Covid-19 financing, inflation and fiscal restriction



During the pandemic, governments have limited their spending so as not to increase the public debt. But there is an alternative to this.

The Covid-19 pandemic is producing an economic crisis that could become bigger than the Great Depression of the 1930s. and poverty, but will vary from country to country, depending on how much states spend to address it, and how well they spend.

Flattening the curve of new cases and reducing the number of deaths requires increasing the capacity of the health system and carrying out social distancing and quarantine policies that, combined with mass testing and tracking of those infected, will allow for their reduction until further notice. an effective vaccine or drug is found. These actions have a cost for companies and for the State.

For companies because they will be forced to limit their activities. For the State because it will need to increase its health expenditures, which are relatively small, but are high when the problem is to neutralize the economic losses that the pandemic is causing: the drop in GDP, business failures, unemployment, hunger among the poorest and fall in tax revenues. To what extent should each government promote quarantines, despite pressure from companies for the state to suspend them? And how much should the State increase its expenditures to reduce these losses or economic costs of closures or stoppages?

No one knows for sure what the costs and benefits are, but two things are certain: first, the State, despite pressure from companies, must radically close the economy and accompany the closure with the tracing of those infected, because, thus , will stop the spread of the virus; second, the more the government spends in a countercyclical way, guaranteeing a minimum income for people and subsidizing companies that have not laid off their employees, the less depression the country will face.

But the government faces a fiscal constraint that obliges it to limit the public deficit and public debt. Therefore, for these two measures to be satisfactory, the financing of these extraordinary expenses will be carried out by issuing currency. If the country has a very sound fiscal condition, its government is likely to spend what it needs anyway. Take the case of Germany, for example. And it will also be able to resist pressure from companies to open up the economy. In most cases, however, countries will underspend and resist companies poorly.

In this article, my aim is to discuss this issue in four sections. In the first section, I will focus on the range of results countries are achieving and their relationship to government spending. In the second, I will discuss how to finance these expenditures. Private finance or “monetary finance”, the issue of currency by the state? And I will argue in favor of the second option. In the following section, I discuss the economic constraints facing governments, particularly the constraint on inflation, and I will argue that monetary finance will not cause inflation. Finally, in the fourth section, I reaffirm the importance of the fiscal restriction, which is especially relevant if we associate it with the exchange restriction. From the perspective of new developmental theory, I will argue that before government spending causes inflation (because the economy has reached full employment), it may cause imports to rise above exports, the current account deficit to rise, and the current account deficit to rise. consequent appreciation of the exchange rate. However, I observe that the fiscal restriction cannot be defined only if the public deficit is balanced; public debt is also part of the fiscal constraint. She must be kept under control. In the case of Covid-19 financing, however, in addition to the respective expenses being exceptional, private financing will lead to a huge increase in the public debt of countries, while monetary financing will keep this debt under control.

different results

How effectively are countries controlling the spread of the virus? China, where the pandemic began in December 2019, has carried out a very effective lockdown, controlling the spread of the disease, so that deaths in mid-May totaled just 4.634, while in the United States, which has a population a quarter smaller, deaths already totaled 109.448, and a considerably higher increase is expected because the spread of the virus started there later than in China. The spread factor (the average number of people infected by someone with the disease) is falling in rich countries in Europe. It is below 1,10 in Germany, France, Italy and Spain, and still at 1,23 but falling in the US and UK. It is under control in Turkey, Vietnam and Argentina, while it is still high in Brazil (1,45) and Russia (1,79).

Such results are related to the quarantine policies adopted by countries and their responsible compliance by people. In the United States, the result was bad and in Brazil, worse, while their respective presidents resisted to act. In Brazil, whose president has made it difficult for state governors and mayors to enforce social distance, the death toll already stands at 33.688 (May 2020), while in Argentina, whose president has adopted a firm defense policy against Covid-19, we only have 588 deaths. The negative results in the biggest countries of Europe are also terrible – United Kingdom and Italy with more than 33 thousand deaths, Spain and France with more than 29 thousand deaths, while Portugal, Denmark and Germany present better results.

There are many questions being asked. How many cycles will there be? How long will the pandemic last? Why did China control the virus so much better than Western countries? The immediate answer I heard to that last question is that this is an authoritarian regime. It is undoubtedly authoritarian, but is democracy to be blamed for bad results in the West? Denmark, New Zealand and Argentina are countries whose political regime is democratic, but they have also controlled the spread of the coronavirus. And, to a lesser extent, also Germany. Perhaps a better explanation is that in countries where neoliberal individualism has gone far, where the main logic is that everyone competes against everyone else, as is the case in the United States and Brazil, the results were worse.

