A truly Keynesian response to public debt?
The issue of debt has risen to the top of the political agenda. Domestically, all parties are agreed that the level of public and private debt in the UK has risen too far.
Internationally, nations like Greece and Ireland are being forced to carry out drastic cuts in wages and public expenditure in order to satisfy their creditors.
But to listen to the debate one feels that John Maynard Keynes lived and wrote in vain. None of the political participants seem to have any real understanding about what the most original economist of the last century wrote.
Discussion is limited to how soon and how fast to cut public expenditure. The Tories say cut hard and fast, Labour say delay cutting unless it harms the recovery.
Neither side seems to have Keynes’ feeling for the interdependence of thrift and debt. There can be no thrift without an equal and opposite rise in debt. One person’s saving is another person’s borrowing.
If government debt is to be reduced, then some other section of the economy must move from financial surplus to financial deficit to compensate. Which other sector do the political parties propose to move into deficit?
During the lead-up to the crisis there were 3 surplus sectors : the rentier class, the company sector, and the overseas sector. These sectors were building up their financial assets. There were two deficit sectors: the state, and households, particularly working class and middle class ones who were building up their debts to the banks and credit card companies.
If the state and debtor households are to start paying off their debt, which of the other 3 sectors is to move into deficit to compensate?
Cutting public sector wages and can temporarily shift borrowing away from the state. Its first effect is to force public sector employees either into debt, or force them to run down their relatively small savings. But employees are much less credit worthy than the state, and quickly cut their consumption, throwing the deficit in turn onto the company sector and the import sector. Firms are more creditworthy than private individuals, but still less creditworthy than the state. Firms will respond with futher layoffs and wage cuts.
Falling tax revenues, increased unemployment benefits, throw the deficit back to the borrower of last resort : the government. In the meantime the productive economy has gone down the tube.
It was against this insane commonsense response to public debt that Kenyes polemicised in the 1930s.
The only sectors onto whom the deficit can be sucessfully shifted are the rentiers and the overseas sector. The rentiers could be taxed at sufficiently punitive rates to run down their financial assets. In compensation the public debt would fall, since the public debt is nothing more than a liability to this class, and within a given national economy, the public debt can only be run down by diminishing the assets of the rentier class.
The only way the assets of the overseas sector can be run down is by eliminating the trade deficit and running a trade surplus. This would imply a much more stringent devaluation of sterling than has so far occurred, which would be no bad thing from the long term working class interest here since it would slow the outward migration of manufacturing jobs.
The UK can do this, deficit countries within the Euro can not. Within the Eurozone, orthodoxy has no real alternative way of dealing with public debt but a race to the bottom like that which impoverished the world after the great crash of 1929.
But all this evades the real cause of public deficit: the growing financial assets of the international rentier class. This can ultimately be dealt with only by one of 3 expropriation processes
1)The Denis Healy solution : tax them till the pips squeak.
2)The Weimar solution : pay them off with newly created state currency to inflate away the debt.
3)The Biblical solution : anounce a jubilee and cancel all debts.
Excellent post Paul – a great way to start the day. WIll tweet it now!
1) Could you explain why it is that the private sector would have to increase its debt?
2) By international rentier class I presume you mean to include pension funds – substantial holders of government bonds globally.
Sure Barney, the first point is simply because monetary and credit operations are a conservative system, in the sense of a system governed by conservation laws – my reference to equal and opposite reactions was not a joke. In mechanics, changes in momentum under particle interactions must sum to zero. In finance changes in credit position must likewise sum to zero. The sum of the changes in credit position over all sectors will be zero, so if the state deficit runs down, other sectors, taken as a whole must have an equal and opposite movement in their credit position.
The rentier class is the class of beneficial owners of financial assets. One would normally see these as being the ultimate owners, but there is certainly a sense in which abstract juridical subjects like pension firms or other companies holding financial assets can function as at least pseudo-rentiers.
Sorry ‘pension fund’ was short fund for the beneficial owners of the financial assets legally owned by the pension fund themselves. My point was that given that pension funds hold disproportionately high levels of gov bonds compared to, say hedge funds, the reduction in value of these bonds under 2 or 3 will hit the former harder. So workers may well lose more lose more than millionares.
Erm, as interesting as the physics analogy explanation is, I was thinking more like a theory of a market for loanable funds or some such. Two things: on a theoretical note you can’t create energy – you can create money, so I really don’t understand how it is a conservation system. Secondly and more importantly, just on a really practical level – I’m a firm; the government cuts its borrowing, am I suddenly seized by a physical force and impelled along the pavement to my friendly neighbourhood HSBC?
