As negotiations over fiscal policy heat up, one thing nearly
everyone agrees on is that U.S. fiscal policy should be
sustainable. The trouble is, there are sharp disagreements about
just what sustainability means. This post explores three different
meanings of fiscal policy sustainability and explores their
significance for current budget debates.
Sustainability As Solvency
The first, and simplest, meaning of sustainability makes it a
synonym for solvency. The proposition that we do not have to worry
about debts and deficits because the government can never "run out
of money" has become a mantra among followers of Modern Monetary
)). As L. Randall Wray puts it in his book
Modern Money Theory
, "When we say that [perpetual government sector deficits] are
'sustainable' we merely mean in the sense that sovereign government
can continue to make all payments as they come due - including
interest payments - no matter how big those payments become."
Strictly speaking, we should refer to the ability to meet
financial obligations in full and on time as
to distinguish it from
which means negative net worth. No one ever seems to worry about
governments' net worth. Discussions of fiscal solvency always
center on whether a government will be able to meet its financial
obligations on a cash-flow basis, or will, instead, run short of
cash and be forced to default.
Is MMT correct in its claim that a government can never become
equitably insolvent? Yes, as long as the proposition is limited to
governments that issue their own sovereign currencies and maintain
floating exchange rates.
A country like Greece could literally run out of euros because
it is a user rather than a sovereign issuer of the euro. Any fiscal
policy for Greece that does not include a mechanism for obtaining
enough euros from some external source to meet its financial
obligations would be unsustainable in the sense of being
inconsistent with equitable solvency.
A country like the United States that has a fully sovereign
currency and a floating exchange rate is in a fundamentally
different position. The U.S. government can always issue as many
dollars as it wants, provided it does not bind itself with
self-imposed restraints like the federal debt limit. Under some
circumstances, fiscal deficits might become large enough to have
undesired consequences (more on that later) but if it wanted to
ignore those consequences, it could always get the dollars it
needed to meet its financial obligations.
Some countries are in an intermediate position between Greece
and the United States. Take Latvia, for example. Although Latvia
issues its own currency, the lats, its solvency is constrained in
two ways. First, the Latvian government has borrowed large sums in
foreign currency. To the extent it has done so, it is in the same
position as Greece; its solvency depends on having a way to obtain
the foreign currency it needs to meet those obligations.
Furthermore, Latvia maintains a fixed exchange rate. That
constrains its ability to meet obligations like salaries and
pensions even when they are denominated in its own currency.
Issuing too many new lats could put unsustainable pressure on the
exchange rate, causing the government to choose between defaulting
on its debts and defaulting on its commitment to maintain its peg
to the euro.
Can we go so far as to say, then, that because a country with a
sovereign currency and a floating exchange rate can never become
equitably insolvent, its fiscal policy can never become
unsustainable? In my view, we cannot. Solvency is only the starting
point for a discussion of sustainability, not the whole story.
According to a second meaning, a fiscal policy is unsustainable
if it causes the ratio of debt to GDP to grow without limit. The
concern here is that a debt that grew without limit would
eventually become unmanageable, leading to some unpleasant
consequence like default, excessive inflation, or forced austerity.
I will refer to this second meaning as
As discussed in an
structural primary budget balance
is a useful indicator of mathematical sustainability. The
structural primary balance is the government's surplus or deficit,
excluding interest on the debt and adjusted to take into account
the state of the business cycle. In any given case, the conditions
for mathematical sustainability depend on the starting debt-to-GDP
ratio, the rate of interest on the debt, and the rate of growth of
GDP. (For details of debt dynamics under various scenarios, see
Typically, the rate of interest tends to be higher than the rate
of growth. In that case, a country that starts with any debt at all
must hold its structural primary balance at a small surplus in
order achieve mathematical sustainability. For example, since 1980,
the interest rate on U.S. government bonds has averaged about 1.3
percentage points higher than the rate of GDP growth. If that
differential were to persist in the future, the federal budget
would have to maintain a primary surplus of about 0.9 percent of
GDP to stabilize the debt at its current level of approximately 70
percent of GDP. If the average inflation rate were to stay at the
Fed's target of 2 percent, interest payments would consume about
2.3 percent of GDP, so the overall balance, including interest
payments, would show an average deficit of about 1.4 percent of
If, given those starting conditions, the primary surplus were
less than its steady-state value of 0.9 percent, the debt-to-GDP
ratio would, over time, increase without limit. For example, if the
primary budget were held exactly in balance, the debt-to-GDP ratio
would double every 50 years. In reality, as of 2011, the U.S.
structural primary balance was in deficit by 5.8 percent of GDP,
according to OECD data. With a structural primary deficit of that
size and given the assumed values of other parameters, the debt
ratio would grow much more rapidly, doubling about every 10
On the other hand, if the primary surplus were greater than the
assumed steady-state value, the debt would shrink steadily as a
percentage of GDP. For example, if the U.S. primary surplus were
held at 2 percent of GDP, the debt would disappear in 50 years,
after which the government would accumulate net assets in a
steadily growing sovereign wealth fund.
