billy blog archive - 2004-06

Friday March 29, 2024 02:22:56

Posted: March 09, 2005

Fiscal policy doublespeak

On the ABC Lateline program last night Treasurer Costello was explaining budget surpluses but unfortunately totally mislead the listeners. Part of the transcript reads:

TONY JONES: Do you have a problem, though, that if you do get a bigger-than-expected surplus, you simply won't be able to spend it without putting more pressure on interest rates?

PETER COSTELLO: Well, the point I make is that Government should be adding to savings. That's what a surplus for a government is - it's savings. At a time when you've got individuals borrowing, at a time when you've got business probably borrowing to go into a new investment cycle - and we want that; that's a good thing - the Government should be contributing to savings. So the Government should have a decent surplus, and that's what I'll be targeting as I do this Budget.

First, in relation to the question from Jones, net government spending puts downward pressure on interest rates contrary to popular belief and the myths paraded under the 'financial crowding out' banner. Net government spending creates liquidity which shows up as excess reserves in the banking system. Competition among banks to try to earn a return on this excess through loans is self-defeating as the private banks cannot themselves purge a system-wide cash surplus. The non-government sector cannot create or destroy net financial assets. Only the government sector can create (destroy) net financial assets.

Second, a surplus provides no extra 'spending capacity' to a government because it is not financially constrained. When the government runs a surplus it 'destroys' financial assets held by the private sector but does not generate a 'stockpile of money' that can be used at some later date. Irrespective of the past budget positions, the government can always spend any amount it wants (subject to real resources being available for purchase). The limits on what it should net spend is set by the savings intentions of the private sector in relation to the priority to achieve full employment. At a minimum, the government should spend enough to maintain an unlimited job offer to anyone who wants to work and cannot find work elsewhere - that is, introduce Job Guarantee.

Third, the concept of a government 'saving' in its own currency is not applicable to anything! It makes no sense to say that a government is 'saving'. This is in contradistinction with the fact that a household can 'save' and store up future consumption in bank deposits or other forms of financial assets. The government issues the currency (as a monopoly), the non-government sector uses the currency. One can spend what they want (the government), the other has to gather funds (the 'finance') before it can spend (non-government).

Fourth, the government surplus is exactly ($ for $) equal to the non-government deficit. When the government runs a surplus it forces the non-government sector into deficit (as a matter of accounting). In Australia's case, the private (domestic) sector is spending more than it earns (evidenced by the current account deficit) which is providing the 'finance' for the foreign sector to accumulate net financial assets denominated in our currency. Overall, national savings are negative. Budget surpluses actually undermine the private sector capacity to save. If the government wanted to lift national savings then it should (as a matter of accounting) run budget deficits.

Fifth, the government surplus amounts to a destruction of private sector purchasing power and places a fiscal drag on the economy. When the private sector begins to save (and there is evidence that they are now doing this in Australia), the government surplus will impact harshly on the level of economic activity and GDP growth and employment growth will suffer. It is nonsensical to run a surplus when the private sector is seeking to save. A major role for a government deficit is to underpin the saving intentions of the private sector to ensure there is enough spending to fully employ the available labour.

I also want to know why the ABC interviewers choose to ask questions on topics they clearly have no knowledge of themselves. Last night's interview with the Treasurer should have demanded to know why the above statements made by the Treasurer were in violation of simple accounting identities (as noted above) and totally inapplicable to a government which issues a fiat currency. Without having this expertise, the interviews become forums for the propagation and perpetuation of myths that allow governments to maintain levels of spending below those necessary to achieve full employment. The interviewer thus becomes part of the problem.

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