Note: the word government is used here in the sense “government and central bank combined”.
The main and valid reason for any entity to borrow arises where the entity spots a legitimate or profitable way of spending money but happens to be short of cash. For example if a business thinks a new machine makes sense, but it doesn’t have enough cash to buy the machine, then borrowing is clearly a legitimate option.
But governments have a near inexhaustible source of cash: the taxpayer. And that applies to governments which issue their own currencies (monetarily sovereign governments) and those which don’t (e.g. Eurozone counties).
Monetarily sovereign countries of course have an additional source of cash, namely that they can print the stuff – though clearly they have to watch inflation when doing so.
Borrowing spreads costs across generations?
One popular excuse for borrowing to fund capital projects is that it spreads to cost across the generations: the generations that will benefit from the expenditure. That argument does not stand inspection. See blog post here. (Clicking on that link may take you to the end of the comments on that blog post - sorry.)
Borrowing means the rich pay?
Another popular excuse for government borrowing is that the funds will inevitably come from the rich, thus there might seem to be a re-distributive element here. There are several flaws in this argument.
1. The rich are not made any worse off: they get government bonds in exchange for their cash. And not only that, but the rich will presumably withdraw a finite amount of lending to the less-well off to fund lending to government.
2. To the extent that the rich DO NOT withdraw loans to the less well-off, what economists call an “injection” takes place. That is aggregate demand is raised. Indeed this is just the standard Keynesian “borrow and spend” remedy for deficient demand.
So if the “borrow so as to re-distribute” policy is carried out on an “all else equal” basis, then it is not legitimate to count the above apparent injection merit as a merit in the re-distribute policy.
3. There is a limit to how long the “borrow so as to re-distribute” policy can go on for before it results in government debt as a proportion of GDP rising to ridiculous levels.
Borrowing with a view to stimulus.
If stimulus is required, then as mentioned above, governments CAN implement the classic Keynsian borrow and spend policy. But what’s the point of government borrowing something (i.e. money) which it can produce in limitless quantities any time? It’s plain daft.
Indeed as Keynes himself and Milton Friedman pointed out, having government just print money and spend money it in a recession (and/or cut taxes) is a perfectly viable alternative to borrowing.
As Keynes put it “the public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money.” See 5th paragraph.
Re Friedman, see p.250, paragraph starting “Under the proposal…”.
So why do governments borrow?
Political cowardice of course!!!! Or put another way, it’s a way of buying votes.
Taxpayers tend to notice tax increases. But they are less likely to blame governments for any interest rate rise that comes from more government borrowing. Indeed, the latter sort of interest rate increase does not even necessarily take place because lenders may make up for their increased lending to government by tightening up on lending criteria to other borrowers rather than actually raising interest rates. In fact the latter phenomenon is taking place right now: interest rates are at near record lows, but small and medium size businesses are complaining about difficulty in getting loans.
Borrowing so as damp down demand.
There is one possibly valid reason for government borrowing, as follows.
Suppose a government borrowed nothing, but it thought that demand and inflation were becoming excessive. Such a government could simply announce it was willing to borrow at above the going rate of interest. That would withdraw money from the private sector, which would be deflationary.
However, this is not “borrowing” in the normal sense of the word. Normally when any entity borrows it is so as to spend the funds borrowed. The above anti-inflation trick would very definitely not involve government spending the relevant funds.
Smoothing tax receipts.
The money received by governments during the year varies from one month to the next, which might seem like a reason to borrow during the months when receipts are low. But why borrow when governments can print money at will? Because the result would be inflationary? Nope.
Entities due to pay a large chunk of tax in X months time will be perfectly well aware that this liability is in the pipe line. Assuming they have the cash to hand, they think very carefully before spending that cash.
Thus a government which has constant spending needs thru the year and erratic tax receipts does not need to borrow in the “lean” months. It can perfectly well print and spend money in the lean months and balance that by having taxes exceed spending in other months.
No government borrowing would cause a shortage of private sector net financial assets?
A possible objection to the above argument is that zero government borrowing would leave the private sector short of net financial assets, which might cause paradox of thrift unemployment. The answer to that is the clearly government must supply the private sector with the net financial assets that the latter wants, but this can be done with cash instead of government debt. Indeed, this is exactly what Friedman advocated in the paper linked to above.
P.S. (22nd Jan) – Controlling interest rates. If government does not borrow, it loses control of interest rates, except to the extent mentioned under the heading “Borrowing so as to damp down demand” above. In short, government would be able to RAISE interest rates, given excess demand and inflation, but it would not be able to lower them, given a recession. Does this matter? I think not and for several reasons.
1. Abba Lerner did not advocate adjusting interest rates with a view to adjusting demand. (He DID ADVOCATE adjusting interest rates, but NOT so as to control demand.) See end of p.39 – start of p.41 here.
2. There is a long list of weaknesses in interest rate adjustment as a means of controlling demand. See here and here.
3. Warren Mosler, as far as I can see, advocated a regime quite similar to the one set out above: that’s a regime where government does not adjust interest rates. See here, final four paragraphs in particular.