Many economists and commentators are instinctively pro private sector and anti public sector when considering the solutions to our prolonged recession. With our government debt situation as it is, a cautionary approach is understandable. But here I want to suggest two examples within the larger debates, where what can sometimes come across as intellectual prejudice needs to be backed up more carefully, and where perhaps a more unbiased basis for differentiation would be preferable.
Alternative Differentiation: Productive verses unproductive debt, rather than public verses private debt.
Part of the initial idea for this short essay came from something in Adair Turner's Cass Business School lecture - "Debt, Money and Mephistopheles: How do we Get Out of This Mess?" on 6 February 2013.
Much debate on macro-policy is bedevilled by a failure to be explicit about those two steps of the logic. As a result the same commentators will sometimes:
In other words, Turner is reflecting on the tendency for prejudice to be shown between the means (or “different levers”) of generating greater aggregate demand, even when the mechanism between the means and the benefit of the end result is, to all intense purposes, the same. This observation of Turner's rings true for me, in that I have noticed automatic assumptions being made that government solutions are inflationary and saddle our children with debt, while private solutions are merely “getting the economy going” and a return to healthy levels of investment. These prejudices are often presented as implicitly obvious, but are in fact only partly or not at all backed up by good economic reasoning.
I noticed recently during the Budget coverage on Sky News, that on the banner at the bottom of the screen they had a counter which was clocking up the government's ever-growing debt. This device I thought provided quite a loaded background to the budget debates, and one could imagine Fox News in the US doing the same. It struck me that, given the Chancellors recent 'Help to Buy' proposals, would there be a case for now, and would there have been a case for eight or so years ago, having a similar counter noting the country's total mortgage borrowings.
One rationale for the discriminating mindset of the free marketeers is that private debt usually represents profit making investment, in that firms have seen an opportunity and aim to exploit it for future gain. In contrast, government spending tends to be just a sucking black hole, satisfying present wants, but not contributing anything concrete to future repayment capability. The repayment of the extra business debt can be borne by new profits generated from the investment, but the repayment of the government debt has to come from the freshly squeezed income of future tax payers and businesses. This suggests that the correct prejudice would be to distinguish between debt which contributed to greater output potential in the future, and debt which did not.
But are mortgages productive investments in this respect? A mortgage can be viewed as a productive and rewarding investment on a personal level, in that it saves paying rent and eventually gains a property asset. But on a national scale, a large increase in mortgage borrowing on a slowly growing housing stock, just represents a distribution of money from up-sizers to down-sizers, or between the generations. This obviously is the debate that the policy has sparked. In Britain, one of the biggest silent revolutions over the past decades, has been that a quiet section of middle aged and elderly society are now sitting on small unearned fortunes in house equity, while new buyers struggle to afford a house. For those who ask; where has all the money gone? this is a large part of the answer, … house equity! In terms of being an economically productive investment, one could argue that the section of any extra mortgage borrowing which motivates new house building is real investment, while the rest is just wasted on unproductive and socially divisive asset price inflation. The higher mortgages caused by the later section will not make future tax payers more taxable.
I have left out the potential of government borrowing and spending in general to contribute to a Keynesian multiplier effect on the broader economy, which is a whole other debate. In terms of using government debt finance to spend in non infrastructure areas merely to reflate the economy, perhaps there is an argument for saying this is a viable policy in general during a recession, and the world as a whole does need it. But perhaps Britain's higher than average exposure to the financial services downturn, and subsequent government debt caused by the British bank bailouts on top of the recession, means that Britain should be given a free pass not to join in with any more of this international aggregate demand boosting efforts, and instead should be allowed to free ride on the government stimulus of other countries. Perhaps this underlying recognition that we need stimulus on a global level is what makes the IMF's present attitude towards Britain seem inconsistent with their past country level advice.
In other words, if your finances are as bad as ours are, but you really need to increase economic activity to compensate for a deleveraging and hoarding private sector, you had better make sure your government borrowing is spent on something that will ease repayment in the future. A return to house building in the South-east directly financed by the government is an option I have sympathy for, as that debt would have a very good prospect of paying for itself.
Alternative Differentiation: Controlled and appropriate base money expansion, rather than public verses private means.
The central topic of Adair Turner's excellent Cass Business School lecture mentioned above, is the subject of Overt Monetary Finance (OMF), or 'Helicopter Money' to give it its flippant nickname.
Turner is all too aware of the prejudiced against public sector interference in general in this area, and against this kind of policy in particular, when he writes:
"To print money to finance deficits indeed has the status of a moral sin – a work of the devil – as much as a technical error. … The ability of governments to create money is a potential poison and we rightly seek to limit it within tight disciplines, with independent central banks, self-denying ordinances and clear inflation rate targets."(p.3)
"Even when it is effectively proposed, overt money finance is the policy that dare not speak its name. OMF therefore maintains its taboo status – and there are good political economy reasons for why that is so. … The challenge is therefore to take the possibility of OMF out of the taboo box, to consider whether and under what circumstances it can play an appropriate role, but to ensure that we have in place the rules and institutional authorities which would constrain its misuse. … It must also be subject to clearly defined disciplines to guard against political economy risks."(p.31)
Much of the austerity narrative used by the Coalition government relies on the concept of it being constrained by our high government debt level. Introduce the idea that the government could print money, and the being responsible narrative falls apart somewhat. There are probably many people who do indeed believe that it would be helpful for money supply to expand presently, and would have supported lowering interest rates if they had had any further room to drop. So you could ask: if base money supply is growing, does it matter if the cat is black or the cat is white? But many of these same people are wary of crossing the printing money Rubicon, due to a lack of faith in political discipline. Recently, again on a TV news program, when this subject was being discussed, one guest interjected vehemently by saying something like “Oh God, so we should end up printing money like Zimbabwe!” But this I think represents an unreasonable prejudice that is not justified by any evidence of rampant corruption or profligacy to be found, and certainly not within the Bank of England itself.
