In this blog I will complete my analysis of the concept of fiscal sustainability by bringing together the discussion developed in Part 1 and Part 2 into some general principles. The aim is to provide a blueprint to cut through the deceptions and smokescreens that are used to deny fiscal activism and leave economies wallowing in persistently high levels of unemployment. So read on.
In considering the offerings from various commentators that participated in the National Journal debate I came up with several hints. Here they are again.
- 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.
- Advancing public purpose is another component of what “fiscal sustainability” means. You cannot define it in its own accounting terms – some given deficit size relative to GDP or whatever.
- We won’t find a definition of “fiscal sustainability” conceptualised by some level of the public debt/GDP ratio.
- Fiscal sustainability is directly related to the extent to which labour resources are utilised in the economy. The goal is to generate full employment.
- The concept of fiscal sustainability is not defined in terms of any notion of public solvency. A sovereign government is always solvent (unless it chooses for political reasons not to be!).
- The concept of fiscal sustainability will not include any notion of financing imperatives that a sovereign government faces nor invoke the fallacious analogy between a household and the government.
- The concept of fiscal sustainability cannot be sensibly tied to any accounting entity such as a debt/GDP ratio.
- The concept of fiscal sustainability will not include any notion of foreign “financing” limits or foreign worries about a sovereign government’s solvency.
These hints can be re-ordered under some general headings which in turn suggest some overriding principles that should be used when appraising whether a particular fiscal policy strategy is sustainable or not.
Advancement of public purpose
The only sensible reason for accepting the authority of a national government and ceding currency control to such an entity is that it can work for all of us to advance public purpose. In this context, one of the most important elements of public purpose that the state has to maximise is employment. Once the private sector has made its spending (and saving decisions) based on its expectations of the future, the government has to render those private decisions consistent with the objective of full employment.
Given the non-government sector will typically desire to net save (accumulate financial assets in the currency of issue) over the course of a business cycle this means that there will be, on average, a spending gap over the course of the same cycle that can only be filled by the national government. There is no escaping that.
So then the national government has a choice – maintain full employment by ensuring there is no spending gap which means that the necessary deficit is defined by this political goal. It will be whatever is required to close the spending gap. However, it is also possible that the political goals may be to maintain some slack in the economy (persistent unemployment and underemployment) which means that the government deficit will be somewhat smaller and perhaps even, for a time, a budget surplus will be possible.
But the second option would introduce fiscal drag (deflationary forces) into the economy which will ultimately cause firms to reduce production and income and drive the budget outcome towards increasing deficits.
Ultimately, the spending gap is closed by the automatic stabilisers because falling national income ensures that that the leakages (saving, taxation and imports) equal the injections (investment, government spending and exports) so that the sectoral balances hold (being accounting constructs). But at that point, the economy will support lower employment levels and rising unemployment. The budget will also be in deficit – but in this situation, the deficits will be what I call “bad” deficits. Deficits driven by a declining economy and rising unemployment.
In this context, the introduction of a Job Guarantee, which is an unconditional job offer by the national government at a fixed (minimum) wage, is a way to achieve high employment levels with the lowest spending impulse. So if the government is worried about nominal demand expansion relative to the real capacity of the economy it, an employment guarantee will be a much better way of sustaining full employment than trying to expand employment by stimulating the private market either by stimulating private firms (buying their output) or by competing with private firms for labour at market prices.
Clearly, a mix of employment guarantee and general spending is preferable to ensure an adequate volume of employment is maintained by high quality public goods provision is achieved.
So fiscal sustainability requires that the government fills the spending gap with “good” deficits at levels of economic activity consistent with full employment – 2 per cent unemployment and zero underemployment.
It cannot be defined independently of full employment. Once the link between full employment and the conduct of fiscal policy is abandoned, we are effectively admitting that we do not want government to take responsibility of full employment (and the equity advantages that accompany that end).
This blog will be continued in Fiscal Sustainability 101 – Part 3b