WILLIAM VICKREY A trans-Keynesian manifesto

[12]

WILLIAM VICKREY

A trans-Keynesian manifesto

(thoughts about an asset-based

macroeconomics)

The term "Post Keynesian" might appear to some to imply that

Keynes is being left behind (as in "postwar"), so I am taking the

liberty of introducing an alternative term that I hope has more of a

connotation of building on or going beyond Keynes (as in "trans-Al-

pine"). Recent changes in demographics and technology have created

a fundamentally new environment in which a reevaluation of the

Keynesian approach in terms of the aggregate demand for and supply

of assets has become appropriate for the purpose of extending the

analysis to a longer-run perspective, though not to that still longer

run in which we are all dead. To clear the way for progress, however,

it is necessary to start by admitting that there are conditions in which

Keynesian demand creation by increasing government debt would

not be effective so that one can be sure to create conditions in which

it will be.

Proposition 1: Georgism validates Ricardian equivalence

In a Georgist community, where the only means of financing the

debt service is by a tax on land value, a public debt becomes in

effect a collective mortgage on the land. A decrease in taxes and

an increase in debt leaves each taxpayer with more cash or bonds

but with property diminished in net market value by a like amount,

so that his net worth is unchanged. Ricardian equivalence is

complete, and the stimulative effect is limited to a relatively

minor liquidity effect; there may also be a saving of interest if the

public debt bears a lower interest rate than private obligations.

And if public del

or other features that enhance land rentals, there will be a substan-

tial stimulative effect.

incurred to finance outlays on infrastructure

Journal of Post Keynesian Economics / Summer 1997, Vol. 19, No. 4

O 1997 M.E. Sharpe, Inc.

495

0160-3477 / 1997 $9.50 + 0.00.

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JOURNAL OF POST KEYNESIAN ECONOMICS

Proposition 2: Debt served by property taxes inhibits

investment

Where the main tax base consists in large part of reproducible or

depletable capital, as with local property taxes, deficit finance will have

a severe inhibiting effect on capital formation or preservation. These

activities would then attract an added share in the burden of servicing

the debt. At low debt levels, the hope may persist that other investors

will come along to take up some of this burden, but at some point this

bubble of hope may vanish rather suddenly, with catastrophic results.

This effect may be mitigated to some extent if the debt is incurred to

finance infrastructure that enhances property values. In most cases,

however, even if investment in improvements continues unabated, if the

debt is financed by taxes on improvements, the investment will fall short

of what would take full economic advantage of the increased produc-

tivity generated by the public investment.

Proposition 3: National deficits still stimulate

At the U.S. federal level, with heavy reliance on taxes based on earnings

(or on consumption), deficit financing shifts tax burdens from present

earning effort and consumption to burdens on future earnings and

consumption, without capitalization in reduced asset values. Thus,

current consumption and income production are encouraged, especially

since, for many, the future burden, if any, will be beyond their horizon.

The result is a strong stimulative effect.

Proposition 4: Fallacious beliefs can be

temporarily self-justifying.

Nevertheless, if a sufficiently strongly held belief prevails in Ricardian

equivalence or its close relative the “crowding out" theory, this may for

a time hold back investment sufficiently to outweigh the stimulus to

consumption, and thus become, for a time, a self-fulfilling prophecy.

Agents are people, not robots imbued with an "irrational passion for

dispassionate rationality" in the single-minded pursuit of net profits.

And even for those not seized with the "crowding-out" fallacy, it would

be irrational not to take account of the irrational reactions of others.

Eventually, however, this must succumb to the realities of increased

disposable income and market demand.

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A TRANS-KEYNESIAN MANIFESTO 497

Having posted these caveats, we can now turn to the core ofKeynesian

analysis as it applies to the contemporary situation.

Proposition 5: Full employment requires

large government deficits

For the industrialized world as a whole, and for most of its constituent

countries individually, it has become impossible, for the foreseeable

future, to achieve sustained adequately full employment without large

and growing government debts and corresponding budget deficits.

On the one hand, increased longevity and duration of retirement, higher

medical costs of care for the elderly, and the loosening of family ties

that call for increasingly individualized provision for old age have led

to a sharply increased demand for assets of various kinds to provide for

retirement. This is in addition to the greater concentrations of income

among those who are more driven to accumula chips with which to

play high-stakes financial games, acquire economic power, or establish

dynasties. These tendencies have all led to a sharply increased demand

for assets, in terms of market value, relative to GDP.

