Give the public debt some respect and end austerity!

3 October, 2018 at 14:05 | Posted in Economics | 12 Comments

The claim that our public debt is excessive has been used as a major justification for austerity – cuts in spending. That massive debt, we are told, 1) must be repaid, 2) threatens our country with bankruptcy, and 3) is a burden on future generations. All these are wrong. Let me explain why …

austerity-george-osborne-desktopBritain’s national currency is managed by our central bank, the Bank of England, owned by the citizens of the United Kingdom (that is, our elected government). As a result, the British government can never default on its bonds. Our government can replace maturing public bonds with new ones. Should private buyers, households and businesses, refuse to purchase the new bonds at the interest rate set by the British government, our government can sell them to the Bank of England …

The debt is nothing more than pieces of paper that the government promises to buy back on a specific date. These pieces of paper can be bought back with new pieces of paper (new bonds) with later buy-back dates. If the private owners of the debt paper do not want the new bonds (new debt paper), our government can sell those new bonds to the Bank of England for cash and use the cash to pay the bond holders.

John Weeks

Today there seems to be a rather widespread consensus of public debt being acceptable as long as it doesn’t increase too much and too fast. If the public debt-GDP ratio becomes higher than X % the likelihood of debt crisis and/or lower growth increases.

But in discussing within which margins public debt is feasible, the focus, however, is solely on the upper limit of indebtedness, and very few ask the question if maybe there is also a problem if public debt becomes too low.

darling-let-s-get-deeply-into-debtThe government’s ability to conduct an ‘optimal’ public debt policy may be negatively affected if public debt becomes too small. To guarantee a well-functioning secondary market in bonds it is essential that the government has access to a functioning market. If turnover and liquidity in the secondary market become too small, increased volatility and uncertainty will, in the long run, lead to an increase in borrowing costs. Ultimately there’s even a risk that market makers would disappear, leaving bond market trading to be operated solely through brokered deals. As a kind of precautionary measure against this eventuality, it may be argued — especially in times of financial turmoil and crises — that it is necessary to increase government borrowing and debt to ensure — in a longer run — good borrowing preparedness and a sustained (government) bond market.

The question if public debt is good and that we may actually have too little of it is one of our time’s biggest questions. Giving the wrong answer to it will be costly.

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  1. Is public debt good? Depends on your trade balance. It’s an accounting identity that The Domestic Government, The Domestic Private, and Foreign sectors must sum to zero. Sending your private sector into debt for any significant length of time is asking for a depression, so countries with a trade surplus must run government deficits. Countries that are major exporters, like Norway, can run a government surplus without sending the private sector into debt.
    http://bilbo.economicoutlook.net/blog/?p=2418

    “increased volatility and uncertainty will, in the long run, lead to an increase in borrowing costs.”
    That depends entirely on if the country has its own currency and if it’s central bank can purchase bonds directly, or if like the US, it can only buy them in the second market. Either way the central banks (which are all only nominally independent, spare the Eurozone) can almost always set the interest rate by credibly offering to purchase bonds till that rate is hit.

    The problems come, when because of financial imperialism, we force smaller countries to take on debt in foreign currency.

    There is a case to be made about countries offering bonds as a risk free investment vehicle for retirement funds and as a safe haven in a storm.

  2. Milton Friedman advocated a “zero public debt” regime: that’s “debt” in the sense of “interest yielding government liabilities”. But he did advocate a stock of “zero interest yielding” debt, i.e. zero interest yielding base money. Warren Mosler advocates the same, as do I. Re the relevant publication of mine (which includes links to Friedman and Mosler) see:

    http://www.openthesis.org/document/view/603834_0.pdf

    “The government’s ability to conduct an ‘optimal’ public debt policy may be negatively affected if public debt becomes too small.” MMTers tend to agree with that, at least in the sense that they attach importance to what they sometimes call “Private Sector Net Financial Assets” (which equals the stock of base money plus interest yielding public debt). PSNFA is clearly an asset as viewed by the private sector, thus the larger is PSNFA, the higher will the private sector’s spending be, all else equal.

    Thus MMTers will tend to agree with Lars’s claim that public debt can be too low. However, Friedman, Mosler and I (if the first two will forgive me speaking on their behalf) don’t agree with Lars’s claim that bonds are needed. To repeat, the latter three individuals claim INTEREST YIELDING public debt is not needed.

