The D word – a time of national rejoicing …

Various estimates about the size of the federal budget deficit are starting to emerge. The Government has acknowledged that the data shows that tax receipts have fallen dramatically and now their budget is in deficit. For me that is a time of national rejoicing … finally … the federal government is doing what it should … resuming its crucial role in financing non-government (in this case) domestic private savings. Finally, there is a net injection of financial assets coming from the excess spending over receipts. Finally, the drain on private wealth that the creation of budget surpluses requires is at an end.

It would have been much better had the government gone back into deficit on their own volition and reversed the fiscal vandalism of the Costello-Howard years. The economy was always going to force them back into deficit through the so-called automatic stabilisers (tax revenue down and welfare payments up) even if they didn’t alter any of their discretionary policy parameters. It would have been much better though had the federal government abandoned the nonsensical neo-liberal rhetoric about the danger of deficits, and, instead, had used their fiscal discretion to revitalise public infrastructure; build a domestic renewable energy industry; fund a Job Guarantee so that unemployment (and time-related underemployment) would have been eliminated (apart from frictional joblessness – moving between jobs etc). Then the deficit would have been virtuous. Now they have a “bad” deficit on their hands – one that is forced on them because the economy if failing quickly. Yes they have injected some billions already in their pre-xmas expansion. But more … much more is needed … and it is needed now!

It isn’t too late for the federal government to turn the “bad” deficit into a “good” deficit by fast-tracking the sorts of initiatives I mentioned in the last paragraph. They should scrap the mean-spirited Work for the Dole immediately and announce an employment guarantee where anybody who wants a job can get one in the public sector at the minimum wage (and the rest of the statutory entitlements). If they can guarantee banks and shopping centres etc then they can surely guarantee jobs. Then they should get spending to repair the damage the surpluses wreaked on our public assets – hospitals, schools, universities, rivers, etc.

The general point is that there isn’t a financial or real crisis so deep that fiscal policy cannot fix it. It is just a matter of how large the deficit has to be to finance the savings desires of the non-government sector. When the latter stops spending and saves instead then the government sector has to fill demand gap. It has to go into deficit to do this. In normal times, if the non-government sector desires to save then the government sector has to remain in deficit.

All this nonsense today from the Federal Opposition about temporary deficits and the dangers of borrowing etc only beggars belief. They clearly haven’t a clue about how the monetary system operates; how the central bank operations desk works; how the fiscal balance interacts with the cash system to influence short-term interest rates and the rest of it. If only they understood that budget deficits actually put downward pressure on overnight interest rates (the short-end of the yield curve that the central bank targets) and that the central bank issues debt to “manage” the liquidity in the cash system so that commercial banks have an interest earning asset to buy with their surplus reserves. In this way, the central bank can maintain its target interest rate. If it didn’t issue the debt, competition between the commercial banks would drive the overnight rate towards the current support rate on excess reserves (below the target rate). In other words, the central bank would lose control over monetary policy. Debt-issuance thus has nothing at all to do with “financing” net government spending. After all, the federal government issues the currency as a monopoly and therefore has no financial constraint.

How big should the deficit be? Well in the 1982 recession – it was around 3.3 per cent of GDP. The recession lingered and unemployment remained very high throughout the 1980s which was a sure sign that 3.3 per cent was not large enough. In the more severe (deeper and longer) 1991 recession the deficit was around 3.9 per cent of GDP at is peak. The 1990s saw unemployment remain high and a new form of labour wastage – underemployment – emerge. Throughout the 1990s, the unemployment rate averaged around 8.8 per cent, hidden unemployment average about 3.3 per cent and underemployment averaged 3.8 per cent. Taken together, the total labour underutilisation rate throughout the 1990s (from 1991:1 to 1999:4) averaged 15.9 per cent. It was total insanity for the government of the day not to massively increase the deficit at the time given how much income was being lost every day, not to mention the human suffering that accompanied the joblessness.

Clearly the deficit was not large enough over the 1991 recession (GDP peak to trough) and was way too small during the weak recovery that ensued in 1993 and 1994. Then we encountered the surplus obsession of Costello which put paid to any significant role for federal government in reducing the labour wastage. They institutionalised high labour underutilisation and then started to attack and bully the victims (the unemployed, disabled, single parents etc) with a pernicious so-called welfare-to-work policy framework.

