Britain Can’t Afford Rachel Reeves (4)

How Rachel Reeves probably thinks about government debt

“the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.”

John Maynard Keynes, The General Theory of Employment, Interest and Money, Chapter 24.

Since Reeves’s obsession with reducing government debt comes from a false theory of money—something that economists at the Bank of England acknowledge—it follows that, to know what she should really do as Chancellor, you need a correct theory of money. That’s why I invented Minsky. It was the first program to enable money to be modelled using the principles of double-entry bookkeeping. In its extended version (now called Ravel, which also does data analysis), it is still the only program to enable the monetary system to be modelled properly.

In this and the next few posts, I’ll use Ravel to explain why Reeves is wrong that reducing government debt is more important than enabling pensioners to pay their winter fuel bills.

I am under no illusion that I can change Reeves’s mind via these blog posts. My target here is rank-and-file Labour Party members. If you want to reverse the Neoliberal takeover of the Labour Party, you need to be able to counter the false theories that Reeves and Starmer are following. Ravel is the only program that will enable you to do that.

In this and the next few posts, I’ll show how you can use Ravel to blow these false Neoliberal ideas out of the water. If you do the same in time with your fellow Labour Party members, then hopefully you can change the government’s policies, and prevent 4,000 or more pensioners from experiencing lonely, painful and pointlesss deaths.

Banks, money, and double-entry bookkeeping

To understand how banks work, you have to understand double-entry bookkeeping. This was invented 500 years ago by Italian merchants to ensure that financial transactions were recorded correctly. Its two basic rules are:

• All financial claims must be classified as either Assets or Liabilities. An Asset is your claim on someone else; a Liability is someone else’s claim on you. The difference between your Assets and your Liabilities is your net worth, or “Equity”; and

• Every transaction must be entered twice, once as a Debit (DR) and once as a Credit (CR)

Conventional economic thinkers like Reeves don’t analyse the economy in terms of double-entry bookkeeping. But Reeves thinks about the government’s finances as if they’re household finances, and we can use Ravel’s double-entry bookkeeping capabilities to show what this picture looks like, and why it’s so scary.

How Reeves (probably) thinks about government finances

Firstly, we need to pretend that the government spends out of a bank account at private banks, just as households and firms do. Call this “Government Deposit”. Call household and corporate bank accounts “Private Deposits”.

Taxation takes money out of Private Deposits, and puts this “Taxpayer Money” into the Government Deposit account. The government can then spend: hire public servants, buy goods and services from the private sector, give pensioners subsidies to buy heating fuel during winter, etc.

If the government spends more than it takes back in taxation, then it has a Deficit—and to finance that, it has to borrow from the banks. Government debt increases each year by the amount of the Deficit.

The government also has to pay interest on the outstanding level of government debt. The table below, generated by Ravel, shows this vision of how government spending works.

This is a very scary picture:

• If the government continues to spend more than it takes back in taxation, then its debt to the banks continues to rise;

• It has to pay interest on this debt, and ultimately, these interest payments might mean that all tax revenue goes to pay the interest—leaving nothing for government spending;

• Banks might even refuse to give the government any more money—they might even take out bankruptcy proceedings against the government!

The only way out of this dilemma is to make sure that spending is equal to taxation, so that the deficit is zero—or even spend less than taxation, so that the deficit turns into a surplus. This will enable the government debt to be reduced, in turn reducing interest payments. It’s arguably worth sacrificing a few thousand pensioners to make this disastrous fate less likely.

There’s just one problem with this picture: though the government does have some accounts at private banks, the government’s main bank account is with the Bank of England. THIS. CHANGES. EVERYTHING. I’ll explain how in the next post.