By Gareth Vaughan
The idea that the Government needs more tax revenue and to ramp up borrowing in order to fund the economy's recovery from the COVID-19 crisis, thus burdening future generations with paying debt back, is "utter and complete total nonsense," according to Steven Hail.
Against the backdrop of COVID-19, this year's Government Budget forecast net core Crown debt to rise from $57.7 billion in 2019 to $200.8 billion in 2024. That would see it rise from 19% of Gross Domestic Product to 54%. With the election looming in September, rising government debt has become an election issue.
But applying an MMT lens to the world shows the conventional way we look at government debt is wrong, Hail says. Hence his response to a question about future generations being burdened with paying it back.
"It's complete nonsense, utter and complete total nonsense," says Hail.
"What is a government deficit? It's just a contribution that a government is making of new dollars to the monetary system. A deposit in the banking system that the government is making, if you like. Is the government going to run out of dollars? No that's technically impossible given our monetary systems."
Hail notes a point made in a recent book by Stephanie Kelton, another MMT economist. In her book The Deficit Myth, Modern Monetary Theory and How to Build a Better Economy, Kelton flips around the conventional thinking that government taxing and borrowing precedes spending. Instead, she says, a currency issuer spends before taxing and borrowing.
The importance of being a monetary sovereign
The New Zealand Government is a monetary sovereign, Hail says. What does this mean and why does it matter? It means the Government issues its own currency which it raises taxes in, has a floating exchange rate that isn't fixed and doesn't guarantee conversion into gold or anything else, and NZ has no significant foreign currency denominated debt.
"So what is the national debt that they are adding to at the moment? It is best described as the net money supply of dollars. It's dollars the government has spent in the system, they've not yet taxed back out of the system," Hail says.
"There can never be a crisis relating to New Zealand government debt. The New Zealand government can never become insolvent in its own currency. And it's not just MMT economists like me that will tell you that. It's right wing conservative central bankers like Alan Greenspan in the US who've explained that in the past. It's Nobel Prize winning economists like Joseph Stiglitz who'll tell you that."
"And actually when you come to think of it, it's obvious. If you are the currency issuer you can never become insolvent in financial liabilities that are in your own currency. And the issuance of interest bearing debt, [such as government bonds], is something that you choose to do. It's not something that you're forced to do," says Hail.
From an MMT perspective, the orthodox way of looking at the Government, the Government Budget in the economy and understanding our monetary system, is 50 years out of date, says Hail.
A key distinction MMT makes is that governments such as NZ's are currency issuers. In contrast individuals, businesses and local government are all currency users. Hail argues this is perhaps the most widely misunderstood important fact about economics.
"You or I, or a local authority like the South Australian state government, we're all currency users. So before we spend dollars we have to go and get them, - earn them, run in our past savings or borrow them prior to spending them. If we borrow them we have to repay them in the future. And if we take on too much debt we can struggle to repay that debt and get into financial difficulties We can potentially become insolvent," says Hail.
"If you see a government that way you think that the Government has to raise money through taxes, or has to borrow money by issuing debt before it can spend. If you're a state government, or a national government which isn't a currency sovereign like the Government of Italy, that applies to you. You have to get money before you can spend it."
"The Italian Government has to get euros before it can spend them and can potentially become insolvent. There's insolvency risk there if they can't at least guarantee the support of the European Central Bank...But that's not the case with New Zealand's government or the Australian Commonwealth Government because they are currency issuers, because they sit at the top of their domestic monetary systems. Instead, as far as the Australian Commonwealth Government is concerned, it spends dollars into circulation which are new dollars. Every dollar that our government spends literally is a new dollar," Hail adds.
"You spend new dollars into circulation if you are the currency issuer, you don't have to go and get the dollars before you spend them."
But if the Government just spends and doesn't tax, if it runs limitless deficits, Hail says of course there'll be too many dollars in the system, there'll be too much spending in the economy, you'll go beyond the productive capacity of the economy, there'll be upward pressure on prices and there'll be inflation. Accelerating inflation, potentially hyper inflation.
"So the role of taxation in the system is to delete some of those dollars from the private sector to limit the ability of the private sector to spend, to create room within the productive capacity of the economy for the Government to spend on public goods and services and infrastructure and all the other things that the Government needs to spend on, without creating inflation."
