This is Part 2 of my little mini-series on what we might conceive fiscal sustainability to be. In Part 1 we considered a current debate on the National Journal, which is a US discussion site where experts are invited to debate a topic over a period of days. By breaking the different perspectives that have been presented to the discussion, we can easily see where the public gets its misconceived ideas from about the workings of public deficits and the dynamics of the monetary system – its leaders. My aim in this 3-part series is to further advance an understanding of how a fiat monetary system operates so that readers of this blog (growing in numbers) can then become leaders in their own right and provide some re-education on these crucial concepts. So read on for Part 2.

Greetings from Amsterdam where I am spending the next few days talking about what drives spatial changes in unemployment at a Tinbergen Institute regional science workshop. The spatial econometric work that I am outlining tomorrow provides the conceptual framework for the construction of the Employment Vulnerability Index, which received a lot of press earlier in the year. But while I was flying over here I thought about the concept of fiscal sustainability which is now getting a lot of press. So this is the first of a multi-part series on what constitutes a sustainable fiscal policy. Its that time again. Time to debrief!

There has been a lot of E-mail traffic coming in after my blog on The Greens the other day. At the heart of the matter is the fundamental difficulty people have in appreciating that there has been a fundamental shift since the 1970s in the way our monetary system operates. This shift redefines how we should think about macroeconomics and the role of a national government which issues its own currency. The defenders of The Greens economic policy clearly misunderstand this historical shift. To really get to the heart of how a modern monetary system functions you have to appreciate the difference between a convertible and non-convertible currency and a fixed versus a flexible exchange rate system. The economics that apply to convertible currency-fixed exchange rate systems bears no relation to that which applies to the fiat currency-flexible exchange rate systems that prevail in most economies today. So before you attack my macroeconomics, make sure you understand what a government can do in a modern monetary paradigm. Otherwise, you are a dinosaur and they became extinct.

There has been a lot of talk lately about the need for the Government to plot a course over the coming years back into fiscal surplus. Our perceptions of fiscal responsibility are being conditioned by the relentless media campaign that this is the best thing for the Government to do. We are being told that cyclical deficits are unavoidable at this time but the “structure of the budget” should point us back to surplus as soon as possible. This campaign is being supported by official looking documents that are produced by Treasury (notably the Budget papers) which have all sorts of technical terms in them that only the cognoscenti understand. The term structural deficit is being touted around in these documents and appearing in the opinion columns. But the way this concept is being represented is very misleading and is deliberately being used to obfuscate the lack of intention by this Government to seriously pursue full employment. Well lucky for me I am part of the cognoscenti and cannot be so easily fooled. Here is the truth.

On Friday, April 24, 2009 there was a story in the Australian entitled Deficit spike may lift rates as Government considers $300bn debt blowout which introduced the next step in the neo-liberal fight to retain control of the policy debate – the dreaded ratings agencies. Accordingly, the Government spending (wait for it) … “blows out the deficit” and this will “jeopardise Australia’s triple-A credit rating, leading to higher interest rates.” So if you cannot win the “crowding out” battle to justify an attack on deficit spending its time to wheel out those credit rating agencies to scare the children of our land. As you will read this sort of reasoning is nonsensical in the extreme.

Policies such as Quantitative Easing which has been in the news lately are predicated on a mistaken belief about the way the banking system operates and how the non-government and government sectors interact. One of the hard-core parts of mainstream macroeconomic theory that gets rammed into students early on in their studies, often to their eternal disadvantage, is the concept of the money multiplier. It is a highly damaging concept because it lingers on in the students’ memories forever, or so it seems. It is also not even a slightly accurate depiction of the way banks operate in a modern monetary economy characterised by a fiat currency and a flexible exchange rate. So lets see why!

The dreaded NAIRU is still about! I was thinking – rather optimistically – that it would just disappear from whence it came! But sorry to disappoint. Some economists just won’t learn. Yesterday the ABS released the latest data from the Australia Treasury Model (TRYM) database. You can get it here. Among other things of great interest that you can find in that database, is the Treasury TRYM model’s estimates of the so-called NAIRU. Sounds scary. Well, it stands for the the Non-Accelerating Inflation Rate of Unemployment and has a central place in neo-liberal mythology. The NAIRU is an important component of the TRYM model and influences the way it produces economic outcomes and policy simulations. So how much reliance should we place on this important component of the policy making process. Answer: not much!. My conclusion: any model that relies on a NAIRU is a crock!