Bill Mitchell – Fiscal space has nothing to do with public debt ratios or the size of deficits

The Project Syndicate is held out as an independent, quality source of Op Ed discussion. When you scan through the economists that contribute you see quite a pattern and it is the anathema of ‘independent’. There is really no commentary that is independent, if you consider the term relates to schools of thought that an economist might work within. We are all bound by the ideologies and language of those millieu. So I assess the input from an institution (like Project Syndicate) in terms of the heterodoxy of its offerings. A stream of economic contributions that are effectively drawn from the same side of macroeconomics is not what I call ‘independent’. And you see that in the recurring arguments that get published. In this blog post, I discuss Jeffrey Frankel’s latest UK Guardian article (August 29, 2018) – US will lack fiscal space to respond when next recession comes – which was syndicated from Project Syndicate. Frankel thinks that the US is about to experience a major recession and that its government has run out of fiscal space because it is not running surpluses. We could summarise my conclusion in one word – nonsense. But a more civilised response follows.

Bill Mitchell – billy blog
Fiscal space has nothing to do with public debt ratios or the size of deficits
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

From Bill in the comments there:

Prakash Loungani — Links

From a new paper by Antonio Fatas:

“This paper studies the negative loop created by the interaction between pessimistic estimates of potential output and the effects of fiscal policy during the 2008-2014 period in Europe. The crisis of 2008 created an overly pessimistic view on potential output among policy makers that led to a large adjustment in fiscal policy during the years that followed. Contractionary fiscal policy, via hysteresis effects, caused a reduction in potential output that not only validated the original pessimistic forecasts, but also led to a second round of fiscal consolidation. This succession of contractionary fiscal policies was likely self-defeating for many European countries. The negative effects on GDP caused more damage to the sustainability of debt than the benefits of the budgetary adjustments. The paper concludes by discussing alternative frameworks for fiscal policy that could potentially avoid this negative loop in future crises.”

The Unassuming Economist
Fiscal Policy and the Shifting Goalposts

Prakash Loungani | Advisor and Senior Personnel & Budget Manager in the IMF’s Independent Evaluation Office

See also

From a new IMF working paper:

“This paper contributes to the open economy local fiscal multiplier literature by estimating regional output and employment responses to federal expenditure shocks in the European Union. In particular, similarly to the literature on foreign aid and growth, I use shocks to the supply of federal transfers (European Commission commitments) of structural fund spending by subnational region as instruments for annual realized expenditure in a panel from 2000-2013. I find a large, contemporaneous multiplier of 1.7 which translates into a cumulative multiplier of 4 three years after the shock. Furthermore, using a novel dataset on bilateral trade between EU regions, I find evidence of demand-driven spillovers up to three years after a shock.”

Fiscal Stimulus in a Monetary Union: Evidence from Eurozone Regions

Also

From a new IMF policy paper:

“This paper reviews the experience with the fiscal space assessment framework that was piloted during 2017–18. In 2016, staff proposed an operational definition of fiscal space and a new four-stage framework for its assessment. These were discussed informally by the Board in June, and a Board paper “Assessing Fiscal Space: An Initial Consistent Set of Considerations”incorporating Directors’ views was published in December. Fiscal space was narrowly defined as the room for undertaking discretionary fiscal policy relative to existing plans without endangering market access and debt sustainability. The framework was developed in response to the need to provide a more systematic approach to assessing fiscal space in the Fund’s surveillance. It was designed as a tool to inform the availability of fiscal space over a 3 to 4 year horizon for discretionary action, as opposed to the optimality of its use. Indeed, it was stressed that the availability of space does not necessarily mean that it should be used or should not be further expanded. The framework was piloted in the Article IV consultations of 34 advanced economies and emerging markets, comprising almost 80 percent of global GDP in PPP terms.”

