Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 5 December 2017

Government debt phobias, and possible cures

After my Thursday post and New Statesman piece, I had a lot of comments that said something along the lines of: I see what you are saying, but we really cannot afford more government debt in this country. This is perhaps not surprising. After seven or more years of a constant stream of politicians and media folk talking about the UK maxing out its credit card, many people just feel it in their bones that the UK government has a serious debt problem. (It isn’t just the UK: here is a compilation from the US.)

How do we undo 7+ years of conditioning? It depends in part on what the fear is. Here are five
  1. The country will go bankrupt

  2. When will the debt be paid off?

  3. Money could go on something more useful than paying interest

  4. Why should my taxes be higher just to pay interest on debt?

  5. What about the ‘burden’ on the children?
1. The country will go bankrupt

A simple truth, which you will not hear in the media, is that in an economy with a flexible exchange rate and its own central bank like the UK, the government can never be forced to go bankrupt, because the central bank can buy the government’s debt.

That of course is exactly what has been happening across the globe - not because central banks were trying to avoid the government going bankrupt, but because these banks were trying to keep long term interest rates low using Quantitative Easing (creating money). For example the Bank of England owns about a quarter of UK government debt (source). That meant that, at the slightest hint that the private sector might not have wanted to buy government debt, the central bank would have done so as part of its policy to control inflation.

At the end of the day, the central bank is a part of government, and so will always buy the debt of the government if necessary. That is why the government cannot be forced into bankruptcy. Could high and rising debt lead to inflation getting out of control? Yes, as Zimbabwe shows. When inflation is well above target and the central bank is creating a ton of money we can worry about that. When inflation is low and close to the target it would be daft to worry about this possibility.

2. When will the debt be paid off?

Here you should just stop thinking about government debt as being like personal debt. One reason it is different is that while a person dies, the country and therefore its government never do. Suppose you lived forever. Would you worry about paying your debt off?

What you should do is two things. First, use debt to spread the costs of investment over a large number of years. Many people are familiar with this, because they take out a mortgage to buy a house or a loan to buy a car. Second, use debt to smooth out fluctuations in your income. So in bad times let debt run up, but be sure to run it down in good times. Governments are exactly the same. For that reason they never have to pay all that debt back, but the ratio of debt to GDP should rise in bad times and fall in good times.

What level of debt to GDP should governments be aiming for in the very long run? This is a very good and interesting question, but to answer it you will probably have to become an economist, because it remains an unanswered question in macroeconomics.

3. All this debt interest could go on something more useful, like paying nurses more.

This was the fallacy I tried to deal with in my New Statesman piece, but here is another way of squashing this fallacy. We cannot just stop paying interest on debt, because that would involve the government defaulting on its debt. So the only way we can replace debt interest with spending more on nurses pay is to pay off all government debt. To do that, we would either have to raise taxes or spend less, and spending less means paying nurses less. It would also likely take about 30 years if you didn’t want a revolution. So 30 years of lower nurses pay just to get, after 30 years, higher nurses pay.

That does not make the idea wrong. But it does make it look rather less attractive than the impossible idea of swapping debt interest with something more useful tomorrow.

4. Why should my taxes go up just to pay interest on government debt

To help answer this question, we need to ask who gets these interest payments? For reasons we have already noted, a quarter of these interest payments go to the Bank of England as a result of its Quantitative Easing programme. The Bank then returns these interest payments to the government. In other words, on a quarter of UK government debt the government pays itself. [1]

Half of UK government debt is owned by the UK private sector. The majority of this is insurance or pension funds. In other words, the interest on government debt is in part helping to pay for your pension. And if by some magic that government debt was not there for your pension fund to buy, that fund would be forced to invest instead in some other, less desirable asset. If you are in the UK and have some money saved in the form of national savings, that is government debt too. The interest of this debt goes to you.

The key takeaway from this is that government debt is always someone else’s asset. If you think that you will end up paying more taxes to pay this debt interest than you will get back in pension payments or whatever, then debt is a distributional issue. You are complaining that you pay taxes (a small amount of which goes on debt interest payments) but you do not have enough wealth to buy government debt and receive these payments. That is a legitimate complaint, but it is part of a general complaint about how income and wealth is distributed, and not something unique to government debt.

And there is this point. If you think you want to reduce government debt because you are paying higher taxes and none of that is coming back to you or your pension, how do you think the government is going to reduce its debt? By raising your taxes of course.

