Transcript Slide 1

Why a Growing Economy needs a
Growing Government
L. RAND ALL WRAY, LEVY INSTITUTE & UMKC
[email protected]
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?
Federal Government Receipts and Expenditures
(QoQ Change)
25
Transfer
Payments
20
15
10
5
0
Consumption
Expenditures
-5
-10
-15
-20
Tax Receipts
-25
Source: Bureau of Economic Analysis and Authors' Calculations
2010-II
2010-I
2009-IV
2009-III
2009-II
2009-I
2008-IV
2008-III
2008-II
2008-I
2007-IV
2007-III
2007-II
2007-I
2006-IV
2006-III
2006-II
2006-I
2005-IV
2005-III
2005-II
2005-I
-30
Foregin Holdings of US Treasuries
(% of total held by Foreign Countries)
80
Brazil
70
Taiw an
60
Hong Kong
Caribbean Banking
Centers
Oil Exporters
50
40
Germany
30
UK
20
China
10
Japan
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Source: US Department of Treasury, November 2009 figures
Note: For some years the holdings of the selected countries have been insignificant, so they are included in the category
Treasury Security Holdings (% of Total Oustanding)
60
50
%
40
30
20
2010 Q1
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
0
2009 Q3
10
7
6
5
4
3
2
1
0
-1
-2
Held by Rest of
the World
Foreign Official
Holdings
Foreign Private
Holdings
Financial Sector
Holdings
Current Account
Balance (Sign
Reversed)*
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
THE CONCEPTUAL FRAMEWORK
Accounting Identity of Financial Balances
PRIVATE SECTOR BALANCE + GOVERNMENT BALANCE = CURRENT ACCOUNT BALANCE
INTERNAL FINANCIAL BALANCE
EXTERNAL FINANCIAL BALANCE
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
Importance of Sovereign
Currency
“[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
31
Government & Foreign Sector
Financial Balances Fiscal Surplus
Current Account
Deficit
Current Account
Surplus
Foreigners Net Save
Foreigners Deficit Spend
Fiscal Deficit
Domestic Private Sector
Financial Balance = 0
33
Domestic Private Sector Surplus
DPSFB = 0%
Fiscal Surplus
DPSFB = 1%
DPSFB = CAB - GFB
DPSFB = 2%
Current Account
Deficit
+1%
+2%
Current Account
Surplus
-1%
Increasing DPS
Financial Surplus
-2%
Fiscal Deficit
Permissible Space for Sovereign Issuers
Fiscal Surplus
Current Account
Deficit
Current Account
Surplus
PSB = 0
Fiscal Deficit
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
Sustainable Space for Sovereign Issuers
Fiscal Surplus
Current Account
Surplus
Private sector
surplus
Current Account
Deficit
PSB = 0
Fiscal Deficit
Possible Space for EMU Nations
with CA Surpluses
Fiscal Surplus
Current Account
Deficit
Current Account
Surplus
-3%
Fiscal Deficit
Sustainable Space for EMU Nations
with CA Surplus
Fiscal Surplus
Current Account
Deficit
Current Account
Surplus
-3%
Fiscal Deficit
Possible Space for EMU Nations
with CA Deficits
Fiscal Surplus
Current Account
Deficit
Current Account
Surplus
-3%
Fiscal Deficit
Sustainable Space for EMU
Nations with CA Deficits
Fiscal Surplus
Current Account
Deficit
Current Account
Surplus
-3%
Fiscal Deficit
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 nongovernment 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 Wray
Professor of Economics, UMKC
Senior Scholar, Levy Economics Institute
[email protected]
www.levy.org
WWW.ECONOMONITOR.COM/LRWRAY/