Assessing Fiscal Space: An Update and Stocktaking

Bill Mitchell — Donald Trump’s tariff hikes are not good policy

I am generally not in favour of trade protection. I grew up in a country that had very extensive protection (tariffs, import quotas) on manufacturing goods, which was justified on a number of grounds – capacity to shift to defense industries; stable employment; and more abstractly, an expression of becoming a ‘modern’ nation, leaving our agrarian roots behind. The initial move to impose high tariffs was that a young industry would take time to develop – the so-called infant industry argument, which goes back to the 1790 Report on Manufactures written by American economist Alexander Hamilton. The problem is that the infant never really grew up and the tariffs just became a cosy rent-sharing margin for unions and multinational corporations. Meanwhile consumers paid excessive prices for deficient-quality motor vehicles (among other products). It is clear that as trade opens up there are workers and regions that lose – and lose badly. The answer is not try to reinvent the past through protection. Rather, it is to use the government’s fiscal capacity to create new opportunities in these regions to ensure that workers disadvantaged by import competition can transit into new jobs with stable incomes. That option is often overlooked because modern governments have become obsessed with austerity. And, as I argue below, that obsession will in the context of Donald Trump’s tariff hikes, work against the European nations that are running ridiculously large current account surpluses....

Bill Mitchell – billy blog
Donald Trump’s tariff hikes are not good policy
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

Bill Mitchell — Fiscal policy is effective, safe to use, and markets know it

The Federal Reserve Bank of Kansas City has just hosted its annual Economic Policy Symposium at Jackson Hole in Wyoming where central banks, treasury officials, financial market types and (mainstream) economists from the academy and business gather to discuss economic policy. As you might expect, the agenda is set by the mainstream view of the world and there is little diversity in the discussion. A Groupthink reinforcing session. One paper that was interesting was from two US Berkeley academics – Fiscal Stimulus and Fiscal Sustainability – which the news reports claimed suggested that governments should be increasing fiscal expansion even though they may be carrying high levels of public debt. The conclusion reached by the paper is correct but the methodology is mainstream and so progressives should not get carried away with the idea that there is signs that some give is emerging, which will lead to more progressive outcomes. A progressive solution will only come when the neo-liberal dominance of my profession is terminated and an entirely new macroeconomics paradigm based on Modern Monetary Theory (MMT) is established. There is still a long way to go though....

This is a must-read for those interested in MMT. Bill also provides links to previous blog posts that are key to understanding the MMT position on fiscal space (policy space) and fiscal sustainability.

The actual constraint is availability of real resources and policy needs to be addressed to effective and efficient use of those limited resources. Financial resources are unlimited for a soveriegn currency so issuer, so policy is never constrained by "affordability."

Policy is too tight if real resources that are available are be idled, which is wasteful and foregoes opportunity. Policy is too loose if effective demand is stimulated in excess of the capacity of the economy to provide goods to meet it, so inflation may result. The goal is run a policy that optimizes use of available resources in the present, while also generating the economic capability to increase real resources for future use.

The purpose of MMT as a "policy science" is showing how this is possible based on the actual operations of a modern monetary production economy. This involves debunking the myths that rest on a failure to correctly understand money monetary operations in the context of the presently existing monetary system, which results in the inability to appreciate the theoretical implications of this for policy.

Bill Mitchell – billy blog
Fiscal policy is effective, safe to use, and markets know it
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

Brian Romanchuk — A SFC Model Of Gold Standard Austerity Policies

This article describes the model that I discussed in an earlier video. Although a Gold Standard is not exactly a pressing topic for most of us, the simplicity of the system makes it easy to demonstrate ways in which we can use stock-flow consistent (SFC) models. In this case, I can explain why austerity was a core component of gold standard thinking....

Why should you care about the gold standard? Because Alan Greenspan said that central banks act as if the world is still on the gold standard. This demands a tighter fiscal stance and more cramped fiscal space than operating under the floating rate monetary system that exists now. The result is demand insufficient to economic potential.

