Written By: - Date published: 9:00 am, March 8th, 2018 - 128 comments
Categories: Amy Adams, Economy, Financial markets, infrastructure, jobs, Keynes, Steven Joyce, tax - Tags: debt, imaginary holes, Modern Monetary Theory
We’re hearing a lot recently about fake news, and with the debates from different sides of the political spectrum so polarised, it can be difficult to even know what’s real. So let’s take a break for a moment and talk about the theory of something we all agree is made up: Money. I thought those of you not wanting to read about the TPP could enjoy an alternative post, and we did happen to have a replacement to one Steven Joyce announced recently.
Amy Adams has now replaced him as Shadow Finance Minister, a position she will likely still face gendered critiques for, (hopefully not from government MPs, but likely from members of the public) as only one woman has done the job of Finance Minister in New Zealand before, and she definitely faced gendered critiques. (A man who did what Ruth Richardson did would likely not have been so universally reviled after the fact, sadly, and may arguably have been regarded as a sound but mean-spirited fiscal manager. Instead, sexism arguably balanced out right-wing propaganda on the economy, and we coincidentally viewed Richardson roughly accurately, which probably felt unfair to her National supporters) I thought I would instead bust in with a hopefully non-gendered criticism that is largely of her backing of her predecessor’s ridiculous claim that Labour will face any sort of “fiscal tightness1,” and her refusal to fill in this imaginary hole they’ve been digging themselves into.
What Grant Robertson may face is difficulty in meeting the BRR promise to bring the debt-to-GDP ratio down to 20% within 5 years, although I will note that the Budget Responsibility Rules were openly predicated on kicking in after under-investment in housing, education, health, earthquake recovery2, and transport had all been handled, which is clearly a much bigger problem than we ever guessed during the election campaign, so if Robertson does have to abandon cutting 5%ish off our debt-to-GDP ratio, he is still soundly within the BRR’s principles, which Joyce has carefully ignored the contingent part of.
This post is going to be heavy on the economics, so apologies in advance, but you all probably know by now my penchant to be heavy on policy and theory. I will try to be available for Q&A or clarification in the comments over the next day or two if you liked the general message but don’t understand all the details, and I’m sure invitably I will have made some mistake or other here.
So, before we discuss why Joyce (and by extension, English and Adams) were wrong, let’s talk very quickly about Modern Monetary Theory. Those of you who remember discussion of Keynesian Economics on The Standard during a prior recession and how it was generally favourably regarded may see some similarities to the idea of counter-cyclical spending here, but without the talk of cycles because in reality that’s a little simplistic.
Modern Monetary Theory (from now on, MMT) is interested largely in countries with a sovereign currency. (for example, the UK Pound is sovereign, the Euro in, say, Greece, isn’t. Being the country in control of creating and destroying a type of money is the relevant thing) Rather than being overly concerned with cycles like Keynes, MMT instead reframes that concept by talking about the overall supply of money3 and whether it is sufficient, too scarce, or too common for the desired supply of real goods and services available within a country, and advocates using fiscal policy to control both inflation and unemployment by trying to get this number exactly right in terms of both supply and circulation of money.
The key to understanding MMT is to think of net government spending as creating money, and net government surplus as destroying it- this is precisely backwards to our usual thinking of budgets, but it is actually precisely accurate in terms of how fiat money, the type of currency we all trade in today, works. MMT claims that the idea of government ever having difficulty “funding” its spending projects is complete nonsense, at least so long as the government has citizens with useful skills and products to sell as taxpayers, and overseas investors who demand its currency. Taxation has a triple purpose under MMT: create demand for official government money, the only way to pay taxes, to change behaviour in the case of tax differentials or sin taxes, and as a means of controlling inflation. (In reality, we actually do borrow money, rather than print it all when we go into deficit, because it has a better record of cushioning inflationary effects, but the important thing is that we retain the option to print money if we need to, which inherently improves our financial position) If those citizens make your resources into useful products, and offer useful skills, and you have access to the infrastructure you need to transport goods around and people to places they can use your services, then you have created significant demand for your fiat currency.
From this perspective, initially, the idea of limits on government spending for a country like New Zealand seem something of a nonsense- money is imaginary, we can just wish debt out of existence, and hey! We’re done!
