and had not been since FDR instituted fiat money, replacing gold backed certificates in the early ’30s. The influence of a central bank on our monetary system is also a very fuzzy issue not well understood in many discussions. Dr Stephanie Kelton often uses a simplistic view of government spending and taxing. She points out that the government spends and then retrieves some part of what was spent as taxes and that, by this process, the money left in the economy is equal to the national debt. Her simplistic argument is both obvious and reassuring but it is not, in a monetary system with a central bank, what really occurs. In the central bank system that national debt money in the economy is scooped up by commercial banks. Over the period from 1934 to 2016 the assets of commercial banks exceeded the national debt by a few percentage points and there is a good reason for the slight excess. Hence, the money the government spends and does not extract by taxing does not stay in the economy; it resides in commercial bank reserve accounts. I suspect Dr. Kelton is aware of this discrepancy in her arguments and I know some of her colleagues are aware of it because they have mentioned the fact in presentations.

  2. John Hermann
    February 11, 2019 at 1:23 am

    I take issue with Charles3000 on where the net financial assets – what he calls national debt money – created by the central government (when it deficit spends) reside. Firstly the Treasury securities are not primarily sold to banks, although they certainly acquire a substantial share. They are primarily sold to bond dealers and large institutional investors. These buyers merely exchange one financial asset for another (i.e. they exchange narrow state fiat money in the form of reserves – and any deposits associated with it – for the broad state fiat money that is Treasury securities). This authorizes the central government to spend the same quantity of narrow money into the real (non-bank) economy.

    • February 11, 2019 at 2:56 pm

      John, I reference only numerical facts reported by the Fed. Over the period 1934 to 2016 commercial bank assets tracked the national debt very closely. I don’t think you can palm it off as a coincidence. It is a process that is built into the monetary system. Also, in the early ’90s banks, for the first time, held more govt debt than non-banking entities.

      • John Hermann
        February 11, 2019 at 4:06 pm

        ” Hence, the money the government spends and does not extract by taxing does not stay in the economy; it resides in commercial bank reserve accounts. ”

        This is the statement that I object to. The net financial assets injected into the real economy when the federal government deficit spends occupy the depository bank accounts of the government’s payees. These are assets unmatched by any liabilities. In the overall process the banks simply exchange one form of financial asset (reserves) for another (Treasuries), so the banks do not acquire any net financial assets when the government deficit spends.

      • February 11, 2019 at 6:58 pm

        John, I understand where you are coming from but that is not the end of the process. You need to look at what banks actually do and realize that a bank cannot operate if no money is in the economy. Banks make loans continuously. When the loan is repaid the loan amount disappears from the economy and the bank also removes a small amount called interest and that interest less the bank operating cost goes into the banks reserve account. Over time this process removes all deficit spending from the economy into the coffers of the banks. Noteworthy is the fact that the bank assets slightly exceed the national debt. That is understandable when you remember that the government does spend some sovereign money, not borrowed, not from taxes, into the economy. Coins now and historically there were US Notes and silver certificates account for the the bank assets being slightly larger that the national debt.. That is the “debt money” process that many decry.

      • Calgacus
        February 11, 2019 at 10:38 pm

        charles3000: We have a national debt because we have a central bank.

        No, we have a national debt because we have national money. Bank reserves at the Fed, FR notes, Treasury bonds are all national debt, all national money. Money is credit/debt.

        charles3000: Hence, the money the government spends and does not extract by taxing does not stay in the economy; it resides in commercial bank reserve accounts.
        &
        John Hermann:The net financial assets injected into the real economy when the federal government deficit spends occupy the depository bank accounts of the government’s payees.

        No, they don’t. If you deposit your government check or cash in a bank, the bank gets the reserves / state money, you get the bank account. That’s why “government spending resides in commercial bank reserve accounts” – because people deposit government checks in banks, not because of some complicated process or interest payments. Saying it is “in the economy” or not “in the economy” is a matter of semantics. In any case the money of the former government check holder / current bank account holder is “in the economy”.

