by [embedded content] The balanced budget paradox is probably one of the most devastating phenomena haunting our economies. The harder politicians — usually on the advice of establishment economists — try to achieve balanced budgets for the public sector, the less likely they are to succeed in their endeavour. And the more the citizens have to pay for the concomitant austerity policies these wrong-headed politicians and economists recommend as “the sole solution.” One of the most effective ways of clearing up this most serious of all semantic confusions is to point out that private debt differs from national debt in being external … A variant of the false analogy is the declaration that national debt puts an unfair burden on our children, who are thereby made to pay for our
Topics:
Lars Pålsson Syll considers the following as important: Economics
This could be interesting, too:
Lars Pålsson Syll writes Daniel Waldenströms rappakalja om ojämlikheten
Peter Radford writes AJR, Nobel, and prompt engineering
Lars Pålsson Syll writes MMT explained
Lars Pålsson Syll writes Statens finanser funkar inte som du tror
The balanced budget paradox is probably one of the most devastating phenomena haunting our economies. The harder politicians — usually on the advice of establishment economists — try to achieve balanced budgets for the public sector, the less likely they are to succeed in their endeavour. And the more the citizens have to pay for the concomitant austerity policies these wrong-headed politicians and economists recommend as “the sole solution.”
One of the most effective ways of clearing up this most serious of all semantic confusions is to point out that private debt differs from national debt in being external … A variant of the false analogy is the declaration that national debt puts an unfair burden on our children, who are thereby made to pay for our extravagances. Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our children or grandchildren and to nobody else. Taking them altogether they will no more be impoverished by making the repayments than they will be enriched by receiving them.
Abba Lerner The Burden of the National Debt (1948)
Few issues in politics and economics are nowadays more discussed — and less understood — than public debt. Many raise their voices to urge for reducing the debt, but few explain why and in what way reducing the debt would be conducive to a better economy or a fairer society. And there are no limits to all the — especially macroeconomic — calamities and evils a large public debt is supposed to result in – unemployment, inflation, higher interest rates, lower productivity growth, increased burdens for subsequent generations, etc., etc.
Through history public debts have gone up and down, often expanding in periods of war or large changes in basic infrastructure and technologies, and then going down in periods when things have settled down.
The pros and cons of public debt have been put forward for as long as the phenomenon itself has existed, but it has, notwithstanding that, not been possible to reach anything close to consensus on the issue — at least not in a long time-horizon perspective.
In classical economics — following in the footsteps of David Hume — Adam Smith, David Ricardo, and Jean-Baptiste Say put forward views on public debt that was mostly negative. Later on, 20th-century economists like John Maynard Keynes and Abba Lerner would hold a more positive view on public debt. Public debt was normally nothing to fear, especially if it was financed within the country itself (but even foreign loans could be beneficent for the economy if invested in the right way). Some members of society would hold bonds and earn interest on them, while others would have to pay the taxes that ultimately paid the interest on the debt. But the debt was not considered a net burden for society as a whole since the debt cancelled itself out between the two groups. If the state could issue bonds at a low-interest rate, unemployment could be reduced without necessarily resulting in strong inflationary pressure. And the inter-generational burden was no real burden according to this group of economists, since — if used in a suitable way — the debt would, through its effects on investments and employment, actually make future generations net winners. There could, of course, be unwanted negative distributional side effects for the future generation, but that was mostly considered a minor problem since when our children and grandchildren repay the national debt these payments will be made to our children and grandchildren.
Central to the Keynesian influenced view is the fundamental difference between private and public debt. Conflating the one with the other is an example of the ‘atomistic fallacy,’ which is basically a variation on Keynes’ savings paradox. If an individual tries to save and cut down on debts, that may be fine and rational, but if everyone tries to do it, the result would be lower aggregate demand and increasing unemployment for the economy as a whole.
To both Keynes and Lerner, it was evident that the state had the ability to promote full employment and a stable price level – and that it should use its powers to do so. If that meant that it had to take on a debt and (more or less temporarily) underbalance its budget – so let it be! Public debt is neither good nor bad. It is a means to achieve two over-arching macroeconomic goals – full employment and price stability. What is sacred is not to have a balanced budget or running down public debt per se, regardless of the effects on the macroeconomic goals. If ‘sound finance,’ austerity and balanced budgets means increased unemployment and destabilizing prices, they have to be abandoned.
Now against this reasoning, exponents of the thesis of Ricardian equivalence, have maintained that whether the public sector finances its expenditures through taxes or by issuing bonds is inconsequential, since bonds must sooner or later be repaid by raising taxes in the future.
Robert Barro attempted to give the proposition a firm theoretical foundation, arguing that the substitution of a budget deficit for current taxes has no impact on aggregate demand and so budget deficits and taxation have equivalent effects on the economy.
The Ricardo-Barro hypothesis, with its view of public debt incurring a burden for future generations, is the dominant view among mainstream economists and politicians today. The rational people making up the actors in the model are assumed to know that today’s debts are tomorrow’s taxes. But — the main problem with this standard mainstream theory is that it simply does not fit the facts.
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.
The 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.
To view government debts in terms of the ‘functional finance’ concept introduced by Abba Lerner, is to consider their role in the macroeconomic balance of the economy. In simple, bare bones terms, the function of government debts that is significant for the macroeconomic health of an economy is that they provide the assets into which individuals can put whatever accumulated savings they attempt to set aside in excess of what can be wisely invested in privately owned real assets. A debt that is smaller than this will cause the attempted excess savings, by being reflected in a reduced level of consumption outlays, to be lost in reduced real income and increased unemployment.