Re: Debt reduction also creates fiscal space

["John O'Donnell" <jackodonnell@xxxxxxxx>]

Clifford Poirot wrote:
>
> I agree with the idea that a prudently managed fiscal debt can be an
> important instrument in promoting growth. Incidentally, this possibility was
> foreseen and argued for by Hamilton.

In Hamilton's time any debt was only redeemable by gold or
silver coin, not paper issue of the central government. The
consequences of paying debt with interest free paper currency
issued by the same government that issues the debt has no fiscal
consequences; such "purchases" only affect the value of the
monetary unit.

> Similarly, the idea that a deficit, during periods of unemployment or
> falling incomes-that is to say, prudent "leaning against the wind" policy
> leads to crowding in, not crowding out, is quite sensible as well.

Again, debt or deficit by a government that issues the paper to
redeem its own debt only affects the value of the currency and,
in turn, the amount of inflation risk added to interest rates. A
deficit, so long as it remains redeemable in paper issue of the
government incurring the debt, in and of itself has no other
effect.

> However, a persistently large deficit leading to growing debt, especially
> when the deficit is structural (not cyclical) and the debt is accumulated
> for projects that add little to overall employment and investment, does
> force the government to tighten monetary policy and raise interest rates.

Yes, if a government wants to maintain the value of its money
issue it will have to borrow from the open market [i.e. -- Not
from the CB who's holdings of government debt are but an
accounting ruse of government holding its own debt.] which is,
in effect, "tightening" monetary policy. There is no distinction
between structural or cyclical deficit in such instances. There
is only the effect on the value of the currency.

> Over a period of time, this sort of loose fiscal policy (which I contrast
> with "leaning against the wind") also realllocates government spending
> towards paying interest rather than spending on productive investments.

Such "loose" fiscal policy as to maintain the value of currency
by borrowing rather than taxes or other revenue measures will
raise interest rates. However, it does not "reallocate"
government spending as such. Spending is not constrained by the
availability of currency from either taxes or borrowing. It is
only the value of the currency that is subject to such careless
policy.

> Here is a rough analogy. If I borrow to buy a house, that is constructive
> borrowing. If I run up my credit card eating at the most expensive
> restaurants, my future consumption will be harmed. In the 1980's, we ran up
> the nation's credit card. Now, in the 90's and 00's we pay for this in the
> current tight fiscal policy. We are made better off by the current tight
> fiscal policy because we are accumulating space to use intelligent leaning
> against the wind policy in the next recession, while eliminating debt.

This would be true if, as in Hamilton's time, government debt
were only redeemable with substance or the issue of another
issuer. [i.e. -- Such as the debt of some countries payable in
U.S. dollars or Japanese Yen rather than the currency of the
debtor.] However, so long as the debt issue is not so
constrained there is no limit to the amount of debt a national
government can incur. It is also why all the predictions about
impending disaster of the enormous growth in the U.S. debt did
not lead to any great increase in interest rates, inflation or
any other dastardly consequences.

You may want to have a look at my _Can It Be?_ article at:
http://www.geocities.com/CapitolHill/1067/canitbe.html

--
			-- jbod

		Tax Privilege, Not People
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