Interview with

Warren Mosler

by

Ivan Invernizzi

09/14/2023

Ivan Invernizzi (II): The first thing I wanted to ask you is what do you think would be an interesting way to enter the debate on reforming the Eurozone’s budgetary rules. As you know, the discussion at the moment is as follows. Germany and a few other member states are essentially proposing a return to the old rule, i.e. a 3% limit, with just one difference, namely that member states will have to set themselves a target to achieve a reduction in their deficit/GDP ratio. The idea is simply to exclude certain types of expenditure from the deficit ceiling, e.g., to exclude spending on green investment, digitization of the economy, etc., from the deficit.

Warren Mosler (WM): That wouldn’t work. In fact, it would trigger a race for all the member states in the zone, who would all seek to run a very large deficit, say 25% of GDP, a level that is probably well above the full-employment deficit. This would be a race to the bottom, since any country that failed to achieve this level of deficit would lose out.

II: I agree with you. So there should be a limit that also takes these investments into account.

WM: Yes.

II: And… Okay, so that’s basically the debate right now. So, what do you think might be a proposal in this debate?

WM: Well, it has to be a bit like most other countries where the limit becomes a political tool for the economy. So, if you think the economy is too slow and you want to see lower unemployment and higher growth, you raise the cap. And if you also want to steer it towards green or something like that, you can demand that a proportion of national spending be devoted to that area. So you could say that the limit is going to rise from 3% to 6% of GDP, but the extra 3% then has to be targeted at the green New Deal or whatever some politicians want. But there has to be a central authority that decides what’s best for the Eurozone, what level of budget deficit you have to pay as a percentage of GDP, whether it should be 3%, 5% or 10%. It must be used as a political tool. In the same way as during COVID.

II: So, like it would be during COVID, when there were no limits.

WM: Actually, there was one, but they gave it up. It was their political tool for COVID. Rather than give it up, they need to start targeting it. In fact, what they have now, which they didn’t have before, is several years of data on what happens with higher deficits, with deficits above 3%. And I think all this shows that it’s not something catastrophic that would happen to the Eurozone if they did that. Now that they’ve experienced it, we’re not going to have interest rates hikes [1], nobody’s going to turn against Greece, and that sort of thing won’t happen. These things happen for other reasons, not because of the deficit ceiling.

II: I agree with you. So, basically, you’re suggesting that there should be a first level of deficit limit, and then a higher level, which includes spending that would be targeted to a specific area.

WM: Yes.

II: And then you suggest, if I’m not mistaken, that they raise or lower the overall deficit ceiling depending on the level of unemployment.

WM: Yes, that’s just a general overview of the economy. They know that reducing the deficit tightens the economy. It restricts net financial assets and income in the economy and tends to slow the economy down. This may or may not be why prices are rising. That’s why it has to be a political tool, not something automatic. If, for example, the price has gone up because Russia has raised the price of gas, it won’t do any good. It won’t bring the price down, because it’s an external shock. But if it goes up because of something happening internally with demand, then they have a tool for that. So you need to know which tools are suitable. Now, the other issue is enforcement, how to enforce it. It’s very difficult to enforce. I think the easiest way to enforce it is to say that governments can’t borrow at all, they can’t sell bonds, they can’t run deficits. And the amount of deficit spending allocated to them will simply be a transfer from the European Central Bank. So, if Italy were allowed to spend 150 billion euros in deficit, then it would receive a transfer from the Central Bank.

II: So you’re saying that, basically, the deficit would be accounted for at the ECB rather than at national level?

WM: Yes, it would be a budgetary accreditation of the ECB. It would reduce the capital of the Central Bank, which is not a problem. And then the ECB would pay interest on that money through interest on reserves if it wants a positive interest rate, which I’m not in favor of, but if that’s what it wants, that’s how it would proceed.

II: I didn’t understand that last part, sorry. So there will be a transfer from the Central Bank to the Treasury, and then what?

WM: That’s right. And then states have to balance their budgets, they’re not allowed to sell bonds, bills, bills, any borrowing at all, locally, nationally. That would be at international level. All financing would come from the international level.

II: So it would be a kind of Eurobond?

WM: Well, yes. So, when the ECB spends this money, transferring these funds, and when the national governments spend them, it appears as reserves, excess reserves, at the level of the Central Bank system, which will therefore simply pay interest on these reserves. So, instead of bonds, interest will be paid on the reserves. Having said that, I would recommend a zero rate, where they pay no interest, but if they want to pay interest…

II: Would you recommend zero interest?

