I have been travelling for most of today so I have to keep this post…
Today I heard that our Federal Finance Minister Lindsay Tanner is suffering from insomnia because of the growing Government debt burden. Poor thing. Why is he worrying himself sick? Well I have the cure. If he reads this blog and understands it I think he will back in slumberland sooner rather than later.
The Finance Minister told ABC news today (paraphrasing from the ABC transcript):
- that he has been thinking about the maximum level of debt the Government is prepared to accept;
- that the Government’s debt burden keeps him awake at night;
- falling revenue and spending on economic stimulus measures have seen the Government’s balance sheet slide into the red;
- the budget deficit is temporary and will be restored to surplus when economic conditions improve;
He then clarified these concerns and said in terms of the maximum level of debt the Government is prepared to accept that
I’d have to say that we are a long way away from where that point might be and I wouldn’t necessarily put a figure on it …
But one of the reasons we’ve put in place a specific strategy for getting the Budget back into surplus is because we understand these things are finite.
So in the interests of helping Linsday sleep better here are some clarifications for him to consider. It will help him “understand” that he is worrying himself for nothing.
First, the concept of a maximum level of public debt it totally erroneous. As I have pointed out before, the debt is not being issued to “finance” the spending on the economic stimulus. The Federal Government does not need to finance its spending in its own currency. All government spending involves making deposits in the commercial banking system (whether directly or indirectly) which increase bank reserves. The central bank has a choice in relation to the excess bank reserves created: (a) do nothing and let the competition between banks in the interbank market drive the interest rate down to whatever is the support rate the RBA pays on overnight reserves; (b) offer the banks an interest-bearing financial asset (a debt instrument such as a Treasury bill) and drain the excess reserves which has the effect of preventing the competitive process in the interbank market from operating and allows the RBA to maintain control of its target rate of interest. Very simple. Debt is issued to allow the RBA to maintain its current stated monetary policy stance (expressed as the target interest rate).
I have been asked by several readers to write a blog explaining quantitative easing. Some watched a TV segment last night (7.30 Report which focused on the Bank of England gymnastics in this regard). I will do that soon (maybe tomorrow). The important point is that countries such as Japan (in the early 2000s) and the UK, at present, have used this technique to stimulate credit markets. But they can only do it if they are prepared to allow the overnight interest rate to approach zero. The central bank has no choice but to issue debt when there is positive net spending by the government adding to the reserves of the banking system if they desire to maintain some non-zero target rate of interest (or an interest above a non-zero support rate).
So, the government (being the consolidation of the treasury and the central bank) could at any time stop issuing debt yet continue to expand net spending if it felt the spending gap in the economy was still present and dragging down aggregate demand and hence employment growth. The consequence would be high employment growth but lower interest rates and less wealth in the private sector.
Similarly, the private sector might decide they don’t want to purchase any more public debt which would place a “market limit” on the level of government debt. Should we worry about that? Not at all. This just means that they would be willing to either hold excess reserves in the banking system earning inferior returns (in Australia the return would be the RBA support rate) or they might increase consumption spending to rid themselves of these excess balances. As a matter of accounting a system-wide reserve excess would not be eliminated by an increase in consumption. But what it would mean is that the private economy would expand and the budget deficit would fall as the automatic stabilisers (more tax revenue and less welfare payments) went to work. So the private spending gap would narrow and the need for net public spending (deficits) would decline to the new level of desired private savings. All good unless you want to have a larger public sector per se, but that is another story.
Second, if red is bad and blue is good then the Government’s budget (Linday calls it the govermnent balance sheet) is sliding into the beautiful azure zone where the Government is now finally providing net financial assets (net government spending) to underpin private saving. That is good.
Third, I think he will sleep better once he actually understands what things are actually finite. If they do put in a “specific strategy” to get the Budget back into surplus then they don’t understand much at all about national accounting and the role that the Budget plays in a modern monetary economy such as Australia. If you want the non-government sector to save then $-for-$ the sovereign government’s budget has to be deficit. That is a matter of national accounting.
- undermine an economy’s capacity to grow with reasonable private debt levels.
- increase the spending gap (fiscal drag).
- mean that the private sector has less to spend than otherwise.
- mean less private employment.
- mean less public employment.
- mean less public infrastructure investment.
- mean less education and training provided.
- mean less public services.
- mean less scope for income support.
A return to budget surplus is not something the Australian government should be aiming to achieve any time soon.
A simple budget game!
Here is an example to help you think about all of this economic jargon. The concepts are simple and the numbers are small which makes it easy to understand and relate to (thanks to Warren Mosler for the original idea for this heuristic).
Imagine the economy is my household which is comprised of me (the parent) and you (the kid)! As the parent I assume the role of “government” and you thus comprise the non-government (private) sector. As the government I decree that I will offer 100 of my business cards per week, if you agree to tend the garden on a weekly basis. These are the cards I exchange at meetings with business associates outside of the household. They are normal size rectangles of cardboard.
