Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
In today’s Melbourne Age we learn very clearly that the previous Federal Treasurer didn’t have much idea at all about how the economy actually works. While he continues to promote his years in office as the great period of fiscal rectitude, the reality is that after 11 years at the wheel he still failed to create full employment. His Treasury years, in fact, will be remembered for his Government’s wilful neglect of the disadvantaged and the on-going and incredible waste of human potential that this disregard created. Now, as he sits at the back of our Parliament smouldering about his lost chance to rule, he thinks he has something to say about the monetary systems. Its a shame he isn’t clever enough to know how little he knows.
Its also lucky he’s not Treasurer anymore although I cannot say the current incumbent is, on recent statements, any the more enlightened. But the previous Treasurer sat by while two major events (a debt-fuelled consumption boom and then the commodity price boom) made his job easy. Even with a growing economy (which had nothing to do with him) he still couldn’t get the broad labour underutilisation rate below 9.4 per cent after 11 years in office. The same rate averaged 12.4 per cent during his tenure. His lack of creativity is exemplified by his obsessive pursuit of budget surpluses which eroded the quality of public service and kept around a million without enough work.
Anyway, he is still trying to sound important. He begins by trying to inveigle us into accepting the household-government analogy which underpins all neo-liberal macroeconomic fallacies. He said:
I’ve often wondered about those advertisements that offer: “Buy now. No payments for 24 months. You pay nothing until 2011.” We all know that you can’t get a new computer or a new home entertainment system for nothing. We all know that if you pay nothing now that just means when you come to pay for it, in two year’s time, you’ll end up paying more, including the interest charges on all those payments you haven’t made for the past two years … When I first heard Prime Minister … before Christmas urging people to “Spend, spend, spend”, I thought he sounded like a spruiker for a furniture store – but less frank with the customers. There was no mention of when the repayments would start. In fact, there was no suggestion that there would be repayments. It was all so good: immediate consumption without any consequences. Except things don’t work that way.
Well in fact, when you are a sovereign government they do, more or less, work that way! The Federal Government, like any sovereign government that issues its own non-convertible currency (that is, within a flexible exchange rate) is not akin to a household who uses that same currency. The financial options facing each are entirely different.
I have dealt with this before but it is worth repeating – over and over and over again. Spending by private citizens is constrained by the sources of available funds, including income from all sources, asset sales and borrowings from external parties. Federal government spending, however, is largely facilitated by the government issuing cheques drawn on the central bank. The arrangements the government has with its central bank to account for this are largely irrelevant. When the recipients of the cheques (sellers of goods and services to the government) deposit the cheques in their bank, the cheques clear through the central banks clearing balances (reserves), and credit entries appear in accounts throughout the commercial banking system. In other words, government spends simply by crediting a private sector bank account at the central bank.
Operationally, this process is independent of any prior revenue, including taxing and borrowing. Nor does the account crediting in any way reduce or otherwise diminish any government asset or government’s ability to further spend.
Alternatively, when taxation is paid by private sector cheques (or bank transfers) that are drawn on private accounts in the member banks, the central bank debits a private sector bank account. No real resources are transferred to government. Nor is government’s ability to spend augmented by the debiting of private bank accounts.
In general, mainstream economics errs by blurring the differences between private household budgets and the government budget. This errant analogy is advanced by the popular government budget constraint framework (GBC) that now occupies a chapter in any standard macroeconomics textbook. The GBC is used by orthodox economists to analyse three alleged forms of public finance: (1) Raising taxes; (2) Selling interest-bearing government debt to the private sector (bonds); and (3) Issuing non-interest bearing high powered money (money creation). Various scenarios are constructed to show that either deficits are inflationary if financed by high-powered money (debt monetisation), or squeeze private sector spending if financed by debt issue. While in reality the GBC is just an ex post accounting identity, orthodox economics claims it to be an ex ante financial constraint on government spending.
The GBC leads students to believe that unless the government wants to print money and cause inflation it has to raise taxes or sell bonds to get money in order to spend. So when you study mainstream macroeconomics you will typically exit the subject with the erroneous understanding that taxation and bond sales function to transfer “money” (notes and coins!) from the private sector to the government so that the latter then has the “money” in the bank which it can then use to spend.
That is what our former Treasurer is trying to tell us is the case! It simply doesn’t bear scrutiny.
What is missing is the recognition that a household, the user of the currency, must finance its spending beforehand, ex ante, whereas government, the issuer of the currency, necessarily must spend first (credit private bank accounts) before it can subsequently debit private accounts, should it so desire. The government is the source of the funds the private sector requires to pay its taxes and to net save (including the need to maintain transaction balances) as we have seen in the previous section. Clearly the government is always solvent in terms of its own currency of issue.
Blithe to all of this theory, the ex-Treasurer says:
The Government is borrowing money, dividing it up and distributing it to families. A typical family … would … have received … $2900 since October last year … And there’s no repayment? Well, actually, the Government borrowed this money so it will have to make the interest payments to the lenders. And since it gets all its money from taxpayers, it’s the taxpayers who will foot the interest bill. In the next two years the Government will increase net debt from zero … to about $200 billion. In round figures, that’s $10,000 for each of our citizens and $40,000 for our family of four. At today’s low interest rates, that’s a bill of about $2000 a year for our typical family.
So the desktop calculator on his desk in parliament house was going flat out to do the sums and divisions. Pity there is no conceptual basis underpinning any of the sums.
Well it should be clear the money they are spending is not sourced from the borrowings. I will explain why the Government borrows below. The ex-Treasurer then gets confused “since it gets all its money from taxpayers” – well just a few words prior he said they get the money from borrowing. Not all lenders would be paying tax. But his overall confusion is much greater than this.
