On September 28, 1976, then British PM gave an historic speech at the Annual Labour…
Australian government debt approaching $A1 trillion – who cares? Everybody it seems but me
The neoliberal era has made humanity progressively crazy when it comes to currency matters. At the moment, this trend seems to have reached new heights of absurdity. I note that the US government is now buying up its own debt with more debt as a cover for the stupidity that its President and his lackeys have launched on the World. By substituting longer-term debt with short-term Treasury bills, the composition of bond demand changes (higher demand for long-term debt – government induced), which lowers the yields. But the debt level overall remains unchanged. This is different to quantitative easing because the Treasury buyback scheme is not facilitated through the central bank creating new bank reserves, but it is equally as absurd. And in Australia, the media is going crazy about the ‘journey to $A1 trillion debt’ as the August bond auctions issued $A4 billion in new issuance in early August. Frothing lines quoting that this means every man, woman, and child (and I presume those who have other gender affiliations) owe $A36,000 up from $A35,700 and that ‘taxpayers’ have to spend about $A30 billion a year now servicing the debt abound. The Australian government responds – buying into the horror story line – that the debt might be a trillion but it is still much lower than that of other English-speaking nations. As if that matters. And, last time I checked, I didn’t owe any money on outstanding federal government bond liabilities and I certainly have never paid any ‘debt servicing’ charges, but I am a taxpayer. The problem is that these fantastical media stories and actions by the crazies in the US government send a signal of impending doom to the public which then complies with all sorts of bad policy moves.
The commentators are having conniptions about the level of federal Australian debt going above the $A1 trillion mark for the ‘first time in our nation’s history’ on August 20, 2026.
What makes this level any different to a smaller or larger $A figure is beyond me – but apparently it marks a sort of line in the sand, beyond which who knows what pestilence will follow.
As at August 21, 2026, total outstanding Australian government securities on issue totalled $A994.8 billion.
– Treasury Bonds $A920.5 billion
– Treasury Indexed Bonds $A41.3 billion
– Treasury Notes $A33 billion
The upcoming auctions for the rest of August are:
August 25, 2026 – Treasury Bond tender (maturity November 2031) = $A1.2 billion
August 26, 2026 – Treasury Note tender various maturities ranging between November 13, 2026 to May 14, 2027 = $A6.0 billion
August 27, 2026 – Treasury Bond tender (maturity December 2035) = $A0.2 billion
The reason that the level has dropped below the $A1 trillion mark is because on August 21, 2026, there was a $A6 billion maturity of Treasury notes which reduced the outstanding debt below the $A1 trillion level.
There are no further maturities this month, which means that by the end of the month, the debt will be above $A1 trillion.
The ABC finance journalist was quoting from William Shakespeare’s Hamlet the other day in his report (August 21, 2026) – Australia’s national debt has hit $1 trillion but it pales in comparison to the US – where he bemoaned the rising trend in the “dirty D word” and the population’s apparent indifference.
He assured his readers that in passing the $A1 trillion threshold, this strike “a chord” with all of us.
I am not sure about that.
He quoted some economist claiming that “You’d rather be here in Australia in regards to public debt”.
Perhaps one would rather be here because the sun shines more and we are approaching the football finals and we don’t have Donald Trump.
But our locational preferences are surely removed from the level of debt the Australian government is liable to repay.
Apparently, we are all about to be hit with ever higher interest rates because of this rising federal government debt level.
Really.
The central bank sets the interest rates, which then feed into the term structure (across the other financial assets short and long).
It claims it sets rates based on the local inflation rate outlook.
It has never said that it will raise rates because outstanding federal government debt is rising.
The economist who was quoted also claimed that there was ill-discipline by government because:
While it was right to go into debt during COVID, we shouldn’t be running deficits, as we are doing, when the economy is close to full employment.
That one again.
I examined that proposition in this recent blog post – A shift to fiscal surplus in Australia would amount to a criminal act by government (August 3, 2026).