On the other hand, the ability of the private sector to supply assets

that have a realizable market value has grown much more slowly.

Capital-saving innovation such as fiber optics, just-in-time schedul-

ing, centralized traffic control, miniaturization, electronic rather than

mechanical calculation and switching, and the shift of demand from

the products of heavy industry to those of light industry and to

services all tend to reduce the ratio of capital to output. Rapid

obsolescence and depreciation of high-tech capital and investments

in R&D and promotion of intellectual property result in a smaller

ratio of net investment in terms of market value of capital to gross

investment. The substitution of publicly owned highways and air-

ports for privately owned railway tracks and terminals has reduced

the base for privately owned assets. All these factors have combined

to keep the ratio to national product of the market value of private-

sector assets, net of liabilities, relatively low.

The result has been a large and growing gap between the private

demand for and the private supply of assets at a satisfactory level of

employment. This gap must be filled by a correspondingly increasing

supply of government assets-federal state, and local if a growing

full-employment trend of GDP is to be realized. If the gap is not so filled,

and the total asset supply held by individuals falls short of what they

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498 JOURNAL OF POST KEYNESIAN ECONOMICS

desire to hold, the curtailing of expenditures by individuals in an attempt

to bring their net worth up to a desired level will reduce sales, produc-

tion, employment, and GDP until the corresponding demand for assets

has been reduced to the available supply. Economists have for far too

long operated in sublime disregard for the macroeconomic implications

of these fundamental changes in the technological and demographic

environment in which economies operate.

Proposition 6: Monetary policy cannot close the gap

The gap between the private demand and the private supply of assets

has become far too large to be closed by any interest-rate or credit-sup-

ply adaptation. On the one hand, the demand for asset accumulation and

the corresponding supply of savings have become relatively insensitive

to interest rates and may even have developed an inverse relationship

as lowered interest rates increase the amount of assets required to

provide a given level of old-age security.

On the other hand, high risk, rapid obsolescence, maintenance, and

other user costs have diminished the long-run responsiveness to

interest rates of investment in productive assets. The implicit assump-

tion of the neoclassical paradigm that the potential for profit-seeking

capital investment would expand without limit as real interest rates

fell, so that there would always be an interest rate that would close

the gap, fails in the face of the reality of uncertainty concerning

conditions that will obtain in the remote future. As interest rates fall,

indeed, more and more remote future conditions, predictable with

greater and greater uncertainty, become increasingly important in

current investment decisions. Even land, the quintessence of durabil-

ity, is subject to the vicissitudes of erosion and climatic change, to

say nothing of shorter-run uncertainties such as changes in tax rates,

zoning, externalities from neighboring uses, and regulatory takings.

One cannot afford a palatial estate merely because a 100 percent

mortgage at zero interest is available

There is also a tendency of econometric studies, usually based on time

series, to overestimate the long-run effect of reduced interest rates in

increasing private investment and asset supply. A reduction in interest

rates may stimulate a spurt in housing construction, for example, but

once the stock has been built up to the new level of demand, construction

is likely to fall back near its old level.

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A TRANS-KEYNESIAN MANIFESTO 499

Proposition 7: Alternative means of closing this gap

are inadequate

For a while after World War II, in most industrialized countries, the gap

between private capital formation and private savings remained small,

in part by reason of reduced or low income levels, in part by the fact that

the expected duration of retirements was still modest, and in large

measure by reason of the high level of opportunities for the repair of

war damages and the filling of the gap left by the suspension of civilian

capital formation during the war. In Germany, this period was extended

by the absorption of East Germany; in Japan, by a spate of export

surpluses. But solving the problem with export surpluses to other

industrialized countries is essentially a beggar-my-neighbor policy not

available as a general solution.

Meeting the problem temporarily through massive export surpluses to

the developing world is possible in principle, but in practice encounters

formidable obstacles. Unstable or corrupt governments often increase

the risks of such investments beyond the level that most private investors

are willing to bear. At best, private investors eventually will expect to

realize a return on their investment requiring the developing country to

generate an export surplus, difficult at best. Even if successful, this

merely brings back the original problem in the lending countries.

