Is the “structural deficit” a useful concept?

The so called structural deficit is that part of the deficit which won’t disappear when the economy returns to normal. OK, it’s a concept of sorts. But having measured it, what does that tell us?

If the structural deficit as £Xbn a year, does that mean that we must work our way towards cutting £Xbn from the deficit? Certainly not! It could be that in two or three years time we will need to cut far more, or it could be far less.

It depends, amongst other things on what the private sector is doing. If the private sector continues to deleverage and hoard cash, the last thing we would need is deficit cuts.

On the other hand if the private sector gets uppity and too confident – if there is a stampede for 110% mortgages – then swinging deficit cuts would be in order. Possibly even a public sector surplus would be in order.

So what’s the use of this “structural deficit” concept? Not much.

Afterthought added 27th June. In other words as the advocates of modern monetary theory (aka functional finance) have been saying for decades, the deficit (or surplus) in any year should be whatever optimises the unemployment / inflation relationship in that year. I.e. the deficit (or surplus) can look after itself. Period, full stop, end of argument.

How to make your National Debt vanish.

As Milton Friedman correctly pointed out, a “National Debt free” regime is feasible if not better than more conventional regimes. That being the case, a switch to a debt free regime should not be difficult. And indeed it isn’t. Governments that issue their own currencies and wishing to make the switch (plus those just wanting to substantially reduce their national debts) should proceed as follows.

1. Adopt policies A and/or B below.

A, cease, or substantially reduce the proportion of maturing debt that is rolled over. Instead, just print money and pay off the relevant creditors. B, stop creating, or substantially reduce the amount of debt created in the first place. Instead, obtain the necessary funds from printed money.

A and/or B would almost certainly be too stimulatory and inflationary. This can be countered by a form of national debt repayment (C) which is deflationary: obtaining the funds for repayment from increased taxes and/or reduced government spending.

This gives governments two levers (A and/or B) and C which can be adjusted to bring any rate of national debt repayment desired, plus any stance on the reflation – deflation scale that is desired.

For example, for a faster rate of national debt reduction, apply more of both (A and/or B) and C. And for a more deflationary method of debt reduction, increase the amount of C relative to (A and/or B).

But that is not a message that Goldman Sachs, other banks or the well paid employees in the world’s financial centres want broadcast. They have an interest in seeing governments heavily in debt. They devote millions and will devote further millions to furthering their interests: foisting debt on governments.

Functional finance.

According to Wikipedea there are three basic principles in functional finance, the second of which is, “By borrowing money when it wishes to raise the rate of interest and by lending money or repaying debt when it wishes to lower the rate of interest, the government shall maintain that rate of interest that induces the optimum amount of investment.”

If Abba Lerner actually said the above, I suggest he was wrong. The idea that governments (politicians in particular) can gauge the rate of interest that will bring the “optimum amount of investment” totally unrealistic.

Moreover, given the huge range of returns that come from investments (anything from plus 100% or more a year to minus 100% or more a year) does it really make a blind scrap of difference whether the official central bank base rate of interest is 2% or 4%?

That is not to say that in a functional finance regime government should not use interest rate changes as a macro economic tool. The main tool under functional finance is changing government income and expenditure. But there would be nothing to stop a "government – central bank machine" changing interest rates as well, so as to influence aggregate demand, inflation and so on.

Update (25th June). Though on second thoughts there is much to be said for the argument that a government - central bank machine can control the quantity of money or the price but not both. Thus under functional finance, possibly a government - central bank machine cannot control interest rates.

Steve Keen criticises Mosler’s Law.

Mosler’s law states that “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it”. See sentence in yellow at top of Warren Mosler’s site.


Steve Keen questions the above law.

Keen’s article starts by attacking crowding out. He says:

“This is the argument that a government deficit 'crowds out' private expenditure, so that overall there's no increase in output and employment. We are told that private projects that would have gone ahead without the deficit are made unprofitable because the government deficit increases interest rates, so that in fact we're worse off because unproductive government expenditure occurs rather than potentially productive private expenditure.

The argument against government deficits begins with: "Let's assume there's a fixed supply of money out there", but that's where it goes wrong.”


The crowding out idea or hypothesis is based (like many ideas, theories, etc) on the “other things being equal” assumption. Obviously IF there is a sufficiently large monetary base increase, that will negate the undesirable effects of crowding out!

If I say that when a car crashes into a wall at 60mph, then more damage will be done than if the speed is 30mph, do I really need to insert the phrase “other things being equal”? I mean, do I need to say “assuming a big foam rubber cushion hasn’t been placed in front of the wall for the 60mph impact”?

Keen then claims “Australia's recent economic performance – when a huge government stimulus meant that the GFC seemed to be reduced from a serious case of pneumonia to a mild cold – should make most people sceptical about this 'crowding out' argument....”

Most of those who support the crowding out idea (which includes me) do not claim that crowding out is complete, i.e. that interest rate rises consequent to increased government borrowing TOTALLY stymies the increase in demand that the above “borrow and spend” strategy is supposed to bring. We just claim that the effect is there. As to the extent of the effect there is widespread disagreement. Thus the fact that Australia’s borrow and spend effort worked does not disprove crowding out.

It gets worse. Keen then says:

As the previous RBA governor Ian MacFarlane put it: "Any government deficits not financed by an exactly coincident issue of debt to the public, for example, would mean a rise in cash and a fall in interest rates."

If some of the government deficit isn't offset by selling bonds to the public, the debt created between the government and the central bank must also be serviced; but that is also a book entry for a government that has a 'captive' central bank. It's only when the government sells bonds to the public (especially the offshore public) at a market-determined rate that it can have problems in servicing its debt.

