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Why a Growing Economy needs a Growing Government
L. RANDALL WRAY, LEVY INSTITUTE & UMKC
WWW.LEVY.ORG
WWW.ECONOMONITOR.COM/LRWRAY/
Fiscal Constraints
• President Obama: Government is running out of money!
• Economists: Unsustainable debt path!• 70% of Americans say progress on Deficit needed this year
• Chinese might stop lending to us!
• Zimbabwe and Weimar hyperinflation!
• Burden our grandkids!
• Look at Euroland!
• Sovereign debt crisis
• Default risk
• Bond vigilantes
Is there evidence of run-away, Weimar/Zimbabwe Deficit Spending?
• Is debt at historic high?• Is govt spending out of control?•Have we hocked ourselves to China?•Does debt burden our grandkids?•Will Entitlements bankrupt our grandkids?
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
2005
-I
2005
-II
2005
-III
2005
-IV
2006
-I
2006
-II
2006
-III
2006
-IV
2007
-I
2007
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2007
-III
2007
-IV
2008
-I
2008
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2008
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2008
-IV
2009
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2009
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2009
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2009
-IV
2010
-I
2010
-II
Federal Government Receipts and Expenditures(QoQ Change)
Source: Bureau of Economic Analysis and Authors' Calculations
Tax Receipts
Transfer Payments
Consumption Expenditures
Foregin Holdings of US Treasuries (% of total held by Foreign Countries)
0
10
20
30
40
50
60
70
80
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Brazil
Taiw an
Hong Kong
Caribbean BankingCentersOil Exporters
Germany
UK
China
Japan
Source: US Department of Treasury, November 2009 f iguresNote: For some years the holdings of the selected countries have been insignif icant, so they are included in the category
Treasury Security Holdings (% of Total Oustanding)
0
10
20
30
40
50
6019
75
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Q3
2010
Q1
%
-2
-1
0
1
2
3
4
5
6
7Held by Rest ofthe World
Foreign OfficialHoldings
Foreign PrivateHoldings
Financial SectorHoldings
Current AccountBalance (SignReversed)*
Source: US Flow of Funds Accounts (for Treasury Holdings) and Bureau of Economic Analysis (for Current Account data)*Current account data is as of the end of 2009; treasury holdings data is as of 2009 Q3
Remember Clinton and Goldilocks?
• 1996: US Federal Govt begins to run surpluses; continued for 2.5 years
• Clinton projects surpluses for next 15 years
• All Gov’t debt will be retired
• But: Private debt explodes and then recession restores deficits.
• Why: The Meaning of Zero:0=Private Bal + Govt Bal + Foreign Bal
Past Attempts at Paying National Debt
PRIVATE SECTOR BALANCE + GOVERNMENT BALANCE = CURRENT ACCOUNT BALANCE
Accounting Identity of Financial Balances
INTERNAL FINANCIAL BALANCE
EXTERNAL FINANCIAL BALANCE
THE CONCEPTUAL FRAMEWORK
Purported Unsustainability of Government Deficits and Debt
• Sustainability issues– Relation between interest rates and economic growth:
If r>g growth of debt– Growth of Debt Bond Vigilantes push up r
accelerating the rise of debt ratios– Excessive Deficit-to-GDP and Debt-to-GDP ratios:
inflation and ultimately insolvency
So: We must show:
a)why govt doesn’t face insolvency, and
b)why deficits don’t raise interest rates
St. Louis Fed
"As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills. In this sense, the government is not dependent on credit markets to remain operational. Moreover, there will always be a market for U.S. government debt at home because the U.S. government has the only means of creating risk-free dollar-denominated assets.“
Government can NEVER run out of Dollars; It can NEVER be forced to default; It can NEVER be forced to miss a payment; It is NEVER subject to whims of “bond vigilantes”.
Myths, Superstition, Old-Time Religion
"I think there is an element of truth in the superstition that the budget must be balanced at all times. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires.” (Samuelson)
Necessity of balancing the budget is a myth, a superstition, the equivalent of that old-time religion.
So what is the truth? If economics is to rise above superstition, we need to know.