The point these characters never acknowledge is that if the nation was close to full employment (which, currently with 10.8 per cent of available labour not working in one way or another, it is not), then the conclusion would be that the current fiscal position is the correct one, given the spending and saving preferences of the non-government sector.
Thus trying to cut the fiscal deficit from that position would only cause rising unemployment and push the economy towards recession.
Context matters and the relevant context is the juxtaposition between the fiscal balance, the private domestic balance and the external balance.
If the latter two balances are such that the external sector is in deficit and the private domestic sector is exhibiting a desire to net save overall, then to fill the domestic spending gap, there has to be a fiscal deficit to maintain the current level of output (and employment).
Whether the composition of the fiscal deficit is desirable is a separate issue to the overall net public spending level.
We might prefer fiscal deficits that result from public spending on education, health, dealing with climate change, public housing, providing public transport to deficits that buy military weapons.
But at the macro level, it is the level of net public spending that must fill any spending gap arising from the overall net saving desire of the non-government sector.
Of course, in Australia, with 10.8 per cent broad labour wastage at present, the actual fiscal deficit is too small and needs to be larger to get us back towards full employment.
The article also, without fully comprehending that the journalist was actually undermining his early warnings about public debt, wrote:
Australian household debt is at an eye-watering 190 per cent of household income … Mostly attached to real estate, that debt exposure makes Australians more vulnerable to interest rate movements than most other countries.
Yes, but remember that if we run fiscal surpluses, either the external sector has to be in offsetting surplus (to fill the domestic spending gap left by the fiscal surplus) or the private domestic sector has to be in offsetting deficit – or some combination.
A rising private domestic deficit to offset a shift to a fiscal surplus means rising private sector indebtedness, exactly the problem this journalist is warning us against, except he does get that with an external sector in deficit (historically around 3 to 4 per cent of GDP), a nation cannot reduce the private indebtedness by moving towards and into fiscal surplus.
I am amazed that these financial commentators who command national audiences don’t understand these elementary analytical facts.
Another commentator with a national audience also went blind last week over the federal debt level.
He invoked the ‘spreadsheet twins’.
Late last week (August 21, 2026), the Age newspapers economics correspondent published this article – How did we get here? The 20-year journey to $1 trillion in debt – which is one of many that have gone crazy about the recent bond market auctions that saw outstanding federal government debt rise above the almost ‘mythical’ and ‘terrifying’ level of $A1 trillion.
The journalist has historically convened the ‘Age Economics Panel’, which provided forecasts from all the known economists in Australia.
I was on that panel for some years but eventually wrote to the journalist telling him that I was no longer prepared to participate because he never used my qualitative comments that accompanied by forecasts and, instead, skewed the reporting to the mainstream ‘anti fiscal deficit’ type comments.
The article in question here is terrible.
He wrote:
1. “When John Howard lost the 2007 election, he could proudly and correctly claim the nation’s finances had never been in better condition. Budget surpluses and government policy such as the sale of Telstra had dramatically improved the nation’s books.”
Reality: the fiscal surpluses were only possible because household debt rose from around 60 per cent of disposable income to close to 200 per cent on the back of a massive private credit binge facilitated by the financial market deregulation.
The end result of that binge was the GFC!
Further, the sale of Telstra (formerly the publicly-owned telecommunications company) has been an unmitigated disaster with respect to reliability of the network (another major outage recently) and the cost of communications for ordinary citizens.
2. He cites the GFC, COVID-19 and an ageing population (increased demand for public health care and aged pensions) as driving up the outstanding federal debt – “So that’s how we got here”.
Then, harking back to the misinformation of the GFC, he quotes the ‘spreadsheet twins’ (Reinhart and Rogoff) who achieved notoriety in that period when they published their doom forecasts claiming the threshold where a government ran out of money had been passed.
Not only was their work based on faulty spreadsheet analysis (deliberate or just a dumb mistake!), their predictions didn’t come to pass.
Wheeling them out again is like a bad dream.
He uses the example that the ‘twins’ invoked to prove their point – Newfoundland and Labrador, which endured a major crisis in 1931 after its fishing revenue collapsed during the Great Depression.