At present the deficit is probably just over 1 per cent, perhaps around 1.5 per cent of GDP. Things are going to get much worse over the next four quarters. I think the Government should be aiming for a deficit of over 5 per cent as soon as they can get the programmes going. Speed is of the essence if we are to prevent a rapid escalation of labour underutilisation which typically takes years to reduce. Remember we went into this downturn with around 10 per cent labour wastage.

And the Government should just ignore the neo-liberal trash coming from the Opposition and the vested interests in business. Its time to spend, spend, spend.

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    9 Responses to The D word – a time of national rejoicing …

    1. bill says:

      Dear David: the points you raise are the conventional arguments that neo-liberal economists use to argue against government intervention into the free market. The failure of governments to intervene goes a long way to explaining why we are in the mess we are now and why labour underutilisation has been so persistently high for so long.

      Briefly:
      (a) Governments don’t spend by “printing money” – they increase bank reserves – credit bank accounts. Increased deficits may be inflationary if there is no excess capacity in the economy – that is, the economy has no ability to respond to the increased nominal demand by increasing production. We are a long way from that situation. In general, if the private sector desires to save some of their income then the spending gap must be filled by the government deficit if production levels are to remain unchanged. Unemployment is a sign that the spending gap is not completely resolved – that is, the deficit is too low. Typically, the private sector will want to save overall, which means that a deficit is a normal part of a functioning and fully employed economy.

      The federal government does not need to borrow money or tax to spend. It is not like a household who has to “finance” its spending. The government issues the currency (as a monopoly) while the household uses it. Totally different dynamics. The federal government is never financially constrained – it can buy whatever there is for sale should it wish. The reason the central bank issues new debt (treasury bonds) or conducts open market operations in secondary debt markets has nothing to do with “financing” spending. The reason is that when the government runs deficits, ultimately there are excess reserves in the commercial banking system. The banks try to lend these on the interbank market but cannot eliminate the overall system-wide excess. But in trying to do so, they put downward pressure on interest rates – that is right! Deficits put downward pressure on rates. If that competition persisted, then the central bank (the RBA in Australia) would lose control of its overnight target rate. So it offers an interest-bearing asset to the banks to drain the excess reserves. It is thus a monetary policy operation designed to maintain the current target interest rate.

      If people didn’t want these bonds – fearing their value would decline etc – then the excess reserves would not be fully drained and interest rates would fall to zero (if you lived in Japan for example) or to the rate that the central bank pays on overnight reserves (in Australia this “support rate” is below the target rate). If account holders didn’t like holding that much “cash” in the banks then they would increase spending. Economic activity would increase and the deficit would fall because the gap in spending had fallen.

      The size of the deficit should not be a policy target. It is largely an artifact of private sector spending (and saving). If the private sector didn’t want the deficit to expand then they should spend more and reduce it. Simple as that.

      There is nothing to fear from a rising deficit. It is sound policy to make sure it is as large as is needed to maintain full employment. Today’s announcement (I will comment on that later) suggests that the stimulus package will not be sufficient given that it will support only 90,000 estimated jobs (not new jobs but existing jobs). It is likely that more than 500,000 jobs will be lost over this downturn which means the deficit has to be much larger than the Government is currently planning for.

    2. bill says:

      Readers, I accidently deleted a comment from David. I have retrieved it from backup and it is now posted after this comment. It relates to my response in the previous comment. Sorry for the confusion.
      best wishes
      bill

    3. bill says:

      David wrote:
      —————-
      Billy,

      I’m a newbie to economics, so please be patient with me…

      You write “… the federal government issues the currency as a monopoly and
      therefore has no financial constraint.” I might be misunderstanding you, but how is
      this different from the suggestion to ‘just print more money’. I thought ‘printing
      money’ to get out of a crisis was a bad idea – hyperinflation being one of the
      likely consequences.

      If the idea is that Government borrows the money, – doesn’t the Government get
      charged interest on money it ‘borrows’? Aren’t those interest charges a constraint?

      Also, if the mechanism for borrowing the money is by issuing bonds – isn’t there a
      risk that by issuing too many, the bonds might start to lose their value (people
      start to suspect/worry that the government can’t pay them back).

