Robert Cauneau

French public finances : an artificial crisis ?

by

Robert Cauneau – MMT France

22 November 2024

Introduction: Redefining the Limits of Public Action

While the budget deficit and French public debt continue to be the subject of heated debate, one thing is clear : most of the discussion revolves around arbitrary thresholds and self-imposed constraints, rather than a rigorous analysis of the real economic limits. Every year, governments present budgets under the banner of austerity, justifying cuts in public services and investments by an urgent need to “control public finances”. But this vision, largely inspired by a neoclassical approach, misses the fundamental issue : for its public policies, the State has a much larger space than it recognizes.

To shed light on this question, the article will begin by recalling the neoclassical analysis of the sustainability of public debt and its fundamental assumptions, before examining the absence of empirical evidence of unsustainability thresholds. It will then explore the alternative approach of Modern Monetary Theory (MMT)1, which redefines the real constraints of fiscal policies, in a floating exchange rate regime. From there, it will analyze the real economic space available to a State for its public policies, while highlighting the concrete impacts of the Eurozone budgetary constraints on public services and the population. Finally, it will conclude on the need to rethink the current rules to allow France to fully exploit its capacities.

Reminder of the neoclassical analysis of the sustainability of public debt

The neoclassical vision of fiscal sustainability can be broken down into 4 points2:

  1. There is a budget constraint based on an accounting identity according to which government spending (including interest payments) must be financed by tax revenues, the sale of bonds and/or the monetization3 of debt. However, neoclassical analysis emphasizes the difference between these financing methods, notably that monetization is inflationary and that selling bonds reduces national savings, implying a constraint on government spending in order to maintain macroeconomic stability.
  2. Interest rates on government debt are determined by market forces : neoclassicals argue that larger deficits will lead to higher interest rates, as the government will have to provide incentives for private lenders to accept its debt securities.
  3. A growing debt-to-GDP ratio is unsustainable and requires future surpluses to stabilize the trajectory.
  4. A trajectory deemed risky by markets could lead to an accelerated rise in real interest rates, thus increasing fiscal pressure.

Although it is based on questionable assumptions, this view is still widely shared today. The assumptions underlying it are questioned in the following sections.

MMT Analysis: A Different Vision Under the Floating Exchange Rate Regime

MMT offers a radically different 5-point reading of economic constraints, particularly in countries that control their currency, under a floating exchange rate regime4 :

  1. The central bank targets interest rates: it adjusts the quantity of bank reserves to maintain its rate target, which invalidates the idea of ​​direct pressure from the markets.
  2. The State is not financially constrained: unlike households or businesses, a State that controls its currency cannot “run out of money”, because it creates it when it spends. It is therefore not limited by its tax revenues or its bond sales.
  3. Sales of government securities drain excess liquidity, keeping interest rates within the targets set by the central bank. They do not finance spending.
  4. Sales of securities do not affect the money supply : money creation occurs through government spending, which alone increases the net financial savings of private sector agents, and not through sales of securities, which only change the composition of financial assets in the economy.
  5. The interest rate on public debt is set by the central bank : it is monetary policy, not financial markets, that determines the cost of national debt.

Thus, for a country that controls its currency, under a floating exchange rate regime, a growing debt/GDP ratio is not unsustainable. Public debt does not constitute a financial constraint.

No empirical evidence shows the existence of a critical threshold for public debt

A recurring argument in debates on public debt is based on the fact that there is a level of indebtedness beyond which economic growth would be threatened. However, no serious study has ever been able to demonstrate the existence of such a threshold. A famous study by Reinhart and Rogoff5 from 2010, which suggested that debt above 90% of GDP was a drag on growth, was largely discredited after the discovery of major methodological errors. On the same type of question, an article by Philip Heimberger6  shows that the econometric literature has so far provided no solid evidence of systematically negative effects of higher levels of public debt on growth.

The real space for economic policies

According to MMT, the limit on public spending by a currency monopoly State is not a financial constraint, but a real constraint defined by the full employment of the resources of its economy7. The state, creating its own currency under a floating exchange rate regime, is not limited in its capacity to create money. However, this capacity is limited in terms of the goods and services that the economy can actually produce. As long as resources remain unused – whether unemployment, untapped production capacity or available raw materials – an increase in government spending stimulates economic activity without generating significant inflation.

Inflation, in this context, is not a limit in itself, but a signal. It indicates that the demand for currency exceeds the supply of goods and services, which occurs when the economy reaches full employment. Beyond this threshold, increasing the government deficit will inevitably lead to higher inflation, because the demand for currency exceeds production capacity. Therefore, at full employment, the government must make allocative choices, that is, decide how to distribute scarce resources between the public and private sectors. Taxation then plays a key role, not to finance spending, but to regulate the demand for currency and thus prevent excessive inflation.

The limit on government spending is therefore not a monetary ceiling. It is the real production capacity of the economy, represented by the full employment of its resources. Inflation, rather than a limit, serves as a valuable indicator to guide economic policies and ensure efficient allocation of resources.