Meeting the demand for assets by a speculative boom in stock market

and other asset prices is a temporary bubble solution that is bound to

burst with catastrophic consequences, as in 1929. Creating property by

government fiat, as in the creation of a salt monopoly, issuing taxicab

medallions, protecting agriculture, or even merely tolerating monopoly,

may help to fill the gap but cannot go very far without serious degrada-

tion of allocational efficiency, or in some cases aggravating the distri-

bution of wealth. There is in the long run no adequate solution without

long-term and continued increases in government debt. Budget balanc-

ing over the business cycle, once thought to be the answer, is no longer

adequate.

Proposition 8: Measures to promote individual saving produce

exactly the opposite of the intended results

One of the more serious fallacies of the conventional wisdom is the

notion that investment and growth can be promoted by measures in-

tended to increase individual saving, such as exemption of savings in

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various forms such as pension plans, reduced taxation of capital

gains, and shifting to consumption taxes. For most individuals, an

attempt to save more means actual reduction in consumption spend-

ing. This increases the bank account of the saver but decreases the

bank account of vendors by a like amount. There is no creation of

"loanable funds," and nothing happens that either encourages or

facilitates the creation of new capital to correspond to the attempted

savings. If anything, funds in the hands of vendors, such as typically

entrepreneurs of one kind of another, would be more likely to provide

the basis for active capital investment than the new funds in the hands

of the saver.

The increased saving of the individual saver is offset by the decreased

income and saving of vendors. In the case of services, such as barber

shops, the effect is immediate; where tangible goods are involved here

may be a temporary investment in increased inventory, but this is soon

converted to reduced incomes of producers as orders are cut back to

bring inventory back to normal levels. In either case, reduced income

eventually results in reduced consumption purchases, GDP, and aggre-

gate saving. Incentives may indeed result in some individuals increas-

ing their saving, but only at the expense of reducing the savings of

others by even more.

Proposition 9: Full employment in open economies requires

floating exchange rates

For small open economies, combining free trade with fixed or narrowly

constrained exchange rates would make it impossible for any one of

them to pursue a full-employment policy independently. Were Denmark

or Spain to attempt full-employment policy through deficit finance in

the context of a European union, much of the stimulus provided would

leak away through the use of the resulting purchasing power to buy

foreign goods rather than domestic, implying the acquisition of domestic

capital assets by foreigners, a corresponding reduction in the supply of

assets available to residents, pressure on the exchange rate, and eventual

collapse of the program.

The answer is to retain freely floating exchange rates so that, when

domestic purchasing power is increased, the demand for foreign goods

will drive the price of foreign exchange and foreign goods up, discour-

aging imports and encouraging exports in such a way as to keep the

economic stimulus at home. Other countries cannot legitimately com-

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A TRANS-KEYNESIAN MANIFESTO 501

olain that this is an unfair trade practice: They would be free to adopt a

similar full-employment policy of their own.

To be sure, for countries large enough or idiosyncratic enough in terms

of resources or tastes to be a significant factor in the international

markets, this would entail some deterioration in their terms of trade.

There is also some danger of generating speculative gyrations in the

foreign-exchange markets at the time of inauguration of the new policy.

But as long as the monetary authorities eschew the temptation to

interfere in "stabilizing" the market, and thus give additional opportu-

nities for speculation on the basis of rumors of such interventions, these

costs would be of little moment compared with the manifold advantages

of real full employment.

More serious is the possibility that full employment would attract a

volume of immigration that would be difficult to handle. In many cases

it can be hoped that family and social ties, linguistic and cultural

differences, and costs of making the transition would keep migration

at acceptable levels, but if not, some restraints on immigration may

have to be imposed.

The Maastricht strictures, if followed, would condemn member

countries to continued high levels of unemployment. Even if the

constraint on deficits were abandoned and a monetary union as a

whole were to attempt a full-employment policy through an increased

supply of government securities, in the absence of a large central

fiscal authority, it is difficult to imagine how the problem of allocat-

ing the necessary aggregate deficit among the various countries could

be handled. The proper sequence is first to secure an acceptably low

level of unemployment and only then to proceed to monetary union.

Otherwise, one is imposing severe hardship on those affected by

unemployment for the sake of a relatively minor benefit to interna-

tional travelers and traders.

The states and localities in a federal system are, of course, the extreme

example of small open economies. Macroeconomic policy must accord-

ingly be carried out almost entirely at the national level. In the United

States, the macroeconomic impotence of local governments is intensi-

fied by their general reliance on property taxes as a chief source of

revenue. The main measure they could take to enhance local prosperity

would be to shift from a property tax to a land or site-value tax, but that

is somewhat outside the Keynesian rubric. But, in any case, it is still

necessary to include state and local debt in balancing the demand for

and supply of assets.

