Why a Growing Economy needs a Growing Government

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Why a Growing Economy needs a Growing Government

• L. Randall Wray, Levy Institute UMKC
• wrayr_at_umkc.edu
• www.levy.org
• www.economonitor.com/lrwray/

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Fiscal Constraints

• President Obama Government is running out of
  money!
• Economists Unsustainable debt path!
• 70 of Americans say progress on Deficit needed
  this year
• Chinese might stop lending to us!
• Zimbabwe and Weimar hyperinflation!
• Burden our grandkids!
• Look at Euroland!
• Sovereign debt crisis
• Default risk
• Bond vigilantes

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Is there evidence of run-away, Weimar/Zimbabwe
Deficit Spending?

• Is debt at historic high?
• Is govt spending out of control?
• Have we hocked ourselves to China?
• Does debt burden our grandkids?
• Will Entitlements bankrupt our grandkids?

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Remember Clinton and Goldilocks?

• 1996 US Federal Govt begins to run surpluses
  continued for 2.5 years
• Clinton projects surpluses for next 15 years
• All Govt debt will be retired
• But Private debt explodes and then recession
  restores deficits.
• Why The Meaning of Zero
• 0Private Bal Govt Bal Foreign Bal

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Past Attempts at Paying National Debt
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THE CONCEPTUAL FRAMEWORK
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Purported Unsustainability of Government Deficits
and Debt

• Sustainability issues
• Relation between interest rates and economic
  growth If rgtg ? growth of debt
• Growth of Debt ? Bond Vigilantes push up r ?
  accelerating the rise of debt ratios
• Excessive Deficit-to-GDP and Debt-to-GDP ratios
  ? inflation and ultimately insolvency
• So We must show
• why govt doesnt face insolvency, and
• why deficits dont raise interest rates

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St. Louis Fed

• "As the sole manufacturer of dollars, whose debt
  is denominated in dollars, the U.S. government
  can never become insolvent, i.e., unable to pay
  its bills. In this sense, the government is not
  dependent on credit markets to remain
  operational. Moreover, there will always be a
  market for U.S. government debt at home because
  the U.S. government has the only means of
  creating risk-free dollar-denominated assets.
• Government can NEVER run out of Dollars It can
  NEVER be forced to default It can NEVER be
  forced to miss a payment It is NEVER subject to
  whims of bond vigilantes.

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Myths, Superstition, Old-Time Religion

• "I think there is an element of truth in the
  superstition that the budget must be balanced at
  all times. Once it is debunked that takes away
  one of the bulwarks that every society must have
  against expenditure out of control. There must be
  discipline in the allocation of resources or you
  will have anarchistic chaos and inefficiency. And
  one of the functions of old fashioned religion
  was to scare people by sometimes what might be
  regarded as myths into behaving in a way that the
  long-run civilized life requires. (Samuelson)
• Necessity of balancing the budget is a myth, a
  superstition, the equivalent of that old-time
  religion.
• So what is the truth? If economics is to rise
  above superstition, we need to know.

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How Government Spends its Own Currency Keystrokes

• Spending ? credits
• Government credits banks reserves bank credits
  account of recipient
• Taxes ? debits
• Government debits banks reserves bank debits
  account of taxpayer
• Deficits ? net credits
• Government net credits banks reserves bank net
  credits account of recipient

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Money as Scorekeeping
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Bond Sales by Government Why the Bond Vigilantes
Cannot Dictate Terms

• Deficit spending ? net credits reserves
• Creates Net Financial Wealth in nongovt sector
• Excess Reserves ? bid overnight rate down
• To Feds support rate (fed funds rate)
• Bonds Interest earning alternative (IRMA)
• Part of Monetary Policy, whether new issues or
  open market sales
• Changes form of Net Financial Wealth (longer
  maturity)
• (NB Surpluses ? net debits ?OMP or Redemptions)

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Self-imposed constraints

• Budgeting, debt limits
• Operational constraints
• Treasury writes checks on accounts at CB
• CB prohibited from buying Treasury Debt new
  issues
• Use of Special Depositories
• Use of Tax and Loan accts

