An interview on 26 October by BBC economics editor Robert Peston with former Fed chairman Ben Bernanke  has revealed that the latter thinks there should have been a stronger fiscal response to the global financial crisis in most countries, rather than their obsession with budget cuts, which left central banks with the primary responsibility of trying to pick up the pieces and keep their economies functioning — despite the moral hazard attached to bailing out the banks with public money.
As chairman of the U.S. Fed during the crash and its aftermath, Bernanke is the most influential central banker of our age, and so his opinions on economic policy should be taken seriously.
What was not discussed in this brief interview was the alternative — which would be anathema to most main-stream economists — of allowing the failed U.S. banks to go to the wall with their shareholders wiped out, and nationalising those banks with the application of government guarantees for all existing bank liabilities and assets.
The money directed to recapitalizing the newly nationalised banks could be repaid to the central government Treasury over time from the banks’ profits, after which time some consideration could be given to re-privatising them.
The response of governments, and especially the U.S. government, to the next financial crisis will demonstrate whether any lessons have been learnt. We might not have much longer to wait, in order to find out.
1. Source: http://www.bbc.com/news/business-34641850
During the past year ERA Review has published various articles highlighting the possibility and desirability of funding essential public services and utilities entirely by government spending, rather than through market operations dedicated only to achieving corporate profits. This alternative to the current system used to be described as a mixed economy, long before major political parties succumbed to the pressure of neoliberal spin and decided to uncritically accept the self-interested recommendations of business and banking economists. The latter groups have never wasted an opportunity to inform us that there is no alternative to state support for corporations combined with austerity for the majority of our citizens (the TINA principle) at a time when corporate profits and corporate tax evasion have ballooned to record levels.
At present there exists, in Australia and other countries, considerable unused capacity for the production of goods and services. In such circumstances a monetarily sovereign government can make use of deficit spending in order to fund essential projects, without needing to worry about the possibility of inflation. Such spending always adds new financial assets to those held by the private sector as a whole, thereby boosting its ability to spend, save and invest, which in consequence exerts downward pressure on unemployment. Public borrowing is the conventional route, however direct funding from the central bank is entirely possible and the latter route has been employed in the past, especially during times of crisis.
There is no shortage of useful projects to which such funding can be directed. Topical and important examples include (a) the provision of government grants to research bodies concerned with developing alternative methods for electrical power generation to those which depend upon burning fossil fuels; (b) increased grants to citizens for the purpose of assisting them to install solar panels on their houses; (c) making education affordable at all levels to those who desire it and are qualified to undertake it, without obliging those at the start of their working life to service crippling education debt – in other words, recognising that education is an investment in the future of our country; and (d) grants to local governments for justified projects.
All of these things, and much more, are possible. What needs to change is the mindset of those who have not understood that the dysfunctionalities in the prevailing economic system can be successfully tackled and eliminated. The first line of attack must include educating the average citizen and the journalists who write for them, who continue to misunderstand the nature of the forces which are moulding and controlling their lives, and also the groupthink of those in positions of power and influence in our society who – in many cases – have been led unwittingly to believe that there is no alternative.
* Quote from the late Prof John Hotson (cofounder of COMER, the sister Canadian organisation to ERA)
It is not unusual to hear from politicians that government spending and household spending operate according to the same overall principles. This narrative usually states that households and governments must both “live within their means”.
And although many astute commentators recognise that attempts to draw an analogy between government and household financing are fallacious, they fail to recognise that the reason for this fallacy runs much deeper than their commonly expressed observation that government expenditure leads to some return in the form of revenue for the government.
For several decades now, currency-issuing countries around the world have been operating without a gold standard to back their respective currencies. Modern currencies are based on pure state fiat money, backed only by the ability and willingness of each central government to tax its citizens.
Unfortunately mainstream economists have largely not yet caught up with the implications of this relatively new situation, and consequently they do not understand the significance of the development of modern monetary theory (MMT) and what it is all about.
Amongst other things, MMT proposes that monetarily sovereign governments (this includes our federal government but not our state or municipal governments) do not need to rely on taxation revenue in order to effectively spend into the economy without having to worry about inflationary pressures or potential rises in interest rates.
Deficit spending, whether accommodated by issuing Treasury bonds to the private sector or more directly to the central bank, allows the central government to inject new net financial assets into the private sector, as deemed appropriate for the purpose of enhancing aggregate demand, boosting the ability of the private sector to save and invest, and reducing the overall level of unemployment. Only central government has the ability to create net financial assets in this way; it never needs to “balance” its budget, and can never go broke.