In the last 40 years, within the framework of neoliberalism, individualism has become hegemonic, “the only game in town”, while the idea of ​​solidarity lost ground. A society in which this happens is a sick society. When a pandemic like this happens, we see how important the state is; it is clear that it is our great instrument of collective action. We see that if we are able to build a true nation, a healthy society, we will be able to count on a State characterized by sensible laws, good policies, and having a state apparatus capable of applying them.

In modern capitalist societies, the State can be a mere instrument of the ruling class, but, within the framework of democracy, it can contribute to the construction of a system of solidarity. Rich countries moved in this direction in the Golden Age of capitalism, but since the 1980s, neoliberal ideology has become dominant and social and moral regression has been enormous, while their economies have grown slowly. China is not a democracy, but this pandemic has shown that there is more solidarity there than in most Western countries.

What will the world be like after this crisis? Will it abandon neoliberalism? Indeed, neoliberalism has been abandoned since the global financial crisis of 2008. But in countries like the United States and the United Kingdom, where individualism has come to the fore, instead of being replaced by social, developmental and environmental capitalism, which is the real alternative to neoliberalism, is being replaced by right-wing nationalist populism, where solidarity and rationality are absent. Something similar but more serious happens in Brazil.

In reaction to 12 years of center-left rule (something that had never happened before in this country), its elites became radically neoliberal and supported the infamous Bolsonaro government, a far-right government. They supported him simply because before the election he chose a neoliberal economist as his Minister of Economy. They played sorcerer's apprentices. Among the evils associated with this government is a disastrous performance in relation to the pandemic. As Francisco Lopes (2020), who closely follows the spread of Covid-19, said, Brazil is a mistake: “Brazil is on the way to becoming one of the infected countries in a world that is converging towards stability”. A real genocide is taking place here due to the obstacles that the federal government imposes on people's isolation.

How to finance?

What will be the economic cost of this crisis? The IMF predicted a drop in world GDP of 5%, but I believe it will be greater. And in every country, economists are predicting a huge increase in public debt. There are two ways to finance the high public spending required: issuing treasury bonds and selling them to the private sector or selling them to the central bank.

The first alternative is a business as usual and involves increasing the public debt; the second means the government “prints money”, an alternative that makes people shudder, because it would mean rising inflation and allow the state to spend without restrictions. However, increasing the money supply will not cause inflation, given the exceptional nature of the pandemic and the importance of spending what is necessary to neutralize it, and, as long as it is well regulated, issuing money is not incompatible with tax restriction.

I support the second alternative. The first, by increasing the public debt, will force citizens, especially the poorest, to pay it through numerous fiscal adjustment policies. On the other hand, a large increase in public debt can lead to less developed countries not being able to pay it and being forced to ask for a demoralizing restructuring of their debts. It is true that the payment of the public debt may not be so onerous if the government manages to keep the interest rate below GDP growth, but this effort will force the country to adopt fiscal austerity, without having any guarantee that it will manage to keep the interest rate low. , and thus to suffer low growth rates for many years.

The UK had such an experience: after the First World War, its debt rose to 140% of GDP, prompting the government to engage in a policy of fiscal austerity that led to a high primary surplus during the 1920s. The Economist,, the results were disastrous. Austerity slowed growth: output in 1928 remained below 1918 output, while public debt continued to rise to 170% of GDP in 1930. After World War II, the UK reduced its public debt from 259% in 1946 to 43% of GDP in the 1980s, but its growth rate over the period was substantially lower than the growth rates of France, Germany and Italy. The United States also reduced its public debt from 112 to 26% of GDP in the same period, but it did so while maintaining a satisfactory growth rate – which was possible then because this country experienced enormous growth with the war.

This is a very serious crisis that mainly affects social minorities and the poorest. The short-term challenge facing governments is making the necessary spending. The possibility of financing Covid-19 expenses without increasing the public debt is important for all social classes and all types of countries. If policy makers know that by issuing money the public debt will not increase or cause inflation, they will have more freedom to spend what is really necessary, rather than spending “what they can”. If they persist in not believing that this is possible, or if they are policy makers in Eurozone countries that do not have the power to issue currency, they are likely to spend less than necessary.

There is still no definitive data on how much the big countries are spending to face Covid-19, but there are already good studies. According to the Brazilian Institute of Economics at FGV (IBRE), there are large variations. Considering only government programs, we have that some countries, such as Australia, Canada, and Japan, are spending a lot (respectively, 10,1%, 9,1% and 6,8% of GDP), while others, such as Italy, France and Spain, are spending little (respectively, 1,2%, 2,0% and 2,7% of GDP).

I don't believe this is by chance. The countries that spend less are exactly the ones that made the big mistake of creating the euro and lost monetary policy autonomy. We saw this very clearly in the euro crisis (2010-2015) and we seem to be seeing it again in the Covid-19 crisis. Germany, in this study, is an exception, spending 6% of GDP, but we know how the country's fiscal account is managed with extreme rigor aiming at huge current account surpluses and a competitive industry. We also know how competent its prime minister, Angela Merkel, is.

