Rajan had an article in the Financial Times earlier this week entitled “Sensible Keynsians know there is no easy option.” The first paragraph reads:
“In the long run we are not dead, we will still be recovering from the Great Recession. We should therefor weigh stimulus policies not just their immediate effect but on their consequences over time. Sensible Keynesians recognise this. They bet that reviving growth through government spending today outweighs the future loss of growth as the debt taken on to fund current spending is paid back.”
Readers with a grasp of Modern Monetary Theory should immediately see the flaws there. They don’t really need to read any further.
Borrowing OR printing money brings stimulus.
The above suggestion that stimulus necessarily means more debt is nonsense. As Keynes, Milton Friedman and others pointed out, stimulus does not need to be funded by extra debt. It can perfectly well be funded simply by printing money. You’d think a self-styled “Professor” writing an article about Keynes would be acquainted with Keynes’s ideas.
Indeed, where a monetarily sovereign government borrows and spends, and then does QE, the end result comes to the same as the government / central bank machine printing money and spending it. Perhaps Rajan hasn’t heard of QE. (Incidentally, I’ll use the word government here in the sense “government and central bank combined”.)
In that a government goes for the “print” option, there is no “loss of growth” (as Rajan claims) when the debt / money is paid back. Reasons are as follows.
Two senses of the word “debt”.
There are actually two senses in which the word “debt” as used above can be taken. First, the result of QE is that the central bank is left holding government debt. And this is essentially a nonsense: it just amounts to one part of the “government machine” owing money to another part of the machine. Those so called debts can be torn up any time. They are to all intents and purposes meaningless bits of paper or meaningless book keeping entries.
The second sense is thus. In a fiat money system, money is a debt. And money created by the central bank is supposedly a debt owed by the central bank to holders of such money.
However, the word debt does not really apply here. As Willem Buiter put it, “These monetary (base money) ‘liabilities’ of the central bank are not in any meaningful sense liabilities, because they are irredeemable…”
But that does not alter the fact that the money printed during a recession may prove a source of inflation come the recovery. If so, some sort of deflationary measure will be required: like raising taxes and reining in and “unprinting” some of the money.
However, and contrary to Rajan’s suggestions, that does not involve a “loss of growth”: it simply prevents excess inflation. Indeed, excess inflation probably results in a lower GDP all else equal than obtains where the 2% or so inflation target that most countries aim for is achieved.
The “real debt” option.
To repeat, Keynes, Milton Friedman etc, pointed out that governments aiming for stimulus have two options: borrow money or print it. Let’s now consider the borrow option.
According to Rajan, paying back this debt involves a “loss of growth”.
Of course it is true that ALL ELSE EQUAL paying back debt is deflationary. But no government with its head screwed on would impose unnecessary deflation. Put another way, paying back debt (as in the above first “money” option) makes sense if the economy is overheating and inflation looms. And as in the case of the above “print money” option, the only net effect is to keep inflation under control: there is no “loss of growth”.
But if the debt IS NOT paid off, is that a problem? Certainly the word “debt” has nasty connotations or overtones. And for simpletons (i.e. Republicans, followers of Rogoff and Reinhart, and the Peterson Institute, etc) connotations and overtones are all they understand.
The REALITY is that if the real or “inflation adjusted” interest paid on debt is negligible (as for example it is in Japan, the US, and UK and various other countries), then such debt comes to much the same thing as money (or monetary base to be exact). That is, monetary base is in theory a debt owed by the central bank on which the CB normally pays no interest.
In contrast, if a significant real rate of interest IS BEING PAID on a country’s debt, that’s more of a problem. But escaping this situation is child’s play. Such a country just needs to print money and buy back the debt. Of course the effect of that could easily be too inflationary. But if inflation IS INDEED a problem, all such a country needs to do is get some of the money for the “buy back” from raised taxes. And as long as the inflationary effect of the money printing equals the deflationary effect of the extra tax, then there is no net effect inflation-deflation-wise.
Closed versus open economies.
In that our hypothetical country is a closed economy, the latter buy-back would result in no “loss of growth” or loss of living standards: all that takes place is a re-shuffling of assets and liabilities between different citizens of the country concerned.
In contrast, where a significant portion of the debt is held by foreigners AND in as far as foreigners take their money out of the country concerned, then then the country’s currency loses value on the forex market. And that certainly results in a standard of living hit for the country’s citizens for a while. But any such hit will be minimal and temporary.
I expanded on the latter point, see here.
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P.S. (25th May 2012). Chris Giles (economics editor of the Financial Times) makes the same mistake as Rajan. That is, he claims that the money or debt used to fund stimulus necessarily needs to be repaid and that this is some sort of problem. See his final sentence here.
P.P.S. (2nd June). Just noticed this blog post which also casts doubt on Rajan’s abilities.
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