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Central Bank Policy

• Consensus central banks always operate on
  overnight interest rate
• Accommodates Demand for Reserves
• Convertible vs. non-convertible currencies
• Convertible can lose control of interest rate
  (Greece)
• Nonconvertible controls overnight rate (Japan)

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Sovereign Currency Summary

• Deficit spending creates private financial wealth
• Note that CB operations do not it buys
  government bonds or lends against collateral
  (helicopter drop is fiscal policy)
• CB Lends Treasury Spends
• Doesnt matter whether bonds must be sold
  firstso long as CB accommodates reserve demand
• Doesnt matter whether CB prohibited from buying
  new issuesroundabout through banks
• Doesnt matter whether Treasury must have money
  in its acct at CB to spendCB and banks cooperate

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DOMAR CAPITAL EXPANSION RATE OF GROWTH, AND
EMPLOYMENT

• Equilibrium is defined as position where
  productive capacity (Yp, or potential output)
  equals national income (Ya, or actual output).
• Want to discover the rate of growth at which the
  economy must expand in order to remain in a
  continuous state of full employment.
•  
• Problem of Growth Output must continually grow
  to maintain full emp. Must look at both the AS
  side and the AD side. Not enuf to just look at
  increasing productive capacity as LF grows. Must
  also look at how Y must grow so that AD will be
  high enuf.
•  
• Keynes ignores the DUAL nature of investment I
  increases productive capacity and generates
  income.

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Principles of Functional Finance (Abba Lerner)

• Government should spend more if there is
  unemployment
• ii. Government should supply more money
  (reserves) if interest rates are too high
• NB Budgetary outcome, Debt outcome should
  never be primary consideration

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Without an expansionary fiscal policy, real
output cannot grow for long. Wynne Godley,
2000
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The Private Sector Cannot Create Its Own Net
Financial Assets

• Assets and liabilities cancel each other out
• Loans create deposits
• Net financial assets must come from outside the
  domestic private sector

• Private Sector Public Sector Current
  Account Surplus Deficit
  Surplus
• (S I) (G T) (X
  M)

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What if the CA is Not in Surplus?

• Can the private sector still achieve a surplus?
• Yes, but only if the government deficit is bigger
  than the current account deficit
• EX 1 4 - 3
• This means that countries with current account
  deficits must run even bigger budget deficits (as
  of GDP) in order to keep the private sector in
  surplus

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Importance of Sovereign Currency
The power to issue its own money, to make
drafts on its own central bank, is the main thing
which defines national independence. If a country
gives up or loses this power, it acquires the
status of a local authority or colony. Wynne
Godley, 1992
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Government Foreign Sector Financial Balances
Fiscal Surplus
Current Account Surplus
Current Account Deficit
Foreigners Net Save
Foreigners Deficit Spend
Fiscal Deficit
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Domestic Private Sector Financial Balance 0
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Domestic Private Sector Surplus
DPSFB 0
Fiscal Surplus
DPSFB 1
DPSFB CAB - GFB
DPSFB 2
Current Account Surplus
Current Account Deficit
1
2
-1
Increasing DPS Financial Surplus
-2
Fiscal Deficit
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Permissible Space for Sovereign Issuers
Fiscal Surplus
Current Account Surplus
Current Account Deficit
PSB 0
Fiscal Deficit
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For Sovereign Issuer There are No Market
Constraints

• The treasury can always raise money by issuing
  securities. The bond vigilantes really have it
  backwards. There is always more demand for
  treasuries than can be allocated from a limited
  supply of new issues in each auction the winners
  in the auctions get to place their funds in the
  safest most liquid form of instrument there is
  for US dollars the losers are stuck keeping some
  of their funds in banks, with bank
  risk. Frank N. Newman, 2013

