Last week, I wrote about how the IMF is presenting a somewhat nuanced view these days. See – IMF now claiming continued inequality risks opening a “social and political seismic crack” (April 21, 2021). But, there was a warning for those who might think this suggests the institution is leaving its mainstream macroeconomics past behind them though. Rather, I think what is going on is a series of ad hoc responses to the growing anomalies that the institution faces between the observed reality and the sort of predictions it has been making based on its core paradigmatic approach. We are observing a specific form of dissonance in many of the current contributions coming out of mainstream economics. This takes two forms: (a) an incomplete response to the current situation (pandemic, GFC aftermath, climate change) where there are conflicting signals being sent; and (b) a tortured attempt to absorb pragmatic narratives within a theoretical structure that cannot consistently accept that absorption. The IMF’s latest blog post (April 20, 2021) – A Future with High Public Debt: Low-for-Long Is Not Low Forever – is a good example of both forms of this dissonance.
The reality that the IMF blog authors observe is now obvious to all:
1. Rising and in some cases relatively large fiscal deficits with capitalism on government life support.
2. Given the institutional practice of issuing public debt to match the fiscal deficits, which most people still, erroneously believe is a funding operation, the rising fiscal deficits have meant rising public debt levels.
3. Interest rates and government bond yields are near zero or negative in most nations. We have seen negative bond yields for long-term debt.
The other reality, that the IMF refrains from recognising, helps us understand why this agreed reality tells us that the mainstream macroeconomics is incapable of explaining these trends and their causal associations.
4. Central banks around the world are buying government debt in massive volumes using their unlimited currency issuing capacity. This has had two consequences: (a) it has demonstrated that the government (via its central bank) can set the yields on its debt at whatever level they chose and they can sustain those levels indefinitely; (b) there are no evident inflationary consequences arising from doing that.
Which has a third consequence of breaking the taboo that mainstream economists have placed on such behaviour.
Taken together we now know that rising fiscal deficits do not drive up interest rates, a proposition that every student enrolled in mainstream macroeconomics courses is forced to rote learn under the ‘crowding out’ fallacy.
Students are also forced to rote learn that such bond-buying by central banks will accelerate the inflation rate. There is no evidence of that happening despite central banks in some nations funding most of the increases in deficits since the pandemic began.
Of course, Japan provides a three decade case study negating the mainstream predictions. Now many of the leading central banks are repeating the lesson.
Why the IMF would ignore the role of the central banks in its analysis is pretty clear. It would interrupt (undermine) their convenient narrative.
The basic argument advanced by the IMF blog post is that eventually the higher public debt exposure of governments will cause them grief.
The part of the pragmatic narrative that the IMF has embraced (the reality) is that:
… countries … [should] … spend as much as they can to protect the vulnerable and limit long-lasting damage to economies … countries should not run larger budget surpluses to bring down the debt, but should instead allow growth to bring down debt-to-GDP ratios organically.
So there is more or less a consensus organising around those propositions now.
It would be unthinkable for any economist to be advocating anything less than this fiscal activism in this period of our history.
That ‘consensus’ is also leading to a rejection of the rigid fiscal rules that economists have imposed on policy makers in various ways, formal or informal, over the last several decades.
The IMF now says that:
More recently, the IMF has stressed the need to rethink fiscal anchors—rules and frameworks—to take account of historically low interest rates. Some have suggested that borrowing costs—even if they move up—will do so only gradually, leaving time to contend with any fallout.
You will note that this ‘rethink’ is highly conditional (on low interest rates).
It is thus based on a misunderstanding of why the fiscal rules, that are based on a premise that a government can become insolvent if private bond investors stop buying the government’s debt or force yields up so high that the situation becomes impossible for the government to proceed, are flawed.
The fiscal rules are not inappropriate because governments have more “fiscal space” as a result of low interest rates.
The fiscal rules are irrelevant because they assume that government is financially constrained in its spending.
The only fiscal rules that make sense must be based on a recognition of real resource limits (such as full employment of labour).
Please read my blog post – The full employment fiscal deficit condition (April 13, 2011) – for more discussion on this point.
Which highlights the central point – that mainstream economists are trying to walk the pragmatic walk at present (because the reality is staring them in the face) but they cannot put all the pieces together into a coherent whole (story) because their underlying framework is incapable of doing that.
So you get this sort of piecemeal approach which is they then try to render comprehensible by absorbing insights back into a flawed theoretical framework.
And in doing so, they miss the point and end up sending conflicting signals.
