Urgently Needed Deficit Financing No Excuse for More Fiscal Abuse Jomo Kwame Sundaram and Anis Chowdhury

Fiscal and monetary measures needed to fight the economic downturn, largely due to COVID-19 policy responses, require more government accountability and discipline to minimise abuse. Such measures should ensure relief for the vulnerable, prevent recessions from becoming depressions, and restore progress.

They should help the most helpless, especially in the informal sector and casual employment. Efforts should also seek to accelerate structural transformation towards the Sustainable Development Goals (SDGs). Progress was already falling behind before the pandemic, e.g., on mitigating global warming.

Unconventional measures

The pandemic and policy responses have created a most unusual situation, demanding extraordinary policy responses to mitigate threats to livelihoods and incomes. Bold initiatives are needed to overcome obstacles to sustainable development.

Unconventional solutions need to be considered as the conventional wisdom is part of the problem, especially since the neoliberal counter-revolution against Keynesian and development economics four decades ago.

In recent decades, counter-cyclical fiscal policies over business cycles have been replaced by annually ‘balanced budgets’ and ‘fiscal consolidation’. This has involved spending cuts for public, including social services, and social protection more broadly.

Taxation has become more regressive, with lower direct tax rates, on wealth as well as corporate and personal income, as indirect taxation, mainly on consumption, has grown. Such tax reforms and regressive government spending have worsened inequality.

Deficit financing inflationary?

Publics often presume that governments tax first in order to spend. In practice, they usually spend first, and then tax. Government spending typically requires more borrowing and debt, traditionally by selling bonds and other securities, including to the central bank.

Selling government treasury bonds to the central bank increases money supply, unless the monetary authority correspondingly reduces its other liabilities. Neoliberal critics insist that increasing money supply, popularly referred to by the media as ‘printing money’, must inevitably worsen inflation.

However, there is overwhelming empirical evidence to the contrary as the US Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan greatly increased money supply over the last decade. They mainly did so by buying private securities, and getting commercial banks to lend more at lower interest rates.

Incoherent, unsupported objections

The ‘Ricardian equivalence’ objection is very different, claiming that when governments borrow, people spend less, in anticipation of higher taxes. This supposedly undermines the intent of greater government spending to raise aggregate demand. But again, there is no strong supporting evidence for this effect.

This argument is not only quite different from the earlier ‘crowding out’ and inflation objections, but also implies that the three neoliberal arguments against deficit financing are mutually contradictory and cannot be coherently sustained.

In contrast, the International Monetary Fund (IMF) found that “debt-financed projects could have large output effects without increasing the debt-to-GDP ratio, if clearly identified infrastructure needs are met through efficient investment”, accelerating recovery from the global financial crisis (GFC).

Similarly, in response to the pandemic induced recessions, the IMF argues that “increasing public investment … could help revive economic activity from the sharpest and deepest global economic collapse in contemporary history”.

‘Sound finance’, fiscal rules

Unfortunately, expansionary fiscal policies are often abused by ‘short-termist’ governments of the day, little concerned about the long- and even medium-term consequences of increased spending, borrowing and debt.

In response, neoliberals invoke ostensible ‘sound finance’ principles. Sound finance seems desirable when spending abuse, wastage and leakages are widespread. However, it has become a pretext for dogmatically opposing bold fiscal measures, however much needed. Neoliberals want fiscal rules to straight-jacket governments, obliging the authorities to balance budgets annually or keep fiscal deficits minimal. Many advocate independent fiscal boards, akin to politically unaccountable ‘independent’ central banks, ostensibly to minimise political influence on government budgetary decisions.

Even when fiscal rules or boards allow some flexibility in times of crisis, or in response to severe shocks, biases towards ‘fiscal consolidation’ and pro-cyclicality run deep, undermining development efforts. Hence, fiscal rules typically hinder, rather than help development.

Counter-cyclical, developmental ‘functional finance’

Instead, ‘functional finance’, proposed by Abba Lerner to mitigate prejudice against fiscal policy activism, is needed. Government spending and taxation policy should instead be consistent with counter-cyclical and developmental fiscal needs.

This was recognised by the Development Committee of the World Bank and IMF in Fiscal Policy for Growth and Development: An Interim Report which observed:
“the problem of fiscal policy design is a reflection of the choice of the fiscal deficit as the policy target. The fiscal deficit is a useful indicator …, but it offers little indication of longer term effects on government assets or on economic growth… There is clearly a need for fiscal policy to incorporate…the likely impact of the level and composition of expenditure and taxation on long-term growth while also maintaining a focus on indicators essential for economic stabilization”.

Oppose abuse, not more spending

Poorly accountable governments often take advantage of real, exaggerated or imagined crises to pursue macroeconomic policies to secure regime survival and to benefit politically well-connected cronies and financial supporters.

Undoubtedly, much better governance, transparency and accountability are needed to minimise the likely immediate and longer-term harm due to ‘leakages’ and abuses associated with increased borrowing and spending.

There has to be much greater discipline and stricter scrutiny of government borrowings, spending and debt, as well as of government-guaranteed liabilities. Consistently counter-cyclical fiscal policy over the course of business cycles provides useful guidance.

Publics and their political representatives, especially in developing countries, must develop more effective modes of disciplining fiscal policy conduct to ensure space for responsible counter-cyclical and developmental spending. However, that task should not block the efforts urgently needed to finance relief, recovery and sustainable development.

Central banks must support governments’ fiscal stimulus packages for relief, recovery and building a better future. This requires complementary fiscal and monetary policies working in tandem for sustainable development.

As such unconventional monetary policies, including ‘quantitative easing’ (QE), in the last decade did not raise prices, there is no reason to presume that central banks buying treasury bonds – to pay for relief, recovery and building a better future – will be inflationary.

Deficit spending ineffective?

Governments can also borrow from the public, e.g., by selling bonds to them. But according to neoliberal beliefs, borrowing from the public will raise the interest rate, ‘crowding out’ private borrowers who cannot afford the higher ‘costs of borrowing’. Hence, they claim, investments will fall, slowing growth.

But for Keynesians, government spending is not inflationary when economic resources are not fully employed or utilised, i.e., as long as there is idle excess capacity, e.g., unemployment.

Keynesians also reject the neoliberal claim that public investment will ‘crowd out’ such private spending. Keynesians stress that economic stagnation discourages private investment. By boosting demand and sales, government spending increases private profits and investment.

Declining private spending or demand thus requires government spending to boost aggregate demand. Government spending on infrastructure, health and education also improves productivity, and hence profitability, offsetting higher borrowing costs. Thus, government spending serves to ‘crowd-in’, not ‘crowd-out’ private investment.

(This article was originally published in Inter Press service (IPS) news on December 8, 2020.)