So we come to the quarter of UK government debt where the taxes you pay that are then paid by the government as debt interest end up overseas. Surely that bit of debt interest is wasted, because it is going to someone overseas rather than someone here. But think about this. Suppose all government debt was owned domestically, and then some pension fund decided they would be better off by swapping their government debt with an overseas asset. Is that pension fund worse off? No, it is better off if its calculations are right. No one anywhere else in the UK is worse off because some government interest is now being paid overseas? If lots of people in the UK decide to do the same it still will not matter. It must therefore be true that selling debt to people overseas, whether directly or indirectly, makes no difference. Your concern is still a distributional issue.

To make this point another way, it would be possible to arrange the distribution of government debt such that everyone who paid higher taxes to cover debt interest received that debt interest back as a return, directly or indirectly via pensions, to their wealth. In that sense, the government paying interest on its debt is just like paying ourselves. To the extent that this isn’t true for you personally is a distributional issue. [2]

5. What about the children?

It is theoretically possible for the current generation’s government to go on a huge spending and tax cutting binge and leave the tab to be paid for by future generations. But that is not what has happened over the last ten years. Debt went up because we had a massive recession, and government deficits help cushion the impact of recessions. Should the government have stopped teaching children to avoid the deficit rising? Of course not, because that would have hurt future generations. Should the government have cut welfare payments to the unemployed to stop debt rising. Again we have good evidence that has a scarring effect on children. Should the government have embarked on an austerity programme that reduced public investment making future generations worse off. It should not.

Trying to cut the deficit by cutting public investment, or government spending that has long lasting effects like education or health, because you are worried about the burden of debt on future generations is, quite simply, idiotic. You are hurting the people you say you want to help.

Does this mean I should never worry about government debt?

In today’s economy, it is quite wrong to say government debt does not matter at all. There is a kind of simple golden rule here. When times are good, the government should be reducing its debt: debt to GDP ratios should be falling. How do you know when times are good? Not by asking politicians, obviously. One reliable sign that times are good is if interest rates are well above their floor. When interest rates are this high, cutting them can completely cushion the negative demand effects of fiscal consolidation (i.e. reducing the deficit). For this reason, austerity - fiscal consolidation in bad times - is completely unnecessary for economies like the UK.

For MMT readers

Before you start writing comments, a simple point. In an MMT world, where fiscal policy rather than monetary policy stabilises inflation, you would never worry about government debt or deficits beyond their impact on inflation. If you like that kind of world, then say that is how governments should be controlling inflation. But as it is, outwith the zero lower bound, governments are using interest rates to do this job. So to tell people not to worry about debt without mentioning the controlling inflation part is just confusing, to say the least.

Summary

We can sum all this up as follows. It makes perfect sense in many situations for the government to increase its debt. Investing when interest rates are very low is one of those situations, a recession is another. Those who tell you government debt should be reduced in all situation at whatever the cost should be ignored, because they are either fools or they have a hidden motive.

It also makes sense for governments to reduce their debt in good times, when interest rates are higher than they are now. [3] But in a economically advanced democracy the reasons why ever rising debt (often called deficit bias) is a problem are to do with economicky things like disincentive effects, and not because it will mean we are all doomed. You should not be frightened about allowing debt to rise when the situation demands it.

[1] Why is the debt held by the central bank counted as debt? One answer is that one day the Bank might sell it to the private sector, so it is a potential liability. But central banks may just let this debt run to term, so it will never be a liability. An alternative theory is that government debt owned by the central banks is kept in the figures to make them look more scary.

[2] Of course no one knows if their taxes are paying this debt interest or not. Even if we are paying ourselves, there is still a problem, which is that these taxes are not lump sum, so they involve a disincentive effect. This is a valid reason for wanting to keep government debt low, but it is not the reason most people worry about.

[3] How about now in the US? Should we worry about the Republican tax bill because it will increase the deficit? As interest rates are off their lower bound and rising, I would say we should, particularly as those who get most of the tax cuts are unlikely to spend them. But we should worry about it a lot more because it is a transfer from most people to a plutocratic elite.      

15 comments:

  1. Just a small technical issue. Under QE, it is not the Gilt coupon that is returned to the Treasury by the BofE, but the coupon less financing costs - the financing cost being Bank rate which is paid on the central bank reserves created by QE. Effectively then, QE is an interest rate swap that swaps the Gilt coupon that the Treasury would have paid into a short term variable rate (Bank rate), which is set by the BofE. That's been pretty profitable up to now for the Treasury (£73bn returned to date, with another £50bn in reserve), but of course, if the BofE had to raise rates significantly at some point whilst QE was still open, those profits could rapidly disappear.

