I am often sent E-mails asking me to explain succinctly (what my other explanations are not!) how public deficits finance saving. What does it mean? How does it work in a macroeconomic system? What is the difference between automatic stabilisers and discretionary budget dynamics? What would have happened if the government had not have increased the growth in spending? All these sorts of questions. So this short blog – to make up for yesterday’s ridiculously long blog – will cover those issues. It should clear up any outstanding issues about why deficits are important to underwriting growth.

Yesterday, regular commentator JKH wrote a very long comment where he/she challenged some of the statements and logic that modern monetary theorists including myself have been making. While I don’t want to elevate one comment to any special status – all comments are good and add to the debate in some way – this particular comment does make statements that many readers will find themselves asking. In that sense it is illustrative of more general principles, points etc and so today’s blog provides a detailed answer to JKH and tries to make it clear where the differences lie. Some of these differences are at the level of nuance but others are more fundamental.

In November last year, during a visit to the LSE, the Queen of England (and Australia to our eternal shame) asked some pointy heads why “if these things were so large, how come everyone missed them?” in relation to the apparent inability of the mainstream economics profession to foresee the crisis. Apparently, the Royal Academy then called a special workshop to discuss this and came up with an answer which they then relayed post haste … as “Your Majesty’s most humble and obedient servants” to Liz. The whole affair represents the standard massive denial that defines mainstream macroeconomics. There are no saving graces. It would be useful if they just desisted for a while and went and played gin rummy.

Why doesn’t this article get headlines in the newspapers? Today I read a recent article – Why Are Banks Holding So Many Excess Reserves? – from two researchers at the New York branch of the Federal Reserve Bank. It is obvious that the authors understand much more about the modern monetary system than most of the journalists, economists and politicians who make so-called informed commentary about such matters. Three messages emerge: (a) bank reserves play an important role in the conduct of interest rate policy and budget deficits put downward pressure on interest rates; (b) the money multiplier conception of economics is inapplicable to a modern monetary system; and (c) the current build-up of bank reserves will not be inflationary. I thought that it would be nice for you to read this stuff from someone other than billy blog (and my fellow modern money travellers!).

The Australian Prime Minister released his second essay over the weekend, in which he outlines his vision for a modern Australia steered towards new levels of prosperity and equity by his government. Well my reading of the 6098 words is that far from presenting an acceptable vision for the future, they rather, outline how his Federal Government has chosen to continue the abandonment of full employment and impose huge costs from the cyclical downturn on the most disadvantaged workers and their families in our communities for years to come.

News Limited is still (mis)leading the way on the deficit-debt attacks. In another appalling piece of misrepresentation and erroneous reasoning, The Australian ran a story from its economics chief, Michael Stutchbury today entitled Now comes time to pay the piper. This newspaper has really excelled in recent months in the lengths it has gone to mislead and lie to its readers on matters relating to the macroeconomy and the conduct of fiscal policy. There will be a piper to pay – that I agree – but it will be because the federal budget deficit is not large enough right now rather than because it is too high.

I wrote the following piece this morning for tomorrow’s local Fairfax newspaper. While some of the content is definitely of local interest there might be some things of interest to the broader debate. Also it is written to fit a column so it doesn’t allow for much elaboration.

In an article in yesterday’s WSJ The Fed’s Exit Strategy, federal Reserve Chairman Ben Bernanke provides an account of some of the operations of the monetary system that I write about in billy blog. While he doesn’t say it explicitly, he confirms that debt is issued to support interest rates (not fund net government spending) and that debt is not necessary at all if the central bank pays a “competitive” rate on overnight bank reserves held at the central bank. He also confirms that inflation is not an inevitable aspect of an expansionary package but it could be. All fundamental propositions of a modern monetary view of macroeconomics. So in one week, a Nobel Prize winner and now the Chairman of the Fed are stumbling around logic that confirms the neo-liberal driven deficit-debt-inflation-higher-taxation hysteria is without foundation.

In Deficits saved the world you read that a Nobel Prize winner not previously associated with Modern Monetary Theory (MMT) is starting to come round. The article by Paul Krugman highlights some of the basic elements of the sort of macroeconomics that I have been writing about for years and which forms the basis of this blog. It shows definitively the point I make about the macro balances – that a government surplus will squeeze the non-government sector into deficit and vice versa. It also addresses the current policy debate which is getting swamped a bit by idiots who are saying that fiscal policy is not working and should be constrained to get the government budget back into surplus.