So to motivate their ‘fiscal space/low interest rates’ narrative but still bring the story back to an austerity bias they have to claim that interest rates (yields) will rise at some point – and by force of their own logic – bring the mainstream story about deficits, debt and austerity – back into the main frame.
The authors ask:
… will borrowing remain cheap for the entire horizon relevant for fiscal planning? Since that horizon seems to be the indefinite future, our answer here would be “no.” … History gives numerous episodes of abrupt upticks in borrowing costs once market expectations shift … Limits to how much can be borrowed have not disappeared, and the need to stay well clear of them is even sharper in a world where interest rates and growth are uncertain.
First, the narrative is conflicting. Deficits are necessary for the “indefinite future” but then they will be unsustainable of this time frame because of the possibility of “abrupt upticks in borrowing costs”.
Second, you can now see why they had to leave the central bank role out of the picture.
The point is that central banks can keep rates and yields low or at whatever level they choose.
Shifts in “market expectations” cannot alter that reality. The participants in the primary bond auctions can seek higher yields if they choose but, ultimately, the central bank has infinite fire power to override those aspirations, even if the bank stays out of the primary issue, which is not guaranteed.
That means that the treasury can always just allow the central bank to buy up all the auction issue, which would render higher yield bids from the priviate bond market investors irrelevant.
But, even if the central bank just limits its activity to the secondary markets, after the auction is completed and the public debt is freely tradable, its purchasing power would soon snuff out high yield auction bids as private investors appreciate the rising demand for public debt would deliver them capital gains anyway.
The IMF blog post continues the Armageddon story:
Theory and history suggest that, when investors begin to worry that fiscal space may run out, they penalize countries quickly. Market-driven adjustments are not necessarily gradual, nor do markets only ratchet up the cost of borrowing once healthy growth returns—indeed, just the opposite seems plausible.
There can be no market-driven adjustments if the government chooses to take the yield dynamics out of the hands of the private investors.
The theory that suggests otherwise is incorrect as history has shown.
The IMF is also still rehearsing the ‘dangerous debt threshold’ argument.
They claim that:
… debt is getting closer to levels that were previously considered dangerous …
And we are confronted with a graph entitled “Dwindling fiscal space”.
I won’t reproduce this piece of propaganda but suffice to say on the horizontal axis is Canada, Germany, France, Great Britain, Italy and the USA.
My edX MOOC students would immediately score a fail for the IMF in this regard.
Regular readers here would immediately score a fail for the IMF in this regard.
Anytime you read an economics article that conflates currency-using governments with currency-issuing governments, you can conclude the content is not worth the time taken to read it.
Germany, France and Italy use a foreign currency – the euro. They are beholden to taxpayers and bond investors to get the euros that they then can spend.
Canada, Great Britain and the USA are currency issuers and are not beholden on anyone for their spending capacity.
Moreoever, you can again see why the central bank activity was not mentioned in the blog post.
Even in the case of the Eurozone Member States mentioned, the massive government bond buying programs run by the ECB, which accelerated last week, are making the private bond markets irrelevant.
The 19 Member States have unlimited spending capacity at present because the currency-issuer in their system, the ECB, is actively funding their deficits, at least to the point, that keeps yields at low and zero levels.
So any analysis of “fiscal space” in this regard that assumes the bond investors call the shots is deeply flawed.
The real politik is clear.
The ECB knows, as well as I know, that if it stops funding the deficits then insolvency issues will arise rather quickly – Italy would probably lead the way.
I cannot construct any situation where the ECB will allow that to happen, now or over the indefinite future.
That is a consequence of the poor choices they made in the 1990s about the fiscal architecture of the monetary union.
As for Canada, the USA, the UK or most nearly all the currency-issuing nations, insolvency or dangerous debt considerations are totally inapplicable.
It is quite interesting to see the machinations of mainstream economists at present.
They are really caught on the hop.
Major parts of their framework have been obliterated by the policy responses of governments around the world, first, during the GFC, but then, definitely, during the pandemic
They cannot deny what is happening.
But they also do not seem to be able to jettison the framework they use to ‘understand’ the world (being kind) or mislead the public so the government can serve vested interests (more likely).
I understand why they cannot do that, which just makes their interventions look pale and inconsistent.
More people are starting to get it.
And then their own ambitions – aspirations, goals, missions etc – will start to receive more airplay.
And it is the Right that is moving faster in this direction while the Left continues to be the Left.
It is time they woke up.
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.