As Turner recognises, by creating money the government would only be doing in a formal and planned way, what in boom times the banks did in a way which was limited only by the extent of the leveraged boom in finance:
"But fractional reserve banks, simultaneously creating private credit and private money, can greatly swell the scale of debt contracts in an economy and introduce maturity transformation. And there is no naturally arising mechanism to ensure that the scale of such majority transformation is optimal. As a result banks can greatly increase the scale of financial and economic stability risks. They can also play an important autonomous role in the creation and destruction of spending power, i.e. of nominal demand, and as a result can generate booms and busts in overall economic activity." (p.11)
In other words, bank creation of money, which can be thought of as their own version of 'debt funded stimulus', systematically over shoots in good times and under shoots in recessions, as Keynes' animal spirits wax and wane. The Bank of England changing interest rates is normally enough to even out this cyclical swing a bit, but at present, when lowering interest rates has run out of steam as a policy, eyes are turning to these other strange and forgotten levers. But right-wingers fear that give the short-termist politicians access to this new lever as a proposed last resort, and they may instead print money for bread and circuses today, and to hell with future price stability. Where as in contrast, at least private sector money creation is more objective, mechanical and derivative of economic activity. But, just because it is derivative of private economic activity, that does not mean that private debt is inherently harmless or without consequence. As Turner states in one of his main conclusions:
"If we got into this mess through excess private leverage we should be wary of escape strategies which depend on creating more private debt." (p.40)
Turner's discussion of nominal GDP targets are a clever suggestion to possibly get around the political temptation to misuse an OMF policy, and a clever solution to the all important expectation implications, which are always key to inflation issues. In this approach, nominal GDP targets are set for the future, and if real growth does not materialise, the authorities aim to meet the target with inflation by printing money. When real growth is weak, spare capacities in the economy mean inflationary spirals are unlikely. When real growth returns, the authorities are obliged, in a black and white fashion not susceptible to political fudging or double speak, to take their foot off the gas and park up their helicopters. The degree to which a nominal GDP target is met at a specific time, then becomes a usefully clear measure of a government's, or the Bank of England's competence, ability and integrity.
Turner argues effectively that Japan would have benefited from targeting nominal GDP during the last 15 years. He also introduces comparisons in the way the US and Britain handled post war debt. The 1930s are the period usually evoked in making historical comparisons with today. But as Western countries have kind of learnt that lesson, and as a result in general already have sunk in the large amounts of government money to try to revive / save their economies (like the WWII spending), perhaps, as Turner hints, it is now the period around the 1950s which are most instructive for today. The 1950's are often considered a golden age for the US despite its WWII debt, so learning from Turner that its debts were “post facto … money financed”(p.27) is significant, and fits in with Turner's inflation rather than deflation biased themes:
"Countries such as the UK and the US, which achieved public sector deleveraging after the Second World War, were only able to do so with growth rates of nominal GDP far above current rates" (EXHIBIT 23-25). [...] "Both rapid real growth rates and inflation rates in excess of interest rates (achieved via effective “financial repression”) were essential to the deleveraging process."(p.16)
Keynes himself was nothing if not agile and unprejudiced in his economic thinking when it came to questions of private verses public solutions. He was also famous for his 'Essays in Persuasion', which sought to stop his contemporary economic generals from fighting the last war, (like inflation today?) or being “the slaves of some defunct economist”. In his discussion to the Macmillan Committee in 1930, in response to the sharp deflation of the period, he had something to say regarding the contemporary recieved wisdom on the subject of money supply, and against the idea of continuing an austerity policy (far more extreme than today's) to reduce domestic real wage costs:
Finally, interestingly in the lecture Turner reveals that Milton Friedman in his early career proposed the concept of governments never having spending deficits or surpluses, but instead printing and destroying currency in either instance to suit. In parallel, the assumption that needed to go along with this approach was that the ability of private banks to create money would be taken away. What a disconcerting and radical set of ideas this sounds to our 2013 ears. And from Milton Friedman who would later become the darling of Thatcherism and Monetarism!
But Friedman argued in an article in 1948 not only that government deficits should sometimes be financed with fiat money but that they should always be financed in that fashion, with he argued, no useful role for debt finance.(p.3)
Second, however, what both my illustration and Friedman’s proposal assume is that all money is base money, i.e. that there is no private money creation (no “inside money” in Gurley and Shaw’s terms)(Gurley and Shaw 1960). This in turn is because in Friedman’s proposal there are no fractional reserve banks.(EXHIBIT 9) [Banks would be made to hold 100% reserves against what they lent out!] In Friedman’s proposal indeed, the absence of fractional reserve banks is not simply an assumption, but an essential element, with Friedman arguing for “a reform of the monetary and banking system to eliminate both the private creation and destruction of money and discretionary control of the growth of money by the central bank ”.(p.7)
When economists of the calibre of Simons, Fisher, Friedman, Keynes and Bernanke have all explicitly argued for a potential role for overt money financed deficits, and done so while believing that the effective control of inflation is central to a well run market economy – we would be unwise to dismiss this policy option out of hand.(p.4)
Note: Interested in economics and economic history, Rob Julian recently wrote an article titled "Keynes on the Slump: A Guide to Keynes' Thoughts During the 1929-32 Crisis, with a Focus on International Relationships and Protection".