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Private sector surplus
Sustainable Space for Sovereign Issuers
Fiscal Surplus
Current Account Surplus
Current Account Deficit
PSB 0
Fiscal Deficit
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Possible Space for EMU Nations with CA Surpluses
Fiscal Surplus
Current Account Surplus
Current Account Deficit
-3
Fiscal Deficit
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Sustainable Space for EMU Nations with CA Surplus
Fiscal Surplus
Current Account Surplus
Current Account Deficit
-3
Fiscal Deficit
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Possible Space for EMU Nations with CA Deficits
Fiscal Surplus
Current Account Surplus
Current Account Deficit
-3
Fiscal Deficit
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Sustainable Space for EMU Nations with CA
Deficits
Fiscal Surplus
Current Account Surplus
Current Account Deficit
-3
Fiscal Deficit
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EURO Non-Sovereign Currency

• Member states gave up own sovereign currencies
• Adopted a foreign currency, the Euro
• Much like a USA state a user of the currency,
  not issuer
• Constrained in its spending tax revenue, bond
  sales, willingness of ECB to lend
• Problem no fiscal equivalent to Uncle Sam in
  Washington

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Euro is the Problem

• By adopting the euro sovereign nations have
  turned into something like U.S. states.
• Unlike U.S. states euro governments have to fund
  pensions and healthcare
• Euro governments had to deal with banking
  problems in the U.S. the Fed did the bailing
  out.

U.S. States Debt/GDP Ratios (Average 1997-2008) U.S. States Debt/GDP Ratios (Average 1997-2008) U.S. States Debt/GDP Ratios (Average 1997-2008) U.S. States Debt/GDP Ratios (Average 1997-2008)
Alaska 15.7 Montana 12.2
Connecticut 12.1 New Hampshire 13.0
Hawaii 12.2 New York 10.5
Maine 11.0 Rhode Island 16.9
Massachusetts 16.5 Vermont 12.6
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Is the US Unique?

• NOother Sovereigns with floating rates obtain
  the same seigniorage income.
• That ability is related to power to impose taxes
  in the domestic currencyonly the State has this
  power.
• While seigniorage income is sometimes equated
  to the total quantity of net imports, imports
  purchased by the non-sovereign population do not
  provide any free lunch. It is only the portion
  of a trade deficit that is due to sovereign
  purchases that provides a free lunch.

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IMPLICATIONS FOR A SMALL COUNTRY LIKEMexico

• With a floating currency, Mex can exogenously
  set its interest rate
• Mexs national government does not need taxes or
  bond sales to finance budget deficits
• national government bond sales function to drain
  excess reserves from the banking systema part of
  monetary policy that allows central bank to hit
  interest rate target
• Mex can financially afford to buy any good or
  service that it is capable of producing
• Mex can afford full employment indeed,
  unemployment is a cost, employment is a benefit
• a national government budget deficit simply
  finances the non-government sectors desire to
  net hoard High Powered pesos
• a current account deficit finances the Rest of
  Worlds desire to net hoard pesos

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Implications of Alternative Currency Regimes

• Government is monopoly supplier of its currency
  determines conditions of supply
• i) floating affordability is never an issue
  consequences of too much spending include
  inflation, too few resources left for private
  sector, exchange rate depreciation
• ii) managed additional constraintsmaintenance
  of foreign currency, run on currency, currency
  crisis
• iii) pegged additional constraintdefault
• NB in all cases, there are always political
  constraints, operational constraints, myth, and
  misunderstanding

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Conclusions

• Currency-issuing Government spends by crediting
  bank accts, taxes by debiting
• Can always afford to spend more
• Issues inflation, exchange rate effects,
  interest rate effects
• Sovereign currency gives more policy space
• No default risk
• Can control interest rates
• Can use policy to achieve full employment

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What I did and did NOT say

• I did say Sovereign Government faces no
  financial constraints cannot become insolvent in
  its own nonconvertible currency
• But it can only buy what is for sale
• I did NOT say that Government ought to buy
  everything for sale
• Size of Government is a political decision with
  economic effects
• I did NOT say that deficits cannot be
  inflationary
• Deficits that are too big can cause inflation
• I did NOT say that deficits cannot affect
  exchange rates
• Sovereign Governments let currency float float
  means currency can go up and down

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Thank youL. Randall WrayProfessor of
Economics, UMKCSenior Scholar, Levy Economics
Institutewrayr_at_umkc.eduwww.levy.orgwww.economon
itor.com/lrwray/