{"id":11716,"date":"2010-09-30T15:30:51","date_gmt":"2010-09-30T05:30:51","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=11716"},"modified":"2010-09-30T15:30:51","modified_gmt":"2010-09-30T05:30:51","slug":"in-austerity-land-thinking-about-fiscal-rules","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=11716","title":{"rendered":"In austerity land, thinking about fiscal rules"},"content":{"rendered":"

\t\t\t\tI am now in Maastricht, The Netherlands where I have a regular position as visiting professor. It is like a second home to me. The University hosts CofFEE-Europe, which we started some years ago as a sibling of my research centre back in Newcastle. My relationship with the University here is due to my long friendship and professional collaboration with Prof dr. Joan Muysken who works here and is a co-author of my recent book – Full Employment abandoned<\/a>. Our discussions last night were all about the Eurozone and I was happy to know that most of the Dutch banks are now effectively nationalised as part of the early bailout attempts. It is also clear that the ECB is now stuck between the devil and the deep blue sea<\/a>. If it stops buying national government debt on the secondary markets those governments are likely to default and the big French and German banks the ECB is largely protecting will be in crisis. Alternatively, every day it continues with this policy the more obvious it is that the Eurozone system is totally bereft of any logic. Once the citizens in the nations that are being forced to endure harsh austerity programs realise all this there will be mayhem. The other discussion topic was the possible revision of the fiscal rules that define the Maastricht treaty. That is what this blog is about.
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\nOn the plane coming over here – in between reading Swedish detective novels and designing my macroeconomic simulation model that I am presenting here I watched the movie The Most Dangerous Man in America<\/a> which is the story of Daniel Ellsberg and the way he leaked The Pentagon Papers to the press in the early 1970s. The leak exposed that four US presidents (Truman, Eisenhower, Kennedy and Johnson) had systematically lied to the American people which ultimately had the effect of putting their troops in fatal jeopardy. 58,000 US soldiers died in the Vietnam sham which was a lie from the start. I note that 2 million Vietnamese also died.<\/p>\n

The point is that the lies also extend to the way the top office runs the largest economy in the world and to the top office in most countries. <\/p>\n

Anyway, there has been a lot of discussion among the commentators of this blog about the constraints that different sectors face in the course of their decision making. While I welcome comments and diversity of perspective and certainly I welcome technical corrections in conceptual matters I have found some of the discussion to be somewhat at odds with my desire to achieve a perspicacious understanding of how the different sectors (government and non-government) work in a modern monetary system.<\/p>\n

The clear intent of some of the inputs has been to suggest that Modern Monetary Theory (MMT) which I have helped to develop as a principle part of my academic work is somehow “simplistic” and misleads people into believing that the government sector faces different constraints to the non-government sector. One comment concluded that the government sector in a fiat-currency issuing nation is financially constrained just like a household. To which I say – BS – which is the polite way of saying rot!<\/p>\n

Understanding what a sovereign government is<\/strong><\/p>\n

We often need reminding of just what a sovereign nation is. The distinction between sovereignty and non-sovereignty is crucial to understanding how the monetary system operates and the options that the government has under the two states. For example, the financial press call Greece a sovereign nation when it clearly doesn’t issue its own currency, has to take the interest rate set by the ECB, and uses a currency that is not floating (for it) in the foreign exchange markets (that is, bears no direct relationship to its net exports and net capital flows). That is not a sovereign nation.<\/p>\n

Essential background reading includes the following blogs – Deficit spending 101 – Part 1<\/a> – Deficit spending 101 – Part 2<\/a> – Deficit spending 101 – Part 3<\/a>
\nThen you should read these more specific blogs – Fiscal sustainability 101 – Part 1<\/a> – Fiscal sustainability 101 – Part 2<\/a> – Fiscal sustainability 101 – Part 3<\/a>.<\/p>\n