Putting it another way, a central government which is monetarily sovereign will always live within its means, because it has a bottomless pit of financial assets (denominated in dollars, and easily convertible into actual dollars if this is required) at its disposal. There is no risk of inflationary pressure from deficit spending in circumstances where the economy is operating below its capacity to produce goods and services (such as right now!). None of this applies to a household, or to household budgeting.
In a recent article in the New York Times [1,2], economist Paul Krugman made the point that “the widespread demand for austerity serves a political agenda, with panic over the alleged risks of deficits providing an excuse for cuts in social spending”. However considering the current state of the global economy, the budget deficits of sovereign governments present no risk of unacceptable inflationary pressures or rising interest rates whatsoever. Indeed, many heterodox economists would go further, by saying that for any economy operating below full capacity its central government has nothing to fear by allowing its budget deficits and spending into the real economy to rise to whatever levels are necessary in order to secure healthy levels of aggregate demand and employment.
Krugman also made the point that in a non-inflationary environment budget deficits and government spending may be easily accommodated by allowing the central bank to make use of its ability to manufacture banking reserves (a form of state fiat money, or base money) out of nothing. This process is sometimes described as “printing money”, even though it is fully recognized that no printing presses are involved in the manufacture of reserves. Here is his account:
“… there actually is a sure-fire way to fight deflation: When you print money, don’t use it to buy [financial] assets; use it to buy stuff. That is, run budget deficits paid for with the printing press.
” Deficit finance can be laundered, if you like, by issuing new debt while the central bank buys up old debt; in economic terms it makes no difference. ”
One of the implications of this is that in a depressed, deflationary economy, conventional fiscal prudence is dangerous folly. In particular, the simplistic and misconceived notion that all surpluses are good and all deficits are bad must be abandoned. This is relevant to the Australian economy, because some informed commentators are now predicting [3-7] that Australia will soon move into recession. In such circumstances, to continue with austerity and the objective of cutting federal budget deficits in order to achieve a surplus at some future time would be to apply a wrecking ball to the Australian economy, at a time when the opposite fiscal trajectory is needed.
It is to be hoped that the new Turnbull government is aware of what is required for ameliorating the effects of any recessionary tendency, as was the Rudd government in the wake of the global financial crisis — as evidenced by its program of fiscal stimulus during 2008-10, which (notwithstanding inadequate monitoring of some spending projects) served to keep recession away from Australia’s doorstep.
The following appeared within an article in the Jul-Aug 2014 issue of the ERA Review
The respective positions of the orthodox (neoclassical) and heterodox (mainly postKeyensian and MMT) viewpoints as they pertain to the role of debt in the modern economy differ profoundly, and may be summarised as follows:
- The economy tends towards a stable equilibrium configuration.
- Private borrowing, spending and saving decisions are always driven by “rational expectations”.
- Banking and money flows don’t affect economic performance.
- Private debt growth does not affect economic performance.
- Public debt (deficit spending) must be minimised since it leads to rising inflation and rising interest rates.
- The economy generally operates far from equilibrium.
- The idea of rational expectations is a fiction unsupported by evidence.
- Banking and the creation of new money by banks matter because they contribute to purchasing power and economic performance.
- Private debt growth (relative to GDP or a genuine progress indicator) must be restrained, because if excessive it will set the economy up for a crash.
- Sovereign government debt (aka Treasury securities) should be allowed to rise to whatever level is required for the operation of a healthy economy.
It is unfortunate that the advocates of MMT (modern monetary theory) and various monetary reform movements including NCT (new currency theory) and Sovereign Money misunderstand each other’s positions. There are important truths in each viewpoint, and I do not see a necessary contradiction between the main thrusts of their respective stories.
A very interesting paper published in Real World Economics Review  by Prof Joseph Huber – a primary advocate of NCT – takes MMT to task on several matters, even though he agrees with some of their analysis. In my opinion Huber’s primary criticism of MMT is unjustified and the assertions and arguments he has given in this regard are flawed. To critique Huber’s paper in detail would require considerable effort, however I would like to draw attention here to one section where his assertions struck me as being obviously incorrect. Let me quote the section:
“ Don’t let yourself be fooled. The biggest part of government expenditure is funded by taxes. Tax revenues represent transfers of already existing money. The money that serves for paying taxes is neither extinguished upon paying taxes, nor is it created or re-created when government spends its tax revenues. In actual fact, this is all about simple circulation of existing money. “
The MMT position that the government injects new money into the real economy when it spends, and withdraws money from the real economy when it taxes and borrows, implies that Treasury’s general account with the central bank (CB) is not actually composed of money at all and is therefore merely an operating account.
