Public Debt Is Economic Nonsense

This paper has been included in the publication
“Ideas towards a new international financial architecture?”

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Public debt has been a widespread problem for mainstream economists have no effective procedure to deal with it and prevent its financial, economic and social negative consequences. This paper argues that the public debt is a macroeconomic phenomenon and not the simple company’s accounting situation mainstream economists imagine and suggests a new approach to the public debt trend based on the difference equation method. The main hypothesis is that public debt has a negative effect on the GDP and tax receipts while its interest expenses expand private credit supply and thus GDP and tax receipts thus providing extra revenue enough to pay the interest on the public debt. However, public debt, interest expenses and credit supply attained so high levels while consumer’s income expanded slowly that the positive effect through private credit is disappearing and no longer can compensate the negative effect of the public debt itself on the tax receipts. Consequently, the public debt may be causing more deficits and more public debt. It may have been thus created a positive feedback process that could lead the public debt to follow an explosive trend. The time trend of the public debt is given by the interest rate on Treasury bonds and the coefficient that measures the negative effect of public debt on tax revenue; the public debt time trend does not depend on the primary surplus. Therefore, austerity programs do not lead the public debt to the desired stability. An experiment applied to the United States in the period 1960-2007 does not allow for the rejection of this hypothesis. The conclusion is that insisting on austerity will lead to more financial crises; a new theoretical approach is required.

Gerson P. Lima, Macroambiente, Doctor in economic theory by the University of Paris (1992), Professor emeritus of macroeconomics at the Federal University of Paraná, Brazil, retired

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19 responses

  • Charles Fasola says:

    The answer is eliminating private banking’s bestowed privilage of fractional reserve lending. Thus restricting their ability to create money through the issuance of debt electronically almost out of thin air. While at the same time the sovereign is provided the opportunity to directly spend into the economy iin the publics best interest.

    • Gerson P. Lima says:

      Thanks for your comment, Charles. I share with you both ideas but I am afraid about their simultaneity. I fear that restoring economics as a real world science will be huge battle with mainstream economists supported by private central bankers that also dominate the communications systems.

  • James Wood says:

    Public debt as a macroeconomic issue is simply credit money creation. As debt in general affects only the time allocation of incomes one might expect that distribution effects are the most important part of public debt creation. This might be further seen to be true if it is noted that debt cannot expand beyond the allocated tax base to support it without requiring a fall in interest rates. If interest rates fall the nominal size of the debt can increase but the funds it generates for its purchasers cannot expand beyond the allocated base. The obvious upper limit is that allocation consumes the entire available amount of taxes.

    So long as no effort is made to constrain the growth of the debt, economic performance depends on the allocation of the money created. If the proceeds of the debt are spent on public support of the real sector then the funds will expand the economy. The purest form of this essentially Keynesian response would be to issue the proceeds of the debt to the poor. Since in the classical model the poor do not save, 100% of the money would be spent on real goods and services generating a classical consumer expansion of the real economy. Firms would earn that money instead of receiving it as debt and generate future investment expenditure from retained earnings; not debt. Income taxes would expand generally funding further expansion of the debt. This expansion could continue up to the traditional full employment equilibrium after which inflation would be generated.

    If the money is spent to support the speculative losses of the banking system the consequence will be the underwriting of those speculative operations allowing them to continue. This is a restricted Keynesian model of support for the financial sector and the consequence is the capture of the debt generated funds into financial speculation. Financial markets will expand in trading volume and prices of financial assets will tend to rise. The real sector will be relatively starved for funds and relative demand will contract in that sector. Incomes for most consumers are generated here so it is no surprise that these incomes are falling and taxes thereupon falling.

    Another consequence will be a shift in the Ginni coefficient upward. High income or high net worth individuals spend their incomes proportionately more for financial assets and receive higher incomes from those assets than the middle class. The poor, of course, do not participate. Thus the flow of public funds to the financial sector should relatively increase the incomes of the financially involved population relative to their participation. This will increase income inequality.

    However, any sector commitment such as the one we have experienced since 2008, would have such an effect in the favored sector though finance is probably unique in its ability to capture and hold the received funds within itself by generating more numerous speculative opportunities. In short the question of greatest importance is the distribution of the monies raised by the issuance of public debt and not its absolute size. The question is not really economic but political. The wealthy are in a position to capture the proceeds of public debt issuance at the expense of the rest of the population and in this case that means essentially a financial, not a real sector expansion.