        John Hermann:These are assets unmatched by any liabilities.
        Never true; a contradiction in terms. Bank accounts are your asset, the bank’s liability. Reserves at the Fed or FR notes are the holders asset, the Fed’s liability. Treasuries are the holder’s asset, the US government’s liability.

        John Hermann:In the overall process the banks simply exchange one form of financial asset (reserves) for another (Treasuries), so the banks do not acquire any net financial assets when the government deficit spends.

        It is right to ignore the shell game of exchanging treasuries for reserves, which doesn’t change anything. But as above, people depositing their checks in a bank does. That makes banks acquire most of the government’s deficit spending, whether held as reserves or Treasuries.

        Bookkeepers, Kelton, MMT thinkers aren’t telling simplistic stories. They’re telling the truth down to the last penny. A common mistake is making things so much more complicated than they really are.

      • February 11, 2019 at 11:11 pm

        I believe the MMT people agree that deficit spending increases bank reserve accounts, enabling them to lend more. The process I described isn’t very complicated and it can be described mathematically rather easily. Interest is a somewhat sneaky issue. For any commodity other than money we would call it rent and the sneaky part is that the rental fee is in the same units as that which is being rented. Would you agree to rent 10 cars for a year with an obligation to repay 11 cars and the 10 being destroyed? Warren in her book quotes Dimon as telling her that banks need a shake down period ever 5 to 7 years. Warren did not believe him but Dimon is correct and a math analysis shows that he is correct.

      • Calgacus
        February 11, 2019 at 11:24 pm

        But the reason why deficit spending increases reserves is simple. It is because people put government checks in bank accounts. If they got paid directly in cash, or cashed their checks at banks rather than depositing them, then it would do nothing for bank reserves or holdings of Treasuries or other NFA. Interest paid by non-government entities cannot have anything to do with it.

      • John Hermann
        February 15, 2019 at 7:07 am

        The reason why bank reserve assets track government deficit spending is that deficit spending embraces (a) the shell game of exchanging newly created Treasuries with reserves, (b) new retail deposits of bank credit money (deposit money) created by the banks in response to Treasury’s directions – the payees’ new assets, (c) new bank liabilities, as the reverse aspect of those deposits, and (d) new reserves created by the central bank, which are assets of the payees’ banks (matching the new liabilities).

        The new deposits owned by the payees are unmatched by any liabilities within the real (non-bank, non-government) economy. In other words, these are net financial assets for the payees. There is of course no change in net financial assets held by the banks.

      • February 15, 2019 at 10:20 pm

        I assume the treasuries/reserves shell game you refer to is the Fed’s OMO. As for the rest of it, the process is much simpler and straight forward. And it can easily be modeled and shown to match historical facts.

      • John Hermann
        February 16, 2019 at 12:52 am

        No, am not referring to open market operations by the Fed. I am referring to deficit spending via the Treasury. The Treasury and Fed work hand in glove in this respect. Whenever the central government deficit spends, it effectively injects a net financial asset (NFA) into the private non-bank sector. This NFA initially take the form of Treasuries created out of nothing, but they are rapidly exchanged for reserves which temporarily become the NFA. However when Treasury engages in the spending, an equivalent quantity of reserves created by the central bank are directed at the payee’s bank (i.e. there is no net change in reserves over time) to counterbalance the liability associated with the newly created bank deposit. The deposit itself (consisting of newly created deposit money, or bank credit money) now becomes the NFA. So the NFA is transformed from one form to another but it never goes away.

      • February 16, 2019 at 4:56 pm

        I do not understand the mechanism by which treasuries”….are rapidly exchanged for reserves …”

      • John Hermann
        February 17, 2019 at 12:09 am

        It’s very simple Charles. A bank pays for the Treasury security with free reserves. The Fed marks down the bank’s reserves account and marks up the Treasury securities account. Its all done very rapidly with computer keystrokes.

      • February 17, 2019 at 12:23 am

        Yes, obvious when a commercial bank buys debt but they do not, by any means, buy all of it.