In reality, debts paid off or recessions powered through by increasing the money supply are often inflationary4, and inflation acts a lot like a flat tax on the economy, meaning that things causing significant inflation are undesirable. Bubbles burst by decreasing the money supply through surplus, on the other hand, tend to suppress employment, which is good if you expect your economy is overall in a bubble, but terrible if you’re in recession. This is why to some degree Keynesianism worked- because often, surpluses in boom times and deficits in lean times are advisable, so long as your economy tends to balance well between recession and growth. There’s also another illusive factor- believing does, to an extent, make it so in the world of finance- business confidence is important regardless of how economics actually works before you factor it in, so the attitudes of a country towards the economy to some degree shape reality. In reality this is probably the starkest limit on New Zealand’s finances, because business here doesn’t seem to understand, the way say, business in Japan does, that a relatively high debt-to-GDP ratio isn’t necessarily a bad thing in a country with a sovereign currency and enough goods and services to buy with such an enlarged supply of government-backed money, and it believes in the fallacy that a government’s budget is like a household budget.
Now, we’ve got the basics down. Let’s look at New Zealand’s specific fiscal position, and you’ll also understand why I’ve mentioned certain examples as I get through this.
New Zealand’s debt-to-GDP ratio is, as of 2016, at about 24.6%, and is long-term is predicted to stay around the same level. Amy Adams claims Labour will need to add an extra $10b to that debt to meet its non-fiscal promises without raising taxes, which with some back-of-the-envelope calculations based on a GDP of about NZ$253.7b in 2016, would be a roughly 4% increase assuming 0% growth5. National’s “fiscal tightness” nightmare scenario is roughly an extra 4% debt-to-GDP, an astounding 28.6% total, even if we round up. This is me being incredibly friendly in my assumptions to Mr. English, Mr. Joyce, and Ms. Adams.
28.6%, nay, even 30%, is nothing in terms of debt-to-GDP ratio. While it might make business a little grumpy in New Zealand, in international terms, that wouldn’t scare a mouse. Labour has proven they can pay off more than 20% of GDP in three terms, easy, which is actually pretty amazing given they did it without austerity policies. With said austerity policies, National has added roughly 19% debt-to-GDP to our ratio, depending on how you measure. It took Greece, a country with no sovereign currency, a debt-to-GDP ratio of over 100% to enter a sovereign wealth crisis. And even that is no guarantee of disaster. Japan, a country with a sovereign currency, excellent natural resources, great technology and infrastructure, (arguably because of their debt) and rock-solid business confidence, maintains a whopping debt-to-GDP ratio of over 250% with no significant ill effects to date, other than perhaps an addiction to deficit spending. Even if we assume the point of runaway inflation is 80%, much less generous than what happened in Greece, which has a fundamentally weaker position than New Zealand does thanks to the Euro, we wouldn’t even be halfway there. We would still be in a very low-inflation position.
And we are definitely nowhere near at risk of even needing to use quantitative easing to pay back debt yet, let alone having high inflation. The only constraints on Labour’s deficit spending to address the social infrastructure problems created by nine years of John Key and Bill English are self-defined ones.
While I am fine with many of the Budget Responsibility rules6, Labour should understand that rather than always wanting to reduce debt, it should instead always be capable of reducing debt, but it should, ideally, wait to do so until our economy is overheated and needs a dose of cool water to start running surpluses, like Cullen did. It puts the country on the most solid of financial grounds, and by refusing to give up deficit spending during lean years, it sets us up to run those surpluses later.
The party should also understand that if inflation is a problem, the solution, to a reasonable extent, is new taxes. Kiwis are pretty under-taxed by OECD standards, at 17.9% average tax for single people, and 6.2% for a couple with children, we are either second-lowest, or lowest among the OECD in 2015, and we have noticable gaps in our wealth tax profile, creating perverse investment incentives.
As usual, the Greens have the obvious policy here: let’s have a tax on realized capital gain. (that is, your net profit from selling capital wealth, like a house. So you’d only pay it if you made an overall profit a year, for most people, by moving from a more expensive house or more expensive housing market, to a cheaper house or cheaper market. Selling a cheaper house and buying a more expensive one would incur zero tax) Genuine landlords could buy properties with the intent of holding on to them for the rent, but speculators and renovators would now pay tax on their income. The Greens propose excluding the family home, but I actually think we could go further and consider whether that’s unnecessary- if an exemption is required, we could try a lifetime sum exemption, (eg. your first $100,000 of capital gains are untaxed) but I think we could actually trial a CGT with no exemption at all, and the only people likely to be effected would be those moving to a cheaper home to pay off a mortgage lump sum, those selling a house they’re underwater on, or to buy some highly expensive but very necessary item or service. If we do need policy to address those situations, though, we could potentially allow those paying off their only mortgage to consider that a capital loss.
In conclusion: National is trying to manoeuvre the Labour-NZF-Green government into sacrificing deficit spending with its economic rhetoric, when in fact they should concentrate on increasing wages, balancing spending to the productive economy and against inflation and unemployment, and spend to address the infrastructure deficit, ignoring the debt entirely until such time as the economy starts over-performing, and then start running surpluses.
