British House of Lords Debt Report starts with false premises and then just repeats conventional fictions

On Tuesday (September 10, 2024), the UK House of Lords Economic Affairs Committee released their first report for the Session 2024-25 (HL Paper 5) – National debt: it’s time for tough decisions – which was the result of their decision to hold an inquiry – How sustainable is our national debt? – into whether “UK’s national debt is on a sustainable path” and whether “the Government’s fiscal rule regarding the national debt is meaningful”. They didn’t need a large-scale investigation to come up with answers to those questions: Yes and Not meaningful- are my answers based on the reality of the currency status of the British government.

The Economic Affairs Committee is stuffed with stuffiness and, even though I took formal studies in British politics and history during my undergraduate education, I have never understood how an institution like the House of Lords can survive given its structure and nature.

But it does and this Committee operates to perpetuate mainstream economic fictions as evidenced by the Report cited above.

Apparently, Britain faces a “grim reality” because according to the Committee its “national debt risks developing on an unsustainable path … “partly because of a flawed debt rule, created by the last Government, and adopted by the new Government in a similar form.”

It is true that the debt rule is flawed and should be scrapped.

But that flaw does not render the trajectory of the outstanding public debt ‘unsustainable’.

What it does is starve the British economy and society of essential public sector expenditure which would enhance the national delivery of quality public services (like those offered through the NHS), improve the flagging public infrastructure, and help prepare the nation for a more effective response to the climate emergency.

Here is something to think about as background to the rest of this blog post.

Last week, I gave a Keynote Presentation to the Anglicare National Conference.

My focus was on how the fictional world created by my profession completely distorts the way we think about policy and the actual policy choices made by governments that are deemed to be acceptable.

One of the issues in Australia is that the State governments built up debt during the early years of the pandemic as part of their emergency programs.

The central bank – the RBA – purchased about 94 per cent of the debt that was issued during that period – both Federal and State and Territory debt.

The States are now under extreme pressure given the escalation of debt, with interest rates now much higher than they were in 2020-21.

As a result, given they are not currency issuers, the States, particularly Victoria, which endured the worst of the early pandemic years, is cutting public expenditure severely and abandoning major projects that will be essential to dealing with future issues such as climate.

I said to the audience that this austerity was totally unnecessary notwithstanding the fact that the States are currency users rather than currency issuers.

I then said – imagine if the RBA officials just typed a zero against the Bank’s holdings of State and Territory debt – what would happen?

First, none of us would know the difference.

Second, the so-called ‘debt emergency’ and all the related ‘debt panic’ which has spawned the austerity would disappear with the stroke of a computer key.

Third, the austerity would be totally unjustifiable.

The audience appeared to be surprised by those statements which tells us how easily we can be roped into narratives that are based on false premises and then extrapolate them into harmful policies.

The other aspect of the current situation, which I pointed out to the audience to their surprise was that the RBA was receiving interest payments from the states/territories as a result of the debt it bought during 2020-21.

Those payments form part of the ‘dividend’ the RBA (the left pocket of government) hand over the Treasury (the right pocket of government).

And the repayment by the States to the RBA of the face value of the debt when it matures also goes back to Treasury (in the most part).

So what we are seeing is a massive fiscal transfer from State to Federal that no-one is talking about, which is also forcing the States to significantly cut back services and infrastructure spending.

Crazy.

It is as crazy as the Federal government issuing debt itself which is then purchased by the RBA – the left pocket loaning the right pocket dollars, then the right pocket paying the left pocket some interest, and the left pocket returning the payments to the right pocket as dividends … etc

How does that relate to the sustainability of outstanding British government debt?

Quite simply that the British government has all the capacity it needs to ensure it can always meet its outstanding liabilities at a ‘price’ that doesn’t impinge on its capacity to services its other ‘expenditure’ responsibilities.

I say that with one caveat – which relates to real resource availability.

Let’s deal with that caveat first because it is important to really understanding what separates Modern Monetary Theory (MMT) from mainstream macroeconomics reasoning.

The whole House of Lords Report is based on the proposition that the British government must fund its expenditure over tax revenue with new debt issuance.

That basis starting assumption is, of course, false.

The fact that the Government issues debt is a convention rather than an essential characteristic or constraint arising from the monetary system.

The mainstream narrative also invokes a fictional representation as to how governments that issue their own currency actually spend each day.

We are lured into thinking that first the government stores up tax revenue which then permits spending.

Then if its spending plans exceed that store of dollars (or pounds in the case of the UK) then the government has to create another store of currency by borrowing it from the non-government sector,

That second store then allows it to run fiscal deficits.

In fact, government spending is ‘funded’ the moment it types numbers into private bank accounts to facilitate the initiatives it is pursuing.

There is no spending out of taxes or spending out of borrowing.

Those operations are quite apart from the typing into bank accounts that define the spending and the latter would continue without those operations.

In most cases, governments introduce voluntary rules and regulations that appear to link the operations with the spending.

But these rules etc are just political instruments rather than being intrinsic to the operations of the fiat monetary system, characterised by the currency as a token issued under monopoly conditions by the government.

Now consider the MMT perspective that the government can purchase whatever is for sale in its own currency without question.

At that level, the statement is trivial.

Of course it has to be so.

But then ask well what are the limits?

And availability, market bid and similar concepts come into relevance.

If there are productive resources attracting zero market bid – such as an unemployed worker – then there is no question the government can hire or get them hired (via private sector stimulus) at any time.

Thus mass unemployment is a political choice rather than reflecting any financial shortfalls.