    And before anyone says that QE means that the government is effectively paying interest at Bank rate to the banks, they in turn are paying interest on the bank deposits also created by QE - usually at a rate equal to or higher than they are receiving on their central bank reserves.

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  2. «had a lot of comments that said something along the lines of: I see what you are saying, but we really cannot afford more government debt in this country.»

    Indeed our blogger is right to criticize the usual mediamacro framing which uses long discussions of the UK government debt not-much-of-an-issue as a way to divert attention from the UK private debt big-and-serious-issue.

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  3. "Here you should just stop thinking about government debt as being like personal debt."

    Totally agree.

    "One reason it is different is that while a person dies, the country and therefore its government never do. Suppose you lived forever. Would you worry about paying your debt off?"

    Totally disagree.

    There are many reasons that government debt is different from personal debt but if this is one, it is a *very* minor one.

    Death is either 1/ early repayment in a limited amount, 2/ no repayment. ie given death you should be MORE inclined to take out debt.

    In short, if I borrow 100, I know I'll be paying it back in full in the case of a government, whereas I'm not certain of that as an individual.

    Here are some better examples of how Gov and Personal debt are different:

    - Ability to print money
    - Ability to raise money through taxation
    - Highly credit worthy (ie debt is less expensive)
    - Liquid secondary market in debt (ie transparent how much will be paid to, say, refinance).

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  4. Many thanks for the explaination. So grateful for the detailed nontechnical arguements we so desperately need. Money creation and value is another area that needs clearing up as well.
    I was struck by what Chris Dillow said, "what about all the opportunities that have been missed by this government choking investment". MPC

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  5. This is not Central to your point, but what characteristics differentiate the UK from Venezuela in regards to government debt? I ask because Venezuela appears to to in liminal state between default and non-default.

    Is it the currency peg (set to between 1/100th and 1/1000th of the black market exchange rate)? Is it the fuzzy relationship between the debt issued by the government proper and the PdVSA (closely controlled state oil company)? Does the 20%+ interest rates affect this?

    Obviously, none of this matters for the US or UK or any other major economy currently, but I'm interested in what assumptions are key for distinguishing dangerous vs necessary or valuable government debt accumulation.

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  6. Re MMT, and speaking as an MMT supporter, my reason for wanting fiscal rather than monetary policy to “stabilize inflation” is that while the free market is obviously not too good at the job (i.e. not good at regulating demand), I see no evidence that it’s the failure of interest rates to adjust that is the cause of this.

    I.e. there is nothing to stop supply and demand adjusting the price of borrowed money. Thus there is little reason to artificially interfere with interest rates. In contrast, there is quite clearly something that stops the Pigou effect working: it’s Keynes’s “wages are sticky downwards” point. (The Pigou effect is that the fact that in a perfectly functioning free market, and given excess unemployment, wages and prices fall, which raises the real value of private sector net financial assets (base money and government debt) which in turn encourages more private sector spending.)

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  7. Hi,
    I take that what you've done is of great benefit and is the only serious game in town. My experience of attempting this is it's very difficult, though someone with your status should have more authority, as the average Joe just rolls their eyes and refuses to listen, they may hear what I'm saying but do not think about it. Yes, they're very close to having been brainwashed.
    Where people seam to be moving is that some are know prepared to except more debt, and its consequences, over the now known costs to society, including their own needs. Fortunately, if that's so it's still worth while trying to break the 'myths' you've outlined as those how've understood should vote for better policies.

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  8. Hi,
    I take that what you've done is of great benefit and is the only serious game in town. My experience of attempting this is it's very difficult, though someone with your status should have more authority, as the average Joe just rolls their eyes and refuses to listen, they may hear what I'm saying but do not think about it. Yes, they're very close to having been brainwashed.
    Where people seam to be moving is that some are know prepared to except more debt, and its consequences, over the now known costs to society, including their own needs. Fortunately, if that's so it's still worth while trying to break the 'myths' you've outlined as those how've understood should vote for better policies.

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  9. Speaking from an MMT perspective, all currency is Government debt. That means all net dollars in all accounts had to be spent by the Government first. Without Government "Debt" there would be no economy. When the economy grows (GDP), or we support a net import trade balance, new money must be added to the economy, or individuals like you and I must go into debt.

