Sometimes I hear economists describe a nation as facing a soft budget constraint. It’s true, but it’s a funny choice of phrase because the literature on soft budget constraints initially was exploring how this caused monumental moral hazard and inefficiencies for firms in the soviet union and other centrally planned economies. This may have some slightly unpleasant implications for if the government explicitly acted as if the constraint they care about is inflation, at least it might under certain types of government self-financing. There is also a more interesting criticism, Daniel Kuehn contends “as James Macdonald argues, public debt has historically been an essential element in restraining government. Hoarded treasure (aside from being macroeconomically inefficient) ensures that sovereigns are unaccountable to their citizens. Citizen creditors ensure that their government stays accountable. Cutting out this debt instrument gives a sovereign all the revenue-raising power of government bonds, without any of the risk of nervous creditors restraining policy. Perhaps a robust republic can be maintained in such an environment, but if the Macdonald point is right, the chance of abuses are very real.” This is why many shudder when some MMT types appear to advocate an abolition of borrowing with politicians simply creating new money themselves directly in case they need more funds.
One good thing about my proposal, which I shall subsequently refer to as Rules Based New Money Financing of Government – RBNMFG (working title), is that it reconciles the moral hazard criticisms towards the ‘deficit owls’ with the demand sucking private debt fuelling criticisms towards the long-run budget constraint types. The committee in charge of RBNMFG is an agent of the government ensuring new money is issued consistent with a rule ensuring no output gad/no deficient demand and/or stable sectoral balances, in the same way that the judiciary is an agent of the government ensuring new laws are implemented consistent with legal precedent or a constitution. In this case the moral hazard problem is greatly diminished because there is a separation between the ‘print financing decision’ makers and the voter appeasing expenditure decision makers.
In sum we have two very useful insights:
(1) Monetary policy needs to be independent to prevent moral hazard and other problems (mainstream)
(2) Deficits might be needed for the foreseeable future to prevent the private sector going into deficit (MMT)
The MMT solution as explained in the first paragraph appeases (2) by violating (1). Mainstream solutions on the other hand might violate (2) in order to appease (1). I proposed the policy of ‘RBNMFG’ to appease both (1) and (2).