National budgets are not constrained!

I received a call from a journalist at the Financial Review today asking how the Federal government could afford to run labour market programs given that it might suffer a substantial revenue loss if it cuts back net migration. I told him that irrespective of what happens to net migration and any losses to tax revenue that that might bring (should they cut it back), the Government will always be able to fund any labour market program if it thought that was the best use of its funds. It brings to mind a new theme in this period of turmoil – how can the government keep its programs going while at the same time bailing out all and sundry? Answer: easy, just keep funding them. The national government is not financially constrained and the size of its budget is nothing that can be determined independent of the shortfall of aggregate demand.

The issue was also raised in an extraordinary statement by the Deputy Prime Minister in relation to fulfilling their education promises. Speaking on Sydney radio 2GB last week she said that the budget was being “pounded” and that the Government has to take responsible decisions about their spending priorities as a consequence. The funds at stake are the $7 billion that the Bradley Higher Education review proposed be spent. She told the interviewer that the global financial crisis had limited the capacity of the Government to spend. Sorry, it hasn’t.

It is clearly correct to make responsible decisions about their spending priorities in relation to the state of the economy. But it is clearly incorrect to imply that because the global downturn is demanding increased government spending that somehow this is coming from a given pool of funding potential. It is not – plain and simple. There is no financial constraint on the Federal government other than that which they voluntarily impose on itself.

Let us not forget that the real problem facing the World economy is a lack of aggregate demand. We know this is the case because employment and output growth have fallen. So if it is a problem of aggregate demand, then governments around the World have the capacity to address this shortfall. In this context, direct job creation is an excellent place to start. It is a great opportunity for creating new public spaces again. If the private sector doesn’t want to use the idle labour resources then the public sector can turn this to our advantage with large-scale public infrastructure and community development employment schemes. If already had a Job Guarantee in place (a minimum wage public sector job to anyone willing and able to work) then the real aspects of the crisis would have been attenuated. But it is not too late to do this. A major announcement should be forthcoming!

This is especially so when you read that the OECD is forecasting that unemployment will hit an average of 10 per cent across all OECD countries by the end of next year, up from an average of 6.9 per cent at the start of 2009. The situation in some countries will be much worse than this.

There are many reasons why aggregate demand has fallen and you might be interested in this short talk (video) from former World Bank Chairman Joseph Stiglitz. While I don’t think he really captures the major problems that the pursuit of budget surpluses generated, he clearly emphasises the insufficiency of global aggregate demand which he traces to rising inequality and previous IMF actions. He says more people are poorer now as a result of neo-liberalism yet government policy has set in place conditions that have transferred purchasing power from those who spend to those who don’t. Then despite real incomes falling, the financial engineers have cajoled the bottom income groups into building up unsustainable levels of debt. He is also highly critical of the IMF especially during the 1980s debt crisis where IMF structural adjustment programs ravaged the standards of living of many less developed countries.

Then we come to the talk-fest that is the G-20 Summit in London. You have to shake your head in despair when we read that the G-20 Summit will probably not recommend any co-ordinated fiscal stimulus largely because the European leaders have given up leading. Even our Prime Minister has made statements along the lines that no real detail about stimulus solutions will emerge. Rather, he claims this is for the IMF to decide. But the IMF is not the organisation that should be deciding these things. It is undemocratic and therefore unaccountable. No IMF official has been imprisoned in the past for the damage they have wreaked on unsuspecting civilians right around the globe.

In an ABC On-line opinion piece today, Stephen Grenville argued for serious IMF governence reform:

… The London meeting could agree to very substantially increase the funds available to the IMF … however … If the fund is to gather the very substantial sums of money needed from the full range of countries that can supply it, it will need radical alteration of its governance, and this can only be achieved by similarly radical intervention by the G20 … The fund has demonstrated its inability to reform through internal processes. The task should now be taken up by the G20 leaders – to impose a governance structure which reflects the political realities of today’s world …

At the moment, memories of the fund’s heavy-handed performance during the 1997-98 Asian Crisis seriously inhibit use … [of its facilities] …

But this all begs the question. Most of the countries are sovereign in their own currencies and it is only the stigma that the neo-liberals have placed on running budget deficits in their own currencies that is preventing them expanding employment growth on their own. While a coordinated fiscal response would be useful, it still remains that a sovereign country can buy all the labour that is idle by paying them a minimum wage.

What happens to the financial system is another matter. You might want to read this article The Quiet Coup which is written by a former IMF insider. While I don’t think the author is representing the work of the IMF very well – their approach has been considerably more harsh than he makes out – his evaluation of the problem is worth considering. In particular, he agrees that the role of banking should be to advance the public interest. The author Simon Johnson, characterises the current policy stance as “… “policy by deal”: when a major financial institution gets into trouble, the Treasury Department and the Federal Reserve engineer a bailout over the weekend and announce on Monday that everything is fine.”

He argues that the plans are always influenced by the financial oligarchs and have nothing much at all to do with advancing the public interest:

Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change.

We will skip the “fairness to taxpayers” comment, which as you will know, is an erroneous statement. Taxpayers do not fund anything! Johnson’s preferred strategy, which he says is “what old IMF hands would say: … [is to] … nationalize troubled banks and break them up as necessary.” He wants the Government to force the banks to recognise their insolvency and the best way to do this is via nationalisation. This would:

… allow the government to wipe out bank shareholders, replace failed management, clean up the balance sheets, and then sell the banks back to the private sector. The main advantage is immediate recognition of the problem so that it can be solved before it grows worse.

