I read an article in the Financial Times earlier this week (September 23, 2023) -…
This morning I was reading the Sydney Morning Herald and Economics writer Ross Gittins was talking about the fact that the ALP election victory in Queensland over the weekend violates the dogma that Treasury officials (federal and state) like to put around. Of-course, Gittins is in his own words “has great sympathy for treasuries” so I never expect him to tell his readers how the modern monetary system actually operates. But at one point, he advances without any critical scrutiny one of the greatest myths propogated by neo-liberals (including treasuries) about the way federal government budgets work. The myth: budget surpluses increase national saving. The truth is they do not. Its that time again. Time to debrief.
Some years ago I asked a federal Treasury heavy why he and his mates were no longer reading us lectures about the need to increase national saving. “Because we got the budget back into surplus,” he replied simply.
Here is a classic from the US Government General Accounting Office (now called the Government Accountability Office) entitled National saving answers to key questions. If you are going to read it, get yourself in a relaxed position and stay calm throughout. It beggars belief how bad this analysis is. On Page 11 we read:
… national saving is the sum of saving by households, businesses, and all levels of government. Gross national saving, which reflects resources available both to replace old, worn out capital goods and to expand the capital stock …”
Sorry, the sovereign government does not save. What sense does it make to save in the currency that you issue? Households save to increase their capacity to spend in the future. How can this apply to the issuer of the currency who can spend at any time it chooses?
Further, the GAO say:
Federal fiscal policy affects the amount of federal government saving and this in turn directly affects national saving. From the 1970s through the mid 1990s, federal deficits absorbed a large share of private saving and reduced the amount of national saving available for investment … Borrowing to finance these deficits added to the federal debt held by the public. In recent years, federal surpluses added to national saving and increased funds available for investment. So far, the federal government has used surplus funds to reduce its debt held by the public. Accumulating nonfederal financial assets, such as stocks, could be another way that government saving could translate into resources available for investment, but this idea is controversial. An additional dollar of government saving and debt reduction does not automatically increase national saving and investment by a dollar because changes in saving by households and businesses will tend to offset some of the change in government saving.
So this is the sort of logic that Gittins is reporting.
As a matter of accounting between the government and non-government sectors, a government budget deficit adds net financial assets (adding to non government savings) available to the private sector and a budget surplus has the opposite effect. The last point requires further explanation as it is crucial to understanding the basis of modern money macroeconomics.
While typically obfuscated in standard textbook treatments, at the heart of national income accounting is an identity – the government deficit (surplus) equals the non-government surplus (deficit). The only entity that can provide the non-government sector with net financial assets (net savings denominated in the currency of issue) and thereby simultaneously accommodate any net desire to save (financial assets) and thus eliminate unemployment is the currency monopolist – the government.
It does this by net spending. Additionally, and contrary to mainstream rhetoric, yet ironically, necessarily consistent with national income accounting, the systematic pursuit of government budget surpluses is dollar-for-dollar manifested as declines in non-government savings.
A simple example helps reinforce these points. Suppose the economy is populated by two people, one being government and the other deemed to be the private (non-government) sector. If the government runs a balanced budget (spends 100 dollars and taxes 100 dollars) then private accumulation of fiat currency (savings) is zero in that period and the private budget is also balanced.
Say the government spends 120 and taxes remain at 100, then private saving is 20 dollars which can accumulate as financial assets. The corresponding 20 dollar bank deposits have been created by the government to cover its additional expenses. The government may decide to issue an interest-bearing bond to encourage saving but operationally it does not have to do this to finance its deficit. The government deficit of 20 is exactly the private savings of 20. Now if government continued in this vein, accumulated private savings would equal the cumulative budget deficits. However, should government decide to run a surplus (say spend 80 and tax 100) then the private sector would owe the government a net tax payment of 20 dollars and would need to sell something back to the government to get the needed funds. The result is the government generally buys back some bonds it had previously sold. The net funding needs of the non-government sector automatically elicit this correct response from government via interest rate signals.
