Purpose and Concepts
The purposes of this brief note are two-fold: first, to establish, by country, the extent to which public sector borrowing contributed to the rise in public debt over the period since 2008; and, second, to draw some policy inferences.
The two indicative fiscal parameters used in this analysis are:
Borrowing = general government primary net borrowing.
Public debt = general government net debt.
This note draws a distinction between budget deficits and the financing of budget deficits.
When private and aggregate demand are depressed then budget deficits are often desirable — and necessary if (monetary) policy interest rates are already at zero bound — as a means to stimulate domestic demand and economic activity. In those contexts budget deficits can be totally appropriate, as they allow governments to inject more money into the economy than they take out.
However, concerns about budget deficits can arise in cases where public debt is already high and ‘conventional’ government bond sales are used to finance the budget deficits. That method of financing raises interest rates and increases the already high level of public debt. These concerns have driven European governments to adopt ‘austerity’ policies. Unfortunately, austerity policies generally depress incomes, demand, tax revenues and output: they increase welfare and unemployment benefit payments, and, through all those channels, increase rather than lower the public debt burden. Austerity policies cannot be relied upon to lower interest rates.
Relevant Fiscal Parameters
The indicative fiscal parameters relied upon in this note — the cumulative increase in general government primary net borrowing between 2008 and 2012 and the increase in net debt between 2007 and 2012 — are reported in Table 1.
The estimates in Table 1 suggest that the on-going use of new government bond issuance as the means to finance on-going budget deficits generally (except for Italy) accounted for between 35 per cent and 100 per cent of the increase in general government net debt of various governments between 2007 and 2012. The estimates, because of technical definitional limitations, represent broad orders of magnitude only.
- In the case of Ireland, for example, had the budget deficits not been financed by issuing new government bonds then, ceteris paribus, the level of net public debt in 2012 would have been 40 per cent of GDP rather than 102 per cent.
- In the case of Japan, had resort not been made to new bond financing of budget deficits then the level of net public debt would have been 93 per cent of GDP in 2012 rather than 134 per cent.
- For the UK, the level of net public debt could have been 51 per cent of GDP in 2012, rather than 83 per cent.
Economic Policy Implications
The general policy implication that can be deduced from the above information is that the public debt crisis may have largely been avoided if governments had financed their increased budget deficits during the crisis by using new money creation (overt money financing) instead of new bond financing.
- The failure of advisers, governments and international institutions to recommend new money financing during the crisis should be of considerable concern to the profession, and to the unemployed.
To the extent that future on-going budget deficits will arise, as is expected in some countries, there is still a case for considering overt money financing. In respect of monetary policy, overt money financing (creating new money and channelling it through net government spending to low income people, infrastructure and the unemployed) could replace the ineffective and wasteful quantitative easing policy as a means to stimulate economic activity. Quantitative easing finances banks and speculators; creates asset price bubbles; distorts risk pricing and resource allocation; causes competitive devaluations and currency wars; and results in reversals and financial distress on exiting the policy. Quantitative easing has no direct positive impact on consumer prices as predicated by the central banks of Japan and the United States.
Fiscal multipliers and marginal propensities to consume ordinary goods and services would be relatively larger under overt money financing than under quantitative easing/new bond financing of budget deficits. Overt money financing offers the most powerful combination of monetary and fiscal policies to combat the dual problems of recessions/depressions and high public debt.
Concerns about any potential inflation threat are misplaced. Under overt money financing the sole purpose of the new money is to finance the initial round of stimulus through the budget: once that stimulus is delivered the new money can be withdrawn from the economy (sterilised), if liquidity is adequate. In any event, inflation — whether demand-pull or cost-push — would only come to the fore when the economy is much closer to full employment. Governments could legislate ahead of events to limit the extent of new money financing if that would placate any inflation fears in the community.
In cases where public debt is already excessive overt money creation could potentially be used to pay down the debt to acceptable levels.
Based on the above simple comparisons, it could reasonably be concluded that one key lesson for the future, based on the experience of the past six years, would be that as a substantial public debt problem emerges in the context of an economic contraction and/or a financial crisis then the desired policy response would be to run substantial fiscal deficits financed by new money. This approach would provide needed economic stimulus without raising interest rates, public debt or inflation. Importantly, present and future taxpayers, including those in Northern European countries, would not be burdened, as is likely under the current approach.
The case for overt money financing of budget deficits has been enunciated and analysed by Abba Lerner (‘Functional Finance and the Federal Debt’, Social Research, 1943); Milton Friedman (‘A Monetary and Fiscal Framework for Economic Stability’, June, 1948); Ben Bernanke (Remarks before the National Economists Club, 2002); Max Corden, ‘The theory of the fiscal stimulus: How will a debt-financed stimulus affect the future’, Oxford Review of Economic Policy, Volume 26, Issue 1; Richard Wood (‘Delivering economic stimulus, addressing rising public debt and avoiding inflation’, Journal of Financial Economic Policy, April 2012 and How to Solve the European Economic Crisis: Challenging orthodoxy and creating new policy paradigms, Amazon Books); Biagio Bossone (‘Time for the Eurozone to shift gear: Issuing euros to finance new spending’, VoxEu, 8 April 2013 and ‘Italy, Europe: Please do something!’, EconoMonitor, 19 April 2013); Willem Buiter and E. Rahbari ( ‘What more can central banks do to stimulate the economy’, Citi, 9 May, 2012); Anatole Kaletsky (‘Suddenly QE for the people seems possible’, Reuters, 9 August, 2012); Samuel Brittan, ‘UK needs to talk about helicopters’, 12 October 2012; Martin Wolf (‘Britain does not have to accept stagnation’, 18 October 2012); McCulley and Pozar (‘Helicopter money: or how I stopped worrying and love fiscal-monetary cooperation’, Global Society of Fellow, 7 January 2013) and Lord Adair Turner (‘Debt, Money and Mephistopheles: how to get out of this mess’, Cass Business School Lecture, 6 February 2013).
The case for monetisation of debt has recently been advocated by Pierre Paris and Charles Wyplosz (‘To end the debt crisis, bury the debt forever’, Vox, 6 August 2013).
An approach to overcoming the constraints of Article 123 of the Lisbon Treaty, which precludes borrowing by governments from central banks to finance public spending, can be found in Biagio Bossone and Richard Wood, ‘Overt Money Financing of Fiscal Deficits: Navigating Article 123 of the Lisbon Treaty’, EconoMonitor, 22 July, 2013.