The flaws at the heart of mainstream (neoclassical) economic thinking are revealing themselves in interesting ways. The latest is that mainstream economists are seriously considering a policy of intentionally inducing inflation (e.g. ~5%), an approach termed market monetarism. The idea is this will both reduce the burden of debt and improve productivity by allowing a real reduction in debt and wages. The irony is that it is only necessary because of an intellectual straightjacket they built themselves that was originally designed to reduce the likelihood of inflation. So they resort to a policy of inducing certain inflation rather that allowing measures that carry a small risk of inflation! This is absurd.
There is a perfectly sane alternative. The problem is collapsing demand because everyone in the private sector is trying to pay of their debts. Instead of inflating away debts demand should be raised by allowing governments to run deficits, i.e. spend more money into the economy than they extract through taxes. It matters little whether taxes are lowered or spending is increased - the important requirement is that there is a deficit. That will restore growth and enable the private sector to pay of their debts. And if done in moderation it won't result in inflation. In essence that is what the USA is doing now, though it is not deliberate policy. Instead, it is a consequence of a political stalemate whereby the Democrat-controlled senate refuses to cut spending and the Republican-controlled congress refuses to raise taxes. It is clearly working; there is some growth, unemployment is dropping, and there is no hint of inflation. In fact, inflation is below its target. Despite this many are still anxious that this policy will eventually bankrupt the government. It is not surprising that they believe this because it seems plausible and politicians and mainstream economists voice the same concerns. But this fear is groundless; the fact that mainstream economist appear to validate it reveals their dishonesty or ignorance.
One of the central neoorthodox beliefs is that governments must balance their budgets. Even liberals like Nobel prize-winning Paul Krugman, who accept that there should be deficit-spending now, believes that this should be followed by government surpluses in good years so that the debt can be paid off over the economic cycle. The fallacy at the heart of this is that it does not recognise that there is no intrinsic need for governments to raise funds in their own currency before they spend. This is because any sovereign state can create its own currency at will. This has been the case since the USA and most other countries abandoned the gold-standard in the 1970's, ushering in the era of fiat money.
While it is technically possible for any sovereign government to create unlimited amounts of its own money there are self-imposed rules in place to discourage them from doing this. The underlying rationale for these rules is to prevent excessive money creation, which could lead to inflation. But it is a serious misconception to think that money creation will always lead to inflation. In fact it is an essential requirement of any growing economy. What matters is that money creation should not be excessive. The best measure of whether it is excessive is whether there is inflation. As noted in a previous post, commercial banks have created almost all the new money in recent decades, largely because of self-imposed rules preventing governments from creating money. Money creation has been privatised.
The sovereign debt problem is entirely a consequence of the self-imposed rules designed to avoid inflation. It is not the same debt that ordinary people and businesses have, where there is an obligation to pay that can only be met by obtaining money from other parties through earnings (taxes) or loans. It is better understood as being savings that parties have deposited with governments (by purchasing bonds) because they wish to earn interest with minimal risk.
These rules require governments to match their spending with tax receipts and, if there is a difference, require them to borrow an amount equal to this difference from the bond markets. Since governments could create their own currency selling bonds is not essential. It is a rule, designed to impose discipline on governments, which can easily be bypassed. For example, in the past the central banks have purchased these bonds from government with money that they have created. This loophole has now been closed so, instead, central banks buy them in the secondary market, from third parties that have themselves bought them. This is quantitative easing. It is a roundabout way of the government gaining access to the money that the central banks can create at will.
Worrying about the government debt is absurd when you realise that it is just the result of a complicated set of self-imposed rules designed to avoid inflation. The debt would not exist without these rules. Central banks could just create the money and provide it to governments to spend with no obligation to repay. Instead they create it to buy government bonds on the secondary market. Since they have infinite capacity to do this governments can never be forced to default on this debt.
Of course the Eurozone is different because there is one central bank with multiple governments. The rules are therefore much more difficult to work around. No-one with influence objects when the Bank of England creates money to buy UK government debt. When the ECB does this there are furious objections and threats of legal action from other states.