A national government in a fiat monetary system has specific capacities relating to the conduct of the sovereign currency. It is the only<\/strong> body that can issue this currency. It is a monopoly issuer, which means that the government can never be revenue-constrained in a technical sense (voluntary constraints ignored). This means exactly this – it can spend whenever it wants to and has no imperative to seeks funds to facilitate the spending.<\/p>\n

This is in sharp contradistinction with a household (generalising to any non-government entity) which uses the currency of issue. Households have to fund every dollar they spend either by earning income, running down saving, and\/or borrowing. Clearly, a household cannot spend more than its revenue indefinitely because it would imply total asset liquidation then continuously increasing debt. A household cannot sustain permanently increasing debt. So the budget choices facing a household are limited and prevent permanent deficits.<\/p>\n

These household dynamics and constraints can never apply intrinsically to a sovereign government in a fiat monetary system.<\/p>\n

A sovereign government does not need to save to spend – in fact, the concept of the currency issuer saving in the currency that it issues is nonsensical. A sovereign government does not need to borrow to spend. A sovereign government can sustain deficits indefinitely without destabilising itself or the economy and without establishing conditions which will ultimately undermine the aspiration to achieve public purpose.<\/p>\n

Further, the sovereign government is the sole source of net financial assets (created by deficit spending) for the non-government sector. All transactions between agents in the non-government sector net to zero. For every asset created in the non-government sector there is a corresponding liability created $-for-$. No net wealth can be created. It is only through transactions between the government and the non-government sector create (destroy) net financial assets in the non-government sector.<\/p>\n

This is an accounting reality that means that if the non-government sector wants to net save in the currency of issue then the government has to be in deficit $-for-$. The accumulated wealth in the currency of issue is also the accounting record of the accumulated deficits $-for-$. <\/p>\n

So when the government runs a surplus, the non-government sector has to be in deficit. There are distributional possibilities between the foreign and domestic components of the non-government sector but overall that sector’s outcome is the mirror image of the government balance.<\/p>\n

To say that the government sector should be in surplus is to also aspire for the non-government sector to be in deficit. In a nation such as Australia, where the foreign sector is typically in deficit (foreigners supplying their savings to us), the accounting relations mean that a government surplus will always be reflected in a private domestic deficit. This cannot be a viable growth strategy because the private sector (which faces a financing constraint) cannot be in deficits on an on-going basis. Ultimately, the fiscal drag will force the economy into recession (as private sector agents restructure their balance sheets by saving again) and the budget will move via automatic stabilisers into deficit.<\/p>\n

The relationships between a sovereign government and the non-government sector cannot be defied. Private debt build up can allow the government to run surpluses for some time (when the balance of payments is in deficit) but not for very long.<\/p>\n

Sub-national governments who use the currency of issue are akin to a household in that they face financing constraints. The only (and major) differences between a household and a sub-national government is that the latter typically has the power to tax (or levy fines) and can thus access cheaper funds in the debt markets as a consequence. While a sub-national government does have some risk of insolvency the reality is that it is extremely low and close to zero.<\/p>\n

Accordingly, the concept of fiscal sustainability involves a conceptualisation of a government which is free of financial constraints and has a range of possibilities that are not available to any non-government entity. It would never invoke a notion of public solvency. A sovereign government is always solvent (unless it chooses for political reasons not to be!)<\/p>\n

Further, given the non-government sector will typically net save in the currency of issue, a sovereign government has to<\/strong> run deficits more or less on a continuous basis. The size of those deficits will relate back to the pursuit of public purpose.<\/p>\n

I also note that some people do not like the term “fiat”. It is what it is – a legislative statement (the “fiat”) that the currency of issue is required to extinguish non-government tax liabilities and is issued under the legislative power vested (as a monopoly) in the national government. It is a totally appropriate term for what it describes. The currency has no intrinsic value. Its value is given by the fiat held and dispensed by government.<\/p>\n

With that discussion in mind, the following constraints can be usefully identified.<\/p>\n

A sovereign government is never intrinsically financially constrained. If you think otherwise then I am sorry to say that you do not understand the nature of the monetary system. Yes, the government may impose a voluntary constraint on itself – for example:<\/p>\n