Friday, 7 February 2020

A new approach to fiscal policy

It’s been twelve years since the global financial crisis brought the world’s economy to its knees. However, after the greatest setback since the Great Depression of the 1930s, there’s little evidence remedies are working.

At the Federal level the government is determined to produce cash surpluses, a supposed indicator of responsible economic management. Yet cash surpluses mean draining more out of the economy by taxation than is returned by spending. When an economy is weak, wages flat, unemployment and under-employment a growing problem, and State governments all struggling to fund services, taking more out of the economy is unlikely to resuscitate the patient.

At the State level the government pretends it is running a surplus when it clearly spends more than it receives.  The government uses the word ‘surplus’ to describe its Net Operating Balance figure. But as its name suggests, this only includes recurrent operating spending, and omits capital spending and equity contributions into government businesses. It’s a misleading measure of the government’s fiscal position.

Shadow Treasurer David O’Byrne ridiculed the government claims of being able to achieve a surplus but in so doing gave tacit approval of the government’s version of a surplus as a desirable goal. It’s not. The unassailable reality is that Tasmania will be running cash deficits for the foreseeable future. There is no alternative. To do otherwise would be grossly remiss. To pretend it’s not is misleading. To continue to conduct an adversarial political exchange on a false premise is derelict. The public discussion should focus on how to fund the inevitable cash deficits of the State government. It’s not a problem unique to Tasmania. It will affect all States.

Let’s sidestep the question of tax reform at this stage. What other possibilities are there? Let’s look at the federal level as any meaningful changes need to start there. There is quite a robust discussion away from the mainstream about additional measures governments can do to revive moribund economies. Helicopter money, printing money are both terms used to describe alternative approaches, but they are pejorative terms rather than useful descriptions.  If a government deficit spends without borrowing it is accused of money printing. If someone want to sound knowledgeable, the term ‘debt monetisation’ may be invoked. It’s made to sound like a path to ruin.

The reality is all government spending, deficit spending or not, follows the same accounting pattern. Both the government’s bank account at the Reserve Bank (RBA) reduces and the payee’s bank account increase. There’s a third party to every transaction, the payee’s bank. Both sides of its balance sheet increase. The extra it owes the payee (a liability) equals the increase in its reserve account with the RBA (an asset). Every time the government spends, bank reserves are boosted. When taxes are paid the reverse occurs.

If a government wishes to deficit spend it can simply do so, creating more reserves in the process. But the deficit hawks say this is money printing and will lead to inflation. This is the dominant mainstream view. But it’s fundamentally incorrect. Inflation occurs when too much money chases too few goods. That’s not the case currently. There’s too little money chasing what’s for sale. Besides extra reserves don’t go anywhere. They are not lent. They only ever get shuffled round the banking system, settling customer transactions with other banks and with governments.

Borrowing is not a prerequisite for deficit spending. Governments can simply spend and create more reserves. The stark choice is between paying interest on extra reserves or borrowing from those reserves, issuing bonds and paying interest on the bonds. The latter adds to government debt. The former doesn’t. Why borrow? In part it’s because bond issuance is a form of corporate welfare for banks. Banks prefer bonds to reserves. They can sell or otherwise trade bonds, unlike reserves.

All around the globe, governments have increased bank reserves enormously without any inflationary effects. In Japan for instance the central bank, the Bank of Japan has acquired half the government’s issued bonds simply by increasing reserves by a similar amount. Why issue bonds in the first place? Why not just deficit spend, create the extra reserves, and pay the minimal interest as required on reserve balances? 

Governments’ primary role is not to achieve a particular fiscal bottom line but to look after its citizens. Tasmania’s deteriorating fiscal sustainability is of critical concern. The writing has been on the wall for a while, but we turn a blind eye and persist with shonky shibboleths, unwilling to contemplate the possibility that something may be rotten. The Federal system is broken. At a time when all States, being service deliverers with backlogs and growing populations, need to run cash deficits, the Federal government is squeezing the economy by taking more out than it should, making it even worse for States whose GST receipts will fall even more. States need a new source of funds and the best available would be funds from the Feds using the untapped fiscal resources at their disposal.

If banks around the world can be rescued with the click of a government’s mouse it would be a simple matter for us to organise much needed funds at the Federal level for spending at the State level. The only obstacle is an unwavering commitment to past failed practices.

(Published in The Mercury 7th Feb 2020)

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