Mike might usefully muse (maybe for more than a minute) on economics professor’s myth busting

In “Mike’s Minute” on December 12, broadcaster Mike Hosking opined that adding to government debt was “bad economics”.

The Government had announced it would spend an extra $12 billion on infrastructure, such as new roading, rail, schools and healthcare projects.

Forecasts showed the Government taking on an extra $19 billion of debt over the next five years. Some of this debt would help pay for these projects.

Hosking huffed this represents a change of direction,

“ … and we join too many other countries adding a pile of debt to the next generation to fund our lack of ability to pay for today’s requirements.

“Money might be cheap, but it’s still not our money, and that’s bad economics.”

Oh dear.  The borrowing has burgeoned since then.

In a more recent “Mike’s Minute”, Hosking insisted that  just because times are tight, unusual, unheard of, or worrying, it doesn’t mean we have to lose our minds.

This time he was advising Finance Minister Grant Robertson to back away from considering a universal income.

Among his concerns:

A universal basic income is a socialist’s dream. It’s about control by the state, it’s about everyone being reliant on the government.

But Milton Friedman – not especially renowned as a socialist dreamer – proposed to give everybody free money in his book “Capitalism and Freedom”.

He mostly referred to this plan as a negative income tax (and he also referred to it as a guaranteed income because that’s exactly what it is.)

But why would Milton Friedman, an outspoken free market capitalist, support giving people money for nothing?

One reason was to reduce government bureaucracy.  A single guaranteed income programme could replace the American government’s maze and mess of more than a hundred separate anti-poverty programs.

We should replace the ragbag of specific welfare programs with a single comprehensive program of income supplements in cash — a negative income tax. It would provide an assured minimum to all persons in need, regardless of the reasons for their need…A negative income tax provides comprehensive reform which would do more efficiently and humanely what our present welfare system does so inefficiently and inhumanely.

 Another reason was to end “the welfare trap.

A guaranteed income removes the dole’s disincentive to work and allows everyone to earn more without being penalised.

But let’s get back to the borrowing and the debt that bothers Hosking.  His anxiety levels will be seriously lifted by the government’s response to the Covid-19 crisis.

The government’s accounts for the eight months to February 29 showed net debt fell below $60b and was 19.2 per cent of gross domestic product.

But in an interview with the New Zealand Herald, Finance Minister Grant Robertson warned the spending programme could have a major impact on New Zealand’s debt levels.

“Quite clearly, in order to cushion the blow economically, we’ve had to undertake some very significant spending programmes,” Robertson told the Herald. “And therefore that is going to have a major effect on our debt to GDP ratio.

“Those numbers are getting finalised as we head towards the Budget, and they’re not far away, those forecasts, but quite clearly it will have a significant impact.”

And:

“Governments around the world are lifting debt to pay for increased health spending and support for their economies. Advanced economies are starting from an average net debt position above 70 per cent of GDP, with the UK around 75 per cent, the US above 80 per cent, Italy above 120 per cent and Ireland above 50 per cent of GDP.”

Our starting point in net debt terms is much lower.

Before Hosking tells us he has not been mollified by our stronger fiscal position and he is alarmed by the intended borrowing programme, he might consult the Mainly Macro blog on the matter of government debt.

Simon Wren-Lewis, Emeritus Professor of Economics and Fellow of Merton College, University of Oxford, has posted an item headed Some myths about government debt and how it is financed

This was prompted by the Bank of England temporarily eliminating the limit on the Ways and Means Facility.

The resultant fuss about this decision – which, in effect, means the Bank of England could credit the government with as much money as it needed in the current crisis – illustrates how pervasive are many of the myths around government debt, Wren-Lewis declared.

Here’s how addresses three familiar examples.

1. It doesn’t matter that we are in a developing economic crisis, like a recession or a health pandemic, we still need to worry about what is happening to government debt.

This is false for any country that prints its own currency, like the UK. In a crisis you should worry about dealing with the crisis. Government debt is what allows the government to put all necessary fiscal resources into fighting the crisis. To worry about debt is like worrying that a fire engine putting out a fire is using too much water.

2.  OK, but we should worry about government debt the moment output stops falling (or in a pandemic, the moment any lock down is relaxed).

Again false. This was the mistake that some large economies made after the Global Financial Crisis (GFC). By worrying about debt they either slowed down, killed or reversed the recovery. Because governments can get the Bank of England to buy its debt (or continue to create money), there is no need to worry about debt until the economy has fully recovered from the crisis. This will be equally true in any recovery from the pandemic.

3. When the government starts financing its deficit by printing money rather than issuing debt, rampant inflation is just around the corner.

Many thought this after the Global Financial Crisis, when central banks started buying government debt through their Quantitative Easing programme, because they bought the debt by creating money. Subsequent events have shown that those who thought inflation was inevitable were completely wrong, as many of us said at the time. The reason they were wrong is because interest rates are at their lower bound, and at the lower bound it does not matter too much how the government deficit is financed. The reason is intuitive: when rates are zero, you are indifferent between cash and short term debt. So why would issuing money rather than debt cause inflation when rates are zero? No reason at all.

Wren-Lewis references Keynes on what is happening:  in a recession you can create a lot of money, because it is willingly held by nervous banks and investors. But outside a recession investors and banks will want to get rid of that money, which will force down rates of interest in the economy, encouraging too much borrowing and discouraging savings.

This excess demand will create inflation. Central banks are only able to control the general level of interest rates in the economy by restricting the amount of money they create – and that’s why government deficits are largely financed by issuing debt.

Wren-Lewis addresses another question:   if we shouldn’t worry about government debt during crises, or as crises are coming to an end, should we worry about it at all?

He responds:

It is a good question, which can only be answered by looking at why having high levels of government debt might be bad. So let’s look at three myths or misunderstandings about government debt.

The three myths are that

• High debt risks financing crises,
• It is a burden on future generations, and
• It crowds out investment.

Readers will learn they have been myth-taken, if they believed those things before reading how Wren-Lewis addresses them.

He ends with the myth that …

Deficits don’t matter as long as they don’t create excess inflation.

His rebuttal:  This is just not true when independent central banks (ICBs) control interest rates, because central banks will vary interest rates to control inflation.

ICBs have been very successful at bringing inflation right down to low levels, which is why no government or opposition is going to abandon them anytime soon. In that situation, deficits that are too large or small will lead to changes in interest rates rather than inflation. (ICB’s are not so good at preventing recessions when inflation is low, which is why we need a state dependent assignment.)

Once recessions, caused by whatever means, are over then it makes sense to have targets for the government deficit (excluding investment) as a share of GDP. What that target should be will depend on a view of what the ideal debt to GDP ratio should be. (For more detail see here.) These targets are there not because high deficits will be the end of the world – far from it. Instead they are a disciplining device for governments. In the past it was thought they were needed to stop left wing governments spending too much, but in the UK and US the more likely problem is of right wing governments taxing too little.

Wren-Lewis concludes that  many people think government debt and deficits are much more important than they actually are.  Hosking – obviously – has not been alone when he prepared his minute musings on borrowed money.