Either way accumulated private saving is reduced dollar-for-dollar when there is a government surplus. The government surplus has two negative effects for the private sector: (a) the stock of financial assets (money or bonds) held by the private sector, which represents its wealth, falls; and (b) private disposable income also falls in line with the net taxation impost. Some may retort that government bond purchases provide the private wealth-holder with cash. That is true but the liquidation of wealth is driven by the shortage of cash in the private sector arising from tax demands exceeding income. The cash from the bond sales pays the Government’s net tax bill. The result is exactly the same when expanding this example by allowing for private income generation and a banking sector.
From the example above, and further recognising that currency plus reserves (the monetary base) plus outstanding government securities constitutes net financial assets of the non-government sector, the fact that the non-government sector is dependent on the government to provide funds for both its desired net savings and payment of taxes to the government becomes a matter of accounting.
This understanding reinforces why the pursuit of government budget surpluses will be contractionary. Pursuing budget surpluses is necessarily equivalent to the pursuit of non-government sector deficits. They are two sides of the same coin. The decreasing levels of net savings financing the government surplus increasingly leverage the private sector and the deteriorating debt to income ratios will eventually see the system succumb to ongoing demand-draining fiscal drag through a slow-down in real activity.
Why Budget surpluses are not public saving
The current Australian Treasurer and many commentators from the financial markets have all recently been talking about “the growing hole in the budget bucket”. Well there is no hole because there is no bucket. To explain this we need to understand what happens when the sovereign government runs a budget surplus.
It is often argued that the surplus represents “public saving”, which can be used to fund future public expenditure. With the current decline in government revenue and the need for a dramatic fiscal injection generating increasing deficits in Australia (and elsewhere), many commentators are erroneously claiming that the Government will run out of funds and will have to postpone or abandon its much-touted infrastructure development plans, including the upgrade of the broadband network.
In rejecting the notion that public surpluses create a cache of money that can be spent later, I note that the Federal Government spends by crediting a reserve account. That balance doesn’t “come from anywhere”, as, for example, gold coins would have had to come from somewhere. It is accounted for but that is a different issue. Likewise, payments to government reduce reserve balances. Those payments do not “go anywhere” but are merely accounted for. In the USA situation, we find that when tax payments are made to the government in actual cash, the Federal Reserve generally burns the “money”. If it really needed the money per se surely it would not destroy it. A budget surplus exists only because private income or wealth is reduced.
In an accounting sense, when there is a budget surplus then base money and/or private wealth is destroyed.
The budget surplus may be applied to running down debt (that is, forcing the private sector to liquidate its wealth to get cash) but this strategy is finite. In recent years the Australian government followed the pattern of several sovereign governments and established the Futures Fund. This amounts to the Treasury competing in the private equity market to fuel speculation in financial assets and distort allocations of capital.
However, this behaviour has been grossly misrepresented as providing future savings. Say the sovereign government ran a $15 billion surplus in the last financial year. It could then purchase that amount of financial assets in the domestic and international capital markets. But from an accounting perspective the Government would no longer have run that surplus because the $15 billion would be recorded as spending and the budget would break even. In these situations, the public debate should be focused on whether this is the best use of public funds. It would be hard to justify this sort of spending when basic infrastructure provision and employment creation has been ignored for many years by neo-liberal governments.
The alternative when a surplus is generated is to destroy liquidity (debiting reserve accounts) which is deflationary. The weaker demand conditions would force producers to reduce output and layoff workers with rapid increases in joblessness. Investment irreversibilities driven by uncertainty of future demand conditions then retard capacity growth and prolong the downturn.
In closing, it should never be forgotten that the pursuit of public surpluses has necessitated an increase in the net flow of credit to the private sector and increasing private debt to income ratios.
The current financial crisis is now evident that a threshold has been reached where the private sector, by circumstance or choice, becomes unwilling to maintain these deficits? It also means that reliance on rising indebtednesses to underwrite private spending is now unsustainable and an alternative growth strategy, based on fiscal expansion has to be introduced.
In terms of fiscal policy, there are only real resource restrictions on its capacity to increase spending and hence output and employment. If there are slack resources available to purchase then a fiscal stimulus has the capacity to ensure they are fully employed. While the size of the impact of the financial crisis may be significant, a fiscal injection can be appropriately scaled to meet the challenge. That is, there is no financial crisis so deep that cannot be dealt with by public spending.