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Proposition 10: “Privatization" or other moves toward full

actuarial funding of old-age pension provisions of social security

systems can be disastrous

How social security systems are funded strongly affects macroeconomic

equilibrium. “Social security wealth," the excess, for current partici-

pants, of the present value of expected future benefits over the present

value of expected future taxes, is an important part of the assets that

individuals rely on to provide for their retirement. While the actual

amount of this wealth as perceived by the individuals concerned (as

distinct from that resulting from actuarial estimates) is highly conjec-

tural, it is a very large quantity. In the United States, it is of the same

general order of magnitude as the formal funded debt. It is vastly greater

than the relatively small social security trust fund, an essentially arbi-

trary and economically rather meaningless figure.

In a complete accounting, this social security wealth would appear on

one side of the national balance sheet as part of individual wealth; on

the other side, a like amount would appear as unfunded liability. Ac-

cordingly, barring major changes in social security programs, it is not

far from the mark, in going from historical data to a scenario for the

future, simply to omit this social security wealth from both sides of the

asset balance. However, given the political clout that balancing the

official budget has acquired as a goal of policy, consideration may well

be given to changes in social security programs, especially for pensions,

that could significantly reduce unemployment.

As a somewhat fanciful extreme, one way to move substantially toward

full employment without continued formal deficits or enlargement of

the explicit government debt would be to abolish the social security trust

fund, now often counted as part of the formal government debt, and

enlarge the amount of social security wealth, as a sort of clandestine

debt. One possibility would be to enact generous pensions to be paid on

the basis of age to all residents, possibly graduated according to their

history of personal income taxes, to be paid for out of future general

fund revenues.

To be sure, many might not consider this promise of future benefits,

payable out of future general tax revenues, as strongly binding as the

present social security arrangements, “paid for" with "dedicated" pay-

roll taxes. Indeed, even these are being considered for downward

revision, for example, by raising the age at which payments begin,

reducing the amounts exempted from income tax, or changing the rules

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A TRANS-KEYNESIAN MANIFESTO

503

for in effect levying in a special surtax on earnings during retirement.

But if sufficient confidence could be engendered that these payments

would in the event be made, and at a sufficiently generous level, other

asset accumulation for retirement might be reduced to the point where

it could be met by private capital formation, and full employment

achieved with an“officially balanced" budget. The fact that part of one's

income taxes are going to “buy" retirement benefits on an individual

basis could serve as a source of confidence in the payments being

ultimately made and allow the income tax to have less of a distorting

influence on current activity. Nevertheless, the success of such a pro-

gram would still depend on the acceptance of the exclusion of the

increased in social security wealth from the official deficit and, in the

financial community, not being panicked by exaggerated projections of

high tax rates. Managing a smooth transition would also require careful

attention.

Proposition 11: Downsizing government is a separate issue

Unemployment-reducing fiscal policy does not require an increase in

the overall size of government operations. To be sure, anarchy-libertar-

ians have combined the mystique of the balanced budget with appeals

to a popular aversion to taxes to promote an indiscriminate downsizing

of government. But full employment can be reached either by high taxes

and even larger government, or by low government and even smaller

taxes. At the extreme, one could have the full-employment economy

assured by a government whose main activity would be collecting

income taxes and distributing the proceeds in old-age pensions, at a level

that would permit individuals to fill their remaining needs for assets

from the private-sector supply. This would obviate the need for a formal

funded debt: Its functional equivalent would be the social security

wealth implicit in the undertaking to pay future pensions.

This might give the appearance of a giant Ponzi scheme, though

without a Ponzi to dissipate or abscond with the funds and preserved

from collapse by the assurance of a continuous intake of new contrib-

uting participants. The participants would, on average, be getting a

return on their income tax contributions roughly equal to the rate of

growth of the economy. In intergenerational terms, one can think of this

as a repayment to the retired cohorts A by working cohorts B of the

contributions previously made by the cohorts A, when they were earn-

ing, to the rearing and education of cohorts B. As compared with the

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504 JOURNAL OF POST KEYNESIAN ECONOMICS

present situation, there would also be a distribution to the various cohorts

of the added product from full employment.

