Macroeconomics 101 … not!

Foreign minister Downer displayed his fundamental macroeconomic ignorance yesterday when he was trying to explain to reporters the accounting behind the relief payments the Australian Government is proposing to aid the tsunami victims. Reported on the ABC he said that “the Government will need to dip in to the Budget surplus to provide relief money to areas affected by the tsunami disaster. The amounts proposed are beyond the government’s current disaster relief fund. For reasons I explain below this fund can be nothing more than a notional accounting allocation that the Government considers it will spend each year on disaster assistance. It does not exist in the same way as you and me (as households) might have saving accounts with actual dollars in them in a building society (or bank) each year.

In the case of the Federal Government there is no actual amount set aside in a vault somewhere. It is just an accounting entry reflecting the contingent intention to spend.

If the Government wants to spend it does so by crediting relevant deposit accounts somewhere in the banking system.

The ‘money it spends’ doesn’t come from anywhere in the same way that taxes it raises do not go anywhere. All these flows are accounted for but no actual stocks of ‘money’ are built up or run down.

But Downer clearly doesn’t understand this point and its significant for the conduct of macroeconomic policy (and the government’s ability to live up to its responsibility and ensure full employment).

He was reported by the ABC as saying that the “Budget is strong enough for Australia to give $35 million … Any sensible government, like any sensible household, sets aside some money for the worst imaginable circumstances and in this case the worst imaginable circumstances have arisen and we’ve got the money to do it.”

Excuse me! The government issues the currency, households use it. Fundamentally different roles with different powers. Households have to finance their spending by earning income, borrowing or running down assets. A federal government which issues (as a monopoly) the fiat currency that we call ‘money’ can spend whenever it wants and previous spending decisions do not change that capacity.

When the government runs a surplus it is just destroying more money than it is creating. It is ripping off purchasing power from the private sector.

But while the private sector loses disposable income that could have been spent on consumption or investment (and more jobs), the government’s surplus does not exist beyond the public accounts.

The effects of the surplus exist – in the form of fiscal drag and typically demand-deficient unemployment but there is no stockpile of funds ready to be drawn down for future needs.

There is no money set aside in any ‘tin shed’ in Canberra.

In the case of the government’s decision to increase disaster relief given the scale of the Indian Ocean tragedy, all this means is that they have decided to spend more in the coming months than they had previously planned and so in accounting terms the amount it records as surplus over this period will be lower (other things equal) than it had previously planned.

Nothing more than that.

The Federal Government always has the capacity (the ability to spend ‘money’) to do what they want.

A surplus yesterday doesn’t allow them any more spending possibilities now than if they had run a deficit yesterday.

It is, of-course, another thing to say that it should always spend what it likes – that is, a political decision and is not constrained by any ‘financing’ limitations.

The balance between private and public economic activity is not something that economic theory can say anything about.

Whether the government is large or small relative to the size of the economy is something that has to be politically decided rather than something economic theory can resolve.

When an economist calls for smaller government (like most neo-liberal ‘think tanks’), they are speaking as citizens, although they hide behind the (alleged) authority of their economic training.

From an economics perspective, however, sometimes the government should cut back its net spending (when there are inflationary forces, for example) but usually, net spending should be positive (that is, a budget deficit) to ensure that the private sector can save as a whole and full employment is the norm.

When there is mass unemployment such as we have endured for around 30 years in Australia (and elsewhere) it is a sign that the budget deficit is too low!

Whether we allow that to happen however is a political choice not an economic one.

The sort of macroeconomic nonsense sprouted without thought by Downer and his colleagues in the Government and which also is trotted out ad nausea by the ALP economic spokespeople is the reason:

(a) why public services have been run down;

(b) why our young people have disproportionately high unemployment rates (given the wholesale abandonment of the apprenticeship schemes we had in the 1970’s); and

(c) why the economy has been forced to endure persistently high unemployment since the mid 1970’s, that imposes huge costs on the most disadvantaged citizens in our communities.

Budget surpluses generally destroy private wealth and employment opportunities. Our toleration of this state reflects the success the neo-liberals have had in persuading us politically to vote for policies that erode our well-being as an overall society and abandon the needs of the vulnerable.

That is enough for today!

(c) Copyright 2004 William Mitchell. All Rights Reserved.

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