Sunday, October 27, 2013

No Conspiracy Needed -- the debt ceiling is Sound Finance

SRW is spinning out conspiracy theories in trying to understand why the Government may not raise its debt ceiling and therefore, begin to default (or delay) on its financial obligations.
A common narrative about the debt ceiling is basically a Frankenstein story: businesspeople funded these Tea Party crazies, and now despite pulling all their levers, they just can’t control the monster they have created. And maybe that’s right. 
But suppose, plausibly, that the Jamie Dimons of the world know what Treasury has assiduously ensured the rest of us do not, which is exactly what Treasury is capable of and planning to do when George Washington bumps his head. And suppose it is debt prioritization plus delayed payments. Is it too much to wonder whether some quarters of the business community — you know, the ones who own the place — may not be pushing quite as hard as they pretend to raise or eliminate the debt ceiling? 
I hope that it is too much to wonder. I hope it is evidence only of my own paranoia that I do wonder.
I have an alternative, which requires no conspiracy. The government is resisting raising the debt ceiling because all members of government feel that the government ought to "spend within its means", just as a household should. They may differ about exactly where that line lies, and how much spending is prudent, and what the timing is, but everybody is basically on-board with the idea that there is a budget constraint that needs to be adhered to.

The reason they believe that a Government is like a household in this respect is because 1) it makes intuitive sense, and 2) economists, who control the debate on this, also share the same intuition. Also, prior to the Great Depression when the US was entirely on the gold standard, this was the right intuition to have, and it remained at least partially correct until Nixon took the country entirely off the standard in the 70s.

But economists do not understand what money is, or the role of it in Government, and the textbooks have not been updated, so Fama may say "spend never" and Krugman may say "spend now, but you'll need to pay it all back later" but these are differences of degree, not differences of kind.

The difference of kind is functional finance, which stands opposed to "sound finance" and sees Government spending is something entirely different in function and role from household spending. If the intuitions of functional finance were dominant in the academic community, then the debt ceiling would be abolished but of course and we would move on to other things.

The revulsion that Lerner spoke about remains strong at Harvard and DC alike.
[The] government should borrow money only if it is desirable that the public should have less money and more government bonds…. This might be desirable if otherwise the rate of interest would be reduced too low… and induce too much investment, thus bringing about inflation…. 
The almost instinctive revulsion that we have to the idea of printing money, and the tendency to identify it with inflation, can be overcome if we calm ourselves and take note that this printing does not affect the amount of money spent…. 
Functional Finance rejects completely the traditional doctrines of "sound finance"…. [It] prescribes… the adjustment of total spending… to eliminate both unemployment and inflation… the adjustment of public holdings of money and of government bonds… to achieve the rate of interest which results in the most desirable level of investment… the printing, hoarding, or destruction of money as needed…. 
[The] result might be a continually increasing national debt…. [This] possibility presented no danger… so long as Functional Finance maintained the proper level of total demand for current output; and… there is an automatic tendency for the budget to be balanced in the long run as a result of the application of Functional Finance, even if there is no place for the principle of balancing the budget….
Responsible Governance means spending what the economy needs, it has nothing to do with budgets.


Blogger Detroit Dan said...

SRW is one of the most insightful commentators I've read anywhere, anytime. But he has a serious weakness in that he engages the (in my opinion) nonsensical market monetarism of people like Scott Sumner. He must be good friends with some of those people. Otherwise, why pay any attention to their patently ridiculous obsession with the power of the central bank to control the world through their very pronouncements?

7:17 PM  
Blogger Greg said...

"why pay any attention to their patently ridiculous obsession with the power of the central bank to control the world through their very pronouncements?"

One reason is that virtually all CBers and most economists we are allowed to hear serious policy proposals from are monetarists in some form. While Sumner may be somewhat unique in his ardent stance in support of what CB are capable of he's not that different in form from the others. I liken him to a 10 on the monetarist scale with others anywhere from 5-8. What we need is a new scale. SRW himself lies somewhere on that scale I imagine.

4:01 AM  
Blogger Ralph Musgrave said...

Re flawed comparisons between households and governments, Samuel Brittan (former chief economics correspondent of the Financial Times) had an article in today’s FT referring to that flawed comparison and the way it dominates the so called “minds” of politicians. See 2nd last paragraph of his article here:

But what is completely bizarre is the way that even so called “professional” economists (particularly at Harvard) don’t get the distinction, as Winter points out.

8:57 AM  

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