This is a followup to my previous post "Who will buy the bonds?". It is also a followup to my January 20th post "Canada and the Eurozone: a comparison". The main theme of that second post is that the Eurozone is like Canada, only without the Federal government of Canada. Eurozone countries are like Canadian provinces. I pointed out some of the dangers for the Eurozone this entailed.
An expansionary fiscal policy, deficit spending, must be financed. For a country with its own money and central bank, financing a deficit is no problem. It can always sell them to the central bank. The deficit can be money-financed, if need be. And that is actually the most expansionary form of deficit spending, because it is most likely to create an excess supply of money, and since money is the medium of exchange, an excess supply of money is a step on the road to creating an excess demand for goods, which is what we want to create. If we can money-finance a deficit, we actually hope that nobody will want to buy the bonds. That was the main point of my first post.
It's very different for a government which does not have its own money and central bank. Like a Canadian province. Or a Eurozone country.
If the government of Ontario wants an expansionary fiscal deficit, it cannot print money, and must sell bonds. If nobody is willing to buy the bonds, it cannot run a fiscal deficit. The same is true for the government of Italy, or Greece, or Ireland.
Suppose now that Ontario (Italy/Greece/Ireland) is able to sell bonds, but only at a higher rate of interest. If Ontario had its own money and central bank, this would not be a problem. The Central Bank of Ontario could step in, and buy Ontario government bonds until the rate of interest were again forced down (to zero if necessary). It would actually be an advantage, in current circumstances, if deficit spending put upward pressure on interest rates, because this would give the central bank the opportunity to buy bonds, sell money, and create an excess supply of money, which people would spend on goods.
But Ontario (Italy/Greece/Ireland) does not have its own money and central bank. Higher interest rates on Ontario bonds would be a bad thing. It would increase the future tax liabilities of Ontario taxpayers, and reinforce any tendency towards Ricardian Equivalence, suppressing consumption demand by Ontario taxpayers. If other Ontario interest rates also rose, alongside interest rates on Ontario government bonds, this would also reduce spending in Ontario.
In a closed economy, an expansionary fiscal policy which pushes up interest rates will crowd out some investment spending, but will still cause a net increase in aggregate demand. The higher interest rate reduces the demand for money, creates an excess supply of money, and more demand for goods.
That is not necessarily true in an open economy which shares a common currency, like Ontario (Italy/Greece/Ireland). The excess supply of money in Ontario will simply cross into other provinces.
Here is the worst case scenario for a Eurozone country (next to being unable to sell bonds at all). The ECB reduces interest rates to zero. Which means zero on German government bonds. Facing rising unemployment, the government of (say) Italy tries to run an expansionary fiscal policy. This increases the perceived default risk on Italian government bonds. The perceived default risk on Italian commercial loans increases as well. All Italian interest rates rise. The rise in interest rates reduces Italian consumption and investment demand. This reduction in private demand may more than offset the increase in government spending, and cause a reduction in output and income.
The rise in interest rates, and fall in income, causes a reduction in the demand for money in Italy. But the supply of money in Italy is endogenous, and demand-determined. It flows to Germany.
In 1991 the NDP government of Ontario adopted a "Keynesian" fiscal policy of deficit spending to try to prevent a recession. It did not seem to work. At the time, I thought that provincial fiscal policies would be unlikely to have much effect because of a high marginal propensity to import goods from outside the province. But perhaps it is also because Canadian provinces do not have their own currency and central bank.
Fiscal policies by individual Eurozone countries are about as likely to work as fiscal policies by individual Canadian provinces. The central bank won't buy their bonds.
Worthwhile Canadian Initiative 
But if the government of Ontario had not run such large deficits, that primarily supported continued levels of public services, the early 1990s would have been much worse. Ontario then went on a great run later in the decade and those deficits, such a horror at the time, actually were not such a big deal.
Marc: Yep. I had originally written “It did not work”. Then I thought “Hang on Nick, you don’t know what would have happened otherwise”, so I added the weasel-words, and changed it to “It did not seem to work”.
