I read an article in the Financial Times earlier this week (September 23, 2023) -…
Earlier this year the President of the European Commission declared that “the euro crisis is a thing of the past” (Source). As with most things the President says the reality is different to his political speak. The latest news is that Germany went backwards in the fourth-quarter 2012 as the on-going fiscal austerity chokes any hope of growth. The data continues to negate the logic that emerges from agencies such as the IMF. In recent days, the IMF, fresh from admitting what amounts to professional malpractice (see – The culpability lies elsewhere … always! for example) – has just published a paper that seeks to classify governments as to whether they are fiscally prudent or profligate. As you will see these concepts might be bandied about in religious meetings but have no meaning in the way the IMF seeks to apply them to the real world economic debate. They are loaded terms that are defined without reference to anything that matters. The problem is that the policy advice that follows from this sort of irrelevant analysis causes massive damage to the lives of people by undermining the capacity of economies to meet the needs of these people.
The New York Times article (January 15, 2013) – German Economy Shrank in Fourth Quarter – said the latest German data showed:
… that the German economy shrank about 0.5 percent in the final three months of 2012, compared with the previous three months. The decline was largely the result of sagging investment by German managers worried about the future of the euro zone.
This article was written in anticipation of the results that were published later than data in Germany.
The detailed fourth-quarter national accounts data will not be released in Germany until February 14, 2012.
Yesterday’s press release from Destatis – German economy withstands the European economic crisis in 2012 – told us that in 2009 real GDP fell by 5.1 per cent. It rebounded in 2010 (4.2 per cent), slowed in 2011 (3.0 per cent) and headed towards zero last year (0.7 per cent).
The detailed Destatis National Accounts data for the – September-quarter 2012 – indicated that the German economy grew by 0.5 per cent in the March-quarter 2012, 0.3 per cent in the June-quarter, 0.2 per cent in the September-quarter, and for 2012 overall 0.7 per cent.
Working with index numbers provided for the three-quarters of 2012 and the overall 2012 result allows one to estimate that the fourth-quarter 2012 result amounted to a real GDP contraction of -0.7 per cent.
The NYTs article quoted one economist as saying:
This idea that Germany is a powerhouse dragging the rest of Europe along with it is a bit of a myth, to be honest … You have a very weak periphery, and a core which is not as strong as everyone seems to believe.
Further, the World Bank has released its latest Report – Global Economic Prospects 2013 – on Monday, which downgrades the more optimistic growth outlook that they had put out last year.
A senior World Bank economist said:
From hopes for a U-shaped recovery, through a W-shaped one, the prognosis for global growth is getting alphabetically challenged. With governments in high-income countries struggling to make fiscal policies more sustainable, developing countries should resist trying to anticipate every fluctuation in developed countries and, instead, ensure that their fiscal and monetary policies are robust and responsive to domestic conditions,
Which goes to the heart of the problem. These multi-lateral agencies do not have much idea at all and perhaps should go back to learning the alphabet before dealing with more sophisticated concepts such as spending equals income and if you cut spending you cut income.
Further, the obsession with the nonsensical notion of fiscal sustainability that these agencies maintain continues to infect the policy process. There is little hope for the unemployed as long as these characters continue to operate in a circular world.
What is this circular world? It is one where you start off with an irrelevant concept and then define other concepts in terms of it (adding more irrelevance) and then pursue targets for the derivative concepts purely in terms of the original irrelevant concept.
So we contextualise the budget outcome purely in terms of a public debt ratio objective and ignore why governments might run budget surpluses or budget deficits as part of their responsibility to advance public purpose including the pursuit of full employment.
This circular world is devoid of any context that matters but in operating in this weird logic space, the policies that emerge create massive damage in the context that is relevant – the labour market (employment and unemployment), the product market (real GDP) and needless to say, the natural environment.
The circular logic justifies governments wasting millions of dollars of national income a day, never to be regained, wiping out billions in personal savings (gone forever) and pushing people into poverty. Millions of innocent children and babies are allowed to die as a result of deliberate decisions taken by governments in the name of fiscal sustainability – defined purely in terms of the irrelevant circular logic.
