Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday 6 January 2013

Avoiding the B word

As I briefly listened to the radio the other morning, I heard the new head of the TUC (Trades Union Congress) talking about macroeconomic policy. She said the government’s policy of austerity has failed, and we need more investment in jobs. The interviewer asked whether this would mean more borrowing by the government. She avoided answering the question.

Unfortunately I have heard exactly the same from many UK public figures who are critical of austerity. It is as if a memo has gone round with the following instruction: whatever you do, do not say your alternative policy will involve more government borrowing. The writer of this memo presumably thinks that the general public believes additional borrowing is bad, and so it is best to avoid any admission that a policy might require it, even if this borrowing is temporary and at very low interest rates. Following Polly Toynbee, the paradox of thrift is too paradoxical for the public.

As some may have noticed, I have an unhealthy interest in macroeconomic spin. If you are concerned about policy you just cannot avoid it, and while it would be nice to pretend that spin does not matter, I suspect it would be a pretence. So, just on the level of spin, I cannot help feel that this fictional memo is ill conceived. Most people sense that when a public figure avoids answering a question, this is because they have something to hide. So in doing so, the effect is both to suggest that the policy will indeed require more borrowing, and that this is a problem, which is why the interviewee does not want to talk about it.

So here are a few alternatives, in the form of an imaginary interview

Q: Wouldn’t this involve the government borrowing more?

A: Yes, it would involve paying for the investment by borrowing. That is what a company would do if it saw a good investment opportunity, and we are always being told that the public sector should learn from good practice in the private sector.

Q: Wasn’t it excessive borrowing that got us into this mess?

A: Borrowing for a good reason is not a problem, as anyone with a mortgage will tell you. Borrowing becomes a problem when it underestimates the risks involved, and when the borrower may not be able to afford the repayments. The financial crisis was caused in part by excessive borrowing by consumers who thought house prices could never fall, but mainly it was banks over-extending themselves. The recession caused high government borrowing, and not the other way around.

Q: But isn’t pubic sector borrowing at record levels?

A: Yes, but so is the desire of the financial markets to buy public debt. This is why interest rates on public debt are so low. The financial markets desperately want to buy government debt, and so they are prepared to get very little back in return. That is one reason why now is just the right time for the government to borrow to invest.

Q: The government tells us that if it borrows more we will become like Greece.

A: This is nonsense. It is no coincidence that all the major countries experiencing a government debt crisis are in the Eurozone, because Eurozone countries do not have their own central bank. Governments outside the Eurozone have no problem borrowing at the moment – as I said interest rates outside the Eurozone are at record lows. If there was a serious risk that the UK would become like Greece, interest rates would not be so low.

Q: Isn’t it wrong for the government to be borrowing more when consumers are so strapped for cash, and often cannot borrow or are trying to rebuild their savings?

A: Exactly the opposite is true, as any economics student will tell you. If consumers are saving more, there is less spending power in the economy. If the government also spends less, we get a recession. That is the basic mistake the government is making. This is the other reason, besides low interest rates, why now is just the right time for the government to borrow more. In a recession, there is no danger that government spending will crowd out private spending, and it is much more likely to stimulate the economy.

Q: But surely no government can keep on borrowing more forever.

A: Of course not. But the right time to cut government borrowing is when the economy is strong, and the cost of borrowing is high.

Q: All politicians will find an excuse to spend more or tax less, and put off the day that borrowing is brought under control. At least this government has had the courage to deal with the problem, unlike their predecessors.

A: As many countries besides the UK are finding, it is much more difficult to bring down borrowing when the economy is weak. By contrast, many governments have succeeded in reducing borrowing when the economy has been stronger. Before the financial crisis, the ratio of government debt to GDP in the UK was below the level when Labour came into office in 1997. Bill Clinton successfully reduced US government debt during the 1990s, when the US economy was growing strongly.      

Q: But government borrowing more now will inevitably mean higher taxes in the future. We should not burden future generations in this way.

