Dialectics of government deficits

An important contribution to the dialectics about budget deficits and government indebtedness at a time when resources are direly needed to rebuild our economy comes from Stephanie Kelton, former Chief Economist of the United States Senate Budget Committee and Professor of Economics and Public Policy at Stony Brook University.

To the likes of Arvind Panagariya and Nobel Prize winner Abhijit Banerjee, who have been advocating expansion of government spending on infrastructure to get our way out of the recession, Kelton’s book, The Deficit Myth , comes as a well-argued reinforcement of a conceptual underpinning.

It also adds grist to the mill of those who have been arguing against “fiscal fundamentalism” derailing development, too much of conservatism about per capita indebtedness denying growth opportunities for the poor and against the thesis that a nation or a State’s budget should be balanced like a household’s.

Whatever it may or may not do, government borrowing in India does not “crowd out” private investment. Investment in government securities by banks and lending do not cancel out mutually in India, for sure.

The book is also contextual as India’s debt level is being panned by critics who say that government debt has reached unsustainable levels and we should not be accumulating further debt onto the head of future generations! Before anyone can jump up and counter this as trivialisation of the issue and fiscal wantonness, let us go through the arguments advanced by Kelton.

The Deficit Myth very convincingly presents a case for jettisoning this mindset of seeing government budget like our own statement of income and expenditure. Published just a couple of months ago, the book has reached Indian stands now.

It has contemporary relevance for India as well. Because we are currently through a great debate on the problems in borrowing by governments to spend for growth, more equitable distribution of the wealth so created and for the overall objective of lifting people out of the current crisis.

It busts six myths and here in brief are these half a dozen fallacies of macroeconomic thinking.

Govt vs household budget

In most conventional discussions, the government’s budget is seen like that of a household. You cannot spend money unless you earn it.

Modern Monetary Theory (MMT) mainly postulates that while a government issues the currency, everyone else uses it. And within the coming into being of fiat currency, the only danger in utilising the power to print and use currency is inflation.

Else, governments have great leverage in utilising the instrument of currency issuance for development.

The inflation angle

We should be targeting to produce a balanced economy rather than a balanced budget. Full employment, even on the basis of a universal job guarantee scheme, and price stability will dictate the policy towards the deficits.

At its core, MMT is about replacing an artificial (revenue) constraint with a real (inflation) constraint. In other words, the government should spend as long as it does not affect prices/inflation.

The national debt factor

The question of debt itself is turned upside down in this section. What matters, says Kelton, is not the size of the debt but whether we can look back with pride on the positive interventions we initiated with that debt. “Perhaps, we should give national debt another name”.

We could just refer to it as net money supply. As long as the debt is owed in the currency of the issuer state, it could be offset by the stoke of a keypad! (Currency issuer can cancel debt too.)

In short, Kelton argues that there is nothing like a national credit card that we should be worried about.

The crowding out argument

Their Red ink is our Black ink. It is a part of the classical thesis that if the government were to borrow heavily, it would deny private entities their space to borrow, crowding them out. Government deficits may make it easier for the private sector to borrow as the budget deficit feeds currency into the general pool available for the economy.

Whether the currency arrives in the form of tax cuts or increased spending, they leave some of us with great spending power. In other words, the minus on one side, becomes a plus on the other side.

Winning at trade — where it is stated that trade peace, not trade war, is something which we cannot live without.

Welfare schemes’ sustainability

You are entitled — which says that as long as the economy has the long-run capacity to produce real goods and services people need, entitlement/social welfare programmes will be sustainable are the last two postulates which Kelton convincingly makes.

Monetary sovereignty is the key to understanding MMT. Countries which have this leeway can use it to exercise policy autonomy, especially if they refrain from borrowing in other currencies. The author also says that either pegging your currency to another or borrowing heavily in a non home-currency will compromise this monetary and policy sovereignty.

Making a strong pitch for a fuller understanding of public money, Kelton is of the view that nations can build better economies especially with near full employment.

Though the book is based on the US experience, it has come at a time when the debate about deficits is raging and money of unprecedented proportions is required to rebuild shattered lives and livelihoods across the world.

It offers food for thought in the Indian context, too.

A fascinating book, it should be compulsory reading for all fiscal hawks here too.

At October-end, the Union government had hit 120 per cent of the estimated budget deficit for 2020-21, having borrowed ₹9.53 lakh crores Our economy will be better off with the insights Kelton proffers.

One of the biggest weaknesses in the Kelton edifice however is the lack of clarity on how MMT will impact the currency markets.

One recalls the “Impossible Trinity” theory of Robert Mendel in the 1960s. No nation can have a free monetary policy, capital account convertibility and a managed/fixed exchange rate, altogether.

The reviewer is a top bank executive. Views are personal