"We've got into the habit in recent decades of governments auctioning things called bonds, debt securities, to approximately cover the gap between what the Government spends and what it raises in taxes...Government bonds do play a useful role in the financial system. Amongst other things they give fund managers, including superannuation fund managers that are going to be providing for peoples' retirement income in the future, attractive, interest bearing, safe assets that they can hold over time," Hail says.
"But governments like the Australian government and the New Zealand government are not obliged to issue those bonds to the private sector. The Government could choose not to auction debt securities and the Government wouldn't run out of dollars under those circumstances. So the Government spends new dollars into the system. Once those dollars are in the system those dollars are available to pay taxes and taxes play an important macroeconomic role in our economy. But they don't literally pay for federal government spending."
A private sector surplus
Hail says when the Government spends more than it taxes, it's just making a net deposit of new dollars in the banking system called a government deficit.
"You could say it's a private sector surplus. They're giving us more than they're taking away from us. And the national debt, that's just the sum of past deficits net of surpluses. The national debt is just dollars the Government has spent into existence that they haven't yet taxed away."
When the Government repays its debt it's "just converting that term deposit back into a transaction account again," says Hail.
"That's all. It's not like a currency user getting into debt where you can get into financial difficulty. It's not like the Government of Argentina issuing US dollar denominated bonds. The repayments on those are a burden on future generations of Argentineans because Argentina doesn't issue the US dollar and can run out of US dollars, and has to go and borrow more or earn those US dollars in order to make those repayments. It isn't like the Greek Government borrowing euros because Greece doesn't issue the euro. Again they're a currency user not a currency issuer. It's completely different to the New Zealand Government or the Australian Government," Hail says.
Excessive deficit spending will show up as inflationary pressures, he adds.
"The deficit spending that the New Zealand Government is doing at the moment, and the increase in what people regard as New Zealand's national debt, is inflation risk. There is no other risk. And while there's no significant inflation risk on the horizon, then not only can you be relaxed about deficit spending by the New Zealand Government, it's much better to think of it as a surplus for the private sector than a deficit for the Government. The time to panic is if they try to rein it back."
Hail argues that Japan, with the highest government debt to GDP ratio in the OECD at around 200%, has not been at risk of a financial crisis. However countries like NZ and Australia, with high household debt levels, have been at risk of a financial crisis. The latest Reserve Bank of New Zealand figures show household debt as a percentage of nominal disposable income at 163.4%. That's the highest it has been since the Reserve Bank data series began in 1998. Meanwhile, servicing as a percentage of nominal disposable income is at a record low of 6.8%, thanks to low interest rates, also at their lowest point in the history of the Reserve Bank data series.
"These [NZ, Australia and Japan], are all monetary sovereign economies. Government debt is never going to trigger a financial crisis in any of these three countries. It's excessive private sector debt, and especially household debt, that's the concern. And if you were to push the New Zealand Government's Budget towards surplus again post-pandemic, you would be weakening private sector balance sheets and either pushing the economy back into a slump once more, or pushing the household sector towards an even higher level of household debt and making the financial system more fragile. And the eventual potential correction more severe," says Hail.
'What it is technically possible to do the Government can always fund'
I asked Hail whether, when applying an MMT lens, the Government could afford the following options if it chose to pursue them; Tackling climate change, increasing military spending, cutting taxes, launching a jobs guarantee scheme, and paying for the rising superannuation and health costs of an ageing population.
"They should always be looking at inflation risk. Because when we say that our governments can never become insolvent, what we are saying is that there is no purely financial constraint that they work under. But there is still a real constraint. So New Zealand has a limited productive capacity. Limited by the labour and skills of the people and capital equipment, technology, infrastructure and the institutional capacity of business organisations and government in New Zealand. That limits the quantities of goods and services that can be produced there is a limitation there. Also it depends on the natural resources of a country," says Hail.
"If you spend beyond that productive capacity it can be inflationary and that can frustrate your objectives, frustrate what you're trying to do. So it's always inflation risks that's important. Within that productive capacity, however, what it is technically possible to do the Government can always fund. So yes, you can fund any of those things but there's always an inflation risk and that inflation risk is not specific to government spending. It's specific to all spending."
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