The special case of the Eurozone

This vision of MMT, according to which the limit of economic policies is based on real capacities and not on financial constraints, can only be fully applied if the State controls its own currency. While the Eurozone certainly operates under a floating exchange rate regime, it imposes specific financial constraints on its Member States, which amplifies, in a completely artificial way, concerns related to the budget deficit and public debt.

Indeed, on the one hand, the Maastricht criteria (3% deficit and 60% debt/GDP) are arbitrary, not based on any economic justification8. On the other hand, unlike States that control their currency, the member countries of the Zone must borrow on the financial markets, due to the ban on direct financing by the ECB, which is also formalized through the obligation of the balance of the Treasury account at the ECB permanently positive. However, this ban is entirely political because, technically, there is no operational difference between indirect and direct financing of the State. Indeed, in both cases, the source of the balance of the public account is the central bank9.

The spirit in which the European institutions were set up thus appears clearly. Inspired by the neoliberal doctrine, the designers of these institutions did not take into account the intrinsic functional characteristics of the monetary system. They preferred to impose an ideology favoring rigor and austerity policies. Indeed, this institutional framework limits the capacities of States to invest and respond to social needs, and thus reinforces economic and social tensions within the eurozone.

For France, deep cuts with deleterious consequences for public services

There is no doubt that the deterioration of public services, as it appears in the 2024 edition of the report of the collective « Nos services publics »10, is a direct consequence of the inability of the French State to express its full potential in terms of public policies. The findings of this report are damning : for twenty years, the increase in social needs has far exceeded the resources allocated to public services, widening a gap. This insufficiency has favored a private offer supported by the State, weakened the capacity of public services to reduce inequalities, and damaged the trust of citizens, as well as the working conditions of public agents.

The spirit in which the discussions around the 2025 finance bill are currently taking place, marked by an obsession with the smallest deficit and by drastic cuts in public spending, sometimes for insignificant amounts, does not bode well for the future of public services. These budgetary choices reflect a narrow accounting logic, where the general interest is sacrificed on the altar of artificial budgetary rules and unfounded beliefs.

Conclusion: Changing the paradigm to serve the general interest

It is therefore entirely legitimate to wonder when our leaders will begin to realize that these drastic cuts are not based on any economic foundation, but rather on their own blind adherence to dogmas inherited from neoliberal doctrine. These beliefs according to which public debt is a burden, deficits must be reduced at all costs, and the State is financially constrained like a household or a business, are not only wrong, but they are deeply damaging to the general interest.

To get out of this impasse, it is imperative that both public decision-makers and those who contradict them become aware of the work carried out by MMT. Understanding it would provide the French State with the keys to fully exploit its potential, design ambitious public policies adapted to social needs, and therefore restore citizens’ trust in public services.

However, such a transformation also requires a courageous debate on the rules of the Eurozone. As long as Member States are constrained by artificial limits, these rules will continue to feed the false illusion of an urgent need to confine the State to a logic of rigor and austerity.

No, French public finances are not in crisis. They are only in the minds of those who, due to a biased knowledge of the intrinsic functional characteristics of the monetary system, or through submission to neoliberal ideology, confine the State to a logic of totally sterile rigor. Putting an end to this ignorance and breaking this ideological straitjacket are essential to enable France to meet the social, climatic and economic challenges of our time, and thus satisfy the general interest.

Notes

  1. The blog intended to introduce MMT can be found here: https://mmt-france.org/
  2. See this article by Scott Fullwiler from 2008: https://www.researchgate.net/publication/228121182_Sustainable_Fiscal_Policy_and_Interest_Rates_under_Flexible_Exchange_Rates
  3. Monetization of public debt occurs when the central bank creates money to directly purchase securities issued by the Treasury, thus allowing the government to finance its spending without borrowing on the markets. This practice is often associated with the idea of ​​“printing money” to cover a public deficit.
  4. See this article by Scott Fullwiler from 2008: https://www.researchgate.net/publication/228121182_Sustainable_Fiscal_Policy_and_Interest_Rates_under_Flexible_Exchange_Rates
  5. The limits and the error of Reinhart and Rogoff are analyzed in this article by Yeva S. Nersisyan and L. Randall Wray entitled « Un excès de dette publique handicape-t-il réellement la croissance ?« .
  6. This article can be viewed here: Do higher public debt levels reduce economic growth
  7. Consult this article by Warren Mosler: https://mmt-france.org/2021/07/30/1ere-escroquerie-les-depenses-publiques-sont-limitees-par-la-fiscalite-et-par-lemprunt/
  8. This article describes how the economist Guy Abeille, at the request of President Mitterrand, proposed the 3%/GDP limit for the public deficit, based on no economic logic : https://www.leparisien.fr/economie/3-de-deficit-le-chiffre-est-ne-sur-un-coin-de-table-28-09-2012-2186743.php
  9. Consult this article by Andréa Terzi from 2019: http://www.ateconomics.com/wp-content/uploads/TERZI-FMM-SUBMISSION.pdf
  10. The report can be viewed here: https://files.umso.co/lib_ufoFEvhlRMwflNFx/b5zy83qih7eo4e80.pdf

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