Yesterday (October 21, 2020), the British Office of National Statistics (ONS) released the latest – Public sector finances, UK: September 2020 – which, predictably tells us that government borrowing was “£28.4 billion more than in September 2019 and the third-highest borrowing in any month since records began in 1993” and that the public debt ratio has risen to “103.5% of … GDP … this was the highest debt to GDP ratio since … 1960.” Shock horror. While I yawn. The financial media went to town on the data. The Financial Times article (October 22, 2020) – UK government borrowing reaches record in first half of fiscal year – claimed the second wave that is now sweeping the northern hemisphere “have dampened hopes” that the stimulus “could be quickly scaled back” which has “fuelled concerns over the US’s mounting public debt”. It didn’t clarify as to who was concerned or why. The old canards seem to die slowly. Meanwhile, the IMF has changed tack somewhat after its tawdry display during the GFC. Overall, we should be relaxed about the records being set (deficits, public debt) and focus on what the net spending is doing to advance our interests. Focusing on the financial parameters will just divert our attention away from what is important.
British fiscal data topping the charts!
The only concern that the FT article mentioned was quoting a management consultant who said the ONS data release:
… may add more tension between the need to respond to renewed Covid outbreaks and preserving the public purse.
Exactly what might “preserving the public purse” mean?
The English meaning of the word – ‘purse’ – is:
… a small pouch of leather or plastic used for carrying money, typically by a woman.
Gender issues beside, a person needs a ‘purse’ to store currency so they can go shopping, which in modern times are more receptacles for credit cards.
So a purse traditionally implies a prior stock of currency.
The currency-issuing government neither has nor does not have currency as a ‘state’ variable. It just spends its currency into existence … boom, there it is – a number in a bank account.
But this idea that there is some trade-off between the health responses and the fiscal capacity of the government is erroneous reasoning and the type of (il)logic that has created such poor outcomes over the last several decades.
When the government spends its currency into existence a flow of spending enters the non-government sector, which stimulate sales, production, income generation, and employment.
Those flows have no ‘state’ – they are not a stock that carries over to another period.
So there is never a question about the capacity of the British government to render those flows as large as they like.
How large should they be?
Consider two scenarios.
At full employment, inflationary pressures will arise if government competes at market prices with non-government spending for productive resources.
To increase its use of productive resources, but avoid inflationary pressures, the government has to ‘free up’ resources.
Taxation is one option because it reduces non-government purchasing power and creates the real resource space to accommodate non-inflationary government spending.
Importantly, the taxes do not provide any extra spending capacity for government.
In the second scenario, idle productive resources can be brought back into productive use with higher deficits. There are no constraints – financial or resource – on such government spending.
Ask yourself where Britain is at present.
The answer is that it is very firmly in the second situation, which means it can just type flows of spending into bank accounts – nothing necessary to ‘preserve’ other than jobs, private incomes, services, health care, and all the things that matter.
Fiscal space is much broader than mainstream economists suggest and can only be defined in terms of available real resources rather than numbers in fiscal statements.
The ONS public finance data tells us nothing about fiscal space.
But there data on unemployment, underemployment, GDP is where we have to go to see how much (non-inflationary) fiscal space there is.
Modern Monetary Theory (MMT) focuses on how policy advances desired functional outcomes, rather than what the state of the deficit might be.
To maximise efficiency and minimise output losses, the responsibility of government is to spend up to full employment.
The fiscal outcome will be whatever is required to achieve that functional goal and will be largely determined by non-government saving decisions (via automatic stabilisers).
Under current institutional arrangement, where the government matches its net spending flow in a period by issuing new debt, the stock of debt obviously rises, which is what the ONS is reporting.
When government bonds are issued to match deficits, the central bank effectively just marks down reserve accounts and marks up a ‘treasury debt’ account.
The bond sales do not alter the net financial worth in the non-government sector in the first instance.
The debt issuance is a redundant part of the process and a hangover from past currency arrangements (pre 1971).
Governments could avoid all the nonsensical commentary about ‘record’ debt levels and the rest of it by abandonding the debt auctions.
Redundant means it is not required to accomplish the goals of the spending.
The current system of debt-issuance in Britain – the gilt auctions – was introduced in 1987 as part of the so-called – Big Bang – which was the “the sudden deregulation of financial markets” that the Thatcher government introduced in 1986.
In July 1995, the Treasury released the – Report of the Debt Management Review – which described the elaborate machinery that had been put in place to facilitate this redundant practices.
Lots of high-paying jobs, consultancies, kick-backs and the rest of it. But little functional purpose other than to maintain the system of corporate welfare that the investment banks had become used to.
It also concluded that “Auctions will constitute the primary means of conventional gilt issuance”, which means that the government allows the private bond speculators to set the yields.
It recognises that, even within a debt-issuance mindset, the alternative (and prior) system of tap sales can “function primarily as a market management mechanism.”
In this blog post – Direct central bank purchases of government debt (October 2, 2014) – I discussed the way the Australian government shifted in the 1980s from a tap system of debt sales to the current auction system.
In the former system, the government set the rate it would pay on debt issued and if the bond markets were not happy with the return and declined to buy the debt, the central bank would always buy the difference.
In the neoliberal era, this was the anathema so they shifted to a system where the government would announce an amount it wanted to borrow and the bond dealers would then bid for the debt by disclosing yields they were prepared to pay.
The auction model merely supplies the required volume of government paper at whatever price is bid in the market.
So there is never any shortfall of bids because obviously the auction would drive the price (returns) up so that the desired holdings of bonds by the private sector increased accordingly.