      • John Hermann
        February 17, 2019 at 1:02 am

        Same story when large non-bank institutional investors purchase Treasury securities from the government. They usually pay for it using bank deposit money, and the investor’s bank commensurately relinquishes the same quantity of reserves. The same exchange mechanism applies.

  3. February 11, 2019 at 1:30 am

    Reasons for budgetary balance are concerned with democracy efficiency that have little to do with economics.

    The unmentioned trillion dollars per year burned by military madness is backed by deficit dollars. Governments should do their jobs patching roads etc. Big jobs by exercise of democracy via bond issues or raise taxes.

    There are consequences to deficit spending; That united states deficit military budget has killed twenty-one million innocent people since ww2. William Blum “Killing Hope”

    • Calgacus
      February 11, 2019 at 10:45 pm

      NO, there is no reason for budgetary balance. Or not to have budgetary balance. It has nothing to do with democracy or how the money is spent. Should the deficit in dollars be divisible by 17? Should it be correlated to whether the Moon is in Sagittarius or not? No.

      Pretty much all you can say flatly is that Government surpluses are logically impossible to sustain, God could not do it. So balanced budgets are a theoretical, ideal, limit, barely possible. And that deficits are the normal and usual thing. Of course they can be too big, or too small. The spending can be criminally insane, as on our military. But that has nothing to do with proper accounting.

  4. Craig
    February 11, 2019 at 8:06 pm

    The problem is we don’t have a way to integrate the insights of both the micro and macro economy…until now with my Wisdomics-Gracenomics.

    It’s true that individuals and enterprise cannot borrow their way out of debt, and its also true that if you don’t have fiscal deficits that the economy will go into recession because people and enterprise save, re-invest savings, depreciation costs in technologically advanced fixed capital economies necessitate relatively large additions to prices and wealthy individuals and enterprises often move large amounts of their savings into off shore tax havens….and all of these reduce the flow of money circulating through the economy trying to liquidate prices in order to keep the economy in a flowing equilibrium.

    So what is the solution? It’s tying a direct and reciprocal price and monetary policy in the form of a high percentage discount to the consumer that is fully rebated back to the enterprise giving the discount at the point of retail sale. This creates an abundant flow of individual income/potential business revenue to the terminal expression point for all forms of inflation and the terminal ending point of the entire economic process,which again, is the point of retail sale. That way you end individual income scarcity and systemic monetary austerity and slay the chronic problem of modern economies, inflation, at the same time.

    Economists are extremely intelligent, but largely being off in abstract mathematical and theoretical focus they have missed the economic significances to be found at the aggregative point of the micro economy and the single integrative point between the otherwise separate disciplines of micro and macro-economics.

  5. John Hermann
    February 12, 2019 at 2:03 am

    John Hermann: The net financial assets injected into the real economy when the federal government deficit spends occupy the depository bank accounts of the government’s payees.

    Calgacus: No, they don’t. If you deposit your government check or cash in a bank, the bank gets the reserves / state money, you get the bank account.

    If you do the accounting of government deficit spending fully then it will all become clear.

    In deficit spending the central bank creates reserves to accommodate the payee’s new bank deposit. The net assets of the bank do not change because the bank also acquires a matching liability. The net result of the process is that the payee acquires a new asset (a deposit containing deposit money, or bank credit money) without a matching liability. A net financial asset has been created and injected into the non-bank private sector by the overall process of government deficit spending.

  6. Helen Sakho
    February 12, 2019 at 2:14 am

    Interesting video. Economists might be “extremely intelligent” but they do always seem to avoid balancing this nurtured gift (unless it has it been gifted to them from above) against realities of the current state of all economies. One wonders, as the case of the UK was taken, if the current Government or any other replacing it were to fund housing, policing, public transport, the NHS, and all other public services for which people have paid taxes for decades, who would go bankrupt? Would they resort to printing plastic money again, and to the tune of how many billions and with what backing? I am assuming here that the cherry picking of the best brains and the most tolerant of physical labourers from other parts of the world would continue, as would the unknown number of undocumented migrants who continue to slave away in the shadow economies of the great Empire…

    And can anyone explain the current state of the Venezuela’s economy? A country rich in oil reserves, starving due to incalculable rates of inflation?