WM: Yes. But if they want to pay a higher rate, then…

II: Yes. So there’d be no need for national bonds?

WM: No.

II: Ok So you could have a first level of deficit, but that’s relative to GDP, or relative to population?

WM: I think you have to start with the ratio to GDP, and then they can always decide politically if they want to change for the population. But to start with, I’d recommend starting with GDP, just to ensure some continuity with what they’ve been doing and not to disrupt.

II: Okay. If you use population, that could be very disruptive.

WM: Well, some countries might suddenly get more than they’re used to, but others might get less. And they might have a high GDP but a low population, so they get less. They can’t deficit spend at all. And they get less transfer from the ECB, so they have to stop paying the police for example, or something like that. You don’t want to do that. You don’t want to cause problems in the first year. This will be a very important step and it will lead to prosperity throughout the Eurzone. So there’s no reason not to do it. And then, if you want to refine it after the first year, if member states aren’t happy with the way it looks and feel it should be population rather than GDP, fine. But they have this function, which uses GDP. GDP per capita is not that different.

II: And you have, say, the central bank or ECOFIN or in any case, the European Commission, a European entity that has to decide whether the deficit limit should be higher or lower.

WM: Who decided to suspend the limits for COVID?

II: The Eurogroup.

WM: The Eurogroup. So that means they can already do it under current policies.

II: And now this question. At what point would the Eurogroup need to say we should reduce the deficit?

WM: Well, if they think that’s the case, that the economy is overheating, unemployment is too low, and they think aggregate demand is too high. And there’s too much spending.

II: When is unemployment low?

WM: Well, if they think it’s good at 3%, then that’s their political decision.

II: Yeah, but if you had to decide yourself…

WM: Personally?

II: Yeah, personally.

WM: Personally, I don’t think I’d worry about it for another 3%. But in the meantime, they’re going to be looking at it all the time. When it gets to 5%, they’ll take a look. And maybe there are structural differences in the Eurozone, where 5% is really zero, because there are people who aren’t going to work, and you don’t, you have high demand and you don’t get new jobs, and prices go up because of excessive demand. You see, let me just say that normally, prices don’t go up because of excessive demand. I’ve almost never seen it. They’ve always started from a supply problem, like energy or something, food. But if they see prices going up because of excessive demand and not enough people working, then at that point they might want to cut back.

II: Okay, but I’m not sure I trust…

WM: Neither do I, but that’s what we have. It’s what we call a democratic process. And if we think they’re making a mistake, if we think they’re cutting spending too soon, then it’s up to governments to take action to change their policy.

II: I have an idea, which is this. With the job guarantee, even if we go to the government, there will always be some sort of short-term unemployment rate. For example, I’m an engineer and I’d like to change jobs…

WM: That’s what we call frictional unemployment.

II: Yes. I remain unemployed for a month and a half, 40 days of unemployment. So this type of unemployment doesn’t originate in the monetary system. It’s just because there isn’t perfect coordination between demand and. So my question is : why don’t you base the new deficit ceiling or deficit adjustment on long-term unemployment? People who have been unemployed for more than three months, for example. So you take this data as an element and try to bring it down to a very low level, for example below 1%.

WM: It’s certainly a contributing factor, but you don’t want to have a strict rule that only looks at long-term unemployment. There may be other things going on that you wouldn’t want to do that for. Somebody has to be in charge of setting that limit, looking at the Eurozone as a whole, looking at its long-term goals. You don’t just want to lock it into one rule. That’s what happened before. You had a rule with a 3% limit. So if that one rule is long-term unemployment…

Ivan: Let’s turn it around. Let’s reverse the question. At what point would you necessarily say that it would be necessary to increase the deficit ceiling.

WM: Well, when the economy is still underutilized, when unemployment is higher than you’d like, when you don’t feel that there are price pressures for bottlenecks that are driving up inflation and you don’t want to add to it that year,

II: But also if there are bottlenecks, maybe that’s just the case, I mean.

WM: Yes, maybe you just want to let prices rise.

II: Yes, I mean, it’s a relative value thing. I mean, you’ve got a bottleneck, I don’t know…

WM: Let’s say food, there’s a food shortage and prices go up. You know, maybe you just want to let some prices go up so people eat less, until the prices come down.

II: Maybe they’ll eat the same, maybe they’ll eat less of other things.