It was a self-governing part of the British empire having broken the colonial yoke in 1907.
It eventually joined the Canadian federation in 1949.
The government had run up significant public debt as a result of development expenditures (a public rail network) and military outlays during WW1.
The military outlays were really a demonstration that the colonial bind had never disappeared as the small nation sent a large number of troops and equipment to support the British in WW1.
They suffered massive losses in the Gallipoli and the Somme as did other British empire nations such as Australia.
In 1931, even though it had its own currency, the nation sought British aid.
Canada chipped in for a while but ultimately pulled out.
Many untruthfully claim that Newfoundland defaulted on its outstanding debt.
That did not happen.
What happened was the Great Depression caused such havoc that the bond markets (in Montreal) would no longer buy the Newfoundland government’s debt.
As a result of the Great Depression crisis, the government handed over administration to the British-appointed Commission of Government, which was a technocratic body of public servants who were ‘managed’ by the British government.
In effect, the elected government gave up and this technocratic body took over day-to-day rule under the control of the British government.
It was back to being a colony.
The British government, in turn, provided Newfoundland with fiscal grants but the crisis only ended (as it did everywhere) when the American and Canadian governments spent up big prosecuting WW2.
After the War, a referendum saw Newfoundland join Canada.
Using this example as one that might befall the Australian government is intellectually dishonest or just plain ignorant.
The reality was that virtually 100 per cent of the debt that the government of Newfoundland issued was denominated in foreign currencies:
1. About 75 per cent in sterling borrowed on the London bond market.
2. About 20 per cent floated in New York bond markets in USD.
3. The rest borrowed in Canadian dollars from Canadian banks.
The local currency, the Newfoundland dollar, was pegged to the Canadian dollar in 1895.
Its debt servicing capacity thus relied on export revenue, principally its fishing exports.
The peg made things worse.
In September 1931, the British government abandoned the gold standard as a result of its own Great Depression crisis, and sterling depreciated significantly against the USD and the Canadian dollar as a result.
The peg meant that overnight Newfoundland’s sterling-denominated debt servicing costs went through the roof and the foreign investors went awol.
I know that the spreadsheet twins love to trawl through historical examples like this that journalists then think they are clever quoting but the specific example above provides ZERO read 0 information that is useful in assessing the financial situation of the Australian government in 2026.
The journalists parting paragraph on Newfoundland – “The inability to repay its debt led the small nation down a road to nowhere. Australia doesn’t want to take that ride” – is ridiculous.
The reality is:
1. The AUD floats and is not pegged to another currency.
2. The Australian government has virtually no foreign-currency denominated debt.
3. The Australian government issues its own currency and can always honour liabilities in that currency without exception.
Conclusion
None of this is to say that the shift across the $A1 trillion line matters a skerrick.
It doesn’t matter at all.
My message to the journalist – if you are claiming to be the ‘senior economics correspondent of the Age and Sydney Morning Herald’ please at least get the historical facts correct.
That is enough for today!
(c) Copyright 2026 William Mitchell. All Rights Reserved.
Best of luck to the Demons to repeat 2021
Sadly, Bill, and as you know, some people do pay a cost for this lack of understanding. It’s those on unemployment queues and the estimated 150,000 Australians who will soon be expunged from the NDIS register and thus deprived of much needed disability support services. I could go on and on.
It amuses me how these people go on about taxes having to be increased to pay for Fed Govt debt. Following the COVID spending, we were told by these characters that taxes would have to rise. Apparently, at this point, the need to increase taxes to pay for the post-GFC spending, which never eventuated because it was never needed, mysteriously disappeared. Presumably, if there is another crisis requiring the Fed Govt to spend big, the need to raise taxes to pay for the COVID spending will likewise disappear.
By god, it must be time for Australians to be hit with a two or three-fold tax increase! Not! Please don’t scare me witless by telling me that the Fed Govt hasn’t yet raised taxes to pay for the Vietnam War effort, The Snowy Mountains Scheme, WW2, and the arrival of the First Fleet!
You’re not the only one Bill.
