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The Progressive Economics Forum

Why the Excitement About Debt?

Further to our recent discussions on this blog about the role of private finance and credit in our present crisis, we present a guest contribution from Ralph Musgrave, an economist in the U.K.

National debts have risen recently, which has caused excessive and unnecessary consternation. The consternation is particularly unnecessary for countries which issue their own currency, and these are the countries considered here rather than individual members of the Eurozone.

The reality is that debt is little different to monetary base (I’ll abbreviate that to “money” henceforth). At least, government debt near maturity is almost indistinguishable from money. So there are essentially just two important questions in connection with debt and money. First, what is the optimum size of the total: “debt plus money”. And second, what is the optimum split of this total as between the two?

As to the first question, money and debt are both financial assets in the hands of the private sector. The larger this total, the more the private sector will tend to spend. Thus ideally this total needs to be whatever size induces the private sector to spend at a rate that brings full employment. No government will ever achieve the latter ideal, but they should certainly aim for it.

As for the split between money and debt, what are the arguments for government running into debt at all? I suggest there aren’t any. As regards the idea that governments need to borrow for stimulus purposes, that is nonsense. In other words, what’s the point of a government borrowing something (money) and paying interest for the privilege, when it can produce money at no cost and in limitless quantities any time? Incurring debt for stimulus purposes makes as much sense as neighbours taking in each other’s washing. Both Keynes and Milton Freidman pointed out that deficits can perfectly well accumulate as extra money rather than as debt.

Of course the stimulatory or inflationary effect of printing money may well be greater, dollar for dollar, than borrowing money. But that is not a problem: government just needs to print fewer dollars for given stimulatory effect than if it goes for the borrow option.

As for borrowing to fund capital investments, that does not make sense either (contrary to popular perception). Governments have an infinite source of funds with which to make capital investments: taxation. As Kersten Kellerman showed, funding investments from borrowing rather than tax makes little sense.

To summarise so far, there is no point in governments incurring debt, but they should certainly aim to issue enough money to induce the private sector to spend at a rate that brings full employment. (Incidentally, the idea that governments should not incur debt is not new: Milton Friedman (p.250) and Warren Mosler advocated this idea.)

And as to REDUCING the money supply, this will certainly be necessary sometimes. That is, the private sector will always have the odd fit irrational exuberance, and to counter this, governments will need to run surpluses and rein in money via extra tax. But this does not make the private sector any worse off: at least it won’t reduce total private sector spending. It simply keeps, or aims to keep aggregate demand at a level that avoids excess inflation. Indeed, and ironically, increasing taxes during a spell of irrational exuberance makes us BETTER OFF in that it should prevent excess inflation.

Disposing of debt. 

To argue, as above, that governments should not incur debt, implies that governments should dispose of all or most of their existing debt and in short order. Against that, it can well be argued that dramatic and sudden changes are best avoided. Plus given that a number of governments are currently paying near zero or even negative rates of interest (after adjusting for inflation), debt reduction is arguably not urgent. But let’s assume a government does want to reduce its debt relatively quickly. There are no big difficulties here.

The first step is to print money and buy back debt (or cease rolling it over). That alone would probably be too stimulatory or inflationary, so to counter the latter effect, a DEFLATIONARY effect is required. And the obvious way to bring this effect is to raise taxes and/or cut public spending. That would give a deflationary effect and produce more money for paying back debt.

As long as the inflationary effect of step one equals the deflationary effect of step two, the net effect is NEUTRAL. That is, there is no effect on GDP, numbers employed, etc, meanwhile debt is reduced at whatever speed is required.

Points that need more consideration.

The above argument, as it stands, is somewhat impressionistic and brief. But this is not supposed to be a full length PhD thesis.

One over-simplification in the above argument is that it ignores the effects of buying back debt held by foreigners. But the effects here are not necessarily large because the debt of country X held by residents of country Y are often more or less negated by debts of country Y held by residents of country X. Second, when debt held by foreigners is repaid, the latter do not necessarily invest their newly acquired cash elsewhere in the world. And if they don’t, there is no foreign exchange effect, thus little effect on living standards in the country buying back debt. And third, if several countries coordinated the above debt reduction ploy, the foreign exchange effects would be further reduced.

Another vexed question relating to a large scale debt buy back is the question as to exactly which income or social groups (if any) are to be net beneficiaries, and which groups would lose out. The political problems here could be difficult. But the strictly economic problems are non-existent.


Reducing national debts is easy and does not, contrary to popular belief, involve significant amounts of “austerity”. Governments should not issue so much debt that they need to pay any significant amount of interest on their debt. Some governments are currently paying a zero or even negative rate of interest on their debt, after adjusting for inflation; thus there is no urgency for those countries to reduce their debt levels.