    4. Dion says:

      So in essence, All you are advocating via Deficit spending is transferring Debt from The Private Sector to the Public? As long as the money supply equals 100% in comparison to the productive capacity of the economy, It doesn’t matter where it comes from? What if the Value of what is being produced within that economy has been overinflated? Why use continuous debt to prop up a flailing system?.

      Why does it have to be a case between Public or Private Debt? and why cant demand be allowed to drop so that Mal investment and unsustainable markets are left to rot away while new profitable and sustainable markets can be developed?

    5. bill says:

      Dear Dion, Thanks for your comment. However, your construction is not at all what my post was about. First, the private sector has to finance all of its spending – whether it be by earning income, drawing on savings, running down wealth or borrowing (or a combination of these). Over the last decade or more the household sector, in particular, has been dissaving and therefore accumulating debt at levels that were always going to be unsustainable. Now a significant proportion of the “wealth” that was generated has gone but the nominal debt remains.

      Second, the public sector does not have finance its spending because it is sovereign in its own currency. It doesn’t have to borrow anything to run a budget deficit and the central bank only borrows to drain excess reserves to maintain control over a positive interest rate. For years now, the Bank of Japan has allowed excess reserves to remain in the overnight system (that is, not issuing enough government paper to drain the injection from the budget deficits) and the result has been a 0 short-term interest rate. That has been a deliberate strategy which has kept investment rates (longer maturities on the yield curve) as low as possible. So there is no need to transfer debt from private to public as you suggest.

      Third, it is true that if nominal demand exceeds the real capacity of the economy then inflation results. But we are so far from that state that such concerns shouldn’t enter the debate at all.

      Fourth, there is some truth in the argument that recessions cleanse bad investments and destroy old and unproductive capital. That will surely happen again. But a responsible government has to do everything it can to prevent recession irrespective of how the underlying dynamics in the economy because unemployment is so devastating. The costs of high unemployment persist for years and have intergenerational impacts. It is also so skewed that the most disadvantaged citizens suffer the most. A sophisticated and caring society would not tolerate such a terrible yet avoidable circumstances.

    6. Dion says:

      “Public sector does not have finance its spending because it is sovereign in its own currency” Sorry that wont wash with me! You don’t get something for nothing, When the Government Finances itself, it is introducing new money into the system, Ie Inflation, Inflation IS the increase in money supply which acts like a hidden tax as its steals value from every dollar in my pocket, so therefor you and me and anyone else who try to save, through inflation, pay for the debt!

      Your Keynesian logic just doesn’t make sense? We got into this situation because of the mantra of Spend Spend Spend!, How in the world is continuing with more of the same going to fix anything? DEBT IS NOT A GOOD THING!, We should be looking to reform our economy away from debt, not getting into ever increasing amounts of it!

      “Third, it is true that if nominal demand exceeds the real capacity of the economy then inflation results. But we are so far from that state that such concerns shouldn’t enter the debate at all.” What do you mean? Everything is already overinflated, ITS THE ENTIRE Reason why we are in this mess to begin with, Prices over the last 30 years have been inflated well beyond reasonable levels due to excessive debt causing malinvestment and a miss-allocation of capital, The market is trying to fix the problem, and our Government is trying to prop it up? Private investment see’s no value in the market because there is NONE!

      That Private investment will not come back until prices reach reasonable and sustainable levels, that could happen in a year or 2 if we let it with a lot of hard times in between, or we can continuously try to prop up a system that in the end is ultimately going to fail anyway (due to us trying to prop it up with massive debt). The problem will last at much longer probably at least a decade or more, more people will lose there jobs over the long run, more people will be impoverished all due to a distorted and malinvested economy.

      “Fourth, there is some truth in the argument that recessions cleanse bad investments and destroy old and unproductive capital.” There is not some truth, there is Plenty of Truth, and in fact it is the most efficient way get rid of unwanted or unproductive capital. You seem to advocate a Economic system that Only ever goes up? How in the world is unproductive capital cleansed from the system, when you have Government deficit spending in order to keep the unproductive capital afloat? It doesn’t work. There needs to be risk, there needs to be downturns in certain sectors as the market dictates otherwise progress comes to a halt, what there doesn’t need to be is Across the board collapses. The only thing different about our economy now in comparison from 3 years ago is that there is no cash flow as the banks have dried up the lending because the market reached a point where it was unsustainable, it reached that point because of the overabundance credit to begin with, throwing fuel on the fire will not help the situation, it will only prolong it!