Saturday morning traditions … a long early ride on my bike (70 odd kms), then off to the local cafe for a cup of tea. Yes, time to read an actual paper paper. Time to talk about the state of the swell and wind direction (off-shore and pumping at present). The big match (Saints v Geelong, both unbeaten after 13 rounds – note no rugby here!). Perhaps some local gossip (who paid off who to get what development up!) … that sort of thing. Probably some politics. But no, before anything interesting could be raised by the assembled regulars … someone (a non-economist who claims he is just interested) had to begin proceedings with “Bill, why does the federal government borrow when you say it does not have too?” Can you put a sock in it, please! What about the surf? But why if they don’t have too? Saturday morning … the problem of being a macro economist. Things started getting ugly at this point.

A regular reader sent me a recent financial market report written by Tokyo-based economist Richard Koo which raises some interesting issues about the association between prolonged recessions and democracy. Koo has achieved some notoriety in the last decade or more by coining the term “balance sheet recession” to describe what happened to Japan during its so-called “lost decade”. He also applies the analysis to the present global economic crisis. While he is not a modern monetary theorist, he recognises the need for considerable fiscal intervention and the futility of quantitative easing. So this blog is about all of that.

Greetings from College Park, Maryland (pronounced Marrilynd! in Australian). It is near Washington (DC) and I have work here (at the UMD) and in the capital for the next 2 days. Weather is hot but we are 189 kms or 2.8 hours from the nearest surf according to Google maps, which is equivalent to being landlocked to me! So no quick surf before work! Losers! I came down here late yesterday (5 hour drive) after a workshop at the Levy Institute jointly hosted with the United Nations Development Program, which was held in upstate New York. No summer up there at the moment but the Catskills Mountains are very beautiful – it is near to Woodstock. Anyway, I left the workshop thinking – bad luck if you are poor!

Yesterday I reported on a document I received from one of the largest international investment banks in the world. That document is part of that organisation’s advice it gives to bond investors. I used some of the document to illustrate that the understandings of how a modern monetary system operates that I write about here are also now out there in the real world – in the financial markets where bonds are bought and sold. I didn’t identify the document because it is a subscribers-only publication sent to me by the author and I respect his privacy. Today’s blog provides some more insights that will help you better understand the public debate and allow you to cut through the nonsense being peddled by all and sundry.

I am now in New York on business for the next few days then off south to the capital Washington. In this blog I want to outline the horrible scenario that everyone has been predicting would happen – the increasing fiscal deficits will increase taxation. I know that has been on our minds. I have reached the ineluctable conclusion that future taxation will increase as a direct consequence of the current deficits. The tax revenue gained by the government will also reduce future deficits. Wouldn’t it be preferable that we didn’t push future taxation up and instead controlled net government spending? If you believed that you would have rocks in your head. In this blog I will be also be discussing debt, inflation, and other nasties.

I am now in the US with a hectic week ahead. At present I am in Florida and for those who haven’t been here just imagine taking a landscape and pouring as much concrete as you can mix over as much of that landscape that you can access. Then once that sets, you build massive high-rise buildings and suburbs that span hundreds of kilometres and you have it. Oh, and plant a few palm trees as you concrete. But then there is surf nearby and before work this morning I am off to check it out. Anyway, in between other things I have been reading the so-called public debt exposition that appears in the latest issue of the The Economist Magazine. It will take a few blogs to work through it but here is Part 1. It might happen that there will be no Part 2 if I get so sick of reading this nonsense.

The talk at present is that while we are hoping for a V we might have to accept a W. Its all about shape. The shape of the future. The shape of the recovery! In Post-Lehman World Will Mean W-Shaped Recoveries we read that Japan’s former economic and fiscal policy minister, Hiroko Ota said that “The worst is over but I can’t say the economy is heading for a recovery at all”, Japan’s recovery may be W-shaped instead of V-shaped. There are some very real reasons why W might rule over V. They all relate to the lack of understanding of the characteristics of a fiat monetary system and the opportunities that such a system presents the sovereign government. Unfortunately, the ignorance (or wilful neglect) among policy makers may force millions of people to endure unnecessary hardship.