The following article by respected Age columnist Kenneth Davidson may relieve a few of you who are suffering from political rhetoric overload.

History shows debt need not be a burden
June 4, 2009

THE more things change, the more they stay the same. The main difference between the Great Depression and the Great Recession is that the authorities at least now know that any attempt to balance the budget in current circumstances would be self-defeating.

Even so, the Rudd Government is spooked by the Coalition, which bangs on insistently about the burden government debt will impose on future generations.

The size of the deficit is less than it should be if the Government's prime concern was to ensure total community spending was in line with the growth in economic capacity. Economic capacity, as measured by the underlying growth in the workforce and labor productivity, will be about 7 per cent in the next two years, and yet GDP growth is forecast in the budget to be only 2 per cent over the same period. As a result, unemployment is expected to grow from 6 per cent to 8.5 per cent.

Even though the budget deficit over the two years will pump $115 billion into the economy, the official figures suggest economic growth will be 5 percentage points, or about $60 billion, less than the underlying growth capacity of economy.

In other words, we are looking at a deflationary, rather than an inflationary gap opening up between national spending and output despite the budget deficit. Cuts in government spending to reduce the debt would open the deflationary gap further and hence increase government debt.

There is no capacity constraint on real economic growth. It should not be beyond the wit of government to come up with sensible expenditure proposals, which can be wound back in three years when, according to official forecasts, private spending will be able to take up the slack. Even so, if inventing useful activities is beyond the wit of government, it would be better for society to invent more less-productive jobs.

The main reason why the Government is not prepared to adopt a more proactive budgetary policy is that the thinking about government borrowing is still essentially mired in the 1930s.

As Keynes observed in the General Theory, published in 1936, gold mining was a wholly wasteful activity (akin to burying banknotes in disused coalmines, which then could be dug up and put into circulation). Currencies were backed by gold (the barbaric relic).

Thus plentiful supplies of gold were associated with strong growth in the world economy, and when new supplies were scarce, world wealth suffered stagnation and decline.

By comparison, Keynes tartly observed, "ancient Egypt was doubly fortunate, and doubtless owed this to its fabled wealth, in that it possessed two activities, namely, pyramid building as well as the search for precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance".

But "we are so sensible, having schooled ourselves to so close a semblance to prudent financiers, taking careful thought before we add to the `financial' burdens of posterity by building them houses to live in, that we have no escape from the sufferings of unemployment", Keynes concluded.

It is not well understood in the popular imagination that all currencies today are fiat money, that is money issued by government through their central banks that is not backed by gold, silver or other securities.

A fiat currency country has the option to borrow from the central bank to finance a deficit by issuing IOUs to the bank in return for currency printed by the mint. The interest on the IOUs is profit to the bank, which in turn is owed to the government. Jobs financed this way do not add to the debt burden.

This is a sensible option when, as in Australia, the economy is operating below full capacity and when the major threat is deflation expectations (which provide an incentive to postpone spending in the hope of lower prices in the future) rather than inflationary expectations (where the expectation is higher future prices and encourages investors to bring expenditure forward).

There is no reason why, when the economy has recovered, that part of the borrowings from the Reserve Bank should not be converted to bonds issued by the government to the public to soak up any excess liquidity that might otherwise finance inflation.

Even so, providing the borrowings are used to finance productive activity that yields a return better than the long-term bond rate, there will be no net debt burden on future generations.

The "barbaric relic" of gold still has an inchoate hold over the popular imagination, and this is probably what is giving the Opposition's unscrupulous and ultimately economically damaging campaign against the "burden of debt" traction in the electorate.

And Kevin Rudd did himself, his party and the country no favours when he dogmatically announced, before the recession became apparent last year, that he was an economic conservative who was committed to balanced or surplus budgets.

It is the task of budgetary policy, in conjunction with monetary policy, to balance the economy as close to full employment as possible constant with price stability irrespective of the size of the deficit.