William Hogarth: Gin Lane: The Original "Culture of Poverty"...
Liveblogging World War II: April 30, 1944: The Russo-German Front, December 2, 1943-April 30, 1944

Worthwhile Canadian Initiative: Functional Finance vs the Long Run Government Budget Constraint: Hoisted from Other People's Archives from Three Years Ago

Nick Rowe: Worthwhile Canadian Initiative: Functional Finance vs the Long Run Government Budget Constraint: "Functional Finance says you only use taxes...

...if you want to reduce Aggregate Demand to prevent inflation. The Long Run Government Budget Constraint says you use taxes to pay for past, present or future government spending. They sound very different. They aren't. There's a general principle in economics: first you eat the free lunches; then you  look at the hard trade-offs. Functional Finance says "first eat the free lunches". The Long Run Government Budget Constraint says "then look at the hard trade-offs".

Suppose, just suppose, that if you kept on doing what you were planning to do, you never had to worry about inflation. Not now, not in the future, not ever. Because Aggregate Demand was too low now, and was projected to be too low forever.... You would print money and spend it. Or print money and use it to finance tax cuts. And you would keep on doing it, more and more, until you got to the point where you did start to worry about inflation. You first eat all the free lunches. That's the underlying kernel of truth in Abba Lerner's Functional Finance.... And I don't know of any mainstream macroeconomist who would disagree. You use taxes only so you don't have to print money. When you get to the point that Aggregate Demand is high enough, so you start to worry about inflation, you use taxes to finance past, present, or future government expenditure precisely because you don't want to print more money and make inflation higher.

Suppose inflation isn't a problem right now... Does that mean the government should print money and spend it? Not necessarily. Print money yes, but instead of spending it on goods, or on tax cuts, it might be better to use it to buy back some interest-paying government bonds. Because even though inflation isn't a problem right now, it may be a problem some time in the future. So you can buy the money back in future, by re-issuing the bonds (and save on interest in the meantime) without having to raise future taxes or cut future spending.... Print enough money to get Aggregate Demand and inflation where you want it to be. That's the free lunch.... Any additional government spending must be paid for, sooner or later, with taxes. The present value of taxes, plus the present value of newly-printed money (seigniorage), equals the present value of government spending, plus the existing debt....

Let's ask a slightly different question. Why do governments pay interest on their debt? Actually, it sounds like a different question, but it's really the same question. Why finance government deficits with interest-paying debt, when you could use non-interest-paying currency? The answer is the same: you pay interest on the debt to encourage people to hold it and stop people spending it. If you cut the interest rate on government debt, will people sell it back to the government for money, spend the money, and cause inflation? If not, then Aggregate Demand is too low... there's a free lunch from cutting the interest rate on government debt. And the government should eat that free lunch....

Now suppose the real rate of interest on government debt is below the real growth rate of the economy.... And suppose it will be like that forever, if you keep on doing what you were planning to do.... The Long Run Government Budget Constraint is undefined. The Present Value of taxes can be less than the Present Value of Government spending. That's another free lunch that needs eating. The economy is dynamically inefficient. The economy wants a Ponzi scheme. And the government should satisfy that demand...

Comments