With the government borrow heavily to fund its pandemic response and recovery, it was suggested he could just write off his debt by printing more money. It sounds like an attractive idea, but it is an idea that would have very negative consequences.

Derived from “modern monetary theory(MMT), the suggestion is that expansionary monetary policy (that is, money creation by the central bank) be used to finance government spending.

According to supporters of MMT, a country that issues its own currency can never run out and can never become insolvent in its own currency. He can make all payments as they fall due. There is therefore no risk of default on its debt.

This is a misconception based on economic misconceptions. He has been fought by economists, liberals and conservatives, including the Nobel laureate and New York Times columnist Paul krugman and Harvard University Greg Mankiw.

So what happens when the government wants to spend more than it increases on tax revenues? It needs to borrow money (called deficit financing), and therefore asks the Treasury to issue debt.

There are three main types of debt: treasury bills, treasury bills and treasury bills.. Treasury bills have the shortest maturity (less than one year) while Treasury bills have maturities of ten years or more. They all need to be repaid in the future.

Debt is typically held by banks, institutional investors, and managed funds (such as Kiwisaver accounts). Since the government is not expected to default on loans, the debt is considered safe. Thus, these bonds can generally be issued at lower interest rates than the bonds of other financial entities.

Increase in money supply: Reserve Bank of New Zealand Governor Adrian Orr announced a change in the official exchange rate in 2019.
Getty Images

Where is the public debt going

When the Reserve Bank of New Zealand (RBNZ) commits to “quantitative easing”He basically buys these government-issued bonds. It does this by printing money to pay for bonds and this money enters into circulation, increasing the money supply.

Quantitative Easing floods the system with liquidity – the amount of money readily available for investment and spending. In turn, this should put downward pressure on interest rates, as money is cheaper to borrow when there is more.

The RBNZ may also lower the official spot rate (OCR) to lower retail interest rates (on mortgage loans and savings deposits). The goal in both cases is to make borrowing cheaper in the hope that businesses will borrow money to invest, thus creating more jobs.

If the RBNZ buys government bonds from the banks and investors who bought them previously, it follows that the creditors have been paid. So why can’t the government just write off this debt?

Read more:
With the mandate to rule New Zealand alone, Labor must now decide what it really stands for

First, it takes away the ability of the RBNZ to act as an independent entity, which in itself is problematic. But even so, the debt doesn’t go away, it just takes the form of that extra amount of money floating around in the economy.

At some point, this extra money will end up being deposited in commercial banks and will be held as reserves which will earn interest from the RBNZ.

The currency in circulation is also legal tender backed by the authority of the government. If no one else is willing to accept it, the holders of that money should be able to sell it back to the RBNZ for something of value in return (US dollars, for example).

One way or another, sooner or later the debt will have to be honored.

house with sign for sale
Overheated real estate markets: When money does not go to business investment, speculative bubbles are a risk.
Getty Images

The risk of inflation

In the meantime, if lower interest rates don’t lead to business expansion and higher output (and there’s good reason to assume they can’t), the bottom line is a plus. large amount of money flowing through the economy without any new production occurring.

This will eventually trigger inflationary pressures, which will worsen the situation for savers and discourage saving. But household savings are fundamental to making funds available to businesses to borrow.

In the absence of an increase in production, this extra money can also end up in non-performing financial assets such as equity and homes, triggering speculative bubbles in these markets.

Read more:
COVID-19 is expected to worsen child poverty. Should the next New Zealand government make temporary safety nets permanent?

Why can’t businesses grow even with lower interest rates? In deep recessions, it is not a lack of credit that holds them back, it is that they cannot sell their goods at the going prices. This reduces the demand for labor, further reducing the demand for goods because more clients are unemployed.

It becomes a vicious cycle of insufficient demand, where the key issue is not credit or liquidity but rather a crisis of confidence. Monetary policy then loses its bite, leaving fiscal policy (via deficit financing or tax cuts) as the only option.

It’s all about trust

However, public borrowing is a long-term game. The whole system, whether it’s deficit financing or printing money, is built on confidence – that the government will honor its debt.

Simply put, no government could satisfy all of its creditors if they wanted to get their money back at the same time. But as long as the government continues to pay the interest on the loans, or at least has the ability to repay some of those creditors (sometimes by borrowing even more), the economy remains stable. The juggler’s balls stay in the air.

Read more:
New Zealand elections 2020: poll shows voters divided on climate policy and urgency to act

If, for some reason, confidence in a government disappears, watch the bullets crumble. Any suspicion of default or failure to meet debt obligations will cause long-term damage to a government’s reputation and its future ability to borrow. No one will want to hold government debt in the form of government bonds.

When this happens we see capital flight – the money leaves the country while people seek a return elsewhere. The value of the currency goes through the floor, with catastrophic effects on the economy, as happened during the Asian financial crisis in 1997.

The economic crisis facing New Zealand is real and deep. Attempting to write off the debt would only reduce confidence in the government and risk aggravating the crisis.

Leave a Reply

Your email address will not be published.