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  10. Selling public debt with Ricardo’s tear gland rhetoric
    Comment on Simon Wren-Lewis’ ‘Government debt phobias, and possible cures’

    Arguing against all kinds of land related taxes, Ricardo took an emphatic social stance: “Such taxes, therefore, fall almost always upon the necessitous person, and must, therefore, be very cruel.” (Principles, p. 154) Needless to emphasize that Ricardo knew quite well that land taxes are normally not a concern of poor people but appear very cruel to rich people.

    As a rule, economists put the poor widow in the foreground and the emotional limelight when they lack sound arguments. Simon Wren-Lewis is no exception, he abuses the underpaid nurses in order to argue against reducing the public debt. When nurses or babies or pandas appear in an economic/political argument the odds are that the general public is taken for a ride.

    The problem with the debt discussion is that it is macroeconomics and macro is scientific garbage since Keynes. The apex of scientific incompetence is microfounded macro. Keynesian macro, on the other hand, and Post Keynesianism and MMT as the latest reincarnation has been based on provably false balances equations.#1 Roughly speaking, macroeconomic profit theory is false and because of this, the whole analytical superstructure is false, and because of this, economic policy guidance lacks sound scientific foundations.

    The point everyone can agree upon is “It makes perfect sense in many situations for the government to increase its debt.” Yes, but it should be added that public debt is always a bad deal for the ninety-nine-percenters.#2 The discussion about deficit spending and inflation is a red herring. The disastrous effect of a growing public debt is NOT on inflation but on the distribution of income and wealth.

    Curiously, the word profit does not appear once in Simon Wren-Lewis’ post. Neither, does it appear in the contributions of MMTers ― the most outspoken champions of deficit spending and the propagandists of the debt-does-not-matter meme.#3

    From axiomatically consistent macrofoundations follows Public Deficit = Private Profit. With deficit spending, the business sector is always better off. The household sector, on the other hand, always holds the bag. It is taxed in real terms in the period of consumptive government deficit spending without realizing it. It is taxed in subsequent periods if interest on government debt is greater than zero, and it is taxed in nominal terms in the indefinite future, i.e. beyond the time horizon, in order to eventually redeem the accumulated government debt.

    Neither orthodox nor heterodox economists have figured out how the price and profit mechanism works. Macroeconomics in general and the profit and employment theory, in particular, is provably false since Keynes.

    Economists’ care for the poor widow and the unemployed teenager and the underpaid nurse, and the endorsement of popular social agendas is, as a rule, rhetorical window dressing. In particular, if the proposed policy is deficit spending and permanent increase of the public debt. The macroeconomic Profit Law states Public Deficit = Private Profit. MMT policy, in particular, is a wellness program for the one-percenters which is realized with the help of the sovereign money issuing state and paid for in real terms by the ninety-nine-percenters.#4

    Egmont Kakarot-Handtke

    #1 Rectification of MMT macro accounting
    https://axecorg.blogspot.de/2017/09/rectification-of-mmt-macro-accounting.html

    #2 MMT, money printing, stealth taxation, and redistribution
    http://axecorg.blogspot.de/2017/11/mmt-money-printing-stealth-taxation-and.html

    #3 MMT: The one deadly error/fraud of Warren Mosler
    https://axecorg.blogspot.de/2017/11/mmt-one-deadly-errorfraud-of-warren.html

    #4 For details of the big picture see cross-references MMT
    http://axecorg.blogspot.de/2017/07/mmt-cross-references.html

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  11. Those are some really good explanations but not the best ones.
    1) State prints its own money. Can you go bancrupt if you could print money? State always printed money and it is nothing new to pay off its debts with newly printed money. SInce state has always printed the money why going histeric about state printing money now? Didn't you know? (talking to inflation scared persons)
    2) No country pays off its debt, ever. Why are you talking about paying off the debt now? FInd me a country without debt, then talk about paying it off.
    3) Debt interest paid is much less in value then the ammount of money borrowed and allready spent. Value of debt interest will tangentially get close to the value of borrowed money but never reach it due to infation. Please calculate to find out how many years will take for debt interest ammount to reach borrowed ammount, include inflation deteriotaing the payments value and see for yourself.
    4)Debt interest is almost never paid by taxes but by new debt. Very rarelly would primary deficit be negative which is when taxes pay some of the debt servicing. But that is so miniscule ammount and occasion that basically taxes never pay for debt servicing, so what are you talking about, what higher taxes to pay debt interest? Debt servicing is almost always paid by new debt, please investigate to learn what you are questioning.
    5)YOu are the child of those that were also asking the same question 30-40 years ago, are you paying off their debts? Why would children be paying off your debts if you are not paying debts off your ancestors incurred? States never pay off their debts, again.