So now that we are trapped in a recession that neoclassical economists failed to predict, and the measures that they previously advocated (austerity, deregulation, structural reform etc) are clearly failing, they are struggling to think themselves out of the imaginary box that they built. They have lived in it for so long that they think the walls are real, and appear to have forgotten why they were constructed in the first place. It is painful to watch.
There is a perfectly sane alternative. The problem is collapsing demand because everyone in the private sector is trying to pay of their debts. Instead of inflating away debts demand should be raised by allowing governments to run deficits, i.e. spend more money into the economy than they extract through taxes. It matters little whether taxes are lowered or spending is increased - the important requirement is that there is a deficit. That will restore growth and enable the private sector to pay of their debts. And if done in moderation it won't result in inflation. In essence that is what the USA is doing now, though it is not deliberate policy. Instead, it is a consequence of a political stalemate whereby the Democrat-controlled senate refuses to cut spending and the Republican-controlled congress refuses to raise taxes. It is clearly working; there is some growth, unemployment is dropping, and there is no hint of inflation. In fact, inflation is below its target. Despite this many are still anxious that this policy will eventually bankrupt the government. It is not surprising that they believe this because it seems plausible and politicians and mainstream economists voice the same concerns. But this fear is groundless; the fact that mainstream economist appear to validate it reveals their dishonesty or ignorance.
One of the central neoorthodox beliefs is that governments must balance their budgets. Even liberals like Nobel prize-winning Paul Krugman, who accept that there should be deficit-spending now, believes that this should be followed by government surpluses in good years so that the debt can be paid off over the economic cycle. The fallacy at the heart of this is that it does not recognise that there is no intrinsic need for governments to raise funds in their own currency before they spend. This is because any sovereign state can create its own currency at will. This has been the case since the USA and most other countries abandoned the gold-standard in the 1970's, ushering in the era of fiat money.
While it is technically possible for any sovereign government to create unlimited amounts of its own money there are self-imposed rules in place to discourage them from doing this. The underlying rationale for these rules is to prevent excessive money creation, which could lead to inflation. But it is a serious misconception to think that money creation will always lead to inflation. In fact it is an essential requirement of any growing economy. What matters is that money creation should not be excessive. The best measure of whether it is excessive is whether there is inflation. As noted in a previous post, commercial banks have created almost all the new money in recent decades, largely because of self-imposed rules preventing governments from creating money. Money creation has been privatised.
The sovereign debt problem is entirely a consequence of the self-imposed rules designed to avoid inflation. It is not the same debt that ordinary people and businesses have, where there is an obligation to pay that can only be met by obtaining money from other parties through earnings (taxes) or loans. It is better understood as being savings that parties have deposited with governments (by purchasing bonds) because they wish to earn interest with minimal risk.
These rules require governments to match their spending with tax receipts and, if there is a difference, require them to borrow an amount equal to this difference from the bond markets. Since governments could create their own currency selling bonds is not essential. It is a rule, designed to impose discipline on governments, which can easily be bypassed. For example, in the past the central banks have purchased these bonds from government with money that they have created. This loophole has now been closed so, instead, central banks buy them in the secondary market, from third parties that have themselves bought them. This is quantitative easing. It is a roundabout way of the government gaining access to the money that the central banks can create at will.
Worrying about the government debt is absurd when you realise that it is just the result of a complicated set of self-imposed rules designed to avoid inflation. The debt would not exist without these rules. Central banks could just create the money and provide it to governments to spend with no obligation to repay. Instead they create it to buy government bonds on the secondary market. Since they have infinite capacity to do this governments can never be forced to default on this debt.
Of course the Eurozone is different because there is one central bank with multiple governments. The rules are therefore much more difficult to work around. No-one with influence objects when the Bank of England creates money to buy UK government debt. When the ECB does this there are furious objections and threats of legal action from other states.
So now that we are trapped in a recession that neoclassical economists failed to predict, and the measures that they previously advocated (austerity, deregulation, structural reform etc) are clearly failing, they are struggling to think themselves out of the imaginary box that they built. They have lived in it for so long that they think the walls are real, and appear to have forgotten why they were constructed in the first place. It is painful to watch.
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