It is true that the Government will pay interest on the debt it issues which provides a steady income stream to the private sector and helps maintain aggregate demand (inasmuch as the debt is held by domestic residents). The way the interest will be paid is identical to the way the Government makes any payment. Someone in Government will type some numbers into a computer which will then show up in the bank account of the bond holder and be available for immediate use. When the bond maturity date arrives the Government will perform the same operation (type some numbers into a computer) and take back the bit of paper (and probably “bin it” once the accounting records are finalised). None of these operations are revenue dependent.
But it is a neo-liberal mythology that has spawned terms like “using taxpayer funds”, “funded by the taxpayer” and similar representations as if the tax collections were transported as notes and coins into some shed and then the Government truck goes around there to get the money so they can spend. Absolute nonsense. The “taxpayer” doesn’t fund anything! It might look as though they do but that is just beause the conservatives have planted that imagery into our perceptions. Very successfully I might add.
To put this in more relief – as my friend Warren Mosler likes to point (him being the expert in pithy sayings) “the funds to pay taxes and buy government bonds come from government spending in the first place”. There are no net financial assets denominated in the currency of issue in the private sector until the Government has spent.
Neo-liberals clearly just cannot get their heads around this national accounting fact. You cannot pay taxes in the currency of issue until the Government has spent the currency! The accumulation of private wealth denominated in the currency of issue is the accounting record of the past deficits. All private transactions net to zero and create no new net financial assets.
Why does the Government issue debt then? Regular reader and billy blog commentator – Mr Lefty keeps saying that people just cannot accept that Government would issue debt if they didn’t need to. Well there are reasons that compel them to issue debt which have nothing to do with the need to “finance” spending. They clearly do not need to finance spending. There are also other reasons for issuing debt which relate to ideology, religion and also the desire to provide “corporate welfare” to the investment banks (more about which in another blog some other day).
But the main reason the Government issues debt is to permit its monetary policy targets to be met. Modern monetary policy is typically represented by the short-term interest rate target that the central bank wishes to set as a statement of what it wants longer-maturity investment rates to be. When the Government runs a budget deficit it adds more to private bank reserves (credits) than it takes out (debits). The net result – excess reserves which earn under the overnight rate of interest. In Australia, the RBA pays a support rate on overnight reserves which is less than the target rate (25 basis points).
Banks then try to increase their returns by lending the excess reserves. But of-course, the excess is what we call a “system-wide surplus” which means that the interbank transactions can never eliminate it because they all net to zero. But the competition in the interbank market which has an excess supply of reserves means that the price is bid down to whatever support rate the central bank offers. In many countries, prior to the GFC, central banks paid nothing on reserves which is how the Bank of Japan was able to keep its rate down to zero yet run massive deficits and issue large amounts of debt each day – they just issued less debt than the yen-value of the net financial assets created by the deficits and let the interbank competition drive the overnight rate to zero. Simple but very effective tactic.
So in these situations, the Government has to “drain” the system-wide surplus of reserves by selling debt – which destroys the net financial assets (reserves) and allows the central bank to maintain the liquidity position commensurate with its target interest rate. So Lefty! – debt issuance is about monetary policy and an interest-rate maintenance operation. As you can see the funds that are used to purchase the debt came from the net spending in the first place. Its a “wash” as they say in financial markets.
The Government (central bank) could decide to offer a return equal to the overnight target rate on all reserves. This would immediately close the incentive that the banks have to lend their excess reserves which means that the central bank could maintain control of its interest rate target without issuing any debt at all. Then the net Government spending would just pile up in the banks (after doing what it did).
If this is still a bit oblique, then I recommend you read (or re-read) my blog – Will we really be paying higher taxes?, including the excellent comment from Professor Scott Fullwiler and the companion blog Will we really be paying higher interest rates? for more detail.
The ex-Treasurer finished by invoking the tired old “mortgaging our kids future” argument.
The critical question is: how many years of interest payments are we in for? … Today’s one-off payments of $2900 are going to look feeble compensation against an interest bill that could last for 10 or 20 years. And that’s why I factor in the kids for a share of the interest payments. They’ll still be coming by the time they get into the workforce.
Sorry, the kids won’t inherit any burdens as a consequence of today’s net Government spending unless the current generation use up all the remaining real resources in the World. Then the kids are in trouble. In the same way as current government spending is not revenue-constrained, the interest payments in the future are not revenue-constrained. The Government’s capacity to spend in the future is unaffected by what it is net spending now.
Then we learn why we are so lucky having ditched the ex-Treasurer. He concludes with this nonsense:
One day Treasurer Wayne Swan will figure out that the easiest way to control budget spending is to reduce new expenditure before it starts … I would recommend that families enjoy the Government’s “buy now, pay later” policy because a bill is coming. And it will be a big one … Retailers wouldn’t get away with the kind of sales technique the Government has engaged in. Retailers have to detail the number of repayments, the interest rate and the all-up cost before the sale. You get the choice of whether to take the package. What’s more, if a retailer gives misleading information, the interest payments will be suspended. Try getting that from the Federal Government!
The reason retailers wouldn’t get away with it is because they are dealing with households who are financially constrained. Further, the major misrepresentation that the Government is guilty of is that it knows it is not financially constrained yet pretends otherwise. Exactly the opposite crime to that the ex-dud Treasurer is accusing them off.
But the real message from the article is that had the previous Government scraped back into office they would not have met the crisis head on with large-scale expansionary policy. When you are staring down the barrel of a 5 or 6 per cent output gap at least, which will mean that before long, you will have more than 20 per cent of your willing labour resources idle in one way or another, then “reducing new expenditure before it starts” just isn’t an option. At least the current lot have understood that even if they are struggling to understand the importance of large-scale public sector job creation right now.
Anyway, the ex-Treasurer is gone and cannot do any more damage.
Oh lucky us!