Robert Peston has been basking in the unusual distinction – for a journalist – of getting a pasting from Paul Krugman, and the somewhat less unusual distinction of criticism from Simon Wren Lewis. Simon has coined a phrase to describe the sub-discipline of macro practiced by journalists: ‘mediamacro’. Part of this caricature is the idea that deficit stimulus is a bad thing, to be curtailed always, and always risks incurring the wrath of markets [aka the gendered ‘Mr Market’].
Both Krugman and Wren Lewis maintain that a country with its own independent central bank, pursuing its own monetary policy, does not need to worry about the effect of markets running from its bond markets, or demanding large risk premia in order not to. Peston responds by saying that there are economists who believe such worries to be founded.
I am one of them.
I agree with Simon and PK that ‘mediamacro’ has recently, in the UK, missed an opportunity to correct an illiterate focus on deficit reduction that prevails in the debate between Labour and Conservative politicians. For reasons best known to themselves, despite a few attempts by SWL, PK and myself and others to explain other ways of thinking, TV commentators have not bothered to put to politicians the notion that deficit spending is positively needed, right now, with the scope for monetary policy loosening severely constrained by the zero lower bound to interest rates, and the uncertain efficacy of further QE. Is this argument too complicated to explain to viewers? Are TV economic journalists ideological deficit hawks?
But, I don’t agree that one can take this as far as to suggest that monetarily independent countries are immune from problems of sovereign default. Recent economic history serves up several examples. None of them suggest that outright default is particularly likely for the UK. But the risk is tangible enough to mean that there has to be some weighing of it against the desire for a persistent fiscal stimulus.
The point of conceptual dispute seems to be the proposition that because you can print your own currency, you will never be short of what you need to satisfy the claims of sovereign bond holders. Ergo, you need never default. Ergo, there need never be default risk premia in your bonds. Ergo you can borrow as much as you like for as long as it takes to stimulate the economy back to full employment.
I don’t dispute that you can money-finance. What I contend is that you would not want to. And for that reason, it isn’t credible to promise it. And so default risk premia will emerge if tax and spending plans are not arranged with sufficient clarity and discipline. Why would you not want to pay your bondholders from the printing press? Surely you are giving them what you agreed to when you signed the loan contract, right? Because seigniorage finance is extremely inefficient, and it would require massive, and colossally damaging inflation to execute. If it came to it, it would be far better, and far more popular to default on a few either rich or remote, institutional bondholders, than devastate the typically less well inflation-indexed poor.
So, in short, at some point, bondholders will demand a default-risk premium, because they know that, if borrowing gets completely out of hand, you will do the right thing for society and default on them. At what point do such things become material? Who knows. Japan seems to be doing fine [in terms of default risk premia at least] at the moment, with gross debt more than twice its GDP. So on that basis, the UK need not stress about deficit reduction over the lifetime of the next Parliament at least. And ‘mediamacro’ ought instead to skewer the politicians on what they are going to do to assist the Bank of England in lifting the economy off the zero bound. [And, while you are at it, ask them why they are not contemplating raising the Bank of England’s inflation target by at least 2 percentage points to reduce the risk of us becoming trapped there again].