How Government Spends its Own Currency: Keystrokes
• Spending credits• Government credits bank’s reserves; bank credits
account of recipient
• Taxes debits• Government debits bank’s reserves; bank debits account
of taxpayer
• Deficits net credits• Government net credits bank’s reserves; bank net credits
account of recipient
Money as Scorekeeping
Bond Sales by Government: Why the Bond Vigilantes Cannot Dictate Terms
• Deficit spending net credits reserves• Creates Net Financial Wealth in nongovt sector
• Excess Reserves bid overnight rate down• To Fed’s support rate (fed funds rate)
• Bonds: Interest earning alternative (IRMA)• Part of Monetary Policy, whether new issues or open
market sales• Changes form of Net Financial Wealth (longer maturity)• (NB: Surpluses net debits OMP or Redemptions)
Self-imposed constraints
• Budgeting, debt limits
• Operational constraints:
• Treasury writes checks on accounts at CB
• CB prohibited from buying Treasury Debt new issues
• Use of Special Depositories
• Use of Tax and Loan accts
Central Bank Policy
•Consensus: central banks always operate on overnight
interest rate
• Accommodates Demand for Reserves
•Convertible vs. non-convertible currencies
• Convertible: can lose control of interest rate (Greece)
• Nonconvertible: controls overnight rate (Japan)
Sovereign Currency: Summary • Deficit spending creates private financial wealth
• Note that CB operations do not; it buys government bonds or lends against collateral (helicopter drop is fiscal policy)
• CB Lends; Treasury Spends
• Doesn’t matter whether bonds must be sold first—so long as CB accommodates reserve demand
• Doesn’t matter whether CB prohibited from buying new issues—roundabout through banks
• Doesn’t matter whether Treasury must have “money” in its acct at CB to spend—CB and banks cooperate
DOMAR: CAPITAL EXPANSION RATE OF GROWTH, AND EMPLOYMENT• Equilibrium is defined as position where productive capacity (Yp, or potential
output) equals national income (Ya, or actual output).
• Want to discover the rate of growth at which the economy must expand in order to remain in a continuous state of full employment.
• Problem of Growth: Output must continually grow to maintain full emp. Must
look at both the AS side and the AD side. Not enuf to just look at increasing productive capacity as LF grows. Must also look at how Y must grow so that AD will be high enuf.
• Keynes ignores the DUAL nature of investment: I increases productive
capacity and generates income.
Principles of Functional Finance (Abba Lerner)
i. Government should spend more if there is unemployment
ii. Government should supply more money (reserves) if interest rates are too high
NB: Budgetary outcome, Debt outcome should never be primary consideration
“Without an expansionary fiscal policy, real output cannot grow for long.”
~ Wynne Godley, 2000
The Private Sector Cannot Create Its Own Net Financial Assets• Assets and liabilities cancel each other out
• Loans create deposits• Net financial assets must come from outside the domestic
private sector
• Private Sector = Public Sector + Current Account Surplus Deficit Surplus
(S – I) (G – T) (X – M)
What if the CA is Not in Surplus?• Can the private sector still achieve a surplus?
• Yes, but only if the government deficit is bigger than the current account deficit
EX: 1% = 4% - 3%• This means that countries with current account deficits
must run even bigger budget deficits (as % of GDP) in order to keep the private sector in surplus
“[T]he power to issue its own money, to make drafts on its own central bank, is the
main thing which defines national independence. If a country gives up or
loses this power, it acquires the status of a local authority or colony.”
~Wynne Godley, 1992
Importance of Sovereign Currency
Government & Foreign Sector Financial Balances
31
Fiscal Surplus
Current AccountSurplus
Fiscal Deficit
Current AccountDeficit
Foreigners Net Save Foreigners Deficit Spend
Domestic Private SectorFinancial Balance = 0
Domestic Private Sector Surplus
33
Fiscal Surplus
Current AccountSurplus
Fiscal Deficit
Current AccountDeficit
DPSFB = 0%
DPSFB = 1%
+1%
-1%
+2%
-2%
DPSFB = 2%
Increasing DPSFinancial Surplus
DPSFB = CAB - GFB
Permissible Space for Sovereign Issuers
Fiscal Surplus
Current AccountSurplus
Fiscal Deficit
Current AccountDeficit
PSB = 0
For Sovereign Issuer There are No “Market” Constraints
“The treasury can always raise money by issuing securities. The bond vigilantes really have it
backwards. There is always more demand for treasuries than can be allocated from a limited supply
of new issues in each auction; the winners in the auctions get to place their funds in the safest most liquid form of instrument there is for US dollars; the
losers are stuck keeping some of their funds in banks, with bank risk.”