WM: That’s true, and so maybe if a fuel goes up, you’ll want to subsidize it. Maybe you want it to go up because you want them to use less of it. There are all sorts of things that could lead to the same thing giving rise to different policies. That’s why you want an entity that doesn’t stick to one rule, but looks at the whole of the Eurozone.

II: As a suggestion?

WM: Perhaps the finance ministers?

II: As a suggestion, you could say that if long-term unemployment is above 1%, or if long-term youth unemployment is above 1%, we should seriously consider getting a higher deficit limit.

WM: Sure, but if at that point inflation is at 20%, there may be something else in the economy that’s causing it, you don’t want to increase the deficit right away. It could simply be a political choice. We don’t want to push inflation from 20% to 25%. Yes, youth unemployment is half a percent above our target, but for now we think it’s more important. That’s why it has to be a political, discretionary tool.

II: If there’s, let’s say, fiscal space to hire people, and there’s inflation, that means there’s no shortage of spare capacity in terms of labor. So it means that inflation isn’t coming from, let’s say, a shortage of labor.

WM: But if, again, if you have a job guarantee, you have everybody employed and you don’t know how many people are in the job guarantee pool, if it drops below 1% or something like that, there’s no longer an anchor for the price of labor. Maybe I don’t want to start again. But I suppose that’s what you’re talking about, use it as a target. That’s fine, but you just don’t want to be stuck where you have to use it as a target. You have to do it, no matter what.

II: Okay, I understand.

WM: I can’t think of all the examples. Anyway. It’s something I hadn’t thought of that comes up, the fact that we can be stuck with this policy and we can’t change it. That’s when you don’t want to find yourself in that situation. That’s the whole debate between automatic and discretionary rules. When you have discretionary power, if the Prime Minister makes a mistake, you kick him out at the next election. But if you have an automatic rule… If things go wrong and you can’t do anything about it because it’s written in the Constitution. So you don’t want to have these rules where, look around, any fool would say it’s time to raise the limit. But no, we can’t, it’s in the Constitution. You don’t want to be bound by that sort of thing. For this kind of policy, you want to have flexibility because it makes no sense to tie your hands in advance. You don’t want to remove political tools in advance.

II: Okay, I see a political problem. If we set up, let’s say, a system like you said, let’s judge whether we need an increase or a decrease in the deficit ceiling for the whole country, for the eurozone as a whole…

WM: Each country did this on its own when it had its own currency. Every year, the Italian parliament decided on the budget. And so they didn’t have any rules. I mean, you wouldn’t want them to have a rule.

IL: I understand, but the political problem is that in some countries like Germany, for example, or I don’t know, the Netherlands, unemployment would be lower. And these countries wouldn’t feel the need to increase the deficit.

WM: Yes, well, we have the same thing in the United States. Oil prices are rising, unemployment may be low in Texas, but high in New York and high in the rest of the country. The government decides what the appropriate policy is. They might increase spending to reduce unemployment everywhere. Texas has very low unemployment, so they spend their money on something else. It’s not a problem when there’s a union like the Eurozone. So if someone gets a little extra, they can save it. They don’t have to spend it. They get a handout, they can pay off their debt if they don’t want to spend it. Maybe they want to increase the allowances for their university system. Maybe they want to increase allocations for their public health system. If they receive these funds from the ECB every year, they can decide what they want to do. Maybe a country has just suffered an earthquake and needs it to rebuild. Another country can build a new soccer stadium. The same goes for the United States. All states receive federal money. Some build soccer stadiums, others offer free public education. So they have a choice. And if they’re wrong and the consumer price index goes up another 1%, so what? The following year, they change and it doesn’t go up again. It’s not like if it started to go up, it would disappear forever. Every year, you can change. You’re not stuck.

II: That’s clear.

WM: It wouldn’t be perfect. And as these things come up, you could make changes. It’s an ongoing process. You could start with something as reasonable as possible, as simple as possible and that people could understand. It wouldn’t be some kind of magic trick or something.

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Notes

The absence of risk of an increase in interest rates mentioned here refers to the absence of correlation, during Covid, between the level of the public deficit of Member States and the interest rates on government securities , that of spreads. It makes no reference in any way to the fact that the ECB subsequently increased its reference interest rates, an operation of a political nature in relation to inflation, and therefore of a completely different order.

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This article is available in French here : mmt-france.org

Illustration : https://fr.wikipedia.org/wiki/Warren_Mosler