Are such extrapolations of the debt-to-GDP ratio something we
should really care about, or are they just a parlor game? Opinions
differ as to whether it is a matter of pressing national importance
to bring the U.S. structural primary balance into consistency with
the conditions for mathematical sustainability.
For example, followers of MMT like to point out that the debt
dynamics become much friendlier if the rate of interest is held
permanently below the rate of growth. If that can be done, then
regardless of the initial values of the debt and the structural
primary balance, the debt-to-GDP ratio always converges to some
finite value. It should be mentioned that many non-MMT economists
worry that attempting to hold the interest rate below the growth
rate over a long period would carry a risk of serious inflation,
but exploration of that issue will have to wait for another
A further, and to my mind more realistic, argument made by some
MMT followers is that the debt will never "explode" because
something will happen to change the parameters of the model before
an explosion takes place. Wray compares the discussion of unstable
debt dynamics to speculation about what would happen to a person
who constantly consumes more calories than he burns.
Mathematically, such a person would eventually "explode," yet we
have never seen an exploding person. Something else always happens
The way I see it, mathematical sustainability is a useful
benchmark for discussion of fiscal policy precisely because it
causes us to focus on the changes that must take place if the
current set of budget parameters implies an impossible outcome.
Will they be changes for the better or the worse? Will they be
changes that come about in an orderly way, or changes that are
forced and unpleasant?
To pick up on Wray's analogy, suppose you step on the scales and
find you are seriously overweight. You are not yet morbidly obese,
but you are gaining steadily. Do the numbers on the scale mean you
are at risk of literally exploding? Of course not, but they do
indicate that you will have to face up to some hard choices. Will
you start exercising and change the way you eat? Or will you wait
until you have developed diabetes or suffered a heart attack, and
then sign up for emergency gastric bypass surgery?
That brings us to the third meaning of sustainability: If a
country has a set of rules and decision-making procedures that
adjust fiscal parameters over time to serve some rational public
purpose, we can say that its fiscal policy is
There is no one set of rules that is consistent with functional
sustainability. For example, many MMT followers favor focusing
fiscal policy on the goal of full employment and adjusting tax
rates to moderate aggregate demand when and if a threat of
inflation develops. (Such a scheme is a descendant of Abba Lerner's
writings on functional finance in the 1940s.)
At the other end of the political spectrum, many U.S.
conservatives favor an annually balanced budget, preferably
enshrined as a constitutional amendment. True, such a policy would
be strongly procyclical. It would require austerity during
recessions and would provide little restraint on spending during
for a detailed critique.) However, procyclical or not, a balanced
budget rule would be "functional" in the sense of providing a rule
that is consistent with mathematical sustainability.
In between, a variety of fiscal policy rules have been proposed.
One such rule would constrain each year's structural primary
deficit to a level consistent with mathematical sustainability.
Unlike proposals for annual balance of the current budget, a policy
of structural balance would allow the free operation of automatic
stabilizers like income taxes and unemployment benefits.
Alternatively, we could allow more room for discretionary
countercyclical policy by requiring the structural primary deficit
to remain on target on average over the business cycle rather than
on a year-by-year basis. Countries like Chile, Sweden, Germany, and
Switzerland provide examples of such rules.
Note that none of these fiscal rules says anything about the
size of government or the content of spending. Any of them could be
adapted to a big government with a generous social safety net; a
big government with a strong defense establishment; or a small
government limited to protecting property and enforcing the rule of
The trouble is that we don't have any workable fiscal policy
rules at all. As Herbert Stein observed almost 30 years ago, "We
have no long-run budget policy-no policy for the size of deficits
and for the rate of growth of the public debt over a period of
years." Each year, according to Stein, the president and Congress
make short-term budgetary decisions that are wholly inconsistent
with their declared long-run goals, hoping "that something will
happen or be done before the long-run arises, but not yet." It
would be hard to find a better characterization of a fiscal policy
that is functionally unsustainable.
What Can MMT And The Rest Of Us Agree On?
In light of all of the above, where can followers of MMT and
non-MMT economists find common ground? I see three potential areas
First, we should be able to agree that there is no point in
arguing over the solvency vs. the mathematical version of
sustainability. Both are valid. They are complementary statements
about different aspects of fiscal policy. Furthermore, neither
approach amounts to more than a formal truism until we add the
concept of functional sustainability.
Second, everyone should be able to agree that fiscal policy does
not have to be procyclical to be "sound." Whatever theoretical
framework we start with, fiscal austerity during a slump is not a
good idea. That should put MMT and non-MMT economists largely on
the same side during the present negotiations over the "fiscal
Third, it should be possible to agree that just because the
government can, in a solvency sense, always "afford" to spend, that
does not mean more spending or lower taxes are always better. Even
when the economy is operating below potential, as it is now, we
need budget procedures that set sensible national priorities and
winnow out spending and tax breaks that serve only to reward
favored interest groups at the expense of the broader public.
Furthermore, we need to recognize that the economy will eventually
return to boom conditions that will call for restraint of aggregate
demand. Better to build in rules now that will ensure that fiscal
prudence operates when needed than simply to "hope that something
will be done before the long-run arises, but not yet."
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