The IMF as Deficit Owl? What’s Wrong with This Argument?

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Jan Kregel
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It seems the IMF aviary has turned on the hawks and embraced the deficit owls. Has the IMF joined the policy shift to MMT? Yes, in part, but it appears to be a viral form of MMT: according to Vitor Gaspar, the IMF’s head of fiscal policy, “Nations’ first priority should be vaccination, while the reduction of public debt is now far down the list of urgent actions… the main role of fiscal policy in the immediate future should be to be stimulative, to help restore economic growth, reduce unemployment and beat Covid-19.”

This is a big shift in IMF policy advice on post-crisis response, Chris Giles notes: “After the financial crisis a decade ago the fund recommended that countries should reduce their debt levels.”

But the pervasive pandemic is not the real reason for the change in feathered preferences: “Mr Gaspar said the IMF’s change of heart towards a relaxed approach to high levels of public debt stemmed from central banks’ reduction in interest rates. The drop in market funding costs means that, although advanced economies’ public debt has doubled as a share of GDP from 60 per cent to 120 per cent over the past 30 years, interest payments have halved from 4 per cent of GDP to 2 per cent.” Or perhaps the IMF is following Keynes’s wish for the euthanasia of the rentiers?

If fiscal policy is the weapon to fight the war against the coronavirus, then the same logic used by Wright Patman, MMT’er before his time, and every other sensible politician when faced with war finance, should raise the question of why the government should pay interest on the money it issues in order to spend. So, to follow the new IMF fiscal logic: If interest rates on government debt were zero, which is very close to conditions in many countries—indeed, some are negative—this should mean that the size of debt ratios should be even less of a concern. But zero interest rate debt is called currency. If government expenditure were financed by currency issue, following Congressman Patman, the government would not have to pay interest. And would it then follow the IMF could stop worrying about debt ratios?

But this is not the problem with the debt argument. Other things being equal, the level of interest rates has an impact on the total debt level associated with a particular level of the deficit. Higher interest rates should then be associated with higher debt ratios and vice versa, so it should be clear that the IMF position has not changed that much: it still prefers lower interest rates and the associated lower debt ratios because that means that it will require less austerity to reduce the debt burden in future.

However, while interest rates represent the costs of debt, they also represent income to someone in the system. Could higher interest rates make a lower deficit necessary to achieve a given impact on growth and employment and lead to lower debt ratios? It largely depends on who receives the interest as income—retired savers and pension recipients, or financial institutions, or even the Central Bank—and the impact on growth and employment. Low interest rates help some financial institutions, but for pension funds and insurance companies they can be a source of incipient financial instability.