I felt compelled to put fingers to keyboard over the weekend about a 3200 word bond market essay by an “International Economics Editor” that was completely devoid of any logic whatsoever.
Eugenio: Fat chance.
I get a blog post from Edgar E Peters, who has written several books that seem to reflect economic reality.
In his recent post (which is rather long so I can’t repeat it here) he seems to be saying that the Fed can only influence rates at short end: quote
“Artificial attempts to reduce rates through changing supply will simply not work. And if the Fed lowers short-term rates hoping to lower long rates, the attempt would backfire. Lower short-term rates would merely add fuel to the AI bubble and increase long-term rates by increasing inflation expectations.”
This seems to be different to Bill’s post above.
I assume that most of the debt is owned by the rich and the government could just tax it.
The Irish government gives me a pension and the taxes it. Ouid Per Quo.
If we were to accept, just for the sake of argument, that public deficits and debt levels were too high how would be go about reducing them?
The mainstream, as you say, threaten that “we are all about to be hit with ever higher interest rates because of this rising federal government debt level.” As often they get things the wrong way around.
Wouldn’t this make things “worse” according to the mainstream narrative? It would encourage more buying of govt bonds, ie encourage higher saving, and so increase public debt levels.
I agree Bill. Absolutely mad. But it is another example of how neoliberals scare the hell out of everybody to try and maintain their ideology.
The rising levels of both private and public debt are clear indicators that the global economy has now inflected from growth, with a decrease in real material prosperity now inevitable. Industrial modernity was always entirely dependent on the easy availability of fossil fuels, with no replacement available, and now the exergy is just too low to prevent a slow collapse.
Sovereign governments will continue to print money in order to maintain the extraction of wealth and resources from the Global South but they are swimming against the current and it will eventually catch them up. Degrwoth has already started. I look forward to Professor Mitchell’s new book on degrowth & MMT to see how he squares this circle of doom.
@ Matthew,
You’ve lumped both private and public debt together. It’s more instructive to separate the two.
If there is an observed link between between rising public debt and lack of growth, a plausible explanation is that governments react by applying, or misapplying, fiscally contractionary policies and central banks react by tightening monetary policy.
Rising levels of private debt could be a sign that both companies and individuals could be resorting to distress borrowing which is more of a symptom of economic problems than a cause. Alternatively it could be a sign that both are borrowing to invest which should be a positive in terms of growth. So the picture is more complex with this type of borrowing.
Incidentally private borrowing, in economic terms, can be considered to be the same as de-saving. So, for example, if I cashed in some savings I could go out and buy a new car. This would have a positive effect on growth.
My point is that _both_ private and public debt is rising. A sectoral balance analysis shows that, absent a change in exports or imports, this can only be true if overall economic activity is now declining. This decline is fundamentally related to the continual fall in the Energy Return on Investment (ERoI) for the fossil fuels upon which the modern way of life depends.
We are entering a phase of simplification and no amount of “renewables” can counter this. The UK government commissioned an independent report that demonstrated this fact many years ago but have willfully ignored the findings ever since. Degrowth is tough to sell at the ballot box…
Reference: https://assets.publishing.service.gov.uk/media/57a08a0340f0b652dd000508/60999-EROI_of_Global_Energy_Resources.pdf
Matthew T Hoare: That is incorrect.
I + G + X (financial injections) = S + T + M (financial leakages)
Hence, (G – T) = (S – I) – (X – M)
If public debt (issuance of govt bonds) is rising because G > T, and private debt is rising because S < I, then X T). Outstanding private debt equals the accumulation of past domestic private sector deficits (S < I).
The difference between G and T does not have to increase for public debt to increase. Nor does the difference between S and I have to increase for domestic private sector debt to increase. Whilst X T and S < I, the difference between X and M does not have to change for public debt and domestic private sector debt to increase. Furthermore, there is no need for GDP to change (decrease, as you argue) for this to occur.
Of course, such a situation is financially unsustainable because a continuation of S T and increasing public debt is unsustainable, as the latter is wrongly believed (assuming the govt is a currency-issuer).