Bond Economics
A SFC Model Of Gold Standard Austerity Policies
Brian Romanchuk

Ellis Winningham — Finding Cuts to Pay For Federal Spending is Obsolete

Ellis Winningham explains the difference between the pre-1971 international gold standard regime and the present monetary system with respect to fiscal space and fiscal stance.

Ellis Winningham — MMT and Modern Macroeconomics
Finding Cuts to Pay For Federal Spending is Obsolete
Ellis Winningham

Carlos Maciel — Brazil May Be About to Give Up its Financial Sovereingty

Temer and his cabinet, who have been working towards the implementation of austerity measures in Brazil since they came to power, have proposed a constitutional amendment that will severely limit Brazil’s flexibility in government spending.

The Minskys

Brazil May Be About to Give Up its Financial Sovereingty
Carlos Maciel

Alexander Douglas and Neil Wilson At Medium on MMT and New Keynesianism

Alexander Douglas At Medium
More on Keynesianism, MMT and interest rates

Neil Wilson comments

Neil Wilson at Medium

My sense is that this has not been the New Keynesian position until very recently, if most New Keynesians even hold it now. Ii is basically saying the MMT is correct with respect to its analysis of monetary economics and functional finance, and that central bank monetary policy is designed to increase fiscal space to make room for public spending by controlling incipient inflation that fiscal injection might cause as the economy approaches capacity.

Bill Mitchell — The ‘fiscal space’ charade – IMF becomes Moody’s advertising agency

MMT versus austerians on defining fiscal space.

The IMF define – Fiscal Space – to be the :

… room in a government´s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy. The idea is that fiscal space must exist or be created if extra resources are to be made available for worthwhile government spending. A government can create fiscal space by raising taxes, securing outside grants, cutting lower priority expenditure, borrowing resources (from citizens or foreign lenders), or borrowing from the banking system (and thereby expanding the money supply). But it must do this without compromising macroeconomic stability and fiscal sustainability – making sure that it has the capacity in the short term and the longer term to finance its desired expenditure programs as well as to service its debt.

It is always good to work with first principles as they will rarely lead you astray. They cut out all the humbug in the media, the statements by politicians and the ideological ravings of vested interests. 

The above definition is not based on first principles but is an ideological statement. It assumes that the government in question has the same constraints that restricted governments during the gold standard when currencies were convertible and exchange rates were fixed....

On December 20, 2011, the credit rating agency Moody’s released a special report – Fiscal Space. This paper informs Moody’s – fiscal space tracker, which purports to present a “fundamentals-based measure of the risk of sovereign debt default”. 

The analytical framework used by Moody’s comes directly from the 2010 IMF paper. The credit rating agency just mimics the approach outlined in that 2010 Staff Position Note.

Bill contrasts this with MMT analysis of fiscal space in the existing floating rate monetary system in which governments are not obligated to exchange their currencies for anything other than themselves. In a fixed rate convertible system, government is contained by a real good that it must obtain. In a floating rate non-convertible system, this constraint is absent for government that issue their own currencies and do not incur obligations outside it, so their real constraint is availability of resources and their financial constraints are domestic price level and foreign exchange rate.

Policy-wise, understanding fiscal space is perhaps the most important aspect of MMT in that policy hangs on the effective and efficient use of fiscal space for achieving public purpose in accordance with democratic principles and processes. MMT analysis of fiscal space illumines the boundaries of policy space.

Bill Mitchell – billy blog
The ‘fiscal space’ charade – IMF becomes Moody’s advertising agency
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

Ralph Musgrave — Fiscal space is hogwash

Ralph shows how it is policy space that is important rather than fiscal space. A country that issues its own non-convertible floating rate currency and doesn't accumulate debt not denominated in its currency has policy space that is limited only by inflation since it cannot become insolvent and can always funds its needs directly as long as real resources are available.

Read it at Ralphonomics
Fiscal space is hogwash

by Ralph Musgrave