One of the champions of this circularity is the IMF. My current policy suggestion is that member governments who contribute to the IMF withdraw their budgets and if the IMF asks why, the governments should respond that they are making their budgets more sustainable and adopting prudent rather than profligate spending.
My second piece of advice is that governments do move towards making their budgets more sustainable by ensuring that the budget deficit is unlocked from this circular thinking and targetted at what matters – eliminating unemployment and poverty. In most cases that will require significant increases in the budget deficits and the abandonment of artificial fiscal rules that stop governments from doing that and, instead, which lock them into these nonsensical but disastrous circularities.
A most recent IMF Working Paper 13/5 – A Modern History of Fiscal Prudence and Profligacy – is a classic case of this circular logic that causes so much policy damage.
The paper is very technical and I do not recommend wasting your bandwidth to download it. The interesting thing about this paper is that it attracted headlines in Australia last week because it led to the accusation that the previous conservative government (1996-2007), which ran budget surpluses on 10 out of its 11 years in office was, according to the IMF, the only national Australian government in 50 years that was “profligate”.
This was incredibly ironic. That government’s actions were not only irresponsible because they oversaw massive labour underutilisation for the entire time they were in office and they accelerated the “blame the victim” rhetoric but they also set the benchmark that the current Labor government is trying to meet – to return the federal budget back to surplus.
As we know the current government will fail to do that because the circular logic violates the reality that ultimately drives the final budget outcomes – the growth in non-government spending. But the obsessive pursuit of the surplus has led to a slowing economy, static employment growth and rising unemployment.
We will know more about how the economy ended 2012 tomorrow when the ABS releases the December Labour Force data. Stay tuned for that.
The ABC News analysis of the IMF Report (January 11, 2012) – Howard rejects IMF’s ‘profligate spender’ tag – said that:
An International Monetary Fund (IMF) working paper has examined the financial records of 55 countries, drawing upon what it claims to be the “most comprehensive” database currently available.
It has identified just four periods between 1913 and 2011 during which it identifies “fiscal profligacy” in Australia’s financial policies, and only two of those have occurred in the past five decades.
According to the analysis, both happened during John Howard’s prime ministership – in 2003, and from 2005 to 2007.
The former Prime Minister was insulted and claimed that:
Government spending as a percentage of GDP declined during the Howard years … According to none other than the governor of the Reserve Bank, Australia’s fiscal position is the envy of the developed world … The reason Australia dodged the global downturn was due to the strong fiscal position of the Howard government.
The latter statement is false. The reason we dodged the global recession is because the federal government introduced a large fiscal stimulus early on in the crisis and exploited the multipliers accordingly. The other reason is that the Chinese government introduced a massive fiscal stimulus, which led to a recovery in the global commodity prices and sustained demand for our mineral resources.
What the previous government had done, in fact, made Australia more vulnerable to the crisis because they had overseen the unprecedented build-up in private sector debt. That debt overhang is still impacting on the attitudes of the households and firms (at least those not investing in the mining sector) and is one of the reasons why the government should be running a much larger budget deficit than it is.
The other side of politics, the incumbent government sought to take solace in the IMF report saying that “the Labor government has made responsible spending choices”. Which just goes to show how loaded and inappropriate the IMF definitions of fiscal prudence and profligacy are. The current government is deliberately rendering people jobless because t has been obsessively pursuing a budget surplus at a time when the non-government sector is clearly unwilling (and correctly so) to drive growth at sufficient rates to absorb the more than 12.5 per cent of wasted labour.
The IMF paper effectively clones the flawed methodology developed by Henning Bohn in this 1998 paper – The Behaviour of U.S. Public Debt and Deficits – which is a technical exercise in econometrics with virtually no economic content, although the author would claim he was contributing to the economic theory. But the underlying economic framework is just circular logic with no relevant or applicable context.