      “But a responsible government has to do everything it can to prevent recession irrespective of how the underlying dynamics in the economy because unemployment is so devastating” In other words, instead of putting our economy back onto the sustainable path, and working towards creating a healthy and fair economy in which inflation doesn’t constantly ruin your ability to save, they continue Spending like drunken sailors in order to play politics and save face, Keeping the people happy and ignorant, but not letting the economy make the CORRECTION it needs to make?

      Our economy personified over the last 10 years has been like a Drug Addict, We are addicted to Debt and want more and more and more, We are now feeling the effects of the drug and our systems are beginning to fail! What do we do?, Wake Up smell the roses and try and get ourselves back on a healthy and sustainable way of living, or do we avoid the pain and continuously dive into deeper and deeper strife? If you where a Doctor what would you say, continue living your destructive ways, or fix the problem and heal yourself? That IS the choice we have right now, and it look like we are going to continue with more of the same, which will result in a slow and painful death for many within our economy!

    7. bill says:

      I am sorry Dion, but I suggest you better learn how a modern monetary system based on a sovereign currency works. Sovereign government’s spend and tax by crediting and debiting bank accounts (respectively). When they do this they introduce or destroy net financial assets denominated in the currency of issue. That is not inflation. There is also no necessary correspondence between this act and debt issuance.

      Inflation is the continuous increase in the general price level. It occurs when the macroeconomic system can no longer respond in any real way to increases in nominal demand. Increased spending (whether it be public or private) may or may not generate that state. It is not inevitable. You need to better understand what the terminology that you are using actually means.

      We got into this situation because the private sector increased spending on the back of ever-increasing debt levels as the government sector was squeezing the private sector’s liquidity via budget surpluses. That was always an unsustainable growth strategy. We should be looking to reduce our reliance on precarious private sector debt. That establishes a fundamental role for budget deficits.

      You say that “everything is already overinflated”: Well there is one resource out there that has zero bid (that is no demand for its services at all) and will increase in quantity over the coming months – the unemployed. This means that it has a zero price in the market. It cannot be considered overinflated. If you read my work I advocate the Federal government buying all that labour at a fixed price below the market (that is, at the minimum wage) and putting it to work for the public good. You cannot generate inflation by purchasing something that nobody else wants! I also identify in my work many activities that are productive and useful for which there is no market demand and hence no private production. These are ideal targets for public expenditure.

      I do not support public funds being used to bail out the excesses of private organisations who should go broke. If the service they provide is considered essential to the well-being of the community then they should be taken over and run as public not-for-profit enterprises. In that sense, I am quite prepared to let the business cycle clean out bad capital. The expansion of public activity does not prevent this from happening. It should be designed to maintain the security of the most disadvantaged workers in our country.

    8. Dion says:

      I will stick by my Austrian Definition of Inflation, the Increase of Money supply, which, when increased over and above the production of an economy, produces higher prices. I understand what you mean when you say that we should reduce precarious private sector debt, but why do Governments have to go into Deficit, why cant they print credit directly into the economy debt free, Why do we need to run on debt in the first place??

      “We got into this situation because the private sector increased spending on the back of ever-increasing debt levels as the government sector was squeezing the private sector’s liquidity via budget surpluses.” I don’t understand? Aren’t you missing the whole point? Your saying Public sector spending must take over the lack of Private spending only in order to Keep the economy growing, isn’t that right? Then if that is the case, you are missing the entire point, Our economy NEEDS to stop growing and return to its pre-inflated levels, the Value is not there, the Market is distorted and it will take much longer to fix if we keep on propping it up with more debt! You are looking at it from the view that nobody should lose their jobs, I disagree, people Have to lose their jobs in order for the rot to be shaken out so that they can acquire new jobs in new profitable sectors, People in general need to have risk attached to their actions also, Otherwise we will always get into more and more debt as people become more and more risk loving, and will always lead to downturns such as this.

      Also America has been deficit spending for a very long time now and there private sector has been amassing massive levels of private debt at the same time, This in any other country would produce inflation, which it has, but has been buffered by the fact that America can export its inflation to the world. If we were to Deficit spend here then when what do we do when the economy picks up again, Stop deficit spending or continue? Because if we continue wont it then cause Inflation, as both Public and Private sectors are creating money?

