Olivier Blanchard in these columns (‘Mediocre Growth, High Risks, and the Long Road Ahead’, April 18) rightly points to the fact that ‘Fiscal consolidation is needed and is proceeding, but is weighing on growth’. He goes on to assert that there is ‘… pressure from markets for immediate fiscal consolidation.’ Blanchard suggests that ‘A search for structural and fiscal reforms that help in the long run, but do not depress demand in the short run should be very high on the policy agenda’. As we suggest below, greater coordination between monetary and fiscal policy also has a role to play.
There are possibly two observations that bear on Blanchard’s reflections. The first is that fiscal austerity, an extreme form of fiscal consolidation, is not only ‘bearing on growth’, but is actually contributing to recessions and depression in periphery countries. The second is that markets are applying pressure for immediate fiscal consolidation because of the need for governments to issue new bonds to finance on-going budget deficits. It is ‘bond financing’ that is the problem. Such issuance of new bonds adds to public debt, and results in market panics and credit downgrades particularly in periphery countries, but also in Japan and the United States, among others.
Budget deficits are a means to push more money into the economy than is withdrawn, and thereby raise aggregate demand. Fiscal deficits are desirable when output is weak or falling. Consequently, periphery countries require on-going budget deficits to lift economic growth. Fiscal deficits, in and of themselves, do not raise public debt.
Nouriel Roubini (‘What’s on Nouriel’s Mind: A Balance-Sheet Recession Calls for Monetized Fiscal Deficits, Not Fiscal Austerity’, April 3rd) refers to the ‘lack of fiscal stimulus and outright fiscal contraction’ as one of the mistakes of the Great Depression.
Roubini refers to Koo who has argued that ‘Monetization is necessary to finance the surge in public deficits and debt…’. Roubini goes on to make a powerful case for on-going fiscal stimulus in periphery countries. He, also, argues for monetization of these deficits.
There are two forms of monetization. Monetization of debt, and monetization of budget deficits. Monetisation of debt is entirely defensive, and does nothing to address the underlying source of the debt problem, as the need to finance the on-going budget deficits continually re-ignites the debt problem. In contrast, monetization of the budget deficit can stop public debt rising in its tracks.
It is no use if a central bank prints new money to finance the budget deficit, because, to obtain that new money the Ministry of Finance has to issue new government bonds to the central bank. This raises public debt as it is measured (see the Executive Summary, IMF Fiscal Monitor, Balancing Fiscal Policy Risks, April 12th).
Governments can directly finance the budget deficit if they, not the central bank, create new currency to do so.
This action would be no more inflationary than the current policy of printing new money to monetize the debt. A legislative limit could, in any event, be set on new money creation for deficit financing purposes. Once the new money is injected, via public spending, into the economy, it can be withdrawn by sterilisation if excessive liquidity develops. The only function of the new money is to finance the new spending: once that is achieved the new money has no other function (See Richard Wood, ‘What would Keynes recommend today?’ EconoMonitor, 15th February. Also see ‘Delivering economic stimulus, addressing rising public debt and avoiding inflation’, Journal of Financial Economic Policy, Vol. 4 Iss: 1 pp 4-24).