    Bottom line is democratic accountability, which is a political issue. We need to move towards accountability. Globally, but one fears that that will be extremely problematic. The real issues (arms trading, AI wars, surveillance, and the like) are never addressed.

    • February 12, 2019 at 2:26 am

      For years when oil was selling at high prices the Venezuelan bolivar was a great , strong currency and the nation could buy their needs with ease. When oil prices fell, the strength of the bolivar also fell and imports could not be afforded plus the ability and resources to produce their own needs had disappeared. This left Venezuela in its present condition with the USA trying to capture the oil producing rights for the large venezuelan deposits, removing it from state control.

    • February 13, 2019 at 12:09 pm
    • Calgacus
      February 13, 2019 at 4:45 pm

      The biggest controllable problem in Venezuela was their crazy exchange rate system. They were obsessed with fixed exchange rates – as an incredibly inefficient way to provide for the poor. It worked out to be a massive subsidy to the opposition and a way to destroy their currency, increase dependency on imports and harm domestic production. This weakened them enough to become easy prey.

      The solution is simple. Don’t fix rates, let them float. You may want to intervene a little now and then – but just don’t oppose massive, reality based movements. It’s like trying to send your army out in the field – against a hurricane. Mark Weisbrot and other sympathetic economists have been giving them good advice for decades – and it looked like they finally might listen – but they didn’t. Michael Hudson’s take is wrong. Tying it to gold – a barbarous relic – is folly. The only thing a currency should ever be tied to is what it is really always fundamentally tied to – the labor, the productivity of the nation’s people.

      Democratic accountability is not sufficient. The Venezuelan left brainwashed itself into the reverse of the truth. They are fanatical – the word is not too strong – that fixed exchange rates is Marxist, leftist while floating is Milton Friedman capitalism. They needed logic and rational understanding. The Bolivarians have and had a lot of it, except in this one sphere of international trade, which wrecked their other good work.

      • Craig
        February 13, 2019 at 9:57 pm

        The ultimate solution isn’t gold of course, though it might be a tactic that Venezuela and other subservient economies with the encouragement of China, Iran and Russia might employ to outflank the US’s monopoly payment systems. But these are just palliative measures for what must eventually occur and that is a new paradigm in finance and economics that is obviously beneficial for all of the individual, commercial agents and the economic system as a whole, and which paradigm also ends private for profit banking in favor of a publicly administered national banking system guided by an unimpeachable ethic like the NATURAL PHILOSOPHICAL concept of grace as in benevolence. The current system with its obviously monopolistic powers over the most powerful factor in the entire economy, namely credit/money, flies in the face of the wisdom of the dictum that power corrupts and absolute power corrupts absolutely. We need to get real about this.

  7. John Hermann
    February 12, 2019 at 3:02 am

    Charles3000: ” … When the loan is repaid the loan amount disappears from the economy and the bank also removes a small amount called interest and that interest less the bank operating cost goes into the banks reserve account. Over time this process removes all deficit spending from the economy into the coffers of the banks.”

    Most of the bank’s income from interest payments on its loans is spent back into the non-bank sectors in order to accommodate the bank’s many costs (including interest to depositors, shareholder dividends, government tax, salaries and bonuses, contractors’ fees, etc etc).

    Even that portion of interest income that is kept as “retained earnings, or retained profit” is usually invested in government Treasuries, either purchased from bond dealers or outright from the Treasury – and ultimately the reserves received as payment onto the Treasury-Fed balance sheet from such purchases authorizes the government to spend the same amount of new money back into the non-bank non-government sectors of the economy. The bond dealers also spend their profit (from the interest margins of their activities) back into the same sectors of the economy. The overall picture is complicated.