After the 2008 global financial crisis, central banks in rich countries engaged in quantitative easing (quantitative easing). The objectives were to increase the money supply or liquidity of the economic system, reduce interest rates and encourage companies to invest. The last objective was not achieved, but a fourth, unintended consequence was a large reduction in the public debt of the countries that practiced it. In the case of Japan, whose debt was immense, the reduction caused by quantitative easing was enormous: the Central Bank of Japan now holds 85% of the country's so-called “public debt”, which means that it has been reduced by 77%; the reduction of the US public debt was smaller, 12%, and this may be the reason why American economists did not pay much attention to the fact.

But doesn't monetary financing imply an increase in public debt? This is not what we see when examining the evolution of the “public debt” of countries that carried out quantitative easing. The public debts of Japan, the United States, the United Kingdom, Switzerland, Sweden and the Euro Zone countries were not adequately adjusted. The fact that the treasury and the central bank are part of the same state was not considered because economists love fictions; because they want to discourage “irresponsible public spending” and because public accounting rules continue to be governed by outdated concepts; these rules do not consider the central bank as part of the state, something that was only true in the early history of central banks when private banks assumed some of the roles that central banks have today.

Orthodox economists reject monetary finance; for them, the only alternative to finance state expenditures that are not covered by current revenues is to remain indebted to the private sector. They say the costs of Covid-19 will be high, but “there is no magic” – after the pandemic, countries will have to resume fiscal austerity to pay the increased public debt. There are good reasons for fiscal discipline, but when funding Covid-19 expenditures, monetary financing makes the most sense. That's what rich countries did after the 2008 crisis, adopting quantitative easing. And that's what some of them are doing again, though they won't say so, to finance the expenses associated with the pandemic.

In the case of quantitative easing, the purchase of public and private bonds was made with the aim of increasing the liquidity of national economies, but the purchase of public bonds had the, perhaps unexpected, consequence of reducing the public debt. I say “perhaps” because it is hard to believe that in Japan, where the original public debt was immense and the quantitative easing was equally immense, the Japanese were unaware that they were reducing their debt. In the current case, in addition to increasing liquidity, this purchase must aim not to reduce the public debt, as occurred with the quantitative easing experience, but to finance expenses with Covid-19 without increasing this debt.

According to IMF projections, at the end of this year the public debt of the rich world should increase from 106% to 122% of GDP. With regard to Brazil, the forecast generally made is for an increase from 78% to 95% of GDP. In any event, the huge state spending necessary for the fall in state revenues will mean large fiscal deficits and, if monetary financing is not adopted, a considerable increase in the public debt and, after the crisis, years and years of paying that debt.

economic restrictions

My case for monetary financing of Covid-19-related expenses poses two immediate questions. Wouldn't this monetary financing cause inflation? Worse, are you suggesting that the state can spend as much as governments want? I start with the second question. I am not saying that economic restrictions, including fiscal restriction, should be ignored. To be a competent policymaker, an economist must be aware of the constraints he faces. But the fiscal constraint is not the only economic constraint, nor the main one.

In this section, I will briefly discuss the main economic constraints that countries face, and particularly the constraint on inflation. And I will argue that in the present case this restriction will not be violated. In the next section, I will discuss only the fiscal constraint.

1) The expected rate of profit.

A series of constraints define a capitalist economic system. Classical political economists and particularly Marx knew the main one: the overarching economic constraint is the rate of profit, or more precisely, the expected corporate rate of profit – the expected rate of profit minus the cost of capital. The growth rate depends on investments which, in turn, depend on the companies' motivation to invest, which finally depends on a satisfactory expected rate of profit. Economic growth is a historical process of capital accumulation incorporating technical progress or increased productivity associated with improved living standards – a process in which the state and state-owned enterprises account for a share of total investment.

At the beginning of the growth process, this participation is usually high, because the main investments needed are in infrastructure and in the basic inputs sector, and because the State has more access to credit than entrepreneurs. But as the economy develops, the private sector becomes financially stronger, while growth requires innovations in new products and new services, and the entire economic system becomes increasingly sophisticated. From that moment on, investment depends on the creativity and managerial capacity of entrepreneurs, whose initiatives only the market system is capable of validating and efficiently coordinating. Thus, the private sector sees its participation in total investment increase to around 80%, under the condition, of course, that the expected rate of profit is satisfactory – capable of motivating companies to invest. Thus, in a capitalist society, profit is the first and foremost constraint.

Indeed, it is a constraint that defines capitalism. The rate of profit need not be "high", but it cannot be "low"; it must be satisfactory – a concept I borrow from Herbert Simon. If we had to give a brief definition of capitalism, we would say that it is the mode of production in which entrepreneurs accumulate capital, with the aim of making a profit. The maximum profit? In principle, yes, but this is a meaningless concept in business terms; companies know the constraints of the market and do not aim at a vague maximum profit, but at the possible profit that they project in their budgets.