You are right that money can be created, but the only agent that can do this in a non conservative fashion is the state. The state can carry out a number of non-conservative operations – I listed 3. It can create unilateral tax obligations which cancel out part of the state debt, it can unilaterally create new cash which cancels state debt, or it could declare some debts to be no longer legally
If the state debt is reduced, then clearly either overseas holders of state debt have to forced run down their holdings or domestic holders of state debt have to be forced to run down their holdings.
The political parties who are agreed that they want to cut the public debt, have not identified whose assets are to be run down to compensate.
Thinking of how the financial system works in terms of abstractions like ‘markets for loanable funds’ is a fundemental mistake, it blinds you to the overall interactions that operate between parts of the system. It was part of Keynes genius that he always saw past such abstractions to a synoptic perceptions of the overall binding relationships.
1) When banks take a deposit of x, and use it to lend 0.4 x to three different people they are creating money; 2) if the state were the only entity able to increase the money supply, monetarism would work wonders, and the only way you could explain M4 would be that the minister was on a mixture of speed and acid.
The second para is true but doesn’t answer my second point disputing that private firms necessarily have to increase their debt.
I think to throw around the word “abstraction” having used a conservation of energy metaphor is perhaps a little risky. You seem to be saying that looking at lots of little piecemeal models blinds one to the interaction of the system. That is a danger of the approach. However, no other approach offers any rigour and is really just a set of assertions, which is why all shades of mainstream economics now use micro-foundations to underpin their macro-models. With all due respect, your argument so far is, as far as I can see, a set of assertions.
I can’t comment on the genius of Keynes: I have seen so many alternate exegeses that the only real conclusion I can draw is that no one really knows what he meant.
Ah, I’ve just understood your argument; by creating money in a non-conservative fashion you mean without creating an equal liability. I was confused by the conservative system analogy – because in phyics that rests on the law that energy cannot be created or destroyed, where as here of course money can be created and destroyed.
Which then makes sense of your second para, and indeed your model as a whole. Essentially an accounting identity model. What your model still doesn’t do though is explain why private firms have to increase their borrowing Working in a closed economy, when the Government reduces its debt those people who have been lenders could use that money to consume instead. Total debt in the economy could shrink.
Yes that is right the conservation that applies is that the change in the sum of liabilties and assets ( +ve -ve money ) which must sum to zero. This is an exact analogy to the change in momentum of particles constrained to move in one dimension under collisions. So the model does stem from basic national accounts identies.
You suggest that “when the Government reduces its debt those people who have been lenders could use that money to consume instead.”
Two points here: why should they chose to do that simply to help the government run down its deficit?
If the government taxed them heavily, then they would be forced to cut their savings, but why otherwise.
Secondly, an increase in purchases of commodities by the wealthy only serves to reduce the government deficit to the extent that a part of the sales price of these commodities resolves to taxes and thus forms additional state revenue.
Otherwise, as Keynes Polish contemporary Kalecki pointed out in the 30s, the expenditure of the propertied classes is essentially self financing. If they buy more commodities, they buy them from other capitalists whose income rises by a corresponding amount.
Gov. stops issuing so much new debt, and pays off what it owes as it comes to maturity. Presto. Less debt. Savers who were previously puchasing Gov debt with their income now have to find a new use for it. They can either lend it to private firms or they can consume it. So there is no necessity that private firms will increase their debt – it is contingent.
You STILL haven’t said in either commonsense terms, practical terms, or via a model of firms’ investment decisions, why private firms would increase their debt!
And in response to why they would increase their consumption: probably not to help cut the deficit, probably because without fresh Gov debt to purchase they will need to find alternatives for their income. They can either save it with the private sector or consume it. Chances are they will do a bit of both. But they could put 100% into either. It is contingent and bugger all to do with accounting identities. Any spend on C will reduce S and therefore reduce Debt.
“But all this evades the real cause of public deficit: the growing financial assets of the international rentier class. This can ultimately be dealt with only by one of 3 expropriation processes”
Sorry if this has already been assaulted in earlier comments. But I would need this explained to some degree. In a narrow technocratic sense, the deficit in the UK has emerged because high spending that was reliant on the continued extraction of value from asset-boom based activities was suddenly uncovered. Financial wealth cratered, and so did the government’s – they don’t seem to be in opposition to one another.
I agree with Keynes that suddenly cutting the expenditure would be lunacy. But at some point we need to be Micawber about this, or the people funding the difference – and yes, it is people – get antsy. That is only fair.
I like your trichotomy of solutions but don’t think you are being fair to DH who was actually quite a good spending cutter – and rightly so given the lunacy going on in the early 1970s under Heath and Wilson.
You are clearly right that the assets have ended up in the wrong hands – bravo for that.
That’ll be right! as we say in Glasgow.
Or at least it will be if they pay off the debt by quantitative easing.
If the government simply cuts voluntary expenditure by say £50billion, then by the
multiplier, the national income will fall by substantially more.