  8. Grayce
    February 12, 2019 at 5:21 pm

    Does anyone believe that the same future “children and grandchildren” who pay off the debt will be the very same “children and grandchildren” who receive the payment? Or alternatively will the reality be an economic redistribution of wealth among “your children” and “my children” with only a mathematical grossing up to make the “society” net of debt?

    • February 12, 2019 at 10:39 pm

      I’m not paying off my Granddad’s debt and my working Grandchildren are not paying off mine. In fact no one will have to pay it off. It is just a number representing the amount of money the government has spent but has not redeemed as taxes.

    • John Hermann
      February 13, 2019 at 1:59 am

      Treasury securities are not really debt at all. The central government never has any difficulty whatsoever in servicing the interest payments — never! And the “debt” may be effectively rolled over in perpetuity. If a bond holder wishes to cash in its bonds at full term, it is usual for Treasury to issue replacement bonds to the private sector (at a price too good to refuse). Better to think of these Treasury securities as a form of “broad” state fiat money, interchangeable with banking reserves – which in turn may be thought of as “narrow” state fiat money. Also do not forget that a government deficit is a surplus for the non-government sectors of the economy, and that the net financial assets created for these sectors by the central government when it deficit spends are essential for the healthy operation of the economy as a whole – allowing its main players to spend, save and invest. The history of central government budgets over at least the past century has been primarily one of deficit spending. This statistic is trying to tell us something important about how the economy operates.

    • Calgacus
      February 13, 2019 at 4:58 pm

      Grayce, yes it can have future distributional effect, but in the cases it is usually brought up, it is quite negligible. Keynes, Lerner, Seymour Harris, Evsey Domar and many others considered such questions long ago. This argument is always used against rational, healthy and sane spending directed at the bottom as for full employment and social services, while larger spending on insane wars and insane X-industrial complexes directed at the top is ignored. Basically – it is worrying about where “the interest” (really more like “the interest on the interest”) is going – while forgetting about where the principal goes.

      James Buchanan and a bit later, other bullshit artists who came up with garbage like government budget constraints were the ones who played word games and destroyed the sound and correct understanding of these issues by those people above. The MMTers have recovered and added to the correct understanding, but IMHO those old guys still have a lot to say, still said some things better. (And the MMTers (Forstater excepted) could do with quoting them more – e.g. Lerner’s work after that article quoted.)

  9. Ken Zimmerman
    February 19, 2019 at 1:02 pm

    Debt is a policy choice, or rather a series of choices. This means debt is a result of power relations which intrinsically operate based on devices for capture, domination, and subordination across all areas of human society, social, political, technological, and economic. Debt is a degrading institutional tool used to control and manipulate all people who are forced to accept it. It alienates society members from one another and from their cultural heritage. And all this is based solely on economic valuations created out-of-sight and in America particularly with little democratic oversight.

    Consider for example, the credit score. In her book “Debt to Society, Accounting for Life under Capitalism,” Miranda Joseph tells this amusingly macabre story about credit score. “The credit score, once a little-known metric derived from a complex formula that incorporates outstanding debt and payment histories, has become . . . so widely used that it has also become a bigger factor in dating decisions. . . . ‘I take my credit score seriously and so my date can take me seriously,’ she said. A handful of small, online dating Web sites have sprung up to cater specifically to singles looking for a partner with a tiptop credit score. ‘Good Credit Is Sexy,” says one site. (Silver-Greenberg 2012)” This is not the end of the story. Credit score is now used in college admissions, for health care, in evaluation of job candidates,

    The level of menacing implications expands when we consider that we’re nearing a point when a democratically elected government can be unseated, thrown out due to the debt it has with outside parties, both other governments and private banks and financiers. Thus far this has happened only in so-called “developing” or 3rd world nations. But consider recently Greece, and before Greece Portugal and Spain. And before this Iran and Argentina. But soon this may also be the situation in France, the UK, and even the US. Then who decides the fate of the world? The richest banks or hedge funds, the richest or most corrupt nations, or both?

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