This rings true because it is not difficult to see why the credits held in Treasury’s general account cannot be regarded as money, in any sense of the word. One of the characteristics of an entity which is entitled to be called “money” is that it is used by a set of marketplace players and may be loaned and transferred between those players. Thus, for example, the credits that banking institutions maintain within their CB accounts (reserves, or exchange settlement funds) must be regarded as a form of money because – apart from satisfying the usual criteria of medium of exchange, store of value, and unit of account – may be loaned between those players and directly transferred between their respective CB accounts. However the credits held within Treasury’s account with the CB are never loaned out or transferred to any other institution under any circumstances. When the central government spends, new bank credit money is created by the payee’s bank and matching new reserves are created in that bank’s CB account. Reserves are not transferred, because the definition of reserves excludes Treasury deposits.
Recent articles in The Conversation * reveal that the Australian federal budget deficit is increasing, for a variety of reasons discussed in those articles. Moreover it is becoming abundantly clear that there is no possibility of having a balanced budget within the forthcoming decade, let alone a budget surplus, notwithstanding the insistence of the Treasurer, the Finance Minister, and the senate leader that a budget surplus remains their ultimate objective.
To quote Ross Guest, Professor of Economics at Griffith University,
“The MYEFO only confirmed that the Treasury and government accept what we’d already been told by independent experts: the federal government budget is shot. There is no prospect with the current level of taxes and array of spending programs of getting spending and revenue back into line within a decade and probably longer.”
But none of the authors listed in these articles seems to think it is appropriate, in a contracting economy characterised by increasing levels of poverty and unemployment, for central government spending to exceed the aggregate of taxation receipts. This view is grounded in their a priori belief that deficit spending is necessarily inflationary and will put upward pressure on interest rates. And it is obvious that the choice of “experts” in the multiple author article was taken exclusively from the ranks of neoclassical economists and business economists. A more balanced selection of the views of “experts” would have included informed contributions from economists like Prof Steve Keen, Prof Geoff Harcourt, and Prof Bill Mitchell.
A lot of confusion and misunderstanding surrounds the topic of borrowing by a currency-issuing central government (CICG), which is the basic mechanism by which government deficit spending is accommodated. Treasury securities (i.e. bonds and bills) issued for this purpose are in many respects as good as money, and short term securities are often referred to as “near money”. The Australian federal government has an unlimited ability to create these financial instruments, just as the central bank (RBA) has an unlimited ability to create state fiat money (consisting of currency and reserves). Treasury securities and state fiat money may be regarded as interchangeable financial entities.
It is essential for understanding the associated monetary mechanics to recognise that when a CICG deficit spends it increases the liquidity ** of the private sector, and that this increase in liquidity is transferred to the community at large. The liquidity of banks and large institutional investors does not change substantially as a result of deficit spending. All that happens in regard to the latter is that one financial asset (Treasury securities) is exchanged for another financial asset (credit money plus reserves). However the receipt of this money by Treasury then authorises the central government to spend an equal quantity of money into the real economy. The net result is that the liquidity available to the private sector as a whole increases by this amount.
Incidentally, it is not even remotely valid to assert that the interest paid out on Treasury securities (notwithstanding that interest is a budgeted item) is paid from tax receipts. Thus, in a normally operating and growing economy – where the stock of Treasury securities is growing in tandem and at the same rate as the rest of the economy (which must of necessity be the case if the economy is to be sustainable and to prosper) – the interest payments may be viewed as being effectively factored into the ongoing issue of new securities.
Moreover, the creation of CICG Treasury securities (aka public debt) may be regarded as equivalent to the creation of new money, by virtue of the fact that the central bank can buy back any of these securities from the private sector at any time the private sector (including the banking sector and the general public) requires more currency and/or credit money. The net outcome of such buybacks by the central bank is the financial equivalent of the government selling Treasury securities directly to the central bank – which some people wrongly describe as “printing money”.
* The Conversation, 15 Dec 2014
- Michelle Grattan article, “Government reveals $40 billion budget deficit, clings to surplus hope”
- Multiple authors, “Federal budget deficit climbs to $40.4bn: experts react”
** “Liquidity” is the conjunction of useable money and any other high quality financial assets which may be readily and speedily exchanged for money.