Friday, January 31, 2014

The optimum debt and deficit policy.

Here is simple set of rules for optimising the size of the deficit and debt. It’s more or less Modern Monetary Theory compliant, but not 100% compliant.
1. If unemployment is excessive, then expand the deficit (or reduce the surplus).
Incidental point: as Keynes made clear, a deficit can be funded either by borrowing or by simply printing money. Quite what the point of borrowing is, is a bit of a mystery. First, borrowing has a deflationary or anti-stimulatory effect (if it has any effect at all). Now what’s the point of doing something anti-stimulatory when you’re trying to impart stimulus? Darned if I know. Isn't that evidence of schizophrenia?
Second, what’s the point of borrowing money when you can print the stuff? The naughty people who have their own back street printing presses for turning out forged £20 notes don’t borrowing money: when they need money they just crack up their printing presses (so I’m told). Their understanding of economics is clearly superior to that of professional economists and finance ministers.
2. However, if a deficit IS FUNDED via borrowing, and the rate of interest demanded by creditors starts to rise too far, there is an easy solution: tell the creditors to get lost.
That is, as debt matures, instead of rolling it over, just print money and pay off the creditors. That may well be too inflationary, in which case just raise taxes and/or cut public spending so as counter the inflation.
Note that the latter increased tax / reduced public spending would not, repeat not reduce living standards (at least not to the extent that an economy is a closed economy – i.e. to the extent that it doesn’t have dealings with other countries). Reason is that the only purpose of said increased tax / reduced public spending is to cut inflation. Put another way, there is no reason to assume any big effect on REAL GDP.
Of course, to the extent that an economy is OPEN, i.e. to the extent that it borrows from abroad, obviously if foreigners can no longer get a nice rate of interest by buying the debt of a given country, then those creditors will seek yield elsewhere. And that will necessisate a devaluation of the currency of the country concerned, which in turn will lead to a cut in its standard of living.
But that’s just another reason for abstaining from borrowing, isn't it? See No.1 above. That is, when a household borrows from some external source, that temporarily raises the household’s standard of living. Then the household has to do some work, earn some money and pay back the debt: that cuts its standard of living. Same goes for countries.
Borrowing makes sense if you don’t have cash to hand and if you have spotted an investment that covers the cost of the interest. But that’s not what’s involved when a country runs a deficit funded by borrowing.
3. The above advocated “no borrowing” policy implies that interest rates are not deliberately adjusted. Does that matter? The answer is “no”: a recent Fed studyshowed that interest rate adjustments don’t work: at least it showed there is little relationship between interest rates and investment spending. Moreover, the optimum rate of interest is presumably the free market rate. I.e. artificial adjustments to the rate will presumably lead to a misallocation of resources.
4. The above rules are also Positive Money compliant, as I understand PM's policies.

P.S. (same day). Rule No.5. If inflation is excessive and it looks like demand pull inflation rather than cost push inflation,  then cut the deficit / increase the surplus.

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