07 May 2020
Concerns are rising about the aftermath of high levels of government spending needed to combat the fallout of the COVID-19 pandemic.
Will the resulting debts be a burden on future generations? Are we mortgaging their future? Shackling future generations? Doubts about the efficacy of government responses to economic crises and the troubling debt overhang have arisen through the past century and taken different forms.
"But surely the debt is loading up a burden for future generations? The questions must be asked: won’t it need to be repaid?”
Can Lloyd George do it?
Initial doubts were expressed by the UK Treasury in the early 1900s over then Prime Minister David Lloyd George’s plan to use public works to reduce unemployment during The Great Depression.
According to the Treasury View, any extra government spending on public works would just prompt an equal and opposite fall in spending by the private sector. Since only a fixed supply of saving was available to fund investment, the government’s efforts would be defeated by crowding out all other spending.
John Maynard Keynes came to Lloyd George’s rescue with the idea of the “investment multiplier”. He showed how borrowing to spend on public works would trigger an income-spending feedback loop by the newly employed. This loop would provide exactly the extra saving required.
That showed government spending is effective in warding off a downturn but what about the debt build-up?
On this, Keynes spent the last years of his life working out the practical details of what is known today as yield-curve control. He believed it was possible - and therefore the central bank’s responsibility - to keep the interest rates on government debt as low as possible.
But surely the debt is loading up a burden for future generations? Surely some generation will need to repay it?
In reality, the products of the future can’t actually be passed back in time. Debt itself cannot directly reduce the productive capacity of the economy. Unless the debt is owed to other countries, future generations cannot actually be poorer.
Public debt built up during a crisis is generally borrowed from one part of society to help out another part of society. As a whole, we are borrowing from ourselves.
In effect, future debt is a debt we owe ourselves. Japan’s government debt - over 200 per cent of the nation’s output - is largely seen as sustainable because it’s mostly owned domestically. Any repayment would be just returning money to itself.
History shows us government debts are never actually repaid. Economic growth, which raises incomes, means the effective value of the debt falls over time.
But the implications of this can be taken too far, especially when it somehow morphs into believing government spending itself causes the very growth that pays it off. No, government spending per se does not induce economic growth. It depends what it is spent on.
Although population increase and technical progress make growth possible, only investment in new productive capacity can realise it. Keynes preferred the “socialisation of investment” over unproductive deficit spending.
To MMT and beyond
On a purely nominal basis, governments that issue their own currency need not fear budget deficits and accruing debts. Basically, how can a government be in debt for money it creates itself?
If the public wishes to increase their saving, the government can satisfy this desire by issuing claims on itself – either government money or government debt. On the flipside of government borrowing are new financial assets which increase the net wealth of the private sector.
Again, this view can be taken too far. Some proclaim the national debt is misnamed and should even be considered safe financial assets to be bequeathed to future generations.
Yet, if taxes drive the fundamental value of government money then isn’t the public at large still in some sense liable for a government debt owned by the few? So isn’t calling these net financial assets somewhat misleading?
To prevent the debt snowballing, interest payments are met with tax revenue. As a debt we owe ourselves, these interest payments go from one part of society to another.
If the debt is held mostly by the wealthy and the taxes fall on wages or consumption goods, then the interest payments could simply become a continuous transfer from poor to rich. Government debt may not be as neutral as it seems.
In a final twist, consider how much control a government - in coordination with its central bank - could have over the rate of interest it pays on its debt.
With free-floating currencies, interest rates can be set without regard to balance of payments problems. The limits of this power are still being tested but certainly Keynes’s policy of cheap money is back in a new guise.
Clearly the confusion and noise surrounding government debt reflects the complexity of its implications - be suspicious of simple explanations.
James Culham is Director, Institutional Portfolio Management at ANZ
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
07 May 2020
27 May 2020