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The deficit myth

Summary:
In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (such as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where they never can run out of money. A fortiori, spending becomes the prime mover, and taxing and borrowing are degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not a major problem since fiat money means that governments can always make more of them.​ In the mainstream economist’s world, we don’t need fiscal policy other than when interest rates hit their lower bound (ZLB). In normal times monetary policy

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In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (such as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where they never can run out of money. A fortiori, spending becomes the prime mover, and taxing and borrowing are degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not a major problem since fiat money means that governments can always make more of them.​

The deficit mythIn the mainstream economist’s world, we don’t need fiscal policy other than when interest rates hit their lower bound (ZLB). In normal times monetary policy suffices. The central banks simply adjust the interest rate to achieve full employment without inflation. If governments in that situation take on larger budget deficits, these tend to crowd out private spending and the interest rates get higher.

What mainstream economists have in mind when they argue this way, is nothing but a version of Say’s law, basically saying that savings have to equal investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. What happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

MMT rejects the traditional Phillips curve inflation-unemployment trade-off and has a less positive evaluation of traditional policy measures to reach full employment. Instead of a general increase in aggregate demand, it usually prefers more ‘structural’ and directed demand measures with less risk of producing increased inflation. At full employment, deficit spending will often be inflationary, but that is not what should decide the fiscal position of the government. The size of public debt and deficits is not — as already Abba Lerner argued with his ‘functional finance’ theory in the 1940s — a policy objective. The size of public debt and deficits are what they are when we try to fulfil our basic economic objectives — full employment and price stability.

Governments can spend whatever amount of money they want. That does not mean that MMT says they ought to — that’s something our politicians have to decide. No MMTer denies that too much government spending can be inflationary. What is questioned is that government deficits necessarily is inflationary.

All real economic activities depend on a functioning financial machinery. But institutional arrangements, states of confidence, fundamental uncertainties, asymmetric expectations, the banking system, financial intermediation, loan granting processes, default risks, liquidity constraints, aggregate debt, cash flow fluctuations, etc., etc. — things that play decisive roles in channelling money/savings/credit — are more or less left in the dark in modern mainstream formalizations of economic theory.

Can a government go bankrupt?
No. You cannot be indebted to yourself.

Can a central bank go bankrupt?
No. A central bank can in principle always ‘print’ more money.

Do taxpayers have to repay government debts?
No, at least not as long the debt is incurred in a country’s own currency.

Do increased public debts burden future generations?
No, not necessarily. It depends on what the debt is used for.

Does maintaining full employment mean the government has to increase its debt?
No.

The deficit mythAs the national debt increases, and with it the sum of private wealth, there will be an increasingly yield from taxes on higher incomes and inheritances, even if the tax rates are unchanged. These higher tax payments do not represent reductions of spending by the taxpayers. Therefore the government does not have to use these proceeds to maintain the requisite rate of spending, and can devote them to paying the interest on the national debt …

The greater the national debt the greater is the quantity of private wealth. The reason for this is simply that for every dollar of debt owed by the government there is a private creditor who owns the government obligations (possibly through a corporation in which he has shares), and who regards these obligations as part of his private fortune. The greater the private fortunes the less is the incentive to add to them by saving out of current income …

If for any reason the government does not wish to see private property grow too much … it can check this by taxing the rich instead of borrowing from them, in its program of financing government spending to maintain full employment.

Abba Lerner

Lars Pålsson Syll
Professor at Malmö University. Primary research interest - the philosophy, history and methodology of economics.

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