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Federal government deficit spending

John Hermann

Recent articles in The Conversation * reveal that the Australian federal budget deficit is increasing, for a variety of reasons discussed in those articles.  Moreover it is becoming abundantly clear that there is no possibility of having a balanced budget within the forthcoming decade, let alone a budget surplus, notwithstanding the insistence of the Treasurer, the Finance Minister, and the senate leader that a budget surplus remains their ultimate objective.

To quote Ross Guest, Professor of Economics at Griffith University,

“The MYEFO only confirmed that the Treasury and government accept what we’d already been told by independent experts: the federal government budget is shot. There is no prospect with the current level of taxes and array of spending programs of getting spending and revenue back into line within a decade and probably longer.”

But none of the authors listed in these articles seems to think it is appropriate, in a contracting economy characterised by increasing levels of poverty and unemployment, for central government spending to exceed the aggregate of taxation receipts. This view is grounded in their a priori belief that deficit spending is necessarily inflationary and will put upward pressure on interest rates. And it is obvious that the choice of “experts” in the multiple author article was taken exclusively from the ranks of neoclassical economists and business economists.  A more balanced selection of the views of “experts” would have included informed contributions from economists like Prof Steve Keen, Prof Geoff Harcourt, and Prof Bill Mitchell.

A lot of confusion and misunderstanding surrounds the topic of borrowing by a currency-issuing central government (CICG), which is the basic mechanism by which government deficit spending is accommodated.  Treasury securities (i.e. bonds and bills) issued for this purpose are in many respects as good as money, and short term securities are often referred to as “near money”.  The Australian federal government has an unlimited ability to create these financial instruments, just as the central bank (RBA) has an unlimited ability to create state fiat money (consisting of currency and reserves).  Treasury securities and state fiat money may be regarded as interchangeable financial entities.

It is essential for understanding the associated monetary mechanics to recognise that when a CICG deficit spends it increases the liquidity ** of the private sector, and that this increase in liquidity is transferred to the community at large. The liquidity of banks and large institutional investors does not change substantially as a result of deficit spending. All that happens in regard to the latter is that one financial asset (Treasury securities) is exchanged for another financial asset (credit money plus reserves).  However the receipt of this money by Treasury then authorises the central government  to spend an equal quantity of money into the real economy. The net result is that the liquidity available to the private sector as a whole increases by this amount.

Incidentally, it is not even remotely valid to assert that the interest paid out on Treasury securities (notwithstanding that interest is a budgeted item) is paid from tax receipts.  Thus, in a normally operating and growing economy – where the stock of Treasury securities is growing in tandem and at the same rate as the rest of the economy (which must of necessity be the case if the economy is to be sustainable and to prosper) – the interest payments may be viewed as being effectively factored into the ongoing issue of new securities.

Moreover, the creation of CICG Treasury securities (aka public debt) may be regarded as equivalent to the creation of new money, by virtue of the fact that the central bank can buy back any of these securities from the private sector at any time the private sector (including the banking sector and the general public) requires more currency and/or credit money.  The net outcome of such buybacks by the central bank is the financial equivalent of the government selling Treasury securities directly to the central bank – which some people wrongly describe as “printing money”.


*  The Conversation, 15 Dec 2014

  1. Michelle Grattan article, “Government reveals $40 billion budget deficit, clings to surplus hope”
  2. Multiple authors, “Federal budget deficit climbs to $40.4bn: experts react”

**  “Liquidity”  is the conjunction of useable money and any other high quality financial assets which may be readily and speedily exchanged for money.

John Hermann

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