    If the monies generated by public debt since 2008 were paid on a sliding scale to the poor one would expect a massive classical Keynesian inflationary boom starting about that time to have been observed. Income inequality would have been reduced, and most real sectors would have experienced heavy demand for their product. A very different outcome and one obviously politically unpalatable to the truly influential whose mantra is austerity.

    The influence of public debt depends on to whom the proceeds of its issuance is paid. Your description totally reflects the expenditure pattern and political dominance of the current age. There is nothing in technical economics that requires your stated outcome from the issuance of this public debt. It is the consequence of creating a public policy that favors a politically dominant financial group which produces these results.

    • Gerson P. Lima says:

      Many thanks for your comment, James. Let me clarify at first that the meaning of “macroeconomic” in this context is that public debt is not a simple company´s accounting situation; it is a macroeconomic decision made by the few that generates important macroeconomic consequences, especially – but not only – the income and wealth concentrations that actually are hurting millions. The implicit message is that calculate the primary surplus as it has been done by mainstream economists is evading a complex question, not solving it. The conclusion is that a new real world theory is required.
      About your phrases “If the proceeds of the debt are spent on public support of the real sector then the funds will expand the economy”, and “Since in the classical model the poor do not save, 100% of the money would be spent on real goods and services generating a classical consumer expansion of the real economy” I would like to remind that this economy expansion must be such that the new tax revenue obtained pay the due interests. However, talking real world economics a debt and especially a permanent and rising debt is something that should be avoided, no matter if one talks people, company or government.
      Your last phrase summarises perfectly the public debt problem. Actually, an explosive debt “…is the consequence of creating a public policy that favours a politically dominant financial group which produces these results”. The mainstream monetarist policy exists since congressmen decided to give away the democratic power of the people to print money for the society’s sake. Of course that the economic policy could be democratic as constitutions impose; people the world around are waiting for real world economists’ works on that.

  • Marco Saba says:

    You can avoid public debt by restoring monetary sovereignty to a democratic public administration, here: How to Turn Banks into Financial Intermediaries

    • Gerson P. Lima says:

      Marco Saba, thank you very much for your comment. You are right; the solution to the public debt explosiveness is no public debt at all. This is my main point and I appreciate Richard Werner very much since he is one of the most founded references on the matter. However, previous papers of mine proposing that central banks be really public were not accepted for publication (the exception is my paper Matemática Agradável – Pleasant Mathematics – but it is in Portuguese and brings no empirical evidence). So I decided to postpone such proposal to a next paper that will present and illustrate many other problems that make monetary policy to be economically unsustainable.

  • pasbaxo says:

    Public debt is governances’ and states’ debts, not production companies’ debt.

  • Gerson P. Lima says:

    You are right pasbaxo, mainstream approach to the matter consider that we are “clients”, not society.

  • pasbaxo says:

    “Preventing public debt is not a monetary concern”.
    Production process delivering per definition debts of 100% GDP value or more to the worlds ten largest concerns could only be approached by new monetary rules easing new debt evitating liquidity streams to production concerns.

    • Gerson P. Lima says:

      The right statement at the end of the paper is “The main conclusion is that preventing public debt explosive trend and avoiding its consequences is not an exclusive mainstream monetary concern”. Actually, what has been used to uselessly attempt to tame public debt is the fiscal policy in the opposite direction.

  • pasbaxo says:

    NB: “GDP” in above delivered remark must be corrected in “product exchange value”.

    • Gerson P. Lima says:

      The paper intends to be part of a new, real world, economic theory but uses current as much as possible.

  • Gerson P. Lima says:

    Sorry pasbaxo, a correction is required: The paper intends to be a contribution to a new, real world, economic theory, but adopts currently used terminology as much as possible.

