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The problem with the ‘endless summer’ theory of government debt

It’s become fashionable among some political circles to advocate for a laissez-faire approach to debt, on the basis that the government can issue as much debt as it likes – for as long as it likes. But there’s one big drawback to ‘just print more money’ argument, writes Pattrick Smellie of BusinessDesk.

Ask a New Zealander who Hairy Maclary is and most will know it’s the shaggy dog in the much-loved children’s tale of that name. An Australian equivalent is The Magic Pudding, a 1918 children’s classic that tells of a pudding that – no matter how often it’s eaten – is constantly self-replenishing.

In Australian politics, to call something a “magic pudding” is to promise something that sounds wonderful but does not exist in the real world.

A hardy perennial “magic pudding” formula in politics is the “growth dividend”. That’s the recipe that relies on claiming a party’s policies will produce a magically higher than forecast level of economic growth. This allows a party to sidestep unhelpful problems like that if the growth dividend doesn’t arrive, taxes will need to be higher or public spending will need to be lower if government debt is to be reduced or kept at prudent levels.

The political judgement at the core of this traditional election year debate is how much debt is either acceptable or credible for a government to run.

This time it’s different

In this year’s election, however, the growth dividend is almost old hat. The unprecedented rate of new government debt piling up in response to the Covid crisis is changing the debate and coinciding with the increasingly fashionable concept of “modern monetary theory” – a new magic pudding recipe that says governments can have as much debt as they like, implicitly without consequence.

Dealing first with the Covid-inspired debt pile-up: Every party in Parliament – even Act – agrees the response to the Covid pandemic has been appropriate, at least in principle. There is plenty of argument about the detail of the policies that have seen 1.7 million workers supported through wage and other subsidies and a $60 billion money hose squirted at all manner of public infrastructure.

The important point is that there is no argument that in times of crisis, it is entirely legitimate for governments to lean heavily not only on their balance sheets, but also on the fact that governments are special creatures when it comes to issuing debt. As long as a country issues its own currency – which New Zealand does – there is nothing, in theory, to stop a government issuing as much money as it likes to achieve anything it likes.

So say the modern monetary theorists and they are absolutely right, but only in the sense that if you throw a lighted a match into a tinder dry forest, it will start a big fire. That doesn’t make it the right thing to do.

The upshot is that, for this year’s election, the government debt debate is unusual for the fact that the two largest political parties – Labour and National – find themselves arguing a relatively conventional approach to the Covid debt inferno while the seekers of “transformational” policy reach for the MMT recipe.

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Rainy day vs endless summer

The conventional approach has two fundamental elements:

  • That the NZ government’s rapid debt creation was not only possible, but also could be achieved without damage to its international credit ratings or economic credibility, because a generation of previous governments reduced Crown debt to very low, arguably unnecessarily low, levels. Ramping debt back up from low levels by international standards was almost a no-brainer.
  • The flipside is that, to be in a position to do so again, it’s necessary to reduce debt levels when things return to something more like normal. Call this the ‘rainy day’ theory of fiscal policy.

Hence the conventional argument breaking out over National finance spokesman Paul Goldsmith’s target to bring net Crown debt from above 50% of GDP post-Covid to 30% within 10 years.

That would still be 10 percentage points higher than it was pre-Covid, but also still far below the levels of almost every other OECD country. His leader, Judith Collins, has also made clear that National is not proposing tax cuts at this election – further evidence that a National-led government would take a conventional approach, favouring debt reduction ahead of a lower tax burden.

Labour has pounced on this as evidence that National must be planning huge government spending cuts and Goldsmith has made clear that National, among other things, would do as it did after the Canterbury earthquakes and suspend contributions to the NZ Superannuation Fund.

Labour

Labour has yet to lay out its fiscal policy in enough detail to know exactly how it would tackle higher Crown debt levels, but in her campaign launch speech on Saturday, prime minister Jacinda Ardern was clear that “keeping debt low is important to us”.

Labour may be willing to live with higher net Crown debt for longer than National because she said low debt “need not be at the expense of health and education, and it shouldn’t mean leaving people behind. That is the difference between Labour and others.” But this is not a radical departure from debt management orthodoxy.

Increasingly heard in opposition to this approach is the new entrant – call it the “endless summer” theory of fiscal policy that says no NZ government need care at all how much debt it issues. The debt need never be repaid because the debt has been created by the government, which owes it only to itself, so it doesn’t matter if it’s written off later.

It’s a wonderful-sounding theory and it’s based on an accurate understanding of how governments and, on a “franchised” basis, banks create money from nothing every day of the week, in good times as well as in crisis.

What the theory misses is that governments and banks can only do that for as long as the people who use that money believe it is actually valuable.

Faith

If faith in a country’s money is shaken, it buys less. And if the country simply keeps on printing more money to try and make up the difference, that currency will buy even less again.

MMT advocates are right to say that governments are not like households when it comes to debt. Households have no power to issue money and if they don’t pay their loans back, the consequences can be swift, harsh and lead to penury. It is also right that governments might as well take advantage of the fact that any debt they do create will be at interest rates that are close to zero and will probably stay there for years – free money, in a way.

Where MMT is wrong, however, is to claim that because sovereign states can issue money at will, there are no consequences to treating that money as if it never existed to start with.

Even MMT advocates concede that if a government chooses to run limitless deficits, the result will be inflation and that money in the system will outrun the productive capacity of an economy. That’s a recipe for destroying the value of wages, savings, and other assets.

To prevent this happening, a government would need to raise taxes to “delete some dollars from the system”. The theory assumes that if governments had limitless capacity to issue new money, they would not only invest it well but would also have the moral fortitude to stop creating new debt when signs of indigestion emerged.

Dream on.

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A particular allure

Right now, however, MMT has a particular allure. The story of the global economic recovery since the 2008 global financial crisis and the response to Covid-19 has been a massive global experiment in MMT.

So far, the global financial system has not only hung together but is, if anything, stronger than it was in 2008 because of the greater requirements on private debt issuers – banks – to hold more capital in reserve, should a new crisis strike. There has also been a clampdown on private debt structures that carried far more risk than anyone realised.

However, this MMT-type experiment has not produced the kind of social equity nirvana that its proponents so often imply would be its result. Instead, in the wake of both the GFC and now Covid policy responses, money created by governments has made its way straight into the price of real assets, increasing wealth for the already wealthy and exacerbating income inequality.

How else to explain the booming stock markets around the world post-Covid and the evidence that parts of the NZ residential property market are currently overheating?

Legitimate debate

There is a legitimate debate to be had about what an appropriate level of government debt is for NZ. There is no magic number. It is ultimately a political as well as an economic calculation.

Reducing it as quickly as Goldsmith proposes looks hairy-chested, given the size of the debt mountain that now exists. However, voters should beware of the suggestion that government debt “simply doesn’t matter anymore”. It does and it always will.

Just because you can print the dollars that pay for lunch doesn’t make it free.

This article originally appeared on BusinessDesk. Their team publishes quality independent news, analysis and commentary on business, the economy and politics every day. Find out more.




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