In many ways, minimizing unemployment would facilitate downsizing

of government. It would reduce the volume of unemployment compen-

sation and welfare payments, eliminate or reduce the need for minimum

wage and other labor regulations, abate opposition to the closing of

superfluous military establishments, and might even significantly re-

duce the cost of the penal system.

Proposition 12: The NAIRU is not an exogenously given datum

The widely held notion that there is a minimal “non-accelerating-infla-

tion rate of unemployment," or NAIRU, currently put by the Congres-

sional Budget Office at 6.0 percent, below which unemployment cannot

be pushed without danger of igniting an unacceptable acceleration of

inflation, lacks historical or analytical basis. (The alternative formula-

tion, NAIRU, would syntactially imply a “natural" rate of unemploy-

ment emerging from a condition of inflation at a steady rate, but this is

not the way the notion is more frequently being used.) In the United

States, the unemployment rate in 1926 is estimated to have been about

1.8 percent, with no noticeable inflation, and no explanation is offered

as to why this cannot be achieved today. Nearly all countries have

enjoyed rates of unemployment of under 2 percent at one time or

another, without serious inflation; in Germany in the 1960s, unemploy-

ment was reportedly as low as 0.6 percent.

The acceptance of such an NAIRU as a norm, with the implication that

if unemployment falls below this level action must be taken to slow the

growth of GDP lest the economy become "overheated," turns efforts to

help welfare clients and others finds jobs into a cruel game of musical

chairs, with work-force advocates threatening to confiscate the crutches

of the less agile while NAIRU acolytes religiously keep the supply of

chairs inadequate and assure an unabated stream of clients.

There might be some theoretical argument for the existence of an

"NAIRRU,"or rate of reduction of unemployment, such that an attempt

to reduce unemployment more rapidly than this, through the pumping

of purchasing power into the economy, would outrun the ability of the

production system to expand production to match. There seems to be

nothing to prevent bringing unemployment down gradually to below 2

percent, with not only a substantial increase in GDP growth but signif-

icant improvement in such areas as poverty, crime, broken families,

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Α TRANS-ΚEΥNESIA Ν ΜΑΝIFESTO 505

homelessness, school dropouts, and drug addiction, provided only that

it is done slowly enough.

Even this NAIRRU is not a constant but can be expected to vary

according to the amount and distribution of excess production plant

capacity, especially in the capital-goods industries, and the level of

education and training in the pool of unemployment labor, as well as the

prevailing mood of optimism or pessimism. It can be expected to get

smaller as full employment is approached and the task of matching job

requirements and qualifications becomes more difficult.

In any case, as full employment is approached and the “reserve army

of the unemployed" is reduced, eliminating its depressing effect on the

wages of the unskilled, there is likely to be a corresponding increase in

the prices of products of unskilled labor, raising the measured produc-

tivity and the status of these workers and resulting in a small one-time

step-up in the overall price level. But this is a far cry from setting off an

inflationary spiral.

Even so, the advantages of a faster reduction in unemployment would

be well worth enduring a little more inflation. An economy with 10

percent inflation and 2 percent unemployment would be far healthier in

human terms than one with 1 percent inflation but 8 percent unemploy-

ment. Not only would the real GDP be some 15 percent larger (according

o Okun's ratio of 2.5), but there would be important budgetary benefits

n terms of lower costs of unemployment insurance, welfare, and the

criminal justice system, as well as alleviation of social problems. Infla-

tion may be akin to legitimized embezzlement, but unemployment is

equivalent to arson. Maintaining unemployment as a prophylactic mea-

sure against a highly problematic threat of a mismanaged inflation is a

cure far worse than the disease.

Proposition 13: Moderate steady inflation has advantages

The optimum rate of inflation is not zero, but a significantly positive

one. The adoption of a target rate of inflation somewhere in the range

of 3 to 10 percent as the norm has several substantial advantages. First,

the higher the target rate of inflation, the more room the monetary

authority will have to lower real interest rates and apply a stimulus to

the economy in the event of a slip away from full employment, until the

slower political process has time to come into action.

Second, inflation coupled with strict accrued nominal income account-

ing turns the income tax base into a base consisting of real net income

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506 JOURNAL OF POST KEYNESIAN ECONOMICS

plus a percentage of net worth equal to the rate of inflation. This

broadens the base, making it possible to have lower marginal rates for

the same revenue, with a smaller impairment of incentives. It also tends

to make the tax more progressive. One can consider the net worth

element in such an income tax as a desirable substitute for the inheri-

tance, estate, and gift taxes, at least in excess of some nominal low rate.