Friedman, Milton (1948)  “A Monetary and Fiscal Framework for Economic Stability”, American Economic Review, Vol. XXXVIII, No.3.,

Kellermann, K. (2007). Debt financing of public investment: On a popular misinterpretation of “the golden rule of public sector borrowing”. European Journal of Political Economy, 23 (4): 1088-1104.

Keynes, M. (1933), “An Open Letter to President Roosevelt”, (See 2nd half of 5th paragraph),

Mosler, Warren (2010)   “Proposals for the Banking System”, Huffington Post (see 2nd last paragraph),

Enjoy and share:


Comment from Paul Tulloch
Time: October 12, 2011, 6:45 am

your last major point is the biggy- the political of why these mechanisms are not used. It would empower governments and also full employment empowers workers and their collective power.

In many ways the neo con movement after the fall of the psot war compromise can be attributed to these two features. In simple terms- Capital basicaly used its powers to emasculate both government and labour as the post war success for workers and government was at the expense of capital’s power. For all readers from the orthodox that question that, you better go back and reread some real history.

So the question becomes, yes governments can run deficits, but the question right now is, why is it the corps are not letting them? If the system fails and occupy wall street, the arab spring, the destruction of greece, the London summer, and other such movemensts become even more wide spread and ingrained into the physce, the corp elites could be facing a major threat to their power base. So why not just go back to the comprimise, where govt can run debt and workers are given collective representation to negotiate power. Why all the nasty reruns of by gone failed social experiments like austerity, and union destruction.

Are there corp elites that somehow still think there is a way through this mess with an austerity based corporatist social dimension still leading the charge.

I will say, that bridge does actually lead to somewhere, and not just a lost generation. At this point in time considering the risks we face, it does lead to some real negative- non-reversible declines.

Comment from Darwin O’Connor
Time: October 12, 2011, 8:05 am

You may be overestimating the elites. They probably understand little more then the average person and a lot less then the people who read this blog. The difference is that they think they are much smarter, after all they are much richer, and they have the power to impose their ideas.

Comment from Victor
Time: October 12, 2011, 10:52 am

The reduction in interest income to individuals and corporations may be deflationary. Perhaps we could spend the bulk of the deficit into the economy; BoC adjusts reserves to keep inflation in check and also still issue some bonds for seniors and other savers ie. Canadian pension funds.

The other issue is that savers who are purchasing the $560 billion debt may move their savings and capital to other countries.

Comment from Purple Library Guy
Time: October 12, 2011, 1:42 pm

I see two possible reasons.
One is related to Mr. O’Connor’s point. Basically, up to now they’ve been pretty sure that wherever there was a disaster they could make money from it and move somewhere else–that there would always be a new money-making opportunity after they’d finished sacking the last place. It’s worked for a long time now. They may be starting to get the feeling it’s not working any more, but they’re so far into the stream it’s a bit hard to change horses.
Related to that, it’s my opinion that if someone says X for long enough and hangs around other people saying X for long enough, they start to believe X even if it started out as a lie. I think they’ve internalized what was originally propaganda to the point where even if on some level many of them know neoliberalism is just a line to feed the masses, they still can’t think past it.

The second point is that how the economy is actually doing matters to the elites much less than we imagine. At the top levels, money is a positional game. It’s less about “How much do I have” and more about “Do I have more than anyone else”. And it’s certainly less about “How well is the economy as a whole doing” and more about “How much money, power and control do we have over the disgusting masses”. It’s quite plausible that a third world style economy would suit many of them right down to the ground. They’d still be rich, and the rest of us would, they hope, be a cheap and obsequious servant class. The contrast between “superwealthy” and “middle class” is far less gratifying than the contrast between “superwealthy” and “serf”. A stagnating or even contracting economy may well be far less significant than that to them. During the Great Depression most of the really rich did fine, they bought up property cheap–they wouldn’t have minded it keeping on going without any social programs or jobs programs.

Comment from Paul Tulloch
Time: October 13, 2011, 6:14 am


You have a very good point, especially relevant for myself. Truly i do not know much about the psychology of these “people” or what motivates them or when enough is enough ornwhether enough actually exists within their space. i am sure the actions of these wealth centered indivduals would surprise most common folk. Hence the dung hole we call an economy. Look at harper right now, picking on some of the lowest paid workers in teh air line industry, mostly women, trying to strip search their right to collectively bargain.

That majority sure is paying off now for the corp elite.

Comment from Jens Skovgaard
Time: October 20, 2011, 3:45 pm

Excellent article. You are exactly right governments can create money especially through a central bank to stimulate the economy. Too much will encourage inflation but you are right there are ways regulate that: through taxes, increased reserve requirements etc. If banks can create money, which they do: 95% of our money suppply, The Bank of Canada can as well. There is little need for austerity. When the money supply contacts through recessions it is appropriate for governments to create money to mitigate this downward fluxuation.

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