A: Not necessarily. By spending more today, we can reduce the need for the government to spend in the future, so taxes need not rise. As far as future generations are concerned, I suggest you ask some of the nearly one million young people who are currently trying to find a job what they think.


  1. Outraged Spaniard7 January 2013 at 00:26

    Unfortunately in Spain the same arguments do not hold. We are trapped in the euromess. The ECB´s reputation is still intact and the deadly institution is perceived too far, too technical to be considered in any way responsible for the economic disaster. There is however an increasing anti-german feeling in the air. In the meantime the Spanish government privatizes public services and punishes the weakest while saying "I´m sorry, it´s not my fault, I just do what I am told to"
    For us the only way out -and a dangerous one- is to leave the euro. That is still considered heresy, so we can expecto a lot more pain to come, no matter who wins next election.

  2. How would you respond to the John Cochrane argument that NPV +ve government investments can't be easily found even at today's low interest rates? He has a view that for x govt investment, the multiplier needs to be 5x (as US federal tax is 20% of GDP). This is a bit disingenuous as governments can invest in projects that generate direct fees as well as general revenue from taxation.

  3. Simon,

    Great article - I love these clear and thoughtful responses to the inevitable questions that come up when/if interviewees dare to mention larger deficits.

    However, one thing I don't understand is this point...

    On the one hand you say the UK is not like Europe because we have our own central bank. Then on the other you agree that "surely no government can keep on borrowing more forever".

    Can you clarify please? Japan is showing no signs of a bond vigilante problem, so what issues do you have with "governments borrowing more forever"?

  4. "How would you respond to the John Cochrane argument that NPV +ve government investments can't be easily found even at today's low interest rates? He has a view that for x govt investment, the multiplier needs to be 5x (as US federal tax is 20% of GDP). This is a bit disingenuous as governments can invest in projects that generate direct fees as well as general revenue from taxation."

    Relating investment requirements to current tax levels seems like a non-sequitir. If the current tax rate is low, should the government invest in nothing? Even if the interest rate is zero and we can easily pay back the debt later on when tax revenue is higher?

    Whether NPV +ve government investments exist is a divisive question. But consider it this way - we have several existing government programs going. Assuming that at some point these programs have a +ve NPV, then the reduced interest rate in recent days increases these programs' NPV. In short, if these programs were a good idea back before the recession, then if anything these programs are a better idea today. It therefore makes no sense to cut existing programs because of a recession. If the proponents of austerity conceded the argument back then, then they should shut up now, especially with the wasteful cost of cancelling many of these projects mid-way.

  5. Personally I disagree with your argument that no government can go on borrowing more forever - assuming you are talking in terms of gross debt, and not the debt to GDP ratio. With sufficient growth, it is trivially possibly to keep on borrowing more forever - and still shrink the debt level in relative terms.

    1. Agree. Another way to say is that a monetary sovereign gov't can borrow forever as long as the long-run growth rate of the real debt is less than that of the nominal GDP. In fact, small and persistent gov't deficits are beneficial as the gov't, by issuing debts, is providing the private sector with a very safe asset which no one else can provide.
      Just as a sovereign can earn seigniorage by issuing currencies, a sovereign shall legitimately earn income (i.e. the deficit) as the ultimate safe asset provider to the economy.

  6. Is there any information on how the monetary system actually works?

    My question is about government spending and "borrowing". If there is a item, an aircraft carrier, appropriated that costs 1 billion dollars/pounds how does it work?

    My assumption is that the govenerment creates the money by crediting through the central banks. So when the congress approves an appropriation the money is then "spent". The central bank accounts are funded with the appropriate amounts. Then at some point at a future date there are treasury auctions/sales. At the point of the actions/sales transfers are made from the central bank reserve accounts (accounts that are held by the entities buying) and converted into treasury securities. No money is "borrowed" it is basically a swap of someones govenerment non-interest bearing notes into govenerment interest bearing securities. And the process is unwound and the central banks accounts are credited with some additional interest when the securities come due.

