Myth #3: But deficits are problematic. Just like individual households and companies, governments must live within their means.
Just as families and firms need to live within their means to avoid the scourge of financial condemnation, so too???this misplaced assumption goes???must governments be constrained in the same way as the rest of us. Relying on borrowing to spend too easily opens the door to insurmountable levels of debt and even government bankruptcy, with very real human and economic consequences. Living better today should not come at the expense of others tomorrow.
Reality Check
Deficit financing in moderation is in fact an important economic policy tool which has allowed governments worldwide to maximize resources and invest in current and future human and economic potential. Like any tool, there are certainly risks of abuse. Excessive deficit financing can burden governments and their people with unsustainable levels of debt which eat up space in national budgets that could be better used to invest in economic, social or infrastructure programs. Prolonged deficit financing can also produce inflation when an economy is operating at or near full capacity or employment, hurting poor people especially hard. Other important limits to this technique apply when a country does not issue its own national currency, as is the case of countries in monetary unions like those in the eurozone. In such cases, the central bank for all the countries in the common currency zone, for example the European Central Bank (ECB), must make a similar agreement with the finance ministry of a country to adopt this deficit-financing technique, buy treasury bonds from the country and then agree to refund the interest at the end of the year in order for this to work.
As elegant as it sounds, however, the simple analogy between sovereign governments on the one hand, and households and companies on the other is based on two fallacies. First, it is founded on a widespread misunderstanding about how modern monetary policies generally work. It is in fact not true that national governments must be constrained in their expenses in the same way as households or companies. Several common-place flexible financing practices of modern central banks are simply unavailable to family and business planners. First of all, government bondholders cannot simply break up governments and sell their assets to recover any losses, as other types of creditors can. Second, businesses and households do not control the money supply. As sovereign states, we vest most national governments with the ability to issue their own currencies. They can and often do ???create??? money at their central banks, use this money to buy treasury bonds from their finance ministries, and in turn those ministries use the money from the bond sales to finance their deficits. The interest that is paid to the central banks which purchased the bonds is then refunded to the finance ministry at the end of the year, thereby creating a type of ???free money??? for governments to use to finance their deficits. This approach has long been widely used by Japan, the US and many other countries. While common among most modern central banks, this type of flexible financing by national governments is something that individual households and companies cannot do.
Furthermore, the risk of inflation is very low during economic slumps, when there is a large amount of underused capacity in the economy (factories sitting idle, investment capital not being used by companies, etc.), high levels of unemployment, and a deterioration in the productive and human potential in the economy.
Nor are all deficits created equal. High levels of deficit developed to invest in long-lasting social, economic and cultural assets in one country are not the same as deficits incurred to no end in another. The real issue determining the sustainability of a country???s debt, in other words, is the end-use of government expenditure. Government borrowing is sustainable if it is used to finance investment, and if the rate of return on such investment is greater than the interest rate payable. Therefore, debt used sensibly and productively over the long term to create things of increasing value into the future (especially investments in human and other productive assets) can boost productivity and growth. Debt servicing in the future is not a problem as long as interest rates on borrowing remain low. In fact, some of the wealthiest nations of the world, with the highest standards of living have huge national debts. For example Belgium???s outstanding national debt is valued at almost 100 per cent of its GDP, and Japan, the global leader today in deficit spending, currently has a debt-to-GDP-ratio of 226 per cent, yet these remain strong economies with high standards of living, and relatively low interest rates.
Deficit hawks like to argue that the pain inflicted by austerity measures in the short-term will provide real long-term gains by controlling deficits and instilling confidence in financial markets. They argue that future generations should not suffer as a result of our current government???s largesse. But this myth misses a key part of the picture. The social, economic and political well-being of future generations depends on the type of society, economy, and government which we build now???will it be one which has progressively invested in essential education, health, housing and decent work programs, or one which is permanently under-resourced, under-capitalized, and crippled by the deterioration of physical and human capabilities?
Human rights response
If governments engage in deficit spending to achieve higher levels of decent, well-paid employment, equitable economic growth and thus increased tax revenues over the longer run, then there is no reason why the actual level of deficit spending (as a per cent of GDP) should in itself be a problem. Targeted, transparent and accountable deficit financing in this respect shouldn???t be seen as shameful, but taken for what it is: an essential tool in maximizing the resources available for the fulfillment of human rights. In one way, then, governments are like households???they need to weigh both sides of their balance sheet. Deficit financing creates liabilities and assets. The real question is what you get for what you spend. Governments which borrow to invest in programs with a real return in social, environmental or economic terms are doing a service to their people, just like a family who takes out a loan to put their child through school or pay for a life-saving surgery. Generating resources to efficiently and equitably invest in people???through education, healthcare, social services and other fundamental human rights???and the environment can boost the overall human, economic and ecological assets of the economy, essential for both increased productivity and human dignity.