Opting for limited inequality of opportunities

Opting for limited inequality of opportunities

While scientists and politicians do not always agree on the plan for how to fight the corona pandemic, there is consensus on one aspect: the economic crisis we have entered as a result may develop to a scale unprecedented for all of us.

Governments around the world are alarmed and doing their best to limit both health and economic damage. As a result, government debt is increasing sharply and the way in which it must be repaid has enormous consequences for society. The gap between rich and poor, as well as the inequality of opportunities, might increase.

Will there be huge cutbacks in healthcare, education and/or pensions? Support from society for such measures is difficult to obtain, not only because the corona virus has increased demand for care (the ‘regular care’ has stood still) and education (teachers, pupils and students have been at home for a while), but also because before the outbreak of the virus, there was hardly room for austerity.

The government could also choose not to repay the debt and hope that it will relatively decrease compared to the Gross National Product (GNP). This is possible if the sum of the real growth of the economy and inflation is higher than the interest that the government pays on the national debt. After World War II, this strategy proved to be very effective, particularly for the United States and the United Kingdom. The strategy worked at the time because the government had a tolerance for high inflation and, in the meanwhile, kept the interest on government debt low by preventing investors from obtaining higher interest rates elsewhere (for example, by setting interest rate limits). The investors were, so to speak, forced to lend their money to the government.

Today, due to globalization and technology, it would be a lot more difficult for the government to keep interest rates low, other than on government debt. However, it is possible to tolerate high inflation: the public debt would then fall relative to GNP. But then, the premium paid in the market to insure against future inflation has recently declined, from which we can deduce that the market does not expect inflation to rise.

If inflation remains low or falls, central banks can buy up government debt (Quantitative Easing) and lower the cost of borrowing money. In concrete terms, buying up public debt means that the central bank prints money in the form of reserves in the financial system, thereby buying up debt. The central bank pays interest on the reserves. Since the central bank is part of the government, the interest that the government pays on the national debt is exchanged for the interest that must be paid on the reserves of the central bank. As long as nominal interest rates are low, this goes well. The situation will change if we face an increase in inflation and the central bank needs to raise interest rates. The government then faces a dilemma: Would the central bank raise interest rates so that the taxpayer pays the bill, or would the central bank keep interest rates low and cause inflation to rise?

An increase in inflation is not necessarily a bad thing for wealthy individuals. The values ​​of real estate and shares rise with inflation, while the values ​​of debt (such as mortgage debt) fall relatively. However, the rest of society, the people without capital, will deteriorate if wages do not rise in line with inflation. Higher inflation can thus bring about a redistribution of wealth that widens the gap between rich and poor, and increases inequality of opportunities. Therefore, my preference in this situation is to target taxes instead of raising inflation. The bill of the corona pandemic is then paid in such a way that the gap between rich and poor, as well as the inequality of opportunities, remains limited. With limited inequality of opportunity, talent is better utilized. This is urgently needed when considering the challenges we face as a society.

Get in touch with Zaid Siddiqi for more information about this column.