The IMF paper opens such:
The terms “fiscal prudence” and “fiscal profligacy” are often used, somewhat loosely, to denote whether fiscal policies tend to lead to a sustainable or unsustainable fiscal position. The latter would correspond, in more academic terms, to whether the government’s intertemporal budget constraint is met-that is, whether the expected present discounted value of all future fiscal surpluses matches the existing stock of public debt.
Which means that:
1. The terms are bandied about at will by commentators.
2. That mainstream macroeconomists have a weird circularity in their definition, which is not even operational. The IMF claims that the “academic” meaning of a sustainable fiscal position is that in present value terms taking into account all future interest rates that there is current stock of public debt is covered by the all future fiscal surpluses.
If you think that concept has any traction then go directly to jail and don’t pass GO!
There is no such thing as an “intertemporal budget constraint”. How would we go about calculating that, even if we were operating within the circular logic. What are the known future interest rates? What are the known future contingencies that will drive the budget outcomes?
Further, the concept of an “intertemporal budget constraint” comes out of micro theory as applied to household. That is, the concept when applied to a currency-issuing government assumes that a government budget is just a big household budget. Clearly, the issuer of the currency is not financially constrained whereas the user of the currency (the household) is. So the conflation is incorrect at the most elemental level.
In the household sense, the concept of an “intertemporal budget constraint” is unmeasurable given we do not have knowledge of all future states. The concept is simple though. A household has consumption opportunities across their lifetime (and we see the concept of a “infinitely lived household” enter the formal papers such is the nonsense that my profession parades as knowledge).
They have a known lifetime income and know what the nominal interest rate and inflation rates will be over this lifetime (so they can calculate a real interest rate).
The idea then is that we solve all possible consumption states to ensure that the preferences for current and future consumption are consistent with how much income one will have available and the substitution possibilities governing using that income now or earning an interest on it in the future.
That’s it. Nothing too difficult. But then you would not want to sit through a lecture on this where the lecturer tries to demonstrate their dynamic algebra and turns what is a piece of nonsense into an agonising exercising in formality that the students get lost in. They get blinded by the techniques (the discounting and integrals etc) and fail to see through the bulls***.
It is easy to see that this notion is totally inapplicable to a currency-issuing government.
The IMF Report claims that:
Although a precise definition of prudence or profligacy has not been established, policymakers, investors, and voters need to take a view all the time, in real time, on whether a country’s fiscal policies are appropriate to support economic growth and achieve other social objectives without causing a fiscal crisis. The focus is on the fiscal stance within the control of the government-usually proxied by the primary fiscal balance (i.e., the fiscal balance net of interest payments).
What would an average citizen say constitutes a “fiscal crisis”? That there was full employment and low inflation and the government was running a continuous deficit equivalent to 3.5 per cent of GDP? I think if we took some polling on that question only the right-wing ideologues in the US Republican party and elsewhere would think that was a crisis.
None of them would be unemployed though.
The reality is that these terms – “prudence or profligacy” – are infestations, which enter the public domains courtesy of agencies such as the IMF who have demonstrated their lack of qualifications to provide input into the policy sphere. These concepts are the work of economists who use models that bear no correspondence with reality.
These models barely have a monetary sector. They talk about unemployment using models without a labour market. Please read my blog – Mainstream macroeconomic fads – just a waste of time – for more discussion on this point.
How is a normal citizen to make up their mind “whether a country’s fiscal policies are appropriate to support economic growth and achieve other social objectives” when they are told by their governments that cutting expenditure will lead to growth at a time when the real economy is in crisis as a result of a lack of spending?
The IMF claim that:
In practice, prudence and profligacy are medium-term concepts. Neither prudence nor profligacy is built up overnight: one or even a few years of expansionary fiscal policies do not necessarily cause a fiscal crisis, if a government’s initial position is sufficiently strong. Conversely, one cannot expect that, in real life, people will wait until infinity to check whether the intertemporal budget constraint is met. A few years of sustained deficits could well suggest that the intertemporal budget constraint is at risk. Thus, judgments regarding whether prudence or profligacy prevails are necessarily made over the course of a few years.