  3. A marketable public debt provides a benchmark and a hedge for the banking cum payments system. It is necessary to stabilize the unit of account. Married to a fiscal system that does a moderately effective job of taxing economic rents, it is a critical element in stabilizing the economy as a whole.
    .
    The function of money in a modern economy is to paper over pervasive uncertainty and public policy in managing money as a public good has to take account of the need of the economy for not just tokens of exchange, but means of hedging.
    .
    The Eurozone screwed itself because the architects did not take sufficient account of the role of “zero-risk” public debt in anchoring the banking and payments system. Now the national debts of countries like Italy carry a risk premium and predictable reactions to public spending increases threaten to ruin the Italian banks as surely as the Italian economy’s slow growth has. “There is no alternative.” has two edges and both cut deep.

    Brexit will seem like genius when Italy goes belly up.

    • I fully agree that public debt in the form of zero interest yielding base money is highly desirable (assuming that that money can be described as “debt” which of course is rather stretching the meaning of the word debt). What I have big doubts about (as did Milton Friedman and Warren Mosler) is whether it is necessary for those holding that money to be paid any interest (and as soon as interest comes into the picture, that money becomes more “debt like” in the conventional sense of the word debt).

      • The government pays interest on a 3-month bill, a 10-year note or a 30-year bond to distinguish those debts from the non-interest-bearing base money that can extinguish those debts.
        .
        Money is so useful economically because it enables people to make deals regarding the future despite the indeterminancy and uncertainty. That the state makes “risk-free” promises to pay money at dates certain and that those promises are exchangeable in a liquid market provides a benchmark and a hedge for the risky promises business must make (with the help of banks as agents and counterparties). The banks can hold the “risk-free” and liquid debt of the government as a hedge against the risks of uncertain fund flows from business activity and enables banks to engage in maturity transformation as a useful financial activity alongside the conduct of payment services.
        .
        Maybe that’s a lot of jargon for some, but I am not sure how to answer you in a way that you can understand, because I am really not sure how or why you have worked your mind into a corner where you imagine it would be desirable for the sovereign to limit itself to issuing only money and not also (interest-bearing) debt.

        • “The banks can hold the “risk-free” and liquid debt of the government as a hedge against the risks of uncertain fund flows from business…”. But what’s to stop them holding zero interest yielding base money “as a hedge”? Plus I fail to see why taxpayers have to be burdened with paying taxes to fund interest on government debt just so as to make private banks’ “hedges” more profitable.

          “I am really not sure how or why you have worked your mind into a corner where you imagine it would be desirable for the sovereign to limit itself to issuing only money and not also (interest-bearing) debt.” I provided a link above to an “Open Thesis” work of mine which goes into that question in far more detail (about 6,000 words).

          “and enables banks to engage in maturity transformation…”. Maturity transformation equals “borrow short and lend long”. Banks can engage in that activity regardless of whether they hold government debt or not, surely? E.g. what’s the big problem with a bank which limited itself to simply accepting short term (instant access) deposits and granting mortgages? Indeed, those two activities account for the bulk of many banks’ total turnover.

          • Maturity transformation equals “borrow short and lend long”. Banks can engage in that activity regardless of whether they hold government debt or not, surely?
            .
            Well, no, I don’t think they can.

      • I was thinking about it some more and I think my puzzlement comes down to this: if the government promises to pay a certain amount at a future date certain, that promise, if exchangeable in a market, will carry an implicit interest rate. Therefore, the only way for the government to not pay interest would be to not make such promises. (AKA issue no debt) Is that what you propose?

        • Yes. Along with Milton Friedman and the two founders of Modern Monetary Theory, Warren Mosler and Bill Mitchell, I advocate no such “promises”. However, in the Open Thesis work of mine linked to above, I concede that if the advocates of funding public investment via borrowing get their act together (which they are nowhere near doing so at the moment) they might be able to make a case for such borrowing).

          • Upthread you seemed to me to be conceding that government debt is needed as a vehicle for financial savings. Now you are saying that there should be no such debt. It seems contradictory.

            • Yes: I “concede that government debt is needed as a vehicle for financial savings”. But I’m also saying that that debt should not pay interest. I.e. it should take the form of zero interest yielding base money.

              • You do realize that would make the only available form of financial savings, hoarding?


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