1 This is a Joyceism, not an actual economic term, as far as I can tell, as the closest term seems to be “tight fiscal policy,” which actually means deliberately slowing down economic growth to pay off debt or prevent a bubble. This is one of the many reasons Joyce has left National a legacy of financial illiteracy. So I have translated it to “unacceptably high risk of inflation to perform to the set policy goals under sensible fiscal settings” in actually meaningful words, as even Joyce’s explanation of being unable to pay for things is absolute rubbish. Robertson would probably not spend significantly less than promised on anything, but might engage in quantitative easing, or borrow money to dig us out of National’s very real hole of underinvestment before risking a default, because he is actually capable of passing his university papers.
2 For various reasons relating to my former employment there, I’m not going to discuss EQC too deeply on this blog. I don’t expect any legal issues but wouldn’t want to bring any down on this site by accident. I talk politics on @MJWhitehead on twitter, so if you want to ask me questions or discuss EQC in general, that is the place. I have my defenses of it and my criticisms. My expertise was in contents, invoice reimbursement, (internally it was called Urgent Works) small-value building cash settlement, and on-average-small-value cash settlement for multiple-unit buildings. (I can only give general impressions on anything else) I have gone into a bit of detail here because I expect this subject not to be mentioned in the comments please. (I also won’t hesitate to block people who come troll my twitter account, but will be patient with genuine concerns and questions) Kia ora.
3 Money, as opposed to Credit. Money is the thing you have when you’re holding a ten dollar note. Credit is what you have when you take out a mortgage, or look at the number in your bank account, and it is even more imaginary than fiat money, because it’s effectively speculating on the likelyhood that you don’t actually want to take your money out of the bank beyond the automatic tax deductions. (which aren’t imaginary) If we start talking credit too much, this will turn into an entire 101 course, and I’m not sure I’m qualified as a teacher to go into that level of detail on this subject. Seriously, I will make you fail your Econ 101 exams. I know the bits relating to government policy chiefly, not the rest, and I cheated by having a professional economist to discuss things with.
4 With the caveat that nobody really understands accurately just how or how much various factors cause inflation, we just have a bunch of experimental results with no good controls. It’s entirely possible there’s a way to do QE (deficit spending without borrowing, aka. printing money) without uneconomic long-term inflation, and there are definitely specific short-term situations in which it’s advisable because letting a depression start is more wasteful than the inflation cost, but overall, it weakens your economic position if the reason your circulation is too low is because you genuinely have enough government money in your economy, but it is, for example, locked up in unproductive investment due to poor tax incentives, such as holiday homes. This is, coincidentally, an excellent theoretical explanation for the observations in the Spirit Level: inequality is costly to the economy overall because money is invested in things that aren’t productive, and circulates too slowly because it is disproportionately saved by the rich, causing inflation as governments add more money to the economy to compensate for the slowing effect that has on growth.
5This is an outrageously friendly assumption to Ms Adams that she does not deserve, but I am making a point about how extraordinarily weak her claim of Labour’s “fiscal mismanagement” is. I have also been very fair to her by characterising her stance as “tripling down.” We’re probably now to “quintupling down” if you count multiple attempts to find anything even slightly resembling a hole by Mr. Joyce, after completely abandoning any pretense he can in fact read spreadsheets, add up to 11.7 billion, or indeed, use terms from economics to describe what his dislikes about his opponents’ fiscal plan.
6The bits of fiscal policy Labour has tried to lock us (both the nation and the Greens) into in a defensive gambit that are the most problematic are the “no new taxes” and “reduce debt to 20% of GDP” bits. I will say that these items are highly controversial and do not necessarily have the same sort of mandate from Green members that their own policy package does, or even the rest of the budget rules. There is no particular advantage to keeping a low debt-to-GDP ratio and looking more fiscally tight in the long-term than your neighbours, (and that, National, is how that term is actually supposed to be used) other than if you want to improve your country’s credit rating, which I don’t think we’re in urgent need to do, quite frankly. Germany, a country whose fiscal policy has been described as unnecessarily fiscally tight compared to the rest of the Eurozone, has three times more debt-to-GDP ratio than Labour wants to maintain in the long run. I think sticking to half or two-thirds of Germany’s example is perfectly adequate.
Image Credit: http://www.wcn.pl/sklep/menu/banknoty1941.html, through Wikipedia, using CC-BY-SA license. This is an actual example of hyperinflation in pre-war Germany. (Edit: Wayback machined the URL)