BEE Partner, South Africa Economy Watch

The International Labour Office (1999) argues:

[A]ny strategy for full employment must be based on a sound macroeconomic framework. To achieve this, unsustainable current account imbalances, or foreign debt accumulation, must be reduced and low rates of inflation achieved. This requires the continuous adjustment of policies, a realistic exchange rate, fiscal discipline and wage moderation (wage increases in line with labor productivity). But in times of global deflation this is not necessarily sufficient as a guide to policy, and a boost to demand may be needed, perhaps going so far as to generate expectations of inflation, in addition to the accepted policy of balancing budgets over the business cycle as a whole (International Labour Office, 1999).

Critics of the Job Guarantee allege that it relies on sustained budget deficits that are untenable. It is true that the government must allow the budget deficit the necessary increases and decreases to maintain full employment for the Job Guarantee to be viable. In this section, we demonstrate that orthodox arguments advising against sustained budget deficits are unfounded. One of the most damaging analogies in economics is the supposed equivalence between the household budget and the government budget. For example, Barro (1993: 367) has written, [W]e can think of the government’s saving and dissaving just as we thought of households’ saving and dissaving.’

This analogy is flawed because it ignores the fundamental difference between the household and government. The household cannot spend before it has sources of finance available (income, savings, borrowing), but must spend to survive. The government, however, can spend without prior financing. Government spending is desired by the private sector because it brings with it the resources (fiat money) that the private sector requires to fulfill its legal taxation obligations. The household cannot impose any such obligations. The government has to spend to provide money to the private sector to pay its taxes, to allow the private sector to save and to maintain transaction balances. Taxation is thus more correctly seen as a vehicle by which the government transfers real resources from the private to the public sector rather than a source of financing for government spending. If people want to save and still be able to pay their taxation obligations in the fiat currency, then there should always be a budget deficit.

The logic, according to those who draw the household analogy, states that to finance the deficit debt would have to be issued. Accordingly bond sales, which will accumulate as debt, finance government. As with a household, rising debt cannot be sustained indefinitely and so spending must be curbed and brought in line with financial reality. In the meantime, demands that debt places on available savings pushes interest rates up and crowds out ‘more efficient’ sources of private spending. These ‘household‘ logicians divide into two camps. In one camp there are the orthodox monetarists who eschew government debt and advocate balanced budgets. Their wrong-minded logic has imposed extremely high macroeconomic costs in terms of lost growth and high unemployment in the western economies since the mid-1970s. The other camp, which includes some Post-Keynesians, while comfortable with using deficit spending to increase economic activity, couches its recommendations in conservative logic bounded by appropriate movements in the debt to GDP ratio. As long as the ratio is stable there is no problem. For example, the Bank of International Settlements (1994) concluded that a deficit is sustainable as long as the government debt to GDP ratio (hereafter the debt ratio) does not increase permanently. A framework for analyzing the relation between deficits and the debt ratio is provided by Bispham (1988) and Glyn (1997).

But when pushed, there is little difference between the two camps. Glyn (1997: 226), an advocate of expansionary fiscal policy to reduce unemployment, however, seems to abandon that logic when he argues, ‘financial markets, the ultimate arbiters of such matters, may look simply at the size of the deficit.’ The BIS (1995: 88) concur, ‘It is difficult to persuade markets that low inflation is sustainable in the presence of large budget deficits.’ Glyn (1997: 227) concludes, ‘Given the experience of the past 20 years it would be difficult to convince that increased deficits at the beginning of the expansionary program would be rapidly scaled down as the private sector took up the main thrust of expansion. There seems little alternative to financing through taxation most of an expansionary programme.’ Further, Glyn (1997: 224) says Mt is misleading to treat them (interest rates) as entirely exogenous. It is likely that beyond a certain level, a higher deficit will lead financial markets to exact a higher real-interest rate.’

The two camps however fail to understand the relationship between fiat currency, public debt and taxation in a monetary capitalist economy, a topic examined by Mosler (1997-98) and Wray (1998). They show the priority of spending and argue that debt issue is not essential for governments to spend beyond tax revenue. Mosier (1997-98) shows that bond issues are essential only to support the cash rates set by the central bank. Deficit spending without Treasury bond sales would generate excess reserves in the banking system, so that government debt helps to maintain a positive overnight interest rate for private banks. Deficits add to the net disposable income of households that provide markets for private production. An endogenous credit economy, then, serves to provide the deposits necessary to make payments, which facilitate production. Higher demand stimulates investment that creates capacity as a legacy to the future. The higher current demand, the higher future productive capacity. Thus spending brings forth its own savings. Savings are not required as a prior pool for spending to occur. The point is clear: When fiat money is used, government spending increases reserves in the banking system. Taxation and borrowing drain the reserves. This gives the clue to the function of borrowing. A deficit generates a net build-up in reserves in the banking system. Spending occurs and private firms and individuals deposit proceeds from selling goods and services to the government in commercial banks, which build up reserves. Unless those reserves are drained from the system, they will earn the official discount rate. The role of the government bond issues is to give these returns a way to earn a return in excess of the discount rate.

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