However, if all the productive resources are currently being bid for – that is being deployed – then the situation changes.

If the government then tries to attract some of those resources by upping the market bid the result will be emerging inflationary pressures.

The only way the government could, in that situation, get access to the use of those resources, without introducing inflationary pressure, would be to reduce the capacity of the non-government sector to use them thus making them available.

Enter taxation.

Taxation reduces the disposable income of the non-government sector and thus reduces the capacity of that sector to make claims on the productive resources available.

The taxation creates unemployed productive resources, which can then be brought into productive use by the government spending within the inflation ceiling.

The taxation doesn’t give the government any extra financial capacity.

It just creates the fiscal space in which non-inflationary government spending can occur.

So imagine that there is a suite of government policies currently in place and the nation is at full employment.

There is also outstanding government debt and the government maintains the convention that it matches the fiscal deficit each period with new debt issuance, noting that the debt issuance doesn’t make the deficit possible – it is just a convention (as above).

Now imagine interest rates rise and those financial pressures are then transmitted into the government bond market such that yields have to rise for bonds to keep their position in the suite of financial assets that people use to define their wealth portfolios.

The government then has a problem.

The flow of income to the non-government sector from the interest payments on the outstanding debt, which is increasingly being issued at higher yields, combined with the existing government expenditure on the suite of policies noted above, may then reach a point where the total spending exceeds the capacity of the productive sector to respond by producing more real goods and services.

In other words, an excess demand (spending) emerges, which would introduce inflationary pressures.

Would we then say that the problem is ‘too much debt’?

The House of Lords Economic Affairs Committee would certainly draw that conclusion.

But an MMT economist would construct the problem in a different way.

They would say that if that specific situation ever arose it was because the government didn’t use its capacities properly.

Meaning?

That the problem wasn’t too much debt but, rather, any debt at all accompanied by the failure of the government to then use its obvious capacity to control yields so that such a problem never arose.

Once you think about the issue in those terms, the conclusions are very different to those recommended by the Economic Affairs Committee.

It is completely within the capacity of the British government to:

(a) run fiscal deficits with no debt issuance.

(b) control all yields on outstanding debt that is issued including newly issued debt, irrespective.

Either condition renders much of the discussion in the Economic Affairs Committee Report moot.

It is very interesting that the Report takes a slightly different view on debt sustainability that the simple – government will run out of cash – line.

It quotes a submission received to the Inquiry (p.13:

… for a country such as the UK that has access to its own central bank, the risk seems to be higher inflation as opposed to an outright default.

And that observation relates to the discussion above.

But mostly they recited the submissions that focused on governments losing “access” to financial markets and/or being forced to endure “higher borrowing costs” as the problem.

Which I think we all know (if you understood the previous discussion) is not applicable to the British government if they bring all their capacities to bear.

I was interested to see the Report refer to MMT (p.12):

Some witnesses endorsed Modern Monetary Theory (MMT) … It posits that governments with their own sovereign currency are not fiscally constrained as they can print money to finance expenditure. History tells us that public spending unconstrained by a fiscal framework is very likely to be inflationary.

Thanks to the Gower team for one submission to the Inquiry along those lines.

The problem, which is an on-going one, is the mischaracterisation of what MMT is.

There is no “printing” going on when governments spend.

Some typing only.

And, as noted above, that is irrespective of the tax and bond issuing operations of government.

But further, the second statement about “History tell us” is one of those dismissive claims that defies that actual record of evidence.

There is no such evidence.

Governments around the world have run continuous fiscal deficits for decades without encountering any inflationary consequences.

In fact, episodes of accelerating inflation are rather rare.

Now, the mainstream economist will say that this is because governments issued debt to offset the inflationary effects of the deficits.

First, before the neoliberal period, central banks used to buy government debt much more than they do now under the now dominant competitive private auction processes.

Second, the idea that debt issuance reduces the inflation risk inherent in the spending is core mainstream thinking – but it is erroneous.

The non-government decision to buy government debt is typically a wealth portfolio mix decision rather than a decision between spending on goods and services or holding wealth in the form of government debt instruments.

In that case, the funds that are used to buy the government debt were not going to be spent anyway.

They would have been stored in an alternative asset.

And if, in some minority cases, the alternative to purchasing the debt was to spend the funds in on goods and services therefore adding to aggregate demand (spending), then the fiscal deficit would decline anyway as a result of the increased economic activity (increasing tax revenue and reducing welfare payments).

And if the automatic stabiliser impact was not sufficient to keep aggregate spending in balance with the supply capacity of the economy then the government could cut its discretionary net spending a little (as above when the economy was at full resource usage).

Conclusion

The Economic Affairs Committee Report is just another restatement of the orthodoxy.

I didn’t have time today to also comment on their analysis of the way in which the fiscal rules in Britain make the problem worse nor their flaky analysis on Japan.

I may come back to that next week.

Book Event this week – Tonight in Melbourne, September 12, 2024

I am looking forward to tonight’s event at Readings Bookshop in Hawthorn (687 Glenferrie Rd, Hawthorn, Victoria, 3122), where I will be talking with ABC Finance personality Alan Kohler about my new book (co-authored by Warren Mosler) – Modern Monetary Theory: Bill and Warren’s Excellent Adventure.

Copies of the book will be available at discount prices ($A29.99) and I will take my pen along if needed.

The event is free but you need to book a ticket.

You can find more details and booking information – HERE.

Alan and I have declared that our aim tonight is – “to have some fun”.

That is enough for today!

(c) Copyright 2024 William Mitchell. All Rights Reserved.