    These answers are much more to the point and to the reality then your good explanations, sir.

    About the answer to MMTers. Monetary policy is bad at controlling inflation especially when it reaches higher inflations and then the interest payments to economy grow which supports higher inflation while at the same time it tries to fight inflation.

    High debts increase fiscal transfers to economy as interest rates grow countering the monetary policy intent and the outcome is much worse on employment untill the policy starts to work. It effectivelly transfers the purchasing power from workers to pensioners where the fiscal transfers end up due to higher interst rates.

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  12. Taking future scenario where UK interest rates do rise above their Zero Lower Bound, and real interest rate exceeds real growth rate, in order to reduce debt/gdp ratio, does SWL believe that public investment should then be cut?

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  13. Jure Jordan

    You say
    (i) “State prints its own money. Can you go bankrupt if you could print money?”

    No, but that is NOT the issue. Distribution is the issue. If the state/central bank creates new money for the business sector to pay the wages for additional workers and the household sector as a whole spends total income on consumption, i.e. Ch=Yw, then the household sector gets the whole output and the price remains constant if average wage rate and productivity are constant, no matter how much the economy expands.#1

    To produce money in order to enable the autonomous transactions between the business and the household sector is the original task of the central bank, that is, it has to see to it that THE ECONOMY never runs out of money.

    If the state issues new money and it is added to consumption expenditures, i.e. C=Ch+Cg, there is a one-off price increase which results (i) in the redistribution of output, and (ii), in the monetary profit Qm=Cg. So, the household sector = ninety-nine percenters is taxed in real terms via the price mechanism and the business sector = one percenters makes additional profit. The real distribution and the distribution of financial wealth changes.

    One can repeat this feat for an indefinite time without inflation. The central bank finances the deficit and public debt vis-a-vis the central bank grows steadily if it is not consolidated by issuing interest bearing bonds or other securities. These financial variants do NOT alter the fact that the wage income receivers are period after period TAXED in real terms without realizing it.

    The price mechanism is NOT an information system as Hayek hallucinated but the very tool of stealth taxation/redistribution.

    (ii) “No country pays off its debt, ever.”

    This is a historical fact. But the indefinite rolling over does not make the debt disappear. The problem is simply pushed beyond the time horizon according to the old policy motto ‘After me, the deluge’. The question is what happens if the debt is eventually redeemed. And the answer is that the market economy breaks down.

    (iii) “Debt interest is almost never paid by taxes but by new debt.”

    True, but this is merely ‘After me, the deluge’ with a vengeance. What MMT is in effect saying is, don’t worry, we will pay neither interest nor principal but, when the day of reckoning comes, redefine debt as gift of the central bank.

    The MMT debt-does-not-matter argumentation appeals to the corrupt part of the population. In the political realm, this kind of half-truth/trickery/deception/fraud is standard procedure. Economics, though, claims since 200+ years to be a science. The real problem starts when academics ignore the separation of science and politics and become the loudspeakers of Warren Mosler’s sales team.#2

    Egmont Kakarot-Handtke

    #1 MMT, money printing, stealth taxation, and redistribution
    http://axecorg.blogspot.de/2017/11/mmt-money-printing-stealth-taxation-and.html

    #2 MMT: Money-making for the one-percenters
    https://axecorg.blogspot.de/2017/09/mmt-money-making-for-one-percenters.html

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  14. This seems to be a roundabout acknowledgement that, actually, government debt does matter, with interest being a real cost to the taxpayer. So does the dispute with mediamacro boil down to a disagreement about whether a debt to gdp ratio of c 90% is high, and whether now would be a sensible time to reduce it given the UK is not in recession and has not been for some time?

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  15. "What level of debt to GDP should governments be aiming for in the very long run? This is a very good and interesting question, but to answer it you will probably have to become an economist, because it remains an unanswered question in macroeconomics." - Surely this level is quite relevant to the current debate? (ie is the UK moving dangerously away from this level)

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