Posts tagged ‘fiscal policy’

14 May 2012

Yes, sovereign currency issuers can always be ‘solvent’ – but don’t be so damned blasé about it

This video on New Economic Perspectives explains the view of modern monetary theorists (MMTers) that a ‘monetary sovereign’ – i.e. one with its own domestically-controlled currency, like the UK or US, rather than a country in the euro area – does not face financial constraints and therefore cannot be forced to default on domestic-currency debts.

I’ve heard this view expressed a number of times to explain why either: (a) the ratings agencies are stupid to downgrade the debts of countries like the US;  (b) governments of sovereign currency issuers are stupid to pursue fiscal consolidation in countries like the UK; or (c) euro members are stupid to have foregone monetary sovereignty by joining the single currency.

The argument behind this is incredibly simple. It goes like this.

(1) Monetary sovereign governments in advanced economies spend, tax and borrow primarily in their own domestic currency.

(2) Their domestic currency can be created at will by their central bank, which these governments can control through legislation.

(3) These central banks have made no legal commitment to maintain the value of their currencies against any other currency or physical commodity – i.e. these are floating, fiat currencies.

(4) Therefore, if a government is ever unable to sell its bonds privately, it can always change the law and force the central bank to create new domestic currency to fund a deficit.

So sovereign currency issuers are always ‘solvent’, in terms of being able to make any debt and interest payments to bondholders in nominal terms, simply by forcing the central bank to buy up the new issuance required to fund these payments.

There is nothing profound about this. It just says that, if all else fails, you can monetise your deficit.

I cannot believe that this is put forward as a serious or practical policy argument.

I am all in favour of the ECB doing what’s needed to prevent continent-wide contagion from a Greek exit, including temporarily backstopping sovereigns. But governments should still do whatever it takes to avoid getting to the awful point of commandeering the central bank to avoid a certain default. And once there, they should do whatever it takes to get off monetary financing, as quickly as humanly possible.

Deflation can be brutal. Today’s Americans learn this from their country’s inter-war history.

Hyperinflation can be so much worse. Today’s Europeans learn this from Europe’s own inter-war history and its bloody, savage, senseless aftermath.

Yes, a sovereign currency can always turn to the printing press to prevent a default. And in extremis, once you’ve reached the point of ‘monetise or default’, monetisation may be the best of a bad set of options.

But don’t ever forget the horrors wrought on their citizens by governments that became addicted to the printing press.  And don’t be so damned blasé about it.

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7 May 2012

Spot the difference

Buttonwood points out that Francois Hollande’s plan to eradicate France’s deficit by 2017 doesn’t on the surface look that different to the UK coalition’s latest budget plans to eradicate our deficit by 2017:

TAKE two countries. One has a government “inflexibly committed to austerity”, lacking a Plan B and dragging the economy down, according to its critics. The second country has a new President who has just declared that his victory is a rejection of austerity. The victory has been hailed as a new dawn for European politics.

The first country, the UK, is aiming to balance its budget by 2017. The second country, France, plans to balance its budget by, er, 2017. Funny old world.

In reality, there’s a bit more to it: the French are trying to cut their deficit from 5.3% of GDP last year, the UK from 8.7%. So we here are still looking at an extra 3.4% of GDP worth of tightening over the five-year period.

But this still touches on my earlier point: rather than being inflexibly committed to austerity, the UK in fact seems to already be in the process of switching to a Plan B as the global economy deteriorates vis-a-vis 2010 forecasts. It’s just that loosening fiscal policy in a modern welfare-state economy with automatic stabilisers doesn’t always require a conscious decision by the government.

6 May 2012

Are we already doing ‘Plan B’ in the UK?

Following the Q1 GDP data, there were calls from the usual politicians for the UK to switch to an economic ‘Plan B’ in place of the coalition’s planned fiscal consolidation.

Martin Wolf’s latest FT column (£££) makes a more nuanced version of the argument – in essence, that front-loaded fiscal consolidation is not credible during a recession, so pressing ahead will itself lead the market to question whether it’s politically possible to cut the deficit – and is worth a read. But it raises an interesting question for me.

Wolf points out that the government is already on course to miss its original fiscal targets set out after the election, but this hasn’t led the market to question our solvency:

Yet remember that when the chancellor announced his fiscal plans in 2010, net borrowing was supposed to be just £206bn between 2012-13 and 2015-16. In the March 2012 Budget this was up to £317bn. Did that colossal failure to hit his target destroy credibility and so lead to explosive increases in bond yields? No.

Entirely valid. But I would interpret this failure to hit the deficit targets slightly differently.

Remember, in a modern welfare-state economy, much of the fiscal stimulus during a recession comes through ‘automatic stabilisers’ (falling tax revenue, rising spending on unemployment benefits, etc) rather than conscious government actions. These can be important: note that the UK’s fiscal stimulus announced in late 2008 was meant to be a £20bn package, but public sector net borrowing actually increased by more than £80bn between 2008 and 2009, of which about £40bn was down to equity injections into RBS/Lloyds – so half of the non-bailout part of the increase in the 2009 deficit was not due to a conscious decision by the Chancellor.

And it’s these automatic stabilisers, rather than any deliberate relaxation of the government’s fiscal plans, that will have led to the changes in the fiscal projections in the next few years – reflecting the extent to which the economic environment (in the UK and abroad) has deteriorated over the last 6-12 months.

As a result of what we can call this ‘non-deliberate fiscal stimulus’, as Martin Wolf in fact separately points out on his blog, the path of the UK’s fiscal consolidation has actually now switched to something quite close to Alistair Darling’s original pre-election budget proposals:

Therefore, without the need for any deliberate decision by the coalition, can’t one argue that we’re already in the process of switching to a sort of ‘Plan B’ in UK?…

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