My motivation for focusing on the topic of fiscal sustainability – although most of my blogs are about this in one way or another – came from the National Journal, which is a discussion site where experts are invited to debate a topic over a period of days. The topic for debate was “What Is Fiscally — And Politically — ‘Sustainable’?” While the debate on the site is very US-centric, the basic principles apply to all sovereign currencies – that is to any fiat monetary system so it is worthwhile having a read to see the opinions that are expressed. The only qualification that I would make is that most of the discussants are anything but “expert” in this field if their utterings are anything to go by. In recent weeks the concept of fiscal sustainability has increasingly entered the economic debate again as public deficits rise in response to the spreading real economic crisis.
In the US, the central bank chairman Ben Bernanke has defined the concept of fiscal sustainability as:
… as achieving a stable ratio of government debt and interest payments to gross domestic product, and setting tax rates at levels that don’t impede economic growth.
I thought we should work out what the economic concept of fiscal sustainability is all about. The political concept might be slippery and ideologically laden but in economic terms, when applied to a fiat monetary system – there are some fundamentals that define what constitutes fiscal sustainability, that are typically lost in the hysteria. In fact, the public debate is littered with statements that conflate the political with the economic and all but render the latter construction of the term meaningless.
Sometimes, this conflation is a deliberate device to blur the debate and to allow the proponent of a particular viewpoint to push a line that a full understanding of the economic concepts would not permit. Other times, and probably usually, the conflation is a reflection of plain ignorance.
So what is this concept of a “stable ratio of government debt and interest payments to gross domestic product” about? How is setting “tax rates at levels that don’t impede economic growth” enter the picture? I encourage readers to review my blogs – Size of deficit 101 and History of Modern Money – which provide some of the basic tools for this discussion.
You will soon see that both elements of Bernanke’s definition reflect his lapse back into gold standard reasoning when convertible money and fixed exchange rates were the defining features of the monetary system. Those days are over for most of the world economies and you simply cannot continue to apply the reasoning that was relevant to the former monetary system, which placed clear “financing” restrictions on the national government, to the current fiat monetary system which is characterised by non-convertible currencies and flexible exchange rates.
One of the respondents to the National Journal debate, Gene Steuerle, VP, Peter G. Peterson Foundation, which is a lobby group that seems obsessed with the irrelevant – deficits and debt. If I was the billionaire that set the foundation up in 2008 I would would have donated the money to medical research in search of a cure for cancer or HIV. I am sure the world would have received a better return on the dollars!
Anyway, the commentator immediately reflects his failure to understand that the monetary system has changed. He appeals to the household-government analogy from the outset. He says that a firm or household would never “decide how to spend every additional dollar it planned on making over the next 100 years” meaning that you shouldn’t commit your future revenue until you know what it is. He says:
Bottom line: sustainability is a minimalist goal; we need slack in the budget, measured as future revenues well in excess of today’s commitments as to how those revenues will be spent.
This is nonsense. A sovereign government is nothing like a non-government private sector entity. One issues the currency (under monopoly conditions) and the other uses that currency and cannot get it before the government net spends. Further a sovereign government is not revenue-constrained which means that its future revenue is as irrelevant as its current revenue for decisions about spending. Government spending comes from nowhere. As I noted the other day – spending funds spending – spending funds itself – because the government can always credit bank accounts and add to bank reserves whenever it sees fit.
Hint: Saying a government can always credit bank accounts and add to bank reserves whenever it sees fit doesn’t mean it should be spending without regard to what the spending is aimed at achieving. I will come back to that but it is a clue as to what “fiscal sustainability” means.
This blog will be continued in Fiscal Sustainability 101 – Part 1b