~Frank N. Newman, 2013
Priv
ate
sec
tor
surp
lus
Priv
ate
sec
tor
surp
lus
Sustainable Space for Sovereign Issuers
Fiscal Surplus
Current AccountSurplus
Fiscal Deficit
Current AccountDeficit
PSB = 0
Possible Space for EMU Nations with CA Surpluses
Fiscal Surplus
Current AccountSurplus
Fiscal Deficit
Current AccountDeficit
-3%
Sustainable Space for EMU Nations with CA Surplus
Fiscal Surplus
Current AccountSurplus
Fiscal Deficit
Current AccountDeficit
-3%
Possible Space for EMU Nations with CA Deficits
Fiscal Surplus
Current AccountSurplus
Fiscal Deficit
Current AccountDeficit
-3%
Sustainable Space for EMU Nations with CA Deficits
Fiscal Surplus
Current AccountSurplus
Fiscal Deficit
Current AccountDeficit
-3%
EURO: Non-Sovereign Currency
• Member states gave up own sovereign currencies
• Adopted a “foreign currency”, the Euro
• Much like a USA state: a user of the currency, not issuer
• Constrained in its spending: tax revenue, bond sales,
willingness of ECB to lend
• Problem: no fiscal equivalent to Uncle Sam in Washington
Euro is the Problem
• By adopting the euro sovereign nations have turned into something like U.S. states.
• Unlike U.S. states euro governments have to fund pensions and healthcare
• Euro governments had to deal with banking problems – in the U.S. the Fed did the bailing out.
U.S. States Debt/GDP Ratios(Average 1997-2008)
Alaska 15.7 Montana 12.2
Connecticut 12.1 New Hampshire 13.0
Hawaii 12.2 New York 10.5
Maine 11.0 Rhode Island 16.9
Massachusetts 16.5 Vermont 12.6
Is the US Unique?
• NO—other Sovereigns with floating rates obtain the same “seigniorage income”.
• That ability is related to power to impose taxes in the domestic currency—only the State has this power.
• While “seigniorage income” is sometimes equated to the total quantity of net imports, imports purchased by the non-sovereign population do not provide any “free lunch”. It is only the portion of a trade deficit that is due to sovereign purchases that provides a free lunch.
IMPLICATIONS FOR A SMALL COUNTRY LIKE…Mexico
• *With a floating currency, Mex can exogenously set its interest rate
• *Mex’s national government does not need taxes or bond sales to “finance” budget deficits
• *national government bond sales function to drain excess reserves from the banking system—a part of monetary policy that allows central bank to hit interest rate target
• *Mex can “financially afford” to buy any good or service that it is capable of producing
• *Mex can “afford” full employment; indeed, unemployment is a cost, employment is a benefit
• *a national government budget deficit simply “finances” the non-government sectors’ desire to net hoard High Powered pesos
• *a current account deficit “finances” the Rest of World’s desire to net hoard pesos
Implications of Alternative Currency Regimes
• Government is monopoly supplier of its currency; determines conditions of supply
i) floating: affordability is never an issue; consequences of too much spending include inflation, too few resources left for private sector, exchange rate depreciation
ii) managed: additional constraints—maintenance of foreign currency, run on currency, currency crisis
iii) pegged: additional constraint—default
NB: in all cases, there are always political constraints, operational constraints, myth, and misunderstanding
Conclusions
• Currency-issuing Government spends by crediting bank accts, taxes by debiting
• Can always “afford” to spend more• Issues: inflation, exchange rate effects, interest rate
effects
• Sovereign currency gives more policy space• No default risk• Can control interest rates• Can use policy to achieve full employment
What I did and did NOT say• I did say: Sovereign Government faces no financial constraints;
cannot become insolvent in its own nonconvertible currency
• But it can only buy what is for sale
• I did NOT say that Government ought to buy everything for sale
• Size of Government is a political decision with economic effects
• I did NOT say that deficits cannot be inflationary:
• Deficits that are too big can cause inflation
• I did NOT say that deficits cannot affect exchange rates:
• Sovereign Governments let currency float; float means currency can go up and down
Thank you
L. Randall WrayProfessor of Economics, UMKCSenior Scholar, Levy Economics [email protected]/LRWRAY/