What is a satisfactory rate of profit in the range that companies consider sufficient to continue investing and expanding production in a given country and time? It is the minimum profit rate that motivates companies to invest. The satisfactory rate of profit is a historically located convention or institution. It is higher than the “normal” profit rate of microeconomics; it is also higher than the profit rate of the company that stops innovating and only invests in the modernization of the factory and continues to produce goods and services whose demand has stopped expanding. It is a “reasonable” rate of profit.

2) The wage restriction.

The salary restriction is defined in two ways; on the supply side, how much wages can increase while remaining consistent with a satisfactory rate of profit; on the demand side, how much they may not increase without causing a drop in demand. In both cases, the constraint is subordinated to the profit constraint – to a satisfactory rate of profit. On the supply side, considering the production-capital ratio stable, this limit is the increase in labor productivity. In the days of classical political economists, the wage constraint was "physical" because the assumption was that the cost of reproducing labor, defined as the subsistence level, defined the wage rate.

Today, it is a relative constraint, because wages continue to be basically determined by the cost of reproducing work, but this cost is socially defined and increases as the level of education and the acquisition of professional skills increases. Thus, as they are above subsistence level in rich countries, wages can rise or fall. Since the neoliberal turn of the 1980s until today, wages for unskilled workers have remained stagnant or have risen less than productivity, while top wages have risen sharply and the rate of profit for companies has remained relatively satisfactory for managers and shareholders.

The new competition represented by developing countries exporting manufactured goods, which began in the 1970s, is one of the causes of the near stagnation of low wages; another was the acceleration of technical progress and the increase in the size of large corporations, which increased the demand for the growing technobureaucratic social class and reduced the demand for low-skilled workers. Both causes are on the supply side.

And the demand side? Wages that grew below productivity diminished the demand for consumer goods that had to be offset by something. The main strategy was to increase credit for the lower classes, which kept demand relatively strong, but it was one of the main causes of the 2008 global financial crisis. The return to neoclassical economics and the rise of neoliberal ideology were fundamental to legitimize the near stagnation of low salaries and the increase in inequality that characterized the period.

3) Demand constraint.

Some might argue that a well-behaved market automatically guarantees a satisfactory profit rate. But this is not true, theoretically or empirically. On the theoretical side, Schumpeter definitively argued that perfect competition and the corresponding normal flow of goods and services only produce “normal profits”, which are essentially equal to the rate of interest. Entrepreneurs demand a higher rate of profit, which only innovations can guarantee – innovations that generate a monopoly advantage.

Keynes, starting from a different perspective, revolutionized economics when he showed that, in capitalist economies, supply does not automatically ensure demand, as the classical and neoclassical do, but suffers from a chronic insufficiency of demand that lowers the expected rate of profit. for long periods, making investments unattractive or just unfeasible.

In the system of economic constraints I am trying to describe, effective demand – the willingness and ability of consumers to buy goods – is our second major economic constraint. The economic literature on this restriction is enormous. Its empirical verification, more than satisfactory. There is nothing to add to this literature except the question of access to demand, but this problem is part of the next constraint – the exchange rate constraint.

4) The exchange rate or restriction of competitiveness.

In addition to the Keynesian argument about insufficient demand, there is a second theoretical reason why the expected rate of profit is not always satisfactory. As New Developmentalism has been discussing since the 2000s, many countries can live with an overvalued exchange rate in the long term, combined with an exchange rate cycle defined by a strong devaluation in successive exchange rate crises and an appreciated exchange rate between them. This fact makes room for a third economic constraint – the exchange rate constraint.

The exchange rate should make companies monetarily and technically competitive – nationally and internationally – but often this does not happen. When a company uses the best technology available, it is technically competitive; when, in addition, the exchange rate is intertemporally competitive and the “country costs”, that is, the tax and infrastructure costs, are similar to those of competing countries, this company is economically competitive. The idea that the policymaker can ignore the exchange rate problem to encourage companies to increase their technical competitiveness is often heard, but it makes no sense.

Why does the exchange rate tend to be overvalued in the long run? In developing countries, except East Asian countries, there is a basic reason: the adoption of two usual policies – the growth policy with external debt and the exchange rate anchor policy to control inflation. Both policies imply current account deficits and require high interest rates to attract the capital needed to finance these deficits. The policy of growth with external debt, based on the expectation that financed goods are capital goods, is self-defeating, because the capital inflows needed to finance the deficit make capable companies in the country uncompetitive and discourage them from investing, while encouraging consumption.