So a government deficit per se isn't going to cause 'crowding out' – as Ian MacFarlane notes, it actually might cause interest rates to fall, which would make private borrowing cheaper and actually encourage private investment rather than stifling it. Private spending itself could expand because of the increase in the money supply caused by the government deficit, or because the private banking system also expanded the money supply by creating more loans.

The phrase “a government deficit per se.....might cause interest rates to fall” is nonsense. Keen is saying that where a money base increase is so large that it smothers the effect of crowding out, the net effect is reflationary or “stimulatory”. Agreed. But it’s the base increase that has the stimulatory effect, not the deficit!

As to money supply increases other than base increases (i.e. money supply increases brought by the commercial banking system), if this occurs IMMEDIATELY AFTER a base increase, it is probably a secondary effect. (Which, just to emphasise, is not to suggest that all commercial bank created money increases are secondary to base increases: indeed Steve Keen has done some quality research, as I understand it, into commercial bank money supply increases that are independent of central bank money supply increases (base increases).

Keen’s second last para has got me beat. I don’t understand it. Ideas anyone?

Keen’s concluding para says,

“Addressing the crisis by running large government deficits alone – without confronting the reality that the private financial system lent irresponsibly for the last two decades – would also enable that irresponsible Ponzi-behaviour to continue, when that's what really caused this crisis in the first place.”

Agreed. In fact this is an obvious enough point. Does Keen seriously think that Warren Mosler or anyone else is unaware of the dangers of reviving irresponsible lending? Obviously the criminal, fraudulent and irresponsible behaviour of banks needs dealing with.

Today’s Financial Times.

I’ve read some daft articles in my time, but this one by Jeffrey Sachs of the Earth Institute of Columbia University takes some beating. This is not the first time I’ve spotted nonsense emanating from this “Earth Institute”.

Sachs ends by claiming that “To rebuild our economies the watchword must be investment rather than stimulus.”. Given that we have record amounts of investment lying idle as a result of the recession, investment is not the immediate priority is it? Doh.

Update (9th June). After writing the above I noticed that Sach’s article came in for a drubbing by Bill Mitchell. As for some of the anti-Sachs language used in the comments after Bill’s article, I wouldn’t repeat some of it – not even on this verbally risque blog.




On the opposite page of the F.T. there is a better article by Philip Stephens, “Free bus passes will test Cameron’s mettle”. As Stephens rightly points out, it is a farce to hand out free bus passes to those who can afford to pay the full bus fare.

But there is more nonsense involved in the whole pensioner travel concession farrago.

First, there are good arguments for some subsidies (e.g. health and education). Thesearguments do not apply well to pensioner travel. For example in the case of health,many people in the absence of the National Health Service would face sudden largebills for medical treatment. In contrast, the bill for essential travel, like going to theshops, is a predictable and modest weekly expense of the same order as the weeklycost of food ( for which pensioners are not given concessions ).

Also, concessions are a poor means of supplying transport facilities to pensioners since about a third are not well served by public transport.

In contrast,if we abolish the entire pensioner travel concession system and hand out the money to less well off pensioners virtually all less well offpensioners get “transport subsidy money” since this money is contained in anincreased state pension. Under a no concessions scenario, pensioners can spend their“subsidy money” on for example home delivery of groceries, taxi trips or subsidisingrelatives’ car running costs where the latter do the shopping.

If memory serves, the rot was started many years ago by Ken Livingstone (former Mayor of London) when he was in charge of a London borough. That borough was the first in the country to issue pensioner bus passes, I think. Winning votes by handing out bread and circuses has always been Ken’s main skill.

For more on this, see here.

Unfortunately there is great emotional appeal in "helping pensioners get around". And emotion beats logic every time.

Greece before the First World War.

Quotation from article by A. Mitchell Innes in the Banking Law Journal, May 1913.

"Again when for many years, Greek money was at a discount in foreign countries, this was due to the excessive indebtedness of Greece to foreign countries, and what did more than anything else to gradually re-establish parity was the constantly increasing deposits paid in to Greek banks from the savings of Greek emigrants to the United States. These deposits constituted a debt due from the United States to Greece and counter-balanced the periodical payments which had to be made by Greece for the interest on her external debt."

Stefan Karlsson is wrong about Beavis and Butterhead.

Beavis and Butterhead were given candy bars to sell by their school. Plus they were given a small cash float. B & B failed to sell any candy bars.

But they were quite keen on eating them. So they used their borrowed cash to buy the bars from each other and eat them. End result: same stock of cash with which they started, and all the candy bars gone.

See here for more on this riveting and tragic story.

Stefan Karlsson claims this is the equivalent of Keynsian money printing. Stefan rarely makes mistakes, but he has here.

The first mistake here is that Keynes’s basic proposition was to have government borrow and spend, the net result of which is the production of government debt (Gilts in the UK or Treasuries in the US). The net result is not extra printed money. However, government debt in the “Gilt Treasury” form is not vastly different from government debt in the form of monetary base (which appears as a liability in central bank balance sheets, and which is thus, at least nominally, a “debt” of the “government central bank machine”.) So that’s a technical quibble.

Second and more important, the brute reality is that if the private sector is deleveraging and/or hoarding cash, it is not spending that cash. That in turn means less demand. That in turn means unemployment.

Put another way, an increased private sector desire to save (cash) means unemployment unless the public sector supplies the extra cash.

And that is not to suggest that we can grow rich just by printing bits of paper with “$100” inscribed on them. But these bits of paper are our economies’ currencies. And the total volume of currency in private sector hands has an effect.