Those on low incomes save a small portion of their income compared to those on
high incomes. Those who are made unemployed by cuts
in government expenditure will indeed save less, but they will not as
you suggest ‘find a new use for their savings’, because they will now
be too poor to save. If the cuts are so severe that they create a massive recession
that could force even the wealthy to live off their capital, in which case the
public debt could be reduced.
You say
This is the key point about what Keynes called the ‘paradox of thrift’. Borrowing by firms is not just voluntary borrowing. A firm can decide to borrow to carry out capital investment, or it can be forced into the situation of involuntary borrowing ( running up its overdraft ) by a shortfall in revenue. If the rentier class save more, this generates a shortfall in revenue that causes the overdrafts of a portion of firms to rise – hence they borrow more whether they intended to or not. This is typically a short term phenomenon, since firms respond by shedding staff. That in turn shifts the deficit back onto the government which has to pay unemployment benefit and which looses tax revenues. The structural position of the state in the circulation process makes it the borrower of last resort.
Yes if G then, ceteris paribus, demand will fall by an amount greater than G becuase of the multiplier. But there is the possiblity that the fall in government demand for savings will lower interest rates for the private sector causing private investment to rise. And this investment have a greater multiplier than G, so overall demand could rise. It is possible.
It is unclear to me that ‘government demand for savings’ is currently holding up interest rates , interest rates are at an unusually low level and this low level could itself stimulate private investment. In Japan this does not seem to have been a great success, though!
Or of course your could say interest rates are surprisingly high given QE. Its an interesting question. Japan is also an interesting question, with the burden on me I suppose – though I would take Japan as prima facie the classic example of the liquidity trap, with a couple of idiosyncrasies thrown on top.
The key point is that the point you have just made was not included in your original analysis, which said nothing about interest rates. And nor is it strong enough to bear the conclusion of your original analysis, which appeared to be a general proposition that cutting G would send the economy into a spiral. Moreover your analysis seemed to say that this flowed simply from the accounting identity.
The only thing I have really been arguing for is that your original model was simplistic and inaccurate and therefore unreliable for the conclusions you drew. A model of accounting identity simply isn’t enough to explain, well, anything. To reiterate the point, your model offers no explanation of interest rates, which you have just implicitly admitted are rather important.
Give us a break!
I have a target set by the site of 600 words, its a blog not an academic paper.
If you want my views on investment and interest rates you will either have to wait for a later post or read the book Classical Econophysics, http://www.routledgeeconomics.com/books/Classical-Econophysics-isbn9780415478489 or some of my technical papers on economics at http://www.dcs.gla.ac.uk/~wpc/reports/index.html#econ
I would not be so disparaging of accounting identities, a large part of the effort of theoretical physics for two centuries has depended on elucidating ‘accounting identities’.
Paul, given some of the discussion above on pension funds’ role in the rentier process, I don’t know what to make of reform for “the takeover of the health-industrial complex and all assets of workers’ insurance and private pension funds into permanent public ownership, with levies against corporate assets for any fund deficits, and with decisive worker participation in their administration” (in essence still calling for a public pension fund monopoly).
This notwithstanding the past discussion on so-called “pension fund socialism” that the two of us had.
The more you post this kind of stuff, the more I am indeed inclined to agree with your “nuclear” solution to debt instead of just state debt.
My only objection to including it in a political program is the (perhaps seemingly) one-time nature of this measure. With state debt, you know that when it’s abolished, the state can quickly rake new deficits, start up a new debt balance, and then abolish it.
One should never use the word ‘fund’ in connection with pensions.
The notion that one can accumulate past income in a fund that will provide
a pension is, from the standpoint of society as a whole, an illusion.
The income of todays pensioners is created by todays workers. A 70
year old today is not eating tins of corned beef and baked beans that
were bought and set aside in the 1960s. They eat food produced by todays
farmers, warm themselves with today’s electricity, and are treated
when ill by current medical staff.
With state pensions this is relatively clear. A threadbare illusion
attempts to label a portion of income tax as National Insurance, but
few are fooled by that. State pensions are met out of taxes on
current workers.
What is less clear is how private pensions are also met out of tax
revenue. Private insurance companies purchase annuities in the form
of government bonds and then pay pensions from the interest on these
bonds. So the taxpayer pays both private and public pensions.
The difference is that the public pension scheme is vastly more
efficient. Civil servants in the Department for Work and Pensions
are not paid million pound bonuses like fund managers in the City,
nor are there any sellers of state pensions who have to be
rewarded by commissions.
The public pays twice over for private pensions : once as taxpayers
to fund the interest on the national debt that actually pays the
pensions, and a second time in their private insurance premiums.
Does “the takeover of the health-industrial complex and all assets of workers’ insurance and private pensions into permanent public ownership, with levies against corporate assets for any deficits, and with decisive worker participation in their administration” sound better?