Disregard my last comment. This has happened to me before. For some reason, when I post my comment, ‘greater than’ and ‘less than’ symbols go missing in the text as does some of the text in between.
I’ll try again:
If public debt (issuance of govt bonds) is rising because G ‘greater than’ T, and private debt is rising because S ‘less than’ I, then X ‘less than’ M.
Debt is a stock concept. Deficits/surpluses are flow concepts. Outstanding public debt equals the accumulation of past govt deficits (G ‘greater than’ T). Outstanding private debt equals the accumulation of past domestic private sector deficits (S ‘less than’ I).
The difference between G and T does not have to increase for public debt to increase. Nor does the difference between S and I have to increase for domestic private sector debt to increase. Whilst X ‘less than’ M is necessary to simultaneously have G ‘greater then’ T and S ‘less than’ I, the difference between X and M does not have to change for public debt and domestic private sector debt to increase. Furthermore, there is no need for GDP to change (decrease, as you argue) for this to occur.
Of course, such a situation is financially unsustainable because a continuation of S ‘less than’ I is unsustainable, not because a continuation of G ‘greater than’ T is unsustainable, as the latter is wrongly believed (assuming the govt is a currency-issuer).
@ Matthew,
“The rising levels of both private and public debt are clear indicators that the global economy has now inflected from growth”
“A sectoral balance analysis shows that, absent a change in exports or imports, [rising levels of both public and private debt] can only be true if overall economic activity is now declining.”
I believe neither of these claims are true. I also don’t believe that the sectoral balances can be used to show levels of private debt. But leaving the algebra of the sectoral balances aside we can see that world economic activity is not declining.
We both agree that both public debts and private debts are rising. The mainstream should, though, care more about the level of private debt and a a lot less about the the level of public debt.
Theories should always be made to explain the observable facts rather than the other way around. World GDP growth last year (2025) was approximately 2.9% to 3.4% So any theories about debt levels have to be consistent with this observation.
https://www.macrotrends.net/global-metrics/countries/wld/world/gdp-growth-rate
Peter Martin: There is one weakness with the simple sectoral balances equation. It only includes the private sector borrowing of credit money used to purchase new goods and services (i.e., stuff that makes up GDP). It does not include the private sector borrowing used to purchase private sector-generated financial assets (e.g., shares and derivatives); previously-produced real assets (e.g., existing property and vault-gold); and virtual-commodities (e.g., Bitcoin). For good reasons, these purchases are not included in a measure of GDP. GDP is designed to measure the real stuff that a nation produces over a given period.
Any new credit money borrowed (a financial injection), until destroyed by taxation or repayments of advanced credit money, must end up in bank accounts as deposits. ‘S’ in the sectoral balances equation is really a measure of ‘deposits’ – money that may have been spent previously on new goods and services (expenditure multiplier process pertaining to GDP), but at the present moment sits idly in a bank account waiting to be spent or be used to extinguish future tax liabilities. That said, a currency-issuing central govt won’t accept credit money as a means of extinguishing tax liabilities until the credit money is converted by a financial institution to the CICG’s base money. A CICG only accepts its own base money as means to tax payments. A financial institution is required to do the conversion – which, if it has insufficient reserves of base money of its own, it does by borrowing base money from another bank with excess reserves at the interbank lending rate set by the central bank, or from the central bank. The conversion is mandatory. It is a condition accompanying the license to create and advance credit money. It is necessary to ensure the payments system functions.
‘I’ in the simple sectoral balances equation does not include all credit money borrowed. It only includes the credit money borrowed and spent on new goods and services (that which makes up GDP). The simple sectoral balances equation also assumes that all ‘S’ (i.e., all deposits) is financed out of income paid to the factors of production used to produce GDP (initiated by financial injections – that is, by G, I, and X). Yet some deposits clearly come from payments resulting from the sale of financial/other real assets. These, too, are initiated by financial injections, some of which is from the borrowing of credit money.