The second customary policy – ​​turning the exchange rate into a monetary anchor to control inflation – also involves overvaluation and is therefore just as self-defeating as the first customary policy. It is true that capital flows are highly speculative, but in the short term; in the long term, assuming constant international reserves, net capital flows will equal deficits and will represent an extra supply of foreign currency that will appreciate the country's currency.

These additional capital inflows will keep the national currency appreciating as long as the current account deficit is maintained. Something that could last for a long time, because local policy makers argue that “we are adopting the policy of growth with foreign savings”, and because since the “Washington Consensus” they have started to count on the support of international agencies. The arguments derive from something that seems obvious (“it is natural for capital-rich countries to transfer their capital to capital-poor countries”), but are essentially misguided. They would be true if we lived in a global state where there would be a single currency and exchange rates would disappear. Or if, by some magic, the excess of capital inflows over outflows did not cause the recipient country's currency to appreciate.

In relation to rich countries, the exchange rate combined with the current account deficit also represents a major constraint. The famous exception is the United States, which issues the dominant reserve currency and, consequently, benefits from the “exorbitant privilege” of being able to run a high current account deficit without the risk of going bankrupt. This country has benefited from this privilege since the 1960s. But for it, too, the restriction exists, not in the form of currency crises (that is impossible), but in the form of long-term overvaluation of the dollar and loss of competitiveness of the industry US manufacturer.

In the context of globalization, competitiveness is today a fundamental restriction that I associate with the restriction of the exchange rate. There is technical and macroeconomic or exchange competitiveness. Microeconomics takes care of technical competitiveness; macroeconomics must take care of exchange rate competitiveness. Both are necessary conditions for economic development, but they do not always go together. Technical competitiveness is a long-term economic problem, currency competitiveness is a short-term problem. Good institutions, well functioning markets, education, infrastructure investment, technology policy and industrial policy are means to technical competitiveness.

A capable macroeconomic policy sees the exchange rate restriction as fundamental, as it is the only means of guaranteeing the competitiveness of the exchange rate. Trying to achieve macroeconomic competitiveness by acting on microeconomic variables, making markets more competitive, as orthodox economists advocate, or adopting industrial policies, as many heterodox economists propose, is a big mistake. There is a relationship between the two competitiveness, but they are relatively autonomous and require independent policies.

The exchange rate constraint should not be confused with the “balance of payments constraint”. Raúl Prebisch used Engel's law, the problem of two income elasticities less than one, to show the competitive disadvantage faced by commodity exporting countries, and to argue in favor of his industrialization project or, in Spanish, “structural change”. Hollis Chenery was the first to misinterpret this problem with the two-gap model that would be “solved” with the inflow of foreign capital. The second was Anthony Thirlwall, who elegantly formalized the model of the two perverse income elasticities, paving the way for countless econometric studies that confirmed what was obvious.

However, “Thirlwall's law”, in addition to favoring the inflow of capital, allowed a “growth model” in which the growth of global foreign trade would limit the country's growth rate – something very far from the experience of few countries that , in the XNUMXth century, made the catch up successfully and today are rich countries. The real constraint on the balance of payments in developing countries is not perverse elasticities, but the tendency to overvalue the exchange rate, which is not endogenous to the economic system, but caused by mistaken economic policies. Engel's law states that as income increases, the proportion of income spent on food falls even as absolute food expenditure increases. It is named after its formulator, the German statistician Ernest Engel.

5) The restriction of inflation. A fifth major economic constraint is the inflation constraint. There is nothing new on this topic since the inertial inflation model of the early 1980s, but since I am making the case for monetary financing of Covid-19, it is time to discuss whether increasing the money supply above the increase in aggregate supply causes inflation; second, if money printing makes a difference, regardless of private financing or monetary financing (the central bank or the private sector buys each country's new treasury bonds), increasing government spending involves increasing the amount of money money.

In both cases there is the same increase in outstanding credit and, therefore, in the money supply, which varies according to the volume of credit. If the government decides on private financing, where will the private sector find the resources to buy the bonds offered by the government? The rentier capitalist has no money available and will go to the financial sector to borrow money. So the money supply will increase anyway. The increase in the money supply is not the cause of inflation, here understood as a “cause” as a factor that accelerates a certain rate of inflation. First, because the money supply is endogenous, as Keynesian theory asserts, as well as modern monetary theory (MMT) and new development theory (TND).

In Keynes's time, this was not so obvious, because then the gold standard had not yet been abandoned and money was still, apparently, commodity money. Since 1971, when the US government removed the last vestige of the gold standard by ending the convertibility of the dollar into gold (which was guaranteed only to other countries, not the private sector), the virtual or trust character of money has been evident. . Changes in the quantity of money in an economy are an endogenous variable. The central bank can influence it, but not determine it, by buying treasury bonds, setting the reserve rate that banks need to borrow, lowering or raising interest rates, but the amount of money depends on government spending and changes in the total volume of credit. This is why the role of the money supply in the inflation process will not cause or accelerate inflation, but will sanction or validate prevailing inflation, ensuring, through increased credit, that real (and necessary) liquidity is maintained.

