One of My Replies to George Kendall on UK Budget Deficits
George Kendall, Andy Blatchford, Peter Martin and I have been having a pleasant, albeit a bit frustrating discussion. Frustrating because the now defunct Bretton-Woods system always manages to obstruct progress towards an understanding of macroeconomic reality. This morning, George replied to Peter and myself, demonstrating that the Bretton-Woods obstruction is still very much alive and well. We can thank orthodoxy for that. Since I’m always on the lookout for opportunities to impart knowledge to the layperson, I thought it a good idea to post George’s comments and mine here as a learning opportunity.
George says:
“I'm still rather baffled by what you guys are saying.
If I've understood correctly, Peter Martin has said that all MMT wants is the Bank of England to raise the target for inflation to 3 or 4% for a couple of years. He's also said that we should return to the policies the UK followed between the end of the war and the seventies.
Then I read remarks like the following: "There is simply no need to intentionally reduce the budget deficit. As I've mentioned elsewhere many times, when the economy moves towards full employment, tax receipts automatically increase as more people are working, which then automatically reduces the deficit towards a condition of balance."
Using words like "there is simply no need to intentionally reduce the budget deficit" sound to me like Venezuela, not post-war Britain.
In post-war Britain, according to the following graph http://prntscr.com/bffq8r , the UK had budget surpluses between at the end of the forties, and near balanced budgets in the late fifties. There was the foundation of the NHS and a massive house building programming, but in other areas there will have been considerable austerity.
Indeed, almost every UK government in history has practiced restraint. Public spending has a tendency to increase, unless actions are taken to constrain it, so even in boom times, if a government wishes to fund new initiatives, they have to constrain spending in certain areas.
I'm not sure of your politics, guys, but when you use phrases like "there is simply no need to intentionally reduce the budget deficit", loud alarms bells go off in my mind.
In my student days, I knew a number of revolutionary communists. I heard of some who voted for Thatcher, because they thought the more rightwing the government, the more likely a crisis that would make the revolution happen.
I presume you would be horrified to be associated with such people, but when you use words that imply that budget restraint is never necessary, those are the people you sound like.
How about, instead, saying: "budget deficits are only a problem if there's a risk inflation will get out of hand"? If I've understood you correctly, and I'm still very confused, that should capture what you're saying, without making you sound like the minister of finance for Zimbabwe.
Words are slippery things in politics. How people speak is often more revealing than the precise logic of what they are saying (hence why I wrote that article). If you get upset about being misunderstood, it might be helpful to use different language.”
My reply to George follows below:
George, allow me to better clarify the position. The reason why "there is simply no need to intentionally reduce the budget deficit" sounds odd to you is because it doesn't apply to post-war Britain (1946-1971). My statement applies to post Bretton-Woods Britain (1971 - Present).
Post-War Britain participated in the Bretton-Woods fixed exchange system (US dollar standard). The US government would convert $ into gold at a fixed rate of $35 per ounce. The gold was the price anchor. So Britain would amass US dollar reserves and if it ran a trade deficit, it would exchange GBP for dollars and then back again, thus reducing the trade deficit and providing a stimulus for the British economy. The problem was that Britain had to maintain the exchange parity with the dollar through monetary policy, therefore, fiscal policy (the ability to expand budget deficits) was voluntarily constrained.
Should the exchange rate be threatened (too much GBP in foreign exchange markets), the BoE had to “mop up” or buy GBP using US dollars. In doing so, the money supply would fall and unemployment would rise, sending the economy into a downturn.
Thus, if Britain expanded its deficit to reduce the unemployment level, the exchange rate would be adversely affected and so, using monetary policy to defend the exchange rate, Britain would then buy up GBP reducing the money supply and cause rising unemployment again. As you can clearly see, the government of the UK was fiscally restrained by the Bretton-Woods system. However, US president Nixon ended Bretton-Woods in 1971.
In post Bretton-Woods Britain, GBP floats freely on an exchange, its exchange rate relative to other currencies is determined by market forces, the UK government no longer agrees to convert GBP to anything but GBP and issues GBP by fiat. Since Britain no longer must maintain a fixed exchange parity with any currency, today, the government of the UK can issue GBP at will, as much as it sees fit for any purpose. In short, because of the end of Bretton-Woods, the supply of GBP available to the UK government is always equal to infinity. The UK gov now enjoys the freedom and ability to buy whatever is for sale in GBP. Taxation today is no longer a funding mechanism, since the GBP is fiat and there is nothing to defend. Taxation serves to reduce spending power, thereby reducing inflationary pressures should they arise.
Note that just because the government of the UK has an infinite supply of GBP, does not mean that it can spend to infinity. Deficits too high can become inflationary. If deficit spending exceeds the real ability of the British economy to produce goods and services, then inflation would result. But, if the deficit is intentionally reduced prior to maximum output or the deficit is too low, unemployment will result.
So, today, in post Bretton-Woods Britain there is simply no need to intentionally reduce the budget deficit, because when the economy moves towards full employment, tax receipts automatically increase as more people are working, which then automatically reduces the deficit towards a condition of balance.