One could expand the sectoral balances equation to include the borrowing and subsequent purchases related to spending on financial/other real assets. One could incorporate them into ‘I’ and ‘S’ or have two new variables. It would be better to have two new variables because ‘I’ specifically relates to private sector borrowing used to purchase new goods and ‘S’ specifically relates to deposits financed out of current income (i.e., current spending on new goods and services). Either way, the simple or the expanded sectoral balances equations would both hold. The simple version would exclude borrowing and subsequent deposits related to spending on financial/other real assets that might otherwise make up ‘I’ and ‘S’. The expanded equation would include them either as more comprehensive measures of ‘I’ and ‘S’, or as two new variables. But the two new variables – one a financial injection, the other a financial leakage – would be equal.
There is another misleading aspect. When private sector borrowing rises (a financial injection), financial leakages rise. If the borrowing is used to finance spending on new goods and services (i.e., is measured by ‘I’), then S, T, and M rise because the spending boosts GDP and S, T, and M are positive functions of GDP. If some borrowing is used to finance the spending on financial/other real assets, GDP does not rise. Nor does ‘I’, and nor do S, T, and M if we take ‘I’ to only include borrowing spent on new goods and services and take ‘S’ to only include deposits created by financial injections spent on new goods and services. However, deposits will rise. In the latter case, borrowing and deposits rise but GDP does not. If we then use the borrowing/GDP ratio as an indicator of private sector debt levels, it appears to have worsened. If we use the I/GDP ratio as an indicator of private sector debt levels, it appears unchanged.
Here’s where the private sector debt problem can be distorted. Assume S = I. If borrowing goes up and all of it is used to buy new goods and services (i.e., ‘I’ rises), then S, T, and M rise. Let’s assume that only S rises. Then we still have S = I except ‘S’ and ‘I’ are larger. Presumably, the additional borrowing is sustainable because the additional income generated from spending it on new goods and services (increased GDP) can service the debt.
Imagine, instead, that borrowing goes up and all of it is used to buy speculative assets (i.e., ‘I’ has not increased). Deposits rise, but GDP doesn’t. Nor does S rise. New deposits will still equal new borrowing. However, the ability of the private sector to service its debts is entirely dependent on asset price inflation. Holders of the assets must rely on asset prices rising, which they can sell at a profit (capital gain) to repay their debts. This is possible only while asset prices continue to rise. As soon as they crash – an inevitability – the system goes into freefall, also an inevitability.
The simple sectoral balances equation can help us identify an inevitable private sector spending crash (i.e., a prolonged period of S ‘less than’ I). Around 2004, Bill Mitchell could see that the prolonged S ‘less than’ I was signalling a future spending crash, which came in 2008 in the form of the GFC. However, the simple sectoral balances equation can’t always identify an impending crash caused by heavy borrowing used to purchase speculative assets, although the two causes often go hand in hand.
Economists need to carefully consider what is going on outside the real economy (where goods and services are produced as a consequence of spending initiated by a financial injection). Borrowing and spending on financial/other real assets that is not included in measures of GDP and therefore does not make it into the simple sectoral balances equation is also important, if only because crashes within the speculative domain have severe implications for the real economy.
Peter Martin: There is another problem with the variables in the sectoral balances equation. ‘I’ denotes ‘investment’ – spending by the private sector on investment goods (productive human-made capital). As a financial injection, it is assumed that all investment is financed by the borrowing of credit money and none from current income (current profits). In fact, it is assumed that all private sector borrowing is spent on investment goods and none on consumer goods. This is clearly ridiculous. A large slice of investment spending is financed out of current income, and a large slice of consumption spending is financed from borrowing. The domestic private sector balance should really be [S – (Ib + Cb)], where Ib denotes investment spending financed from borrowing and Cb denotes consumption spending from borrowing. Ib and Cb would be private sector financial injections, but Iy and Cy (investment and consumption spending financed by current income) would not.