      How can you say employing all of the people who are currently unemployed will not cause Inflation, It wont cause competition with current labour markets, but what about the increase in income for these people? Wont the extra buying power create further inflation in goods such as Food? you say “you cannot generate inflation by purchasing something that nobody else wants!” But unless the Government can efficiently and aptly use this labour to create what the market demands, which is highly unlikely due to lack of Government foresight and bureaucracy, then prices for those items will rise as you have just increased demand without increasing supply, as these new workers ARE buying goods that everyone else wants. I have noticed commodity prices falling due to lack of investors, but I am yet to see big drops in the prices of everyday goods, Food and essentials are still sky high and I don’t think they will fall much as people cut there spending to exactly that Food and essentials.

      “I also identify in my work many activities that are productive and useful for which there is no market demand and hence no private production. These are ideal targets for public expenditure.” Why create something, or waste capital, investing in something in which there is no demand? I don’t understand how that will help an economy, maybe in the short term due to cash flow, but what about the long term costs, the opportunity costs? And to imply that you know better than the market at what needs to be produced sounds pretty arrogant to me, how can a small group of people decide fairly and equitably whats best for the rest of the country without riding roughshod over those who disagree.

      I agree with all of your sentiments, I just don’t see how using debt to get there will help, Infact, in a economy in which there was no debt, only interest free credit creation, monopolized by a Government held totally at ransom by an EDUCATED populace, then it could work well, I see how the system can work, but the checks and balances are not there, A small centralized group of people have too much power to do what they like with our money.

    9. bill says:

      Dear Dion

      You say:

      I will stick by my Austrian Definition of Inflation

      Okay, its fine if you want to use your own definitions – but don’t expect much communication. No working economist would agree with your definition.

      You then say:

      but why do Governments have to go into Deficit, why cant they print credit directly into the economy debt free, Why do we need to run on debt in the first place??

      Well that is the point. I suggest you read some of my earlier blogs or other published work. You clearly haven’t taken it on board. The sovereign government doesn’t have to increase debt to run a deficit. The only reason the central bank issues debt is to maintain its control over the cash system and therefore allow it to keep hitting its target interest rate each day.
      Then you suggest:

      Also America has been deficit spending for a very long time now and there private sector has been amassing massive levels of private debt at the same time …

      This is plainly wrong. Here is the recent history (last decade) of the Federal US budget. The Clinton surpluses were the source of the private dis-saving and private debt build up in the US economy.

      Year Surplus/Deficit (-)
      2007 -$162.0 bln
      2006 -$248.2 bln
      2005 -$318.3 bln
      2004 -$412.7 bln
      2003 -$377.6 bln
      2002 -$157.8 bln
      2001 $128.2 bln
      2000 $236.2 bln
      1999 $125.6 bln
      1998 $ 69.3 bln

      You then say:

      How can you say employing all of the people who are currently unemployed will not cause Inflation, It wont cause competition with current labour markets, but what about the increase in income for these people? Wont the extra buying power create further inflation in goods such as Food?

      The unemployed are already in the public sector being kept on income support. The difference between this and the minimum wage is not that much. Our modelling suggests the net injection would be $8.3 billion to employ 560 thousand people under these conditions (allowing for the extra spending by the unemployed). That is a long way short of $42 billion and all the projections are that inflation will fall over the next 18 months even with the $42 billion stimulus.

      Finally you say:

      Why create something, or waste capital, investing in something in which there is no demand? I don’t understand how that will help an economy … And to imply that you know better than the market at what needs to be produced sounds pretty arrogant to me, how can a small group of people decide fairly and equitably whats … (sic) … best for the rest of the country without riding roughshod over those who disagree.

      The problem is that the private market has shown itself to be highly flawed and a very poor “judge” of where to best place resources for efficient use. So when you say why invest in something in which there is no demand … my answer is that the private market is not the ultimate arbiter of what is useful. It works on private benefits and costs and ignores in the calculations social benefits and costs. The social costs of unemployment are so high that intervention is needed to ensure that the wasted labour is put to use creating social value that the private market place cannot countenance. Ever been down the Great Ocean Road in Victoria? That was built by public job creation during the 1930s depression. It definitely has great value. The private market never would have built it. There are countless examples such as that.

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