Christine Lagarde, head of the IMF, made a revealing aside last week by commenting in an interview that when she thinks what would have happened in the UK if the government had not embarked on its recession-inducing deficit reduction programme, 'I shiver'. I find it revealing because I have been struggling to work out to what extent what the stated views of mainstream policymakers are a product of sincere ignorance or calculated dishonesty. I think this fairly frank admission of fear shows that ignorance plays an enormous role. Also revealing has been the open discussion by many commentators, including some in Germany, of inducing inflation as a solution to the stagnation induced by the global financial crisis. What this reveals is a genuine fear of sovereign debt and default that is so great that they are willing to tolerate inflation to resolve the problem.
This is deeply ironic because the only reason that sovereign default is considered to be a possibility is that we run our monetary systems according to self-imposed rules that are there to PREVENT inflation. It seems we have forgotten that these rules are self-imposed and/or why they were adopted in the first place.
A useful analogy would be a community that introduce traditions of not eating desert and avoiding alcohol to prevent common problems of obesity and alcoholism. Both policies make sense because they remove temptation. Eventually these self-imposed dietary rules are adopted as strict customs by their descendants. One day these descendants are faced with a catastrophic disaster as a result of which the only food available is desert and the only drink is beer. Do they stick to their customs at the risk of starvation or dehydration? Or do they recognize that, as these customs originated from self imposed rules designed to avoid problems that are far less threatening, they should ignore them.
This is the situation we face now with government deficits and debt. Countries that issue their own currency can never run out of money. They can never be forced to default voluntarily on debts in their own currency, as they can and do create money in unlimited amounts. Because this power, if abused, carries the risk of inflation we have adopted rules to restrain it.
The first rule is that we should raise taxes to match government spending. These taxes are not strictly necessary because fiat money is created through the act of spending. What they do is remove from circulation money that the government introduced by spending. These rules give the appearance that governments have to raise revenue before they spend it. The truth is that they don't have to. The main reason for taxation is to prevent excessive money creation, which could lead to excessive demand and thus inflation.
The second rule is that if the revenue raised by taxes (or the money removed from circulation by taxes) is less than the money created by government spending, the government is required to sell bonds to the market to a value that matches the deficit. While the sale of bonds serves some useful purposes there is no real need to borrow to fund government spending. However requiring governments to sell bonds to match deficits gives the appearance of mounting government debt. Because excessive private sector or personal debt is dangerous and therefore something to be feared, having a rule that means that deficit spending leads to growing government debt provides a powerful psychological restraint on deficit spending.
Recall that the real danger of deficit spending is inflation. For currency-issuing governments debts are self-imposed and voluntary, and they can never be forced to default on them. The fact that mainstream policymakers are considering actually inducing inflation rather than embracing policies (deficit spending) which carry a small risk of inflation reveals that irrational fear of debt underlies their policy error.
This is deeply ironic because the only reason that sovereign default is considered to be a possibility is that we run our monetary systems according to self-imposed rules that are there to PREVENT inflation. It seems we have forgotten that these rules are self-imposed and/or why they were adopted in the first place.
A useful analogy would be a community that introduce traditions of not eating desert and avoiding alcohol to prevent common problems of obesity and alcoholism. Both policies make sense because they remove temptation. Eventually these self-imposed dietary rules are adopted as strict customs by their descendants. One day these descendants are faced with a catastrophic disaster as a result of which the only food available is desert and the only drink is beer. Do they stick to their customs at the risk of starvation or dehydration? Or do they recognize that, as these customs originated from self imposed rules designed to avoid problems that are far less threatening, they should ignore them.
This is the situation we face now with government deficits and debt. Countries that issue their own currency can never run out of money. They can never be forced to default voluntarily on debts in their own currency, as they can and do create money in unlimited amounts. Because this power, if abused, carries the risk of inflation we have adopted rules to restrain it.
The first rule is that we should raise taxes to match government spending. These taxes are not strictly necessary because fiat money is created through the act of spending. What they do is remove from circulation money that the government introduced by spending. These rules give the appearance that governments have to raise revenue before they spend it. The truth is that they don't have to. The main reason for taxation is to prevent excessive money creation, which could lead to excessive demand and thus inflation.
The second rule is that if the revenue raised by taxes (or the money removed from circulation by taxes) is less than the money created by government spending, the government is required to sell bonds to the market to a value that matches the deficit. While the sale of bonds serves some useful purposes there is no real need to borrow to fund government spending. However requiring governments to sell bonds to match deficits gives the appearance of mounting government debt. Because excessive private sector or personal debt is dangerous and therefore something to be feared, having a rule that means that deficit spending leads to growing government debt provides a powerful psychological restraint on deficit spending.
Recall that the real danger of deficit spending is inflation. For currency-issuing governments debts are self-imposed and voluntary, and they can never be forced to default on them. The fact that mainstream policymakers are considering actually inducing inflation rather than embracing policies (deficit spending) which carry a small risk of inflation reveals that irrational fear of debt underlies their policy error.
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