Investment Manager GMO Debunks Mythology of “Sound Finance,” or Deficit Hawkery

Yves here. Sometimes it is best to let things speak for themselves. In that spirit, I am embedding a very important paper by the well-respected investment management firm GMO which debunks the tenets of “sound finance,” meaning the claim that governments need to balance their budgets. I expect to be referring to it regularly, particularly the section on why debt does not burden future generations, a particularly nasty bit of fear-mongering used to pit the young and old against each other, as opposed to rentiers and socialism for the rich.

To encourage you to read it in full, below is the executive summary:

In the context of the role that debts and deficits play in overall economic policy, in this paper I focus on the philosophy known as “sound finance,” which includes adherents who believe that governments should seek to balance their budgets. I, however, take a different view, and believe that the role of government when dealing with budget deficits should be one of “functional finance,” which ensures that the policies implemented help to reach the overarching goals of macroeconomic
policy (generally held to be full employment and price stability).

This paper attempts to show why the proponents of sound finance are mistaken by defining and unpacking a series of “myths” that are foundational to, or at least helpful to, convincing us that sound finance requires that governments run a balanced budget. Though not a complete list, following are the “myths” presented:

Myth 1: Governments are like households

Myth 2: Printing money to finance budget deficits is inflationary

Myth 3: Budget deficits/high debt lead to high interest rates

Myth 4: Budget deficits are unsustainable

Myth 5: Debt is a burden on future generations

To conclude, I offer some thoughts on the actual impact of monetary policy on the real economy, which I believe to be quite small. These thoughts include a brief discussion about how fiscal policy, once the nature of government debts and deficits is fully understood, can be a viable alternative to monetary policy.


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  1. Benedict@Large

    There’s a serious font problem in both the display and the download. Squares replace “th” and “fi”, and there’s omegas, parallelograms and the like crapping up other text.

    Can we find a better copy? I have a couple of people who are interested, but can’ work through the glitches.

    1. Yves Smith Post author

      I think it depends what version of Adobe you have, but the version I put up now should be OK. Sorry for the trouble. Never had this happen with a pdf before.

  2. diptherio

    Good clear explanation of functional finance (apart from the text-rendering weirdness). Definitely one to keep around for skeptics stuck in the conventional mind-set.

  3. wayne moss

    Maybe I’ve been blessed with a lack of education, but ‘functional finance’ seems bloody obvious. So why do I always find myself failing to convince well-educated liberals that the government can “afford” to put everyone to work? Seems my liberal friends view the world through an anti-capitalist narrative (in which they are the natural Hero) and they won’t be content until they’ve punished the privileged and eliminated human greed from our genetic blueprint.

    1. vteodorescu

      Yes, I do seem to have acquaintances and friends like that… :). Anti-capitalist to their fingernails, but ultimately they sing from the capitalist hymn sheet. Sun Tzu’s advice comes to mind, about knowing your enemy, otherwise you will lose the battle, and knowing yourself, otherwise you lose the battle…

  4. UnhingedBecauseLucid

    [“: At some point in the future, everyone alive today will be dead. At that
    point in time the bonds that make up the government’s debt will be held entirely by our children and
    grandchildren. That debt will, of course, be an asset for those who own the bonds (just as it is today).
    There may well be distributional issues if all of those bonds are owned by, say, the grandchildren of Bill
    Gates, but these will be intragenerational issues, not intergenerational ones. “]

    How about a physics\environmental one… ? …or a macro-economic one ?
    If money is perpetually unanchored, then there is a very finite developmental potential for most EM countries, as the real nature of the capitalist system becomes essentially a role playing game — [which it truly is]– but you know, gotta keep the bullshit story alive…

    I know for a fact that J. Grantham is quite aware of the first, but I wonder if he ever gave any thoughts to the second ?

    I guess Adair Turner will come in at this point and just tell me that such concerns are valid, but it remains a manageable thing if the scale remains within reason…
    Of course, being “within reason” with demographics such as they are, is something he’d have to explain to me….along with how could our off-the-chart-dumb politicians be trusted with the task…?

    Have you guys seen Justin Trudeau talk ? Jesus $&4$|ng (?”/$T
    The US is contagious…we’re stuck with a hilariously phony bimbo now because of you !

  5. MikeNY

    Interesting paper and interesting timing by GMO.

    What developed economies need, to ward off deflation, is redistribution of wealth. Fiscal stimulus can be used as a tool to redistribute wealth downward; this makes oligarchs relatively poorer, which is why they usually oppose it. Monetary stimulus makes oligarchs relatively richer, which is why they usually support it. There are peaceful ways to redistribute downward, and there are violent ways to redistribute downward. I’m sure GMO has thought this through. Their pessimism frightens me a little bit.

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