A little mistake by Brad DeLong which Abba Lerner would not have made.

Brad DeLong argues that excess unemployment leads to a semi-permanent loss of productive potential because employers fail to invest the amount that would be suitable at full employment. Thus, so he argues, having government borrow and spend now is highly beneficial because in addition to the normal and not too spectacular increased GDP that comes from “borrow and spend”, the above loss of productive potential is avoided. And the latter is where the real benefit of borrowing and spending in 2012 comes in.

That is his basic arument and there is nothing wrong with it. But at the end of his article, he makes a slight mistake. He argues that current low interest rates make “borrow and spend” even more worthwhile than normal, because borrowing costs are currently low.

The flaw in that argument is that interest payments are just TRANSFERS, which are not a REAL cost. That cannot be set against or compared to any increased REAL output that comes from borrow and spend.

That is, when government borrows, interest is paid to those who have lent to government. While the people who PAY for this interest are taxpayers. But that is simply a TRANSFER between two groups of people: the net cost to the nation is nothing, or thereabouts.

To illustrate, suppose one had the option of increasing GDP in such a way that the interest so called “cost” actually EXCEEDED the rise in GDP. According to DeLong (as I understand him) that option would not be worthwhile.

I say it WOULD BE worthwhile, because the increase in GDP is a REAL benefit, whereas the interest rate so called “cost” has no effect whatever on total incomes for the population as a whole: to repeat, it simply boosts the income of one lot of people at the expense of another lot.

But . . . going ahead with “borrow and spend” in those circumstances would lead to a rise in governemnt debt, and possibly an exponential rise. Shock horror.

So there must be something wrong with the DeLong model. And what is wrong is that the basic idea of borrowing so as to fund government spending is one big nonsense. As Abba Lerner, said, in a recession, government should simply create new money and spend it into the economy.

Or as I put it two years ago on this blog, “Borrowing is particularly nonsensical given that when a government borrows, it borrows “stuff” (i.e. money) which it can produce an infinite supply of at no cost. Government borrowing money is a bit like a dairy farmer buying milk at the supermarket when there is a thousand gallon tank of milk a few yards from his house.”

If government “prints” instead of borrowing, that disposes of interest payments. Thus the only question for government is: “Will printing and spending (and/or cutting taxes) boost GDP without exacerbating inflation too much?”

As to which DEPARTMENT of government ought to take this stimulus decision, it is technical decision, a mile above the heads of politicians. Thus the decision is best taken by the central bank or some fiscal committee made up of economists (fallible as they are).

In contrast, there is the decision as to whether the stimulus takes the form of extra public spending or tax cuts. That is a POLITICAL decision which ought to be left to politicians and the democratic process.


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