The debate about the notorious Rogoff/Reinhart spreadsheet has taken an interesting turn. Recall that they argued strongly that high government debt is a bad thing as it depresses growth, and they provided evidence in the form of an analysis of the relationship between government debt and growth since the war. They claimed that the evidence shows that once debt gets above 90% of GDP growth slows sharply to zero. This was the evidence used by numerous politicians and commentators to justify imposing austerity on economies that were struggling economically.
It turns out, thanks to investigations by a graduate student, that their evidence was wrong, the result of a spreadsheet error and dubious selection of data. They have come back strongly, arguing, firstly, that the data still shows a relationship, albeit a weak one, and secondly, that they always acknowledged that austerity was not the whole answer. Then they go on to point out, as an illustration, that one of them has argued for policies that increase inflation to 5-6% to reduce the burden of debt.
This is a revealing comment because it shows that they do not know what they are talking about. I say this because anyone who understands how fiat currency systems work knows that the only risk posed by government deficit spending is inflation. There is no risk of government default or insolvency. The government (which includes its central bank) cannot run out of money. To think so is ridiculous. In fact they are the only agency that can create the base money required to pay taxes, and there is no intrinsic limit to much they can create. It follows that they cannot go insolvent. Period.
It is true that there are self-imposed rules on government spending which give the appearance that it is limited by revenues. These rules have one primary purpose: to prevent the sort of excessive money creation that could cause inflation. Taxes are required to control private sector demand, not to raise money for government spending. Economist who really understand the monetary system know this but believe that it is important to run fiscal policy as though tax revenues fund spending because this provides the discipline needed to constrain excessive growth in government spending. It also makes it easier to justify spending cuts or spending restraint if one can claim that there is just not enough money, that the government is 'broke'. For a sovereign government that creates its own currency this is always a lie. The only intellectually honest reason for restraining or reducing government spending in a fiat currency system is to prevent or reduce inflation.
The fact that Reinhart and Rogoff raise concerns about the dangers of government deficit spending and then suggest that a solution to the problem of debt is to create inflation reveals that they are not actually worried about deficit spending causing inflation. Instead they are worried about the possibility that the growing debt will become a problem for the US government because they might have trouble raising the funding, similar to what has happened to Eurozone countries, and indeed numerous other countries who have defaulted on their debts.
Unfortunately they don't seem to recognise the CRUCIAL difference between governments who have debts in their own currency, that they issue, and governments with debts in currency that they do not create. The latter include Eurozone governments and all governments who borrow in foreign currencies. Countries with their own currencies, like the USA, UK and Japan, are never revenue constrained and so cannot be forced to default on debts in their own currency. Not only can these countries not default, they can also control the interest rates that they pay on their debt. So there is no danger of them being forced to pay crippling interest rates on their debt. These facts are demonstrated by the very low rates payable on government debt in such countries, despite high deficits and increasing debt levels.
It follows that for the vast majority of countries deficit spending and government debts do not pose a solvency or funding problem. There is a risk that large deficit will lead to inflation, but this is only likely to be a problem if the economy is running at full capacity. In this case the extra demand from government could cause prices to rise. This is not likely when the economy has plenty of spare capacity which is the case when there is high unemployment. There might be a risk but it is only a small risk, and it is easily dealt with by cutting the deficit if inflation picks up.
The discussion above should make it clear that Rogoff and Reinhart are seriously mistaken. It makes no sense to oppose deficit spending when the only real risk of deficit spending is inflation and recommend instead intentionally inducing inflation. Why oppose a policy (deficit spending) that has a small risk of inducing inflation and favour instead a policy of actually inducing inflation? Assuming that they are not being deceptive, they appear to believe that the US government could have serious trouble 'funding' their spending, revealing ignorance if how their own monetary system operates. This is something one might expect from many people as it sounds like common sense. But surely academics who study government debt should know better?
It turns out, thanks to investigations by a graduate student, that their evidence was wrong, the result of a spreadsheet error and dubious selection of data. They have come back strongly, arguing, firstly, that the data still shows a relationship, albeit a weak one, and secondly, that they always acknowledged that austerity was not the whole answer. Then they go on to point out, as an illustration, that one of them has argued for policies that increase inflation to 5-6% to reduce the burden of debt.
This is a revealing comment because it shows that they do not know what they are talking about. I say this because anyone who understands how fiat currency systems work knows that the only risk posed by government deficit spending is inflation. There is no risk of government default or insolvency. The government (which includes its central bank) cannot run out of money. To think so is ridiculous. In fact they are the only agency that can create the base money required to pay taxes, and there is no intrinsic limit to much they can create. It follows that they cannot go insolvent. Period.
It is true that there are self-imposed rules on government spending which give the appearance that it is limited by revenues. These rules have one primary purpose: to prevent the sort of excessive money creation that could cause inflation. Taxes are required to control private sector demand, not to raise money for government spending. Economist who really understand the monetary system know this but believe that it is important to run fiscal policy as though tax revenues fund spending because this provides the discipline needed to constrain excessive growth in government spending. It also makes it easier to justify spending cuts or spending restraint if one can claim that there is just not enough money, that the government is 'broke'. For a sovereign government that creates its own currency this is always a lie. The only intellectually honest reason for restraining or reducing government spending in a fiat currency system is to prevent or reduce inflation.
The fact that Reinhart and Rogoff raise concerns about the dangers of government deficit spending and then suggest that a solution to the problem of debt is to create inflation reveals that they are not actually worried about deficit spending causing inflation. Instead they are worried about the possibility that the growing debt will become a problem for the US government because they might have trouble raising the funding, similar to what has happened to Eurozone countries, and indeed numerous other countries who have defaulted on their debts.
Unfortunately they don't seem to recognise the CRUCIAL difference between governments who have debts in their own currency, that they issue, and governments with debts in currency that they do not create. The latter include Eurozone governments and all governments who borrow in foreign currencies. Countries with their own currencies, like the USA, UK and Japan, are never revenue constrained and so cannot be forced to default on debts in their own currency. Not only can these countries not default, they can also control the interest rates that they pay on their debt. So there is no danger of them being forced to pay crippling interest rates on their debt. These facts are demonstrated by the very low rates payable on government debt in such countries, despite high deficits and increasing debt levels.
It follows that for the vast majority of countries deficit spending and government debts do not pose a solvency or funding problem. There is a risk that large deficit will lead to inflation, but this is only likely to be a problem if the economy is running at full capacity. In this case the extra demand from government could cause prices to rise. This is not likely when the economy has plenty of spare capacity which is the case when there is high unemployment. There might be a risk but it is only a small risk, and it is easily dealt with by cutting the deficit if inflation picks up.
The discussion above should make it clear that Rogoff and Reinhart are seriously mistaken. It makes no sense to oppose deficit spending when the only real risk of deficit spending is inflation and recommend instead intentionally inducing inflation. Why oppose a policy (deficit spending) that has a small risk of inducing inflation and favour instead a policy of actually inducing inflation? Assuming that they are not being deceptive, they appear to believe that the US government could have serious trouble 'funding' their spending, revealing ignorance if how their own monetary system operates. This is something one might expect from many people as it sounds like common sense. But surely academics who study government debt should know better?