And if there are ‘concerns’ about the debt in the financial markets it is not showing up in the auction data.
The following graph shows the latest gilt market auction bid-to-cover ratios which are well above 2 mostly – which means there are twice as many sterling bids than the gilts on issue.
Please see this blog post – Bid-to-cover ratios and MMT (March 27, 2019) – for more information on that.
Enter the IMF to tell us why all this debt worry is misplaced
The IMF – Fiscal Monitor: Policies for the Recover – issued October 2020, provided data for this graph.
It shows the discretionary fiscal response since the pandemic began and up to September 11, 2020.
The two components of the discretionary fiscal responses have been:
(a) Additional spending and foregone revenue (temporary tax cuts).
(b) Liquidity support – loans, guarantees and equity injections by government.
There has been huge variation across the nations shown in terms of the bias towards (a) or (b).
In general, additional spending is much more expansionary than items under (b).
The IMF make an interesting point:
Advanced economies and large emerging markets account for the bulk of the global fiscal response … their central banks were able to provide massive monetary stimulus and purchase government or corporate securities while retaining credibility to deliver low inflation … their treasuries were able to finance larger deficits at low interest rates.
Of course, any central bank can purchase its own government’s debt – left pocket/right pocket stuff.
And any central bank can keep yields low on that debt if they desire, which means the ‘low interest rate’ story really is misleading.
But the important part of what is going on right now is that:
1. “The fiscal response, coupled with the sharp decline in output and government revenue, will push public debt to levels close to 100 percent of GDP in 2020 globally, the highest ever.”
2. And, yes central banks are buying most of the debt:
Central banks in several advanced economies and emerging market and middle-income economies have facilitated the fiscal response by directly or indirectly financing large portions of their country’s debt buildup.
So nothing to see here.
Record debt issuance, central banks buying the new debt, government buying and owning its own debt, end of story.
But, while there is nothing to see here in terms of the ‘economics’, this is a huge shift in mindset.
The IMF admit that the:
… massive fiscal support undertaken since the start of the COVID-19 crisis has saved lives and livelihoods.
So fiscal policy is not ineffective as many mainstream economists have led us to believe over the last several decades.
Now it is saving lives and livelihoods.
Paradigm shift underway.
The IMF cannot quite let go:
Record-high public debt levels limit the room for further fiscal support …
No. Especially when the central banks are buying up the debt and can buy all of it if the government wanted. Japan anyone!
Meanwhile, in the Eurozone, the game must be nearly over.
The IMF projections suggest that by 2025, the debt ratios in the Euro area will be 80.9 per cent of GDP, with France at 114.6 per cent, Italy at 141.5 per cent, Spain at 106.4 per cent.
Both France and Spain among the big 4 will violate Stability and Growth Pact deficit limits and I suspect Italy will too (given the ridiculous IMF forecasts to the contrary).
They will not be able to return to their fiscal rules within any foreseeable time horizon.
So how will that play out?
The point is that during the GFC, the IMF was out there forcing governments to cut net spending and accelerate the pace of consolidation which really meant they were just consolidating the elevated levels of unemployment and poverty.
Now, 10 years later, there is some give in their position and we are not reading anything about “growth friendly austerity”.
In their recent – World Economic Outlook, October 2020: A Long and Difficult Ascent – (released October 2020), the IMF project that world output will languish and fiscal deficits will have to remain at elevated levels for the foreseeable future.
I have just finished an academic paper that will be published soon (details available later) where I argued that Capitalism is now on life support with fiscal policy dominant.
Significantly larger and sustained fiscal deficits will be required indefinitely and that we should be comfortable with that.
Focusing on the size of the deficits is to focus on the wrong problem. The way out of the crisis requires an orthogonal shift in policy thinking and new theoretical understandings.
The usual narratives about the dangers of deficits and public debt are giving way to a new understanding.
This policy shift is diametric to what mainstream macroeconomists have been advocating for decades and their analytical framework cannot provide an understanding of the fiscal space available to governments nor the consequences of these policy extremes.
MMT has consistently advocated a return to fiscal dominance and disabuses us of the claims that deficits and debt are to be avoided.
MMT defines fiscal space in functional terms, in relation to the available real resources that can be brought back into productive use, rather than focusing on irrelevant questions of government insolvency.
MMT economists have always held the view that a focus on deficits and debt aimed at assessing solvency thresholds and the like has never been justified and has underpinned destructive policy interventions that have undermined prosperity.
Now, as never before, the scale of the socio-economic-ecological challenges before us requires a rejection of the deficit/debt scaremongering. Meeting these challenges will require significant fiscal support over an extended period.
Such fiscal support is necessary to sustain income growth to allow the non-government sector to reduce its debt levels and to provide for jobs growth. But it should also target longer-term challenges, such as restoring some self-sufficiency in manufacturing; reforming the gig economy that has exposed millions to poverty during the pandemic; supporting regions that have experienced a major loss of firms (for example, tourist destinations); address the housing crisis; and, importantly, accelerate the transition away from carbon-intensive production and consumption.
Even before the pandemic, the climate issue suggested large fiscal deficits would be required in the transition phase. The health crisis has added another dimension to that need.
The old orthodoxy does not provide a reliable framework for understanding these options and consequences.
It is likely that relying on ‘business as usual’ will result in an inadequate level of fiscal support being provided and a premature withdrawal of that support as the old debt and deficit themes return.
MMT provides a comprehensive macroeconomic framework, which allows us to understand that the problem into the future will not be excessive deficits and/or public debt.
Rather, the challenge is to generate productivity innovations derived from investment in public infrastructure, education and job creation.
And relax about the deficits and record debt.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.