However, there is a long-standing fear among people that state money funding will cause inflation. And then there is the quantity theory of money that supported this idea – an old and well-worn economic myth. Which, most likely, originated from ancient times, when inflation was called not an increase in prices, but an uncontrolled increase in the amount of money in the economy.

This myth was resurrected by monetarism, the first attempt by neoclassical economists to develop an alternative to Keynesian macroeconomics in which aggregate supply rather than aggregate demand was the relevant variable. The basic claim of monetarism was that if central banks tightly controlled the money supply, inflation would be controlled. In the economic literature there is an identity, the equation of exchange (MV = Yp), in which M is the amount of money, V is the velocity of money or the number of times money circulates in a year, Y is national income ep, inflation. It is an identity because it starts from the definition of the speed of circulation of money (V = Yp / M).

Monetarists, however, turned this identity into a theory – the quantitative theory – assuming that the velocity of money is constant and claiming that increasing M causes rising inflation, p. Apparently, this theory is true because there is a close correlation between the quantity of money and inflation, but first, V is not constant, the velocity of money is extremely variable, changing with the economic cycle.

Second, there is no reason to say that it is the increase in M ​​that causes the increase in p; it makes more sense to say that it is rising inflation that requires the nominal money supply to increase. A national economy needs a level of liquidity or amount of money commensurate with its GDP to function – to allow transactions to run smoothly. When, for some reason, inflation increases or accelerates, the nominal money supply needs to increase so that the real quantity of money – the liquidity of the economy – is preserved.

To understand this, it helps to visualize the necessary monetary liquidity of the system with the amount of lubricating oil that allows the machine to work smoothly, without friction. Thus, the nominal quantity of money is endogenous and, given the real quantity of money required, it is inflation that requires its increase to remain constant in real terms. Keynes didn't say this literally, but he showed that the amount of money in an economy is endogenous. Here in Brazil, I learned about the endogenous character of money from Ignácio Rangel, who had this idea by observing the Brazilian reality of the early 1960s. Among post-Keynesians, Basil Moore, in 1979, theoretically showed the endogeneity of money.

The theory of inertial inflation, in the form in which it was developed in Brazil (the country that had the longest and most radical experience of this type of inflation), showed this definitively in the 1984 article that defined this theory more broadly and that states this in the title itself, “Factors accelerating, maintaining and sanctioning inflation”. The accelerating factor for inflation can be a supply or demand shock, but in most cases and logically it is the excess of demand in relation to supply; formal and informal price indexation is the inertial or maintenance factor, which makes inflation resistant to the usual policies adopted to control it; and the formal and informal indexation of the economy is the sanctioning factor that keeps the real quantity of money constant in an environment where inflation is reducing the nominal quantity of money.

As for the empirical rejection of monetarism, quantitative easing has definitively demonstrated that monetarism is meaningless. The central banks of rich countries bought directly from the treasury and the private sector about US$ 15 trillion without increasing the rate of inflation. Why, then, does the quantitative theory of money have such a long history?

First, because it is apparently true. Second, because the increase in the money supply determines inflation for an etymological reason: originally the word “inflation” simply meant an increase in the amount of money in circulation. The power of an etymological tradition is strong. Third, a political economy rationale: inflation above 3% or 4% a year is bad for everyone, but especially bad for rentier capitalists and financiers; it is worse for them than for the productive capitalists whose prices can be changed by inflation. Thus, they support any policy that seems difficult against inflation, even if it doesn't work or works poorly.

The tax restriction

I end the analysis of economic restrictions and Covid-19 with the fiscal restriction. My understanding is that this is the main restriction and that the financing of government expenditures required by issuing money will not signal indifference, but respect for it insofar as it will be a way to protect the fiscal condition of each country that uses it.

The fiscal restriction is obvious and the best known. Good ministers of finance generally have a daily duty to protect the treasury of rent seekers (from the capturers of public assets) and maintain a balanced fiscal budget. And it is something that economic history bears out. Countries that were economically successful and today rich countries observed fiscal discipline, such as the United Kingdom, France and the United States, which carried out their industrial and capitalist revolution in the XNUMXth century, or those such as Japan and South Korea , who did this in the XNUMXth century.

Perhaps considering this fact, but probably due to their hypothetical-deductive method that needs no empirical verification, orthodox economists defend that an austere fiscal policy defined in this way (a balanced budget) is the only legitimate policy. Why would that be true? The traditional argument goes like this: if fiscal discipline is observed, the market will take care of the rest; otherwise, the state will spend more than it collects, run a fiscal deficit, financing the deficit with growing debt, the money supply will increase, and inflation will follow. This is false because the market doesn't take care of the rest and because increasing the money supply doesn't cause inflation. Liberal orthodoxy offers two additional reasons.