This is important for a number of reasons. Firstly, the general assumption that all ‘I’ is financed from borrowing and that no ‘C’ is financed from borrowing has provided support for the false belief that raising interest rates reduces aggregate demand by reducing investment spending. Firms supposedly compare the rate of return on investment with the interest rate and if the latter rises, ‘I’ falls. It turns out that changes in ‘I’ are best explained by expectations of future spending levels based largely on recent spending levels (the accelerator theory of investment), not on interest rates. Higher interest rates simply increase borrowing costs, which are passed on in the form of higher prices. Firms increase prices knowing they can still sell their goods because they know that workers will receive a pay rise to near enough offset the price rises. It’s all part of the dynamic inflationary process. It is also assumed that households are not directly affected by interest rates because all ‘C’ is assumed to be financed out of current income. All the assumed stuff is sheer nonsense, of course.
It turns out that households are affected by interest rates, but not in the aggregate. One person’s interest payment is another person’s interest income. Distributional affects only. Households still borrow to spend hoping that the increased repayments can be offset be demanding an even higher pay rise. Dilution of union power has rendered this more difficult, but it all feeds into the inflation dynamic with little impact on aggregate demand. Thanks to the RBA’s interest rate policy, inflation did not fall as quickly as it could have in Australia after the peak of the COVID pandemic had the RBA left interest rates on hold.
Secondly, mainstream economists distort consumption spending theories by calling any ‘C’ not financed from current income as ‘autonomous’ consumption spending. I queried this with my tutor when I was an undergraduate student and got told not to worry about it. “It’s trivial”, I was told. It does matter and it’s not trivial. Nor is it autonomous spending. It represents consumption spending financed from borrowing (new financial injections) or from drawing on past savings (injection of past financial leakages) and it varies a lot, especially when the private sector is forced by govt spending cuts to borrow heavily or draw on past savings to maintain spending desires (thus having to abandon its net-savings desires). This so-called autonomous C spending goes up as a consequence. Result? A prolonged period of S ‘less than’ I (rising private sector debt). When the private sector can no longer keep doing this, the so-called autonomous C spending crashes. Result? A sharp shift to S ‘greater than’ I, and a crash in private sector C spending. GFC-like stuff!
A big problem with consumption expenditure theories is that they fall into the trap of conflating the financing of C spending and the behavioural factors affecting C spending. Keynes’ consumption function does not explain C spending. It is a financing equation (Cf) where a Cf curve ratchets up (a gradual shift up of the vertical intercept) when the private sector increases borrowing to finance C spending (S ‘less than’ I) and dramatically shifts down when the private sector heavily saves to pay back its debts (S ‘greater than’ I).
The insights of Daniel Kahneman better explain C spending behaviour. People dislike losses of a particular value much more than they like a benefit of the same value. When GDP falls because of cuts in G, people borrow/draw on past savings to maintain C spending. Hence, there would be a second behavioural/motivation equation (Cm) where the Cm curve would be very flat. The Cb and the Cm curves would always intersect at the prevailing level of C spending. Why? Because the prevailing level of C (illustrated by the Cm curve) must be financed some way (illustrated by the Cf curve).
Without wanting to complicate things too much, there would be another long-run consumption financing curve that would pass through the origin because, in the long-run, all C spending must be financed by income. Although the Cm and the short-run Cf curve would intersect at the prevailing consumption spending level, the intersection point would lie off the long-run Cf curve. When C spending eventually crashes, both the short-run Cf curve and Cm curve dramatically shift down so that their intersection point is back on the long-run Cf curve. GDP correspondingly crashes unless there is a govt response (i.e., an increase in G). The intersection of all three curves represents a long-run equilibrium (or long-run homeostasis, as I prefer to call it). In 2004, when Bill Mitchell predicted the impending crash (GFC), in my diagram one would have observed a prolonged period of the intersection of the Cm and short-run Cf curves lying off (above) the long-run Cf curve. A shift variable based on the private debt/GDP ratio passing a threshold point could be incorporated into the short-run Cf equation to have it dramatically shift down to the long-run homeostasis point, which is what occurred in 2008.
This is something I’ve worked on (I need to return to it) and haven’t seen elsewhere. It helps to explain booms and crashes, especially when an eventual crash is the result of govt austerity measures.