You say, naturally: “Why would I want your worthless business cards?”
I reply (reflecting my knowledge of how modern monetary systems like the household work): “because to stay living in the house I expect 100 business cards a week to be paid in taxes”.
You say: “when do I start work!”
Immediately, by imposing tax obligations in the currency of issue (the business cards) I have created a demand for the currency and this allows me to transfer private resources (your work in the garden) to the public sector (the nice garden). However, also note that I have to spend the 100 cards each week before you can pay the tax of 100 cards – which clearly means that the taxation can never be considered a source of revenue which “finances” or allows me to spend the cards in the first place. The cards come from no-where and I have the monopoly rights to spend them. I am never financially constrained in my own business cards (the currency).
So this sort of currency is what we call a fiat currency – being made legal by legislative fiat. It has no intrinsic worth and its value is tax driven. Just like the Australian dollar!
Note that I probably would never “print” any cards. I would run some spreadsheet on the house computer and just keep “bank entries” to record all the outflows (spending) and inflows (taxation). All the transactions would just be numbers entered into relevant columns. If I slipped up and added a 0 to my spending one week, I wouldn’t have to “print” 900 new cards. You would be better off by 900 cards because it would show up as a deposit in your account. But nothing else would be required. Same as in the Australian economy.
Now under these conditions, the household budget would be balanced each week: I spend 100 cards and you pay 100 cards. You are unable to accumulate any cards (that is, save) because you can only get access to the volume of cards that I make available via spending. Same as in the Australian economy.
What if I wanted to teach you to save as preparation for managing your own affairs when you became an adult? Well the only way you can save is if I, for example, decided to employ you more each week and offered, say, 120 cards per week as wages (government spending) yet continued to tax you only 100 cards. The same effect could have been if I reduced the tax rate and held spending constant or a combination of increasing spending and reducing taxes.
Whatever, and lets stick to the spending of 120 and the tax of 100, the budget now goes into deficit of 20 cards per week. You now can save 20 cards per week because my spending (the government spending) has provided the “finance” to permit you to do that. As the weeks go by you could accumulate more and more savings (numbers in the spreadsheet would increase) and you would soon see that the non-government saving over time is the exact record of the cumulative deficits being run by me (the government). Same as in the Australian economy.
Now, you might want to make more money (cards) on your savings. The only way that can happen is if I offer you a government bond (a bit of paper saying that if you deposit your savings with me each week I will pay them back at some future time plus some interest all in business cards). So the offer of a new financial asset – the household debt instrument (the bit of paper) gives you a chance to compound your saving and maybe take a holiday – not work some weeks but still pay taxes!
So the debt issuance in the household establishes a non-zero rate of interest in the household and increases your wealth. I didn’t have to issue the bond to keep running the deficits. The bond just replaced non-interest bearing savings (reserves in our “banking” system) with an interest-earning asset (the bond). Same as in the Australian economy.
Now lets say I am reading Lindsay Tanner and I get the feeling we have to get back into budget surplus to be a responsible government. So I tax 100 cards but cut my spending on garden work to, say 90 cards per week.
Can you predict what will happen now? Well in that particular week there are not enough cards “spent” to generate the funds necessary for you to pay the tax. There are 10 cards short. The household (government) budget is in surplus for that week to the tune of 10 cards. But this shortage of cards liquidity in the private sector (that is, you!) means that you will:
(a) Demand more work to earn the shortfall – noting that the household has now reduced employment levels (in hours) and there is some underemployment creeping in. If I made the example more complicated with 2 or 3 kids in the house I could have easily cut spending by not paying anything to one or more of the kids thus creating unemployment.
(b) Try to sell some of your possessions to get some cards. In this simple case, you will offer your bonds (the bits of paper) for sale to get the funds. So the surplus starts to eat away at your wealth portfolio. I would be boasting to Lindsay that I was running down the government debt – “getting the debt monkey off the government’s back” – which may help me sleep better – but you would just be feeling less well off (and maybe developing insomnia!).
(c) Start to run down any savings that are not being stored in bonds. Either way you run down your wealth holdings.
But in aggregate, the budget surplus is squeezing your card liquidity and forcing you to run down wealth. Same as in the Australian economy.
If I kept running budget surpluses, you would eventually run out of assets and your labour would be severely underutilised. You might be able to persuade me to start lending you the money (I might set up a privatised bank in the household) and this would keep you afloat (paying the taxes) as long as you were prepared to accept increasing private debt levels. But this is not a sustainable option. Same as in the Australian economy.
So I suggest that Lindsay should go back to the basics. He should stop listening to his neo-liberal financial advisors who clearly also would benefit from learning exactly how a modern monetary economy such as Australia operates. Then he should chill out about the debt and realise that if the Australian economy is to enter its next long growth phase, the Federal budget will have to be permanently in deficit.
Have a nice sleep tonight Lindsay!