First, this public investment will crowd out private investment. But that depends on the industry in which the state invests. If the State invests in the same competitive sectors as the private sector, exclusion will be inevitable. On the other hand, investing in infrastructure and basic input sectors, the two non-competitive sectors towards which public investment should be directed, will create demand and promote private investment in the companies that supply goods and services to these two sectors.

Second, fiscal discipline would be necessary “because the State could go bankrupt” – this explanation makes no sense. A nation-state is not a corporation; if you are indebted in your own currency, you will never go bankrupt because you can always issue money and pay your debts; if it is indebted in foreign currency, the problem is more serious, but the new developmentalist theory is inflexible in condemning countries and their governments to be indebted in foreign currency. Only when the economy is growing very quickly do investment opportunities increase and the marginal propensity to consume falls while the marginal propensity to invest increases – only under these exceptional conditions does external indebtedness not turn into consumption but into investment.

Let's now look at better reasons for governments to limit their spending. A first reason, known and good, is inflation. If the government increases its spending and the country's aggregate demand exceeds supply, inflation will accelerate and spending will have to be reconsidered. However, this is not the case for necessary Covid-19 spending; there is no demand pressure. A second and more general reason why government spending must be carefully and tightly controlled is that there really is "no free lunch", but there is rent seeking free. Greed over government spending is always huge because it's free.

In any case, even when it is necessary to increase public spending, as is the present case, competent economic policy makers have as one of their main roles the defense of the State treasury. The moment we relax fiscal discipline, the social contract – which requires everyone to abide by the law and be reasonably committed to the public interest – is also relaxed, and the likelihood of misspending and corruption increases.

The third reason involves the combination of the exchange rate and the fiscal constraint: governments must adopt fiscal discipline to prevent increased demand from causing a current account deficit and appreciation of the national currency. In this case, irresponsible government spending has not yet started to cause inflation, as the country resorts to additional imports and incurs a current account deficit, but appreciation of the national currency is already taking place. This third reason derives from new developmentalist theory, where the exchange rate constraint, which we could also call the current account constraint, plays a key role.

Therefore, excessive government spending, which disregards the fiscal restriction, will successively create three evils: first, the increase in the current account deficit and the appreciation of the national currency; second, rising inflation; and third, the currency crisis. The economic history of countries that have consistently developed is also a history of fiscal discipline. Not because fiscal largesse bankrupts the country, nor because public investment impedes private investment, but because good politicians and competent policy makers combine theory (which is always incapable of considering all possibilities) and intuition to make their decisions. They know that fiscal discipline is part of the social contract that every nation requires to build a good and developed society. A social contract that can and should contain a national development project for the country to grow quickly and achieve the catch up.

By causing a current account deficit and appreciation of the national currency, fiscal indiscipline seriously harms the country's monetary competitiveness, causes inflation and, at the limit, the accumulation of current account deficits increases the country's external debt and can lead the country to a currency crisis. In fact, fiscal discipline and current account control go hand in hand. If rising fiscal expenditures raise effective demand above domestic supply, this does not lead to inflation unless the economy is at full employment, but it does cause a current account deficit which is a negative factor in the growth process.

We then have “twin deficits” and an overvalued exchange rate. When this happens and both the current account deficit and the public deficit become high, the government is unable to lower interest rates to depreciate the currency, and is led to carry out fiscal adjustments to regain its competitiveness. But this is a costly policy (it involves recession and unemployment).

Thus, we return to the exchange restriction, now not because the country's government is engaged in the wrong policy of growth with foreign debt (which is equivalent to exchange rate populism), but because it is irresponsibly spending more than what it collects - which configures fiscal populism . Or because the two populist processes, fiscal and exchange rate, reinforce each other.

In summary, the fundamental reason why countries should keep their fiscal account balanced is the restriction of the exchange rate – it is to keep the country competitive internationally. Companies must be technically competitive, but in addition, the country must guarantee an exchange rate that remains competitive. Current account deficits mean that the country is consumption-oriented rather than production-oriented; it means that people value immediate consumption and are not concerned with capital accumulation and growth.

Therefore, there are good reasons to support the fiscal restriction, but how to define it? Is it just having a balanced budget? Or does it also include keeping public debt under control and relatively low? This is not the time to discuss this issue, but one thing is important to emphasize: the public debt is not the result of the simple accumulation of public deficits. When, for example, the Central Bank bails out banks in crisis, the cost is not considered in the deficit. Central Bank gains or losses resulting from changes in the exchange rate are also not considered in the fiscal deficit or surplus, but are in the public debt.