The terms “prudence and profligacy” are the sort of words you would read in the bible and be battered with by some evangelical impostor who is predicting the end of the world unless we stop having sex and imprison males or females who happen to like having sex with the same sex.
They are loaded terms. Prudence sounds good and profligacy sounds wasteful and bad.
So what is prudence and profligacy measured against?
From any reasonable standpoint, wasteful would be a fiscal position that allowed millions of people to be unemployed and not contributing to the national income of the nation. That would be a state where the daily losses in national income would be enormous.
With willing labour resources, the only sustainable fiscal position would be to ensure there was sufficient spending in the economy to generate enough jobs to match that willingness on the supply side.
So maintaining mass unemployment would be profligate behaviour by a government. Mass unemployment is the single largest waste that an economy can suffer.
Which means that by any reasonable standpoint, prudence is ensuring there is no waste of real resources (and no over-use to meet the objections of those who think I am a manic pro-growth advocate – wait for Part 2 of my Modern Monetary Theory (MMT) and environmental sustainability).
These interpretations of the concepts are also meaningful in terms of what budget deficits are and what they can achieve. So they have traction with the purpose of net public spending.
That purpose is not tied in any reasonable sense to a public debt ratio, which is a meaningless financial construct. The purpose of net public spending is to advance the welfare of the citizens.
I know most Post Keynesians even think there is a limit on how much outstanding public debt a nation can endure. I don’t think there is a limit. First, the private bond markets do not call the shots in the case of sovereign nation. Please read my blog – Who is in charge? – for more discussion on this point.
Second, the central bank can ensure that interest rates stay at zero or close to indefinitely. So there can never be an inevitable blowing out of interest service expenditure. The point is that there would never be an issue paying the interest for a currency-issuing government but the scale of payments could strain the real resources of the nation if the central bank allowed yields to be determined at all times in the private auction markets.
Third, a currency-issuing nation never is in danger of financial insolvency.
Fourth, an peripheral to these issues, such a government never needs to issue debt anyway so the discussion is tied into the circular logic from the outset – that is, it assumes there is a financial constraint on the government (because it is asserted to be just a “big household”) that cannot be overcome. That is the starting point of the circularity.
The IMF has different ideas (following the Bohn approach).
While admitting that “the economics profession has not yet developed a universally accepted indicator of fiscal sustainability” that doesn’t stop them using the flawed approach from Bohn.
The approach they use is that the primary fiscal position has to be such that the debt ratio is stationary. Further, periods of prudence would occur if “in the event of a shock to the debt ratio, the fiscal policy response would be sufficiently strong to bring the debt ratio gradually back to its initial level”.
So if the private sector spending collapsed and the automatic stabilisers drove up the public debt ratio (both because the deficit rose and the GDP fell) a prudent response would be for the primary fiscal response to go to surplus.
But why would it not be prudent to go into bigger deficit to stimulate growth and deflate the larger stock of debt away with an even larger change in GDP (it is a ratio after all)?
That is one of the flaws in this approach. The framework has recognised problems. The IMF say that “estimated fiscal policy reaction function is too high to be politically feasible or realistic”. Meaning that it melts the economy so badly that it would make no sense to call that behaviour prudent.
I will leave it to you to read the econometric tests and approaches which are interesting. But then so is a game of chess or trying to count the angels on the top of a pinhead.
The point is that the entire discussion of fiscal sustainability cannot be self-referential – that is, defined in terms of some irrelevant benchmark.
The only meaningful discussion about whether a nation is wasting its fiscal capacity or not has to be contextual and that context is the real economy. Invented terms such as a fiscal crisis or sovereign debt crisis have no place in the design of fiscal policy. A sovereign, currency-issuing government can never face a fiscal or sovereign debt crisis.
Please read the following introductory suite of blogs – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3 – to learn how Modern Monetary Theory (MMT) constructs the concept of fiscal sustainability.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.