These succession taxes are inherently so capricious in their impact that

they have given rise to an entire industry of “estate planners," and so

vulnerable to avoidance as taxes levied on infrequent occasions that can

be avoided by a temporary shifting of wealth to forms outside the

jurisdiction.

Third, steady inflation gives more scope for the lowering of real rates

of interest, stimulating growth and reducing income inequality in the

long run. There may be some adverse impacts in the short run on

low-income individuals, but this is likely to be much smaller than what

is perceived by those who focus on the increase in consumer prices

without allowing for growth of nominal income. Those with mortgages

or who owe other debts, in particular, will tend to gain rather than to

lose.

Fourth, inflation increases the seigniorage profits from the outstanding

issue of currency, a burden falling mainly on those engaged in black

market and illicit activities.

The main advantage of a zero rate of inflation as a norm is its salience,

in that it is easier to obtain agreement among agents involved that this

is in fact the norm to be pursued, than to obtain agreement that the rate

should be 1 percent rather then 2 percent. This salience may also make

it easier to obtain agreement on the steps to be taken to correct deviations

from the norm.

On the other hand, if the real interest rate is low-say, 2 percent-a

zero inflation norm would severely limit the ability of a monetary

authority to provide a stimulus in the event of a downturn. Vigorous

action against a threatened overheating might also be inhibited by a fear

that it will be impossible to stem a downturn if the braking action should

overshoot the mark. Thus, with a 4.5 percent inflation norm, there may

be a better chance of keeping inflation between, say, 4 percent and 5

percent than of keeping it between 1 percent and 2 percent. Once the

salience of the zero inflation norm is breached, a moderately high

inflation rate may provide a lower degree of uncertainty about future

prices than a low inflation rate.

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A TRANS-KEYNESIAN MANIFESTO 507

Proposition 14: Unemployment is not needed to control inflation

Even if inflation should threaten to get out of hand as a result of a

vigorous full-employment policy, there are ways of keeping it under

control that do not involve tolerating unemployment. One of these would

be a system of tradeable rights or warrants to value added, whereby

anyone who ends an accounting period without holding warrants suffi-

cient to cover his value added would be subject to a suitable penalty tax.

Warrants would be issued to firms for successive periods on the basis

of previous value added with adjustment for changes in inputs of prime

factors such as invested capital and labor.

Abba Lerner, shortly before his death, had been suggesting the use of

a market in rights to raise prices as an inflation control. This was

analogous to proposals then circulating for markets in rights to emit air

pollution, the raising of a price being considered to have an externality

in terms of its contribution to inflation analogous to that of air pollution.

In terms of practicality, this was a nonstarter, given the difficulty of

checking on a vast variety of commodity and service prices. When the

added difficulty of providing for the pass-through of increases in the

prices of supplies and components was considered, the analogy to gross

receipts taxes led naturally to recasting the proposal in terms of value

added, which maķes the proposal practical. Many countries have exten-

sive experience with value-added taxes, and social security and income

tax records provide the information for the basic allocation of the

warrant issue.

Unlike value-added taxes, failure to include informal sectors is not a

serious problem. Purchases by formal-sector firms from informal sec-

tors can be treated as pseudo-prime inputs. Prices of informal-sector

outputs will still tend to keep pace with those of the formal sectors. Firms

enjoying strong markets for their products will be able to realize higher

value-added profits only by purchasing warrants from firms having a

less fortunate experience, effecting a kind of profit sharing among firms

and reducing risk to investors.

Ultimately, some form of third major macroeconomic control instru-

ment is necessary, in addition to monetary action through interest rates

and fiscal action through income generation, if full control is to be

exercised over three major macroeconomic variables: the rate of infla-

tion, the level of employment, and the division of the product between

current consumption and provision for the future. While with a sufficient

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dihedral, one can fly a plane in good weather and make gentle turns with

rudder and elevator, it was the Wright brothers' invention of wing warp,

later realized as ailerons, that allows landing in a cross-wind without

disaster. If value-added warrants won't do the trick, it is up to economists

to devise something that will.