At certain times, we know that countercyclical budget deficits are the way to go; they must not jeopardize the financial health of the country. Now, given the huge and extraordinary expenses required by Covid-19, which policy affects the fiscal constraint more: resorting to monetary financing and keeping the public debt untouched or resorting to private financing and creating a huge tax burden for the future? In the second section of the article, I already discussed the evils associated with rising public debt.


In summary, in the context of the Covid-19 pandemic, countries should not limit government spending in the name of fiscal restraint. It is now more important to save people's lives, their jobs and the survival of companies and, with that objective in mind, not to save – something that governments will do if they consider that the huge expenditures needed will mean a bigger public deficit. For this reason, and to avoid the burden of a large public debt in the near future, I advocate monetary financing of Covid-19 expenses.

To justify this, I briefly summarize my view of basic economic constraints in capitalist societies. They are the profit constraint, the demand constraint, the exchange rate constraint, the wage constraint, and the tax constraint. First, I showed that monetary financing of the high spending required by Covid-19 will not cause inflation. Second, I paid special attention to the fiscal constraint and added a new, fundamental reason why it is a real constraint (excessive spending, before reaching full employment and causing inflation, can cause increased imports, current account deficits, and appreciation of the national currency). In fact, monetary financing will not involve chronic current account deficits, it will not involve easing or weakening the social contract, and it will avoid a large increase in public debt.

In advocating fiscal and exchange rate restrictions, I did not advocate “fiscal austerity” – an orthodox right-wing policy that heterodox economists like myself strongly criticize. My definition of austerity is certainly narrower than the populist definition that identifies it with fiscal discipline. Austerity, for me, is doing two things: first, rejecting the policy of countercyclical fiscal deficits, and second, when the economy faces not only inflation but also external imbalance, engaging only in fiscal adjustments as if the country were a closed economy, instead of using macroeconomic tools to depreciate the national currency and, in this way, distribute the adjustment costs between wage earners and rentier capitalists.

Modern Monetary Theory, which also sees the money supply as endogenous and is very clear that a nation-state cannot go bankrupt, often deduces from this correct premise that the state does not face a fiscal constraint. As Warren Mosler notes, "Government fiat money necessarily means that public spending need not be based on revenue." Randall Wray, in turn, in his book on Modern Monetary Theory, states that “sovereign governments need not borrow their own currency to spend”. These two statements are only partially true and they are dangerous. They open space to deny the fiscal restriction.

TMM economists have made innovative and serious contributions to the critique of neoclassical or orthodox fiscal austerity, but what Keynes has already said on this subject is enough. I doubt that even progressive politicians will adopt his views on economics. If not carefully adopted, the corresponding policies can easily cause a loss of international competitiveness, inflation and, with the exception of the United States, a currency crisis.

The capable politicians and policymakers who have led today's rich countries to grow and achieve catch up they were generally courageous and innovative, but they were also prudent economists. Although heads of government can, in certain circumstances such as the current ones, resort to monetary financing without incurring risks, they must be deeply convinced of this. Good politicians are not willing to offer finance minister jobs to economists who scorn fiscal restraint.

* Luiz Carlos Bresser-Pereira He is Professor Emeritus at the Getulio Vargas Foundation (FGV-SP). Author, among other books, of In search of lost development: a new-developmentalist project for Brazil (FGV).

Originally published on Political Economy Magazine, vol. 40, nº 4, pp. 604-621, October-December/2020.


Allen, Kate and Keith Fray (2017) “Central banks hold a fifth of their governments' debt”, Financial Times, August 15, 2017.

Bresser-Pereira, Luiz Carlos and Yoshiaki Nakano (1984) “Accelerating, maintaining, and sanctioning factors of inflation”, Brazilian Journal of Political Economy 4(1) January 1984: 5-21. In English, only in the online version of the journal.

Chenery, Hollys and Michael Bruno (1962) “Development alternatives in an open economy: The case of Israel”, Economic Journal, March 1962: 79-103.

Lopes, Francisco L. (2020) “Covid-19: will Brazil stabilize until August?” Market, 5 June.

Moore, Basil J. (1979) “The endogenous money stocks”, Journal of Post Keynesian Economics, Autumn 1979, 2(1): 49-70.

Mosler, Warren (1996) Soft Currency Economics II. Christiansted: Valance Company.

Rangel, Ignacio M. (1963) The Brazilian Inflation. Rio de Janeiro: Brazilian Weather.

Thirlwall, Anthony P. (1979) “The balance of payments constraint as an explanation of international growth rates differences”, Banca Nazionale del Lavoro Quarterly Review 128: 45-53.

Thirlwall, Anthony P. and M. Nureldin Hussain (1982) “The balance of payments constraint, capital flows and growth rates differences between developing countries”, oxford economic papers 34(3) November: 498-510.

Wray, L. Randall (2015) Modern Money Theory: A Primer on Macroeconomics for Monetary Sovereign. 2nd revised edition. London: Palgrave Macmillan.


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