Tuesday, June 21, 2011
The big Public Sector Borrowing Requirement farce.
The Public Sector Borowing Requirement (PSBR) is one huge nonsense. This world is full of emperors with no clothes. That is, farces which are so big that no one notices them.
PSBR is a term that has rather fallen out of use in the UK. But alternative terms with the same meaning are still used. Anyway I’ll stick with “PSBR”.
The PSBR is defined by the Financial Times Lexicon as “The term used in the UK for the government's budget deficit in a particular fiscal year. It refers to the fact that the deficit (the excess of spending over revenue) is made up by government borrowing. The amount that a government has to borrow in a particular period of time to cover the difference between the money it gets from taxes and the amount it spends.”
The first reason to be suspicious of the whole PSBR concept, as defined above, is that it applies microeconomic thinking at a macroeconomic level. That is, everyone knows that if a microeconomic entity, like a business or household, has a deficit of £X for the year, then it must borrow £X (assuming it has no cash to spare). But macroeconomics is a different world.
SOMETIMES microeconomics works at the macroeconomic level, but not in this case. Reasons are as follows.
When government wants to boost the economy, a popular method is Keynsian “borrow and spend”. That is government borrows £Ybn and spends £Ybn. And that supposedly raises aggregate demand. That is, the effect of “borrow and spend” is alleged to be stimulatory.
There are actually good reasons for thinking this policy works. One is that the net effect, taking the above example, is that private sector net financial assets rise by £Ybn. That is government borrows £Ybn from the private sector and spends same (i.e. channels the £Ybn back into the private sector). Plus government gives bonds worth £Ybn to those it has borrowed from. Net result: the private sector is up by £Ybn.
Noticed the farce yet? If not, read on.
Now if government runs a deficit of £Zbn, then applying microeconomic thinking, and the above FT definition, it needs to borrow £Zbn. Put another way, if government did NOT borrow the £Zbn and simply printed £Zbn of new money to make good the tax shortfall, the results would be inflationary (assuming the economy was at capacity).
So the purpose of borrowing the £Zbn is to give a demand reducing effect that cancels out the demand increasing effect that would arise from simply printing and spending £Ybn.
But wait a moment. In the case of Keynsian borrow and spend, the effect is supposedly the OPPOSITE! That is, the effect of “borrow and spend” is supposed to be demand increasing!
Of course where borrow and spend is supposed to be demand reducing, government could let interest rate crowding out do its worst: that is, it could let interest rates rise as a result of said borrowing. But given the disagreement amounts economists as to the extent of the crowding out effect, it is hard to say what the effect would be.
Conversely, when the aim of borrow and spend it to RAISE demand, government could intervene and make sure interest rates DON’T rise, or even lower them (and no doubt governments normally do this). But in either scenario, why bother with the concept “PSBR” at all? From the above argument, it would seem that it is interest rate adjustments that do the crucial work. So why not just adjust interest rates as required and forget all about the PSBR?
Indeed, even interest rate adjustments are a farce, if the arguments I put here are correct. That is, the real work is done by having government print and spend money (or the reverse, that is, rein in money via extra taxes, and “unprint” or extinguish money).
Or as Abba Lerner said, the important point about an item of tax or spending or anything else, is the EFFECT. The actual figures – in particular the effect on the size of the deficit or surplus or the PSBR is irrelevant.