That’s the trouble with drawing lessons from the past: we see (more or less) what happened, but we don’t see what would have happened otherwise.
Nick has no time for his lax critics and takes matters into his own hands…I am having trouble with this (disarming, I tell you!) candor, you (fellow lax critics, wanting to take control of your own ping pong bat…now that you have had a backhand smash demonstrated for you)?
How to stage the response?…expand the “Whatevacouldahappened?” to the general problem of referential opacity (Things were just so different then…let’s just ignore all that an wing it…BushCo.)… associate it with “Whocouldanode?” and form a wider, possibly more coherent picture where some people do know, exploiting others who do not (like the ping pong bat handle is not the flat endofit…whocouldanode? –ping pong players is who.)
Ok, I need a recess already…I know…my laxity needing to assert itself…I can recover. I must.
Calmo, you should try to be more intelligible. I can’t make heads or tails of most of what you’re saying.
test
test 2:
Intelligible…I’ve heard of it…sorta like intelligent, but less fleeting, less demanding and less durable…and of course no warranty.
Shucks, if you rise only to the level of intelligible, you have been sassed (likely by some half wit…or a full wit on a half bad day).
No doubt about it, Andrew, I am dreaming about rising to the level of “intelligible” and having a half good day…soon.
Ok, looks like “Your data cannot be accepted” is sleeping.
There are worse constraints than not meeting some intelligibility standards…like episodes of total “supply constrained” micro economies like this one.
So Nick pre-empts his critics by softening up his original “it did not” to ” it seems did not” (“weasel-wording” he says, but I am more than tickled…scratched, possibly clawed, with this heavy-handedness –it is the conservative scholar mode (a small matter, this…lie: Nick is so much more than this pipsqueak scholar costume. He is a teacher…not to be confused either with dime-a-dozen professors.)
So here is the tickle: Nick feels compelled to provide a role model for his audience, some of whom might need guidance on what a student performance looks like (and hence the Mach line, the “weasel”, to (over?) exhibit what an ongoing inquiry should look like) [Absolutely Socrates]…rather than a collection of somewhat non-inquisitive, non-interacting but plenty of experting and grandstanding at the symposium, you know?
And here is the scratch (more or less):
That’s the trouble with drawing lessons from the past: we see (more or less) what happened, but we don’t see what would have happened otherwise.
It is a small trouble (don’t let any philosophy students tell you otherwise). If it weren’t, there would be no public policy…just winging it…like BushCo.
The practice otherwise is that we do see most of what happened and have reasonable estimates about what could have happened. We learn from History…not always, but usually…more rather than less…anso it comes as no surprise that History is still taught, public policy still practiced…and witchcraft, only on halloween.
And the claw: an important component of the financial and economic mess is the failure of the previous US administration to obtain and/or process data. The 12M “illegal aliens”, a guess, only part of the severely underfunded regulation…a deliberate strategy to build the GOP case for a smaller, less interfering Government in that Free Enterprise economy. It seems like a small matter to discover that books were not kept to former standards and/or not made available to make informed decisions. But without records or poor records or fudged records, public policy can only get (un)lucky and we might as well surrender to the witches. The US records inadequate meant that her trading partners’s data also…not to mention the real demons, the transnationals.
calmo: I have to ask: are you a philosophy student, or prof, or ex-student, or ex-prof?
I think some (but not Mark Thoma) would call me a reader…out of embarassment that I seem to have no…station.
But I am shameless.
Proud even.
You are not just talkin to anybody…I have a high school diploma.
Sure, a steal from Lily Tomlin (as receptionist among her many not only acting talents).
Ok, I am an Ex…ping pong player. But there is no contest about which one works better.
I know of no other line that puts me in such good graces with dubious inquiring parties…from JWs to Financial Advisers…even within some academic circles. If you put it out there that you have a high school diploma, you get real attention, (laughter, but sometimes crying too) not just lame ass politeness masquerading as idle curiosity about something they have no clue about.
Everybody knows where you are with a high school diploma.
Proud.