Hard economic truths cannot be wished away Roger Bootle
Ihave just read a book entitled The Deficit Myth by the American economist Stephanie Kelton. The book was dangerous even before coronavirus struck but it is even more so now when governments are racking up huge deficits and the ratio of government debt to GDP is soaring. It appears to suggest that we shouldn’t worry about this debt and should just lie back and enjoy it.
It would be very nice to believe that our concern was based on a myth. Unfortunately, in economics, if something is very nice to believe, you probably shouldn’t.
In fact, the propositions espoused by Professor Kelton are a peculiar mixture of truths, half-truths and downright falsehoods. That’s precisely what makes the book so dangerous. Ready embrace of the bits that are true may seduce you into believing the bits that aren’t.
The book is an exposition of what is known as Modern Monetary Theory. It has its adherents in many countries. Prof Kelton was economic adviser to Bernie Sanders, and MMT influenced those around Jeremy Corbyn when he was Labour Party leader. So this is not just an academic curiosity.
At one point Prof Kelton asserts: “MMT demonstrates that the federal government is not dependent on revenue from taxes or borrowing to finance its spending…” That sounds pretty radical.
Yet there are some places where the book seems simply to be reasserting the precepts of Keynesian economics for the benefit of an audience that has never comprehended them before. I suppose that has some value. These Keynesian nuggets are propositions with which I wholeheartedly agree.
At one point she says, “increasing the deficit doesn’t make future generations poorer and reducing deficits won’t make them any richer”. That is a message I have repeatedly conveyed in this column. The interest paid on government bonds doesn’t disappear into a black hole. It is received by the bondholders.
Mind you, this doesn’t mean that there aren’t potential problems for future generations as a result of fiscal largesse because, unless governments resort to inflation, other things equal, higher debt means higher interest payments that have to be financed somehow or other. In the end, they are financed out of reduced spending or increased taxation. Taxes distort and depress incentives and hence economic growth. So having a set-up that implies more taxes in future is hardly to be recommended.
Prof Kelton also says that it is misleading to think of the finances of the government in the same way that you would think of the finances of a household. This too is classic Keynesianism. There are options open to governments that aren’t open to households. What’s more, increased spending and borrowing by governments can, in the right circumstances, end up actually reducing deficits and debt ratios.
It is also true, as the book says, that governments don’t necessarily have to borrow from the markets. Unlike households, they can finance themselves by printing money. Moreover, in some circumstances they should.
But what is shocking or revelatory about this? Governments have been doing this now for years and are currently doing it on a massive scale.
Granted, they have been doing this indirectly, rather than directly. They have issued bonds, which central banks have then bought and, in the process, created money. But so what? The distinctions between monetary and non-monetary financing can sound theological at best. And the institutional barriers surrounding government access to the money printing press can seem arcane. Nevertheless, they are critically important for preventing inflation.
In parts of the book, Prof Kelton appears to recognise these limits. And she certainly recognises inflationary constraints. At one point she says: “that’s not to suggest that deficits don’t matter, so we can throw caution to the wind and simply spend, spend, spend.”
She also says: “Of course, MMT recognises that deficits can also be too big.” Well, that’s a relief!
So what is she saying? She seems to be claiming that MMT provides a new theoretical framework. Yet it would be pretty extraordinary if the basic theory concerning the public finances, money creation and inflation were to be proved wrong in 2020.
Admittedly, Keynes made some revolutionary contributions to economic theory in the Twenties and Thirties that still hold good today.
But even he recognised that there were constraints and he would certainly not have given his support to unlimited government borrowing or monetary financing.
So maybe it is just about magnitudes? In 2010, the economists Carmen Reinhart and Kenneth Rogoff claimed that the historical evidence suggested that 90pc was the key level for the ratio of debt to GDP. Once you got above this point, they said, government debt caused serious problems for an economy.
To me, that number always looked arbitrary at best. And it jarred with UK experience.
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years with debt above that level than we have with debt below it. More recent experience has proved that, at least in the short-term, governments can reasonably operate with debt well above 90pc of GDP, as Japan has done for ages.
If that is what Prof Kelton is saying then she is in good company – including Olivier Blanchard, formerly chief economist of the IMF.
This isn’t a provenance that you would normally associate with the ditching of concerns about orthodox finance. And, indeed, he doesn’t throw these overboard.
He just argues that, because of very low interest rates, which he expects to be sustained for a good while, it is now safer to run with higher ratios of government debt to GDP than was true in the past.
He is probably right about this – even though there are continued dangers, which he himself acknowledges. The Deficit Myth
is a catchy and attractive title for a book. Unfortunately, what it has to say that is true is by no means new.
And what it has to say that is new is downright false.
Professor Stephanie Kelton was economic adviser to Bernie Sanders