Proposition 15: Treasuries should refrain from monopolistic

exploitation of their dominant position in the short-term markets

To enhance efficient allocation of capital investment, treasuries should

borrow in short markets rather than long up to the point of making

compounded expected short-term rates equal to long-term rates. The

risks reflected in financial liquidity preference involving unexpected

changes in interest rates (as distinct from risks of the borrower's failure

to make timely payments) are essentially zero-sum risks in which the

gains from unanticipated interest-rate changes to those on one side of

the market are balanced by losses to those on the other side. There is no

presumption that the social returns in terms of productivity to short-term

investment, such as in inventory that can be financed on the basis of

short-term interest rates, are any greater than from investments typically

financed by long-term obligations. Bringing the long and short rates into

line would tend to shift investment from short-term to long-term types

of investment until the marginal productivities are equalized. In effect,

the market demand for liquidity is one that can be satiated at little or no

cost by the Treasury, so that liquidity should be supplied free of charge,

or nearly so. In effect, treasuries would enhance economic efficiency by

behaving as competitive price-takers rather than as partial monopsonist.

Proposition 16: Large government debt can have a

stabilizing effect

In the event of a downturn, when market values of private assets fall,

the market value of outstanding government obligations will tend to

remain constant in money terms, or even, in the case of longer-term

obligations, to increase if interest rates fall. The result is that the

proportionate fall in the total net market value of assets will be less than

it would have been in the absence of government debt, mitigating the

downturn. Similarly, the presence of a large long-term government debt

will enhance the effectiveness of a reduction in interest rates induced by

monetary policy. The existence of large government debts may be one

Full Employment and Price Stability 107

A TRANS-KEYNESIAN MANIFESTO 509

reason we have not had a recurrence of a depression of the severity of

the 1930s.

There would even be something to be said for giving some priority to

longer-term securities, such as by going to zero-coupon bonds instead

of annual interest bonds, for the sake of the higher stabilizing effect,

though if bondholders fail to "mark to market" either in actual accounts

or in overall appraisals, some of the stabilizing effect may be lost. One

could even argue for lengthening the maturity of the zero-coupon bonds

beyond the point of matching maturities to the preferences of the market

for specific maturities, for the sake of an additional stabilizing effect.

On the other hand, a large public debt exacerbates the effect of inflation

in producing unemployment in that inflation not only absorbs purchas-

ing power that would otherwise induce added output, but reduces the

real value of outstanding debt and thus induces reductions in spending

to recoup some of the loss of net worth. With private debt, which appears

on both sides of private balance sheets, this effect occurs to a minor

extent, if at all.

Proposition 17: A larger government debt can increase the real

heritage left to future generations

The conventional wisdom that national debts are a burden on future

generations is a fatal fallacy that is almost the exact opposite of reality

under conditions of underutilization of resources. A larger supply of

government bonds induces a higher level of spendings, and hence of

sales and of production. Increased sales induces increased investment

to provide the capacity to meet the increased demand. This means an

increased heritage of real capital plant and equipment, to say nothing of

the enhancement of human capital induced by fuller employment. Under

current U.S. conditions, each billion dollars of increased public debt can

be expected to result, over a medium long run, in an increase of about

two billion dollars in private investment.

The main disadvantage presented by a large government debt is the

need to obtain revenues to finance the debt service. But, as long as the

economy is growing steadily, implying a need for the amount of gov-

ernment debt to grow at a comparable rate, so that much of the interest

will be covered by the needed increase in the debt, while the remainder

would be covered by increased revenues from a higher GDP and

reductions in unemployment and welfare benefit payments. Even in the

event of a cessation of economic growth, as from a decline in birth rates,

108 Full Employment and Price Stability

510 JOURNAL OF POST KEYNESIAN ECONOMICS

exhaustion of natural resources, and failure of technology to advance

productivity, the problem is merely the reflection in financial terms of

the fundamental problem of providing for the increasing wants of

retiring cohorts out of the product of the working cohorts.

The core substance of all of this is that it is necessary to stop thinking

of inflation and government deficits as the prime evils. Instead, it is

necessary to recognize that government deficits are a rough measure of

the net contribution of governments’ disposable income, that govern-

ment bonds provide a needed placement for larger individual savings to

provide for retirement, and that it is not the level of inflation but its

uncertainty that hampers productivity. Thus, larger deficits, a larger

supply of government bonds, and possibly some increase in inflation

rates are necessary and proper means to mitigate unemployment as the

far greater evil in terms of human welfare. While it may have been good

advice to John Alden to be thrifty and balance his budget or even

accumulate a surplus, it is foolish to apply this by analogy to a national

government planning for the twenty-first century.