Monday, January 30, 2012

Ghosh – IMF authors define “fiscal space”.

Atish Ghosh (of the IMF Research Department) and co-authors tell us what they mean by “fiscal space”. (H/T to J. Portes).

Turns out that what they mean is pretty much as expected, which is thus.

There is a limit to what a country can borrow before creditors get worried and start raising the interest they require for further lending. According to Ghosh & Co this limit comes where the debt to GDP ratio is around 100%. They seem to be unaware that this ratio for the UK just after World War II was over 200% without any big problems. (See 3rd and 4th charts here). They also seem to be unaware that Japan’s public debt is also around the 200% level, yet the yield on ten year Japanese debt is around 1%. Lending to someone for ten years at 1% strikes me as a HUGE VOTE OF CONFIDENCE in the relevant debtor.

But that 1% for ten year figure does not of course stop the debtphobes, the economic conservatives and economic illiterates from getting their knickers in a twist on the subject of Japanese debt. This doom laden article in the Wall Street Journal article points out that the cost of insuring Japanese debt for five years has risen from $155,000 to $222,000 for $10million of debt. Now if get out your pocket calculator, you’ll see that that equates to reducing the interest on the debt by the catastrophically large figure of 0.0044%. In other words, if you want to insure your Japanese debt, the rate of interest you get effectively declines from 1% to 0.9956%. All I can say is that the sky must be about to fall in – in Japan anyway.

Ghosh & Co also claim that creditors’ views of a country will be influenced by that country’s past performance in paying off debt, which is reasonable enough: lending to someone with a past record of alcohol abuse and a poor employment record is riskier than lending to a more trustworthy debtor.

Anyway, the much vaunted “fiscal space” according to Ghosh & Co is the difference between a country’s EXISTING debt level, and the level at which interest rates charged to that country lead to the situation running out of control. Or as they put it:

“Once the primary surplus does not keep pace with the higher interest payments on rising debt, there comes a point – a debt limit – beyond which, in the absence of extraordinary fiscal adjustment, debt dynamics become explosive and default becomes inevitable. Our definition of fiscal space is then simply the difference between current debt ratios and this debt limit.”

Well there is just one problem with all this. The IMF authors are assuming that fiscal stimulus can come only via increased debt. That is, they’re assuming that the only form of fiscal stimulus is the classic Keynsian “borrow and spend” policy.

As I’ve pointed out a hundred times on this blog, and as both Keynes and Milton Friedman pointed out, for a monetarily sovereign country (that’s one that produces its own currency) an alternative to debt financed fiscal stimulus is to do the funding via plain straightforward old money printing – inflation permitting. (Of course the policy is then no longer purely fiscal in that a money supply increase is involved at the same time. I.e. the policy then becomes fiscal plus monetary – but never mind.)

In fact I’d go further. As I’ve also pointed out several times on this blog, monetarily sovereign governments do not need to borrow. In fact I’d go further still: it is COMPLETELY LUNATIC for a monetarily sovereign country to borrow. What’s the point of borrowing something you can produce in infinite quantities yourself and at no cost?????? Anyway that’s my own what you might call “extremist” view. So I’ll stick to something nearer the convention unwisdom from now on.

Having said that (inflation permitting) a monetarily sovereign country which is not trusted by potential creditors can always fund fiscal expansion via money printing, it is possible that the mere fact of printing could make the creditors even more worried.

Well that again is no problem. The relevant country can simply print yet more money and pay off creditors as their debt reaches maturity. It’s possible that that money printing might be inflationary, but in that case all the relevant country needs to do is to raise taxes by enough to give a deflationary effect that cancels out the above inflationary effect. (Well actually it is SLIGHTLY more complicated than that as I explain here, but basically the above “print and tax” policy is the way to get rid of national debt, if that’s what a monetarily sovereign country wants to or needs to do.)

Of course, as Ghosh & Co point out, some countries do not have a good record when it comes to imposing enough tax on the population when required. But such a country is on the road to ruin ANYWAY: i.e. regardless of any arguments to do with “fiscal space”.

So what does this “fiscal space” idea amount to? For a monetarily sovereign country, the idea amounts to nothing.


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