  • pasbaxo says:

    Quantitative Easing to governments and production companies is missing the link as long as QE amounts are created by Central Banks whereas the CB plus the underbanks are ressorting under private legal persons. The problem of ownership to new created amounts is essential to be solved in the sense of expropriation to the CB.. If not the QE money-stream will again stay in loan concept to companies to create new debt problems and as a closed treasury source to governments’s budgets.. The association from Central Bank to Policy organs like Central Governments should be linked more expressively , subjected to parliamentary voted legalization in banklaws a.o.. The Minister of Finance or the President should be linked to the Central Bank as President CB to enable QE execution via electronic multiplication of banknotes to be made appliccable to governmental purposes, like governmental budget expenditure replacing taxes to governments and loans to production companies via Miinistries of Finance and Economy. This whereas taxes and loans appeared as insufficient means to rule governments services and companies production. There is no absolute necessity to believe that
    those two pillars could create a debtless system, annual balances reports revealing other financial circumstances.
    Besides the lack of legal public person to the governments could mean a serious barrier to build up a trustable financial system.
    Upheaval of taxes could mean an elevation of the product exchange level whereas more money is available to consumers if not obligated to pay taxes, Production companies could deliver more quality and more variety in products if subsided by redemptionfree QE amounts. Price stabilization stays condition.

    • Gerson P. Lima says:

      Thank you for your comment pasbaxo but, sorry, I cannot see its connection to my paper. Could you please tell me how your comments are related to my work?

  • pasbaxo says:

    Public debt is of course no economic nonsense in the practical sense ,whereas it exists more or less as particle within the total financial economic household of nearly every monetary Union. May be you mean it as a taboo subject to professional theoretical economists. The solution is not to be found by tax on the production sector,f.i. by means of product exchange tax and enterprise tax, whereas the product sector is bowing under the same problem. Induction of backless liquidities could be a solution to the relievance of debts in both sectors, if approached to receivance of liquidities appliccable to special tasks formulated via budget estimations beforehand. The row of catastrophees mentioned as nearly inevitable consequences could be sought to be prevented, not only by gradual application, but also by a more adequate position of the Minister of Finance as receiver and distributor of backless liquidities to both
    sectors. Financial liquidities inflation could origin in an expressively independent position of the Central Bank as independent legal person, keeping the created money within its own finanncial sector with the bank as owner , loaner and speculator .

  • Gerson P. Lima says:

    Sorry pasbaxo, but I still cannot see how your comments are related to my work. Clearly, my point is that under normal conditions indebted governments act in contradiction to the accounting logical “practical sense” that nobody – especially if already indebted – can eternally spend more than the earnings. “Of course” such an attitude imparts to public debt an explosive tendency. Of course the scientific challenge that arises is falsifying this conclusion, what in this case requires the demonstration – and not simply a discourse on hypotheses – that normally public debt generates tax receipts increases that are sufficient to pay the due interests. Of course you may alternatively collect and present data showing that normally public debts the world around tend to vanish. Of course if you miss the point of conference’s papers I fear you risk proposing byzantine discussions that bring no positive contribution to an outstanding intention of redirecting the economy science to real world concerns. Of course as expected from any serious researcher I would appreciate it very much if I have any clear critical observation on my work; this is the way science progress.

  • M.M. van Wijck says:

    Awaiting expiring of debts could burst the bomb. Vanishment is not a usual term. Only interest payment could not be valuated as relievance of the total sum. Expiring could mean: no more possiblitiy to borrow
    as countermeasure whereas no relievance is showed (initial cause of crisis).
    Besides many Central Banks could create banknotes without creating debts to themselves , the notes or their account value possibly to be outlended to other i.c. foreign banks , the latters’ Central Bank being not able to print backless and debtsless banknotes themselves as consequence of a lack in their monetary system. ECB is an example : their obstinate refusal to relieve governments’ debts by debtless and backless banknote emittence and permitted reproduction appears ridiculous in the light of another monetary policy legalized and practicized by other states cq Central Banks cq banks. It leads to heavy backpayance loads to the debtor whereas the claimer has only to bear the paper- and print costs.

  • pasbaxo says:

    Central Bank reformed to public legal person under Government as public legal person and as presidency of Central Bank could prevent banknotes ownership of Central bank and could consequently prevent necessity to outlending financial furnishment to Government still bowing under debts. No complicated study is necessary to realize such or a comparable arrangement . The government could take distribution of financial means to deficient governments’ and product enterprises’ accounts in its own hand, in a managing function. Ownership to be recognized to addressees. Needed monetary articles to be voted by parliament.