A major problem for economies around the world is government debt. This matter has been mentioned in other posts. Many governments have been running a deficit on their annual budget for years. It is not universally realised that these deficits are cumulative. A smaller deficit in the current year than in the last does not mean that government debt has fallen. Every year in which there is a deficit of any size adds to the overall government debt. At one time, merely paying interest on the accumulated government debt was the third largest item in the annual budget of the U.S.A, after social security and defence, and the second largest item on Sweden’s budget after social security. These payments merely take care of interest and do not reduce the principal.
Merely running reduced deficits or balanced budgets does not reduce this burden of interest payments. It is necessary to run a surplus, year after year, and plough it straight back into reducing the principal. The effect of such a procedure, through raised taxes and reduced government spending, is considerable.
Three questions arise:
(i) Why do such debts pile up?
(ii) Do they matter? Do they need to be paid back?
(iii) How can they be paid back without economic dislocation and upward pressure on unemployment?
First, the debts are incurred mainly for two reasons that have already been discussed in other posts and will be recapitulated briefly here.
The deficit financing that helped the world out of the Great Depression was long thought to be a general remedy for any economic slowdown. In fact it was a good specific remedy for the particular type of slowdown that the Great Depression was, but for modern recessions it was necessary to go back to Keynes’ theory and use it to devise different remedies. To use the Great Depression method actually aggravated the modern disease it was meant to cure and created an ever-growing public debt.
Helping this was the implicit assumption that involuntary unemployment was solely a function of the economic “growth” rate (i.e. throughput increase, TI) without any other factors affecting it. So the solution to unemployment has always been seen to be a higher TI rate and the way to achieve full employment was seen to be high TI sustained indefinitely.
Of course we have seen that endless TI is impossible and that wage levels are an important determinant of the involuntary unemployment rate.
As for private debt, the reasons for its accumulation have been discussed elsewhere.
Second, why can’t the government of, for instance, the U.S.A., simply declare that the accumulated debt no longer exists, wipe the slate clean, and carry on with no red ink in the budget books? This seems like a really stupid idea but something like it actually happened in the State of New South Wales in Australia during the Great Depression, and far too many of the general population think it is a serious practical method of coping with deficits, so it has to be mentioned.
This would be saying to all the people who put their money in the banks, individual savers, clubs, companies, “All right, all that money we’ve borrowed has become a free gift, thank you very much, forget about getting it back”. The money borrowed by the government still belongs to all the bank’s depositors; it is their property that they count among their assets and they expect to earn interest by leaving it with the bank to lend to others. For the government to announce that the federal debt no longer existed would be to grab sizeable fractions of everybody’s savings and profits as a totally unauthorised tax. This option is legally and politically impossible.
So, why can’t the government simply print enough money to pay back the whole federal debt in one go? They own the mint. Again, this stupid idea has to be mentioned because it has not only been suggested, but actually tried, in Germany in 1923.
Thus to increase the money supply suddenly by a large proportion without any comparable increase in the flow of goods and services in the economy would rapidly and greatly increase the true inflation rate. This would feed on itself by reducing consumer and investor confidence, creating upward pressure on interest rates, creating an “inflationary psychology” (quite a real and powerful factor as was found in Germany in 1923), reducing economic activity, and creating upward pressure on wages. Unemployment would rise. It would be difficult to get out of the mess, having got into it. The print-more-money option is quite unthinkable. Unfortunately it has been thought of in recent history, as, for instance, Chileans know to their grief.
The answer to Question (ii) is yes, the debts do matter, and there is no choice but to pay them back.
So how can this be done? Reducing debt is like losing weight. There are only two ways of losing weight; reduce food intake and increase physical activity. So with getting out of debt there are only two ways; reduce expenditure and increase income. With losing weight the difficult part is doing the two things without damaging the health of the lightening body; so with wiping off government debt, the difficult part is reducing government outlays and increasing revenue without crippling the economic system.
The difficulty here is not so much devising methods that in theory would work, but rather putting them into practice against the opposition of people to particular measures affecting them and of politicians who naturally desire to stay in office beyond the limited term between elections. The end result of getting out of debt is a benefit to everybody, but it is difficult to sell those long-term benefits when the price is deprivation in the short term.
The political problem lies beyond the scope of this posting. If it could be made politically achievable, then the following measures are suggested.
Achieve sustainable full employment first by applying the wage freeze and wage indexation systems discussed in the postings on wages and wage fixing.
Apply the reduced indexation to social security payments discussed in the posting “Coping with Aging Populations”.
Don’t try to pay off the accumulated principal of the debt for a while. Keep servicing it and make the policy a firm one of not increasing it any further. This would mean achieving a balanced budget, for safety’s sake one running a small surplus, for every financial year. The money amount of the principal being not increased will gradually shrink to an ever smaller fraction of total national throughput measured in money terms and of government revenue and expenditure. This will make the debt ever less threatening and easier to pay.