Godley further shows that under all scenarios, debt/gdp stabilises at some combination of interest rate, growth rate and primary deficit/surplus – provided there is full employment. So debt/gdp does not “spiral out of control” if government produces as much of it as people need in order to save. On the contrary, in my view government creating a plentiful supply of safe assets is essential for financial and economic stability. Deliberately restricting the supply of safe assets by, for example, running a primary surplus in combination with low interest rates (so debt/gdp falls) causes instability: when government doesn’t create enough safe assets, the private sector creates faux safe assets, which give the impression of being safe when they are not and are consequently mispriced. When the inadequacy of private sector “safe assets” is exposed, there is a violent crash and a flight to real safe assets, creating bubbles. The 2008 crash was not caused by investors seeking too much risk: it was caused by investors looking for safety, and the private sector attempting, and disastrously failing, to provide it.
But of course we don’t have full employment, so our ability to support even the safe assets we already have is curtailed, and lots of people are struggling to maintain essential consumption because their incomes aren’t high enough. For these people, saving is a distant dream. Maybe that’s what we should be concentrating on, really.Credit Writedowns
Wynne Godley: Interest rates, growth and the primary balance
(h/t Lambert Stether at Naked Capitalism)