On 30 March, the Government announced the $130 billion JobKeeper Payment to help keep Australians in jobs as we deal with the significant economic impact from the Coronavirus. This brings the Government’s total support for the economy to $320 billion across the forward estimates, representing 16.4 percent of annual GDP.
How can the government afford this when we have been told for years government spending is too high, we are in desperate need of a government surplus and government debt is imposing a huge obligation on future generations?
The answers to these questions are disarmingly simple. The assumptions in the questions are all false.
Governments with the power to issue their own currency, like the Australian Government, do so by simply crediting the accounts of the recipients of government spending. They do this every day. These expenses are not taken out of some other account containing tax receipts as many people imagine. Neither are they only spent once raised through borrowing. They are just spent by crediting the recipients/ accounts.
A budget deficit is nothing more than a measure of the amount of money spent in this way and which has not yet been taxed back by the government over the budget period.
The Australian Government does not have to finance its spending by raising taxes or by borrowing. It can simply spend by crediting the account of the recipient of the spending which is what it does- taxing or borrowing only after it has spent the money.
So why does the government choose to offset its spending through taxation or borrowing?
One of the main reasons is to control inflation. If there is too much money in the economy chasing too few goods and services increased demand will push prices up. Taxation claws back government dollars that have been spent by the government into the economy so there is less money chasing the goods and services. Taxation is deflationary.
While all spending is potentially inflationary (whether government or private spending) the amount of money in the economy does not determine whether there will be inflation. Inflation only results where the amount of money in an economy exceeds the productive capacity of that economy to produce enough goods and services to absorb the money.
But what about borrowing? If you lived in a village and you had the only printing press in the village, why would you ever borrow money from the villagers to finance your spending? Why wouldn’t you just print more money? Again the reason is inflation. If you put more money into the village economy than the village can produce in goods and services inflation will result. If you want to spend money to buy the village a new bridge, but you do not want to increase the amount of money in the village economy because you are worried about inflation, then one way of doing this is to borrow the money from the villagers.
When the Australian Government wishes to finance spending by borrowing from its villagers (or some of them) it usually does this by issuing government bonds. A government bond is similar to the better-known term deposit that a householder might open in the bank. There are a few differences- the bond requires payment of a principal amount (which is refunded upon maturity), the interest rate (yield) on a government bond is usually higher than a term deposit, the bond is government guaranteed and the bond can be traded by the holder on the secondary bond market before it matures. But basically a bond is just a savings account the bondholder has with the government.
However, this does not answer the question as to why a government would finance spending through debt (issuing bonds) in circumstances like exist now. We have not had significant inflation for years and the pressures brought about by the virus, although uneven, are deflationary in their overall impact.
The answer to this puzzle is that, when the government does not offset its spending through taxation, it chooses to offset it through debt. It does not need to do so. There are at least three reasons for this choice.
First, as SA economist Bill Mitchell has pointed out in an interview with Alan Kohler, in the 1990s when Peter Costello was running budget surpluses there was no need to issue government bonds. But then powerful interests within the investment community complained. They liked to have government bonds which are government-guaranteed to provide a fixed rate of return in order to diversify their investment portfolios and as a benchmark against which to evaluate riskier higher-yielding investment products.
Mitchell has described the contemporary bond market as an unnecessary type of corporate welfare.
The second and more important reason is that pretending that tax or debt finance are the only ways in which governments can finance spending is a way of imposing financial discipline upon governments. Once the public at large realizes that the only limit to spending by a currency-issuing government is inflation then demands upon the government to spend will proliferate.
Basically most economists do not trust our politicians enough to control spending in ways that prevent inflation in the face of such demands. With these self-imposed limits, governments can always answer demands for spending by saying we cannot afford to borrow more or by asking “do you really want to pay more taxes?”
Third, private banks, which are a powerful lobby group, do not generally like government spending. Government surpluses lessen the amount of money circulating in the economy. Government deficits increase the amount of money in the economy. The less money in circulation in the economy the more demand there will be for private bank loans.
It is a legitimate question to ask whether, if not constrained by the requirement to repay debt, governments can be trusted enough not to spend beyond the productive capacity of the economy and thereby cause inflation.
But the Coronavirus crisis, which comes on top of the slower acting, but even more dangerous, climate crisis, raises the question about whether we can afford NOT to trust them.