Orthodoxies asserting that central bank functional ‘independence’ is necessary, and that maintaining an independent money issuing authority is always desirable, are simply not valid in all circumstances including, in particular, that of a debt/depression scenario. Budget deficits do not increase public debt. Rather, it is the new bond financing of budget deficits that increases public debt. In debt stressed conditions, interest rates rise as well as risk premia increase. Bond financing of large budget deficits was the method adopted around the world as a reaction to the global financial crisis. That approach contributed substantially to the upward spiral of public debt. This debt spiral could have been largely avoided by financing those budget deficits via new money creation rather than via new bond financing. Consequently, new bond financing is not the only way, or the best way, to finance on-going budget deficits in debt-ridden countries.
‘Fiscal austerity,’ which is now coming under increasing challenge, is an established ‘orthodoxy’ in Germany and some other European countries, whereas it is considered an unproven ‘paradigm’ in many other countries. Austerity policies — by lowering tax revenues without cutting tax rates — create ‘unhealthy’ budget deficits: and, when austerity-based deficit reductions are achieved by actually raising tax rates the problems contributing to demand contractions are compounded. The view, recently expressed, that abandoning fiscal austerity is now impossible is simply irrational, and wrong.
The orthodoxy that asserts that austerity and massive unemployment can be relied upon, and are the desired means, to reduce real wages and prices to improve profitability and competitiveness is misconceived (see later) in countries suffering high debt, deficient demand, downward wage rigidity, and already high unemployment.
With the above mentioned orthodoxies of questionable value and under challenge, a new macroeconomic policy strategy — involving new paradigms — is urgently required to address the unfolding economic crisis, particularly as it is developing in Europe.
The above are excerpts from Richard Wood’s book “How to Solve the European Economic Crisis: Challenging orthodoxy and creating new policy paradigms,” now available on Amazon.