    My point is the term "borrowing" is incorrect and needs further definition.

  7. Milton Friedman and Warren Mosler have argued for a regime in which there is no government borrowing at all. I.e the only liability issued by the government / central bank machine would be cash, or monetary base to be exact. I agree with them.

    For Friedman, see para starting “under the proposal.. (p.250) here:

    For Mosler, see second last para here:

    Also while I like most of hypothetical interview above, I don’t agree with the answer to the first question above, that is that borrowing by a micro economic entity makes sense, therefor borrowing by a macro entity like the government / central bank machine makes sense. I set out detailed reasons here:
    But one reason is that it is daft (at least on the face of it) to borrow something (i.e. money) which you yourself can produce at zero cost.

    Another reason is that investments made by government (e.g. a hospital) are extremely small change or “petty cash” for a government of a country like the UK. That is, the UK government can easily pay for any investment out of current income.

  8. Not great to be honest. The spin is there but it is not well presented for the cause.

    It looks like written for readers of this blog, which is simply too difficult for general use. A much to small part of the population to make a difference.
    Also will not work towards politicians. The ones dealing with it (at least the ones with more or less your views), know how it would work. Whether or not it will work is another issue but not relevant in this respect. They would probably like to use it if it can be sold.
    They are however not looking for the solution, they are looking at ways to sell it, so it has some sort of majority support. That is the spin you should try to give it. There are people that would want to sell it out there if the story would be sellable.
    The story as presented is however simply much too complicated for that, it should be simplified all uncessary stuff out; easier language; more logic in the different steps; in general better summarised. They probably have looked at it, but are not able to sell it properly.
    So much closer to something a politician can sell (as you know they are often not that clever themselves).

    Next point is convince sceptics. Not the notorious ones they never accept it even if it would guarantee 5% real annual growth for the coming decades. But the mildly sceptic ones, the ones that can be convinced. And should be convinced to get sufficient backing.
    On 2 issues. Government/politics itself, summarised half the population thinks it stinks. But also on the topic itself. Some things are counter-intuitive (this will be the difficult one probably).
    Best alternative make it clear to the target group that they will be better off. In this respect it hardly matters if it works or not, people are easily convinced when they get something they will not have to pay for, whatever the reason.

    Anyway unlikely to happen under the present government. May be only close to the next election but more to buy votes than for any other reason as they simply donot believe in the set up. Combined with probably that as there is a crisis they also want to use it for other political purposes (like cutting fat from the welfarestate or eroding the welfarestate whatever you prefer).
    Anyway, a lefty with a beard is probably not the right salesman to sell it on the right side of the spectrum.

    Likely you have to go for the opposition. Present it as an alternative they can use to get more votes. Or gives them a posibility to drop the current government which is however not very likely to happen.

  9. Excellent post. You hit the nail on the head - Cameron never looses a chance to refer to the previous governments 'excessive' 'unsustainable' blah-blah borrowing and spending. It works.

    The only thing worse than having a neo-liberal party in government is having the opposition parrot the same failed dogma (but in a watered-down version) in the asumption that it is what the potential voters want to hear. in fact economically there is no 'opposition'.

    This defecit mania is interestingly a world-wide state of affairs (see USA, Australia, Europe). The simple-minded 'household budget' comparision needs to be negated at every opportunity - unfortunately the mainstream media credulously repeat the neo-liberal laissez-faire narrative originated by mainstream paid-for revolving-door economists and used by both so-called 'left'-wing and right-wing parties in a constant vomitous stream of effective propaganda.

  10. Listening to many of the proponents of increased fiscal activism suggests that their problem is less the fear of mentioning public sector borrowing, and more an inability to explain how it would work.

    The arguments against it seem to be accepted by most on both sides in this debate, as well as the journalists whose questions imply unlikely assumptions about the economy.


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