The US Treasury Secretary clearly is against this option. He told the media in January that “We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system …” Yes he would but with most of the big US banks probably technically insolvent now what option will the US Government have but to put them into receivership (nationalise them) and then try to restructure them before, perhaps, reselling them into private hands.

However, nationalisation is the approach that Sweden took in 1992 when to stop its economic crisis deepening. Nationalisation would not only give the government control of all assets but would also provide a better means of pricing the toxic assets (probably zero price) and would punish the shareholders and bosses who profited in the boom but left the rest of us floundering with the products of their high risk behaviour and flawed decision making. This is preferable to continually protecting the shareholders and executives by bailing them out with public funds.

My friend and some-time co-author Warren Mosler argues that we should “Redirect banking to serve public purpose … [which would] … (a) Ban banks from all secondary markets; (b) Allow bank lending only to serve public purpose; and (c) Do not use the liability side of banking for market discipline.” All good ideas.

But instead the policy makers are falling into the erroneous logic that credit is contrained because banks do not have enough money to lend. I have been at pains to point out that if the Government stimulates the real economy – business firms will soon start seeking working capital and banks will feel confident that they can lend again. It is all traced back to the parlous state of aggregate demand. So bank bailout plans are largely missing the point and have constructed “monetary” policies which do nothing much to stimulate spending. A lot of assets are being shuffled around but very little actual job-creating spending is being done.

This is the challenge for the G-20 and for the Australian government. Spend where it will directly stimulate output and employment.

This Post Has 4 Comments

  1. Henry Ergas, chairman of concept economics writes an article in todays “The Australian” titled: “Rudd on the road to disaster”. In it he declares “Ultimately, all government spending must be paid for from taxes that have high economic costs”. This guy is a trained economist! How is it Bill, that trained economists can misunderstand the very fundamental nature of their own subject? He says that he dispenses advice to telstra – that probably explains a fair bit.

    It appears to me that the functioning of the eonomy has changed quite a bit since, say, Whitlam was in power. Electronic transactions were all but unheard of, to the general public at least. Did the feds back then actually have to physically collect physical paper notes in order to tax? Even then, I guess that their spending would have only been constrained by how fast they could print and distribute new paper.


  2. Dear Lefty

    Henry Ergas is a right-winger who has long been an advocate for privatisation and deregulation. He is not a macroeconomist by training having concentrated on the other side of the discipline – microeconomics. That group of economists are particularly blighted in their understanding of how the real world works. They see the world through the blinkered and ridiculous view presented in the orthodox textbooks which are essentially apologies for the worst aspects of the capitalist system. The lack of concern for the public interest that this type preach is the reason we have this crisis. I could say more about him but I won’t.

    In a modern monetary economy, no government spending has to be paid for by taxes – now or in the future. Anyone who says differently does not understand how the monetary system works.

    There were still bank accounts and various bits of paper flying around to record transactions. There were telephones and other devices (mainframe computers) which communicated decisions. The government has never really printed paper (as you term it) to spend – not in the modern era.

    best wishes

  3. It seems extraordinary then that Whitlam felt the need to engage Khemlani to try to raise funding for national projects. I heard something disturbing about Rudd seeking a petrodollar loan to “pay” for any further defecits.

    I still have trouble getting my head around the idea that the people who have the ability to create money spend at will without any need to earn or borrow first don’t appear to realize that they can – and actually do – do this. Or maybe they do………? No – Rudd, Swan and Tanner et al MUST understand that tax dollars are not paying for anything and must understand that they create money out of the air. Otherwise, it would be like a mechanic who doesn’t understand how a car engine works.

    Could be some upheaval if the public ever thought that it was not necessary to pay near as much tax as they do since it doesn’t fund anything.

  4. Dear Lefty

    There was a difference in Whitlam’s time. Australia was still operating under a fixed exchange rate. The importance of this is that fiscal policy is not free and has to support monetary policy which, in turn, is primarily being adjusted to defend the exchange rate. So if the country tried to use fiscal policy to expand and it had an external trade deficit then the exchange rate would have been under selling pressure. In this case, monetary policy would have to intervene and buy up $AUD and sell foreign exchange in the foreign exchange markets. The problem though is that the purchase of the AUDs led to domestic recession. So you got this stop-go pattern of economic growth. Under those circumstances, governments would “sterilise” the foreign exchange intervention by simultaneously buying bonds (debt) in the local markets when they were buying AUDs in the foreign exchange markets to avoid the domestic consequences of keeping the exchange rate in parity. The sterilisation transaction would pump liquidity into the economy as the foreign exchange transactions were taking it out. The same held in times of upward pressure on the exchange rate except the transactions were reversed: sell debt locally; sell AUD externally.

    But under a flexible exchange rate system which really came into operation in the 1980s, monetary policy doesn’t have to defend the AUD and so fiscal policy can do what it wants.

    Do they get it? I have spoken to the top echelons of each national party and I can conclude they do not understand how the system works. They are advised by orthodox economists who have never been trained to understand how the system really operates.

    best wishes

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