The Rockliff Government’s financial mess in Tasmania has been well explained by economist Saul Eslake, independent MLC Ruth Forrest, and others paying attention.

It is now canvassing the sale of government assets in a desperate attempt to copy the errors of other governments rather than address causes.

State governments have an obvious financial constraint governed by their revenue, spending and borrowing – although there is always the possibility of extra grants from the Commonwealth.

States often struggle to balance their budgets because of their role in expensive service provision in the context of increasing populations, the modern fetish for low taxation, and structural problems in state-federal financial arrangements, including constitutional provisions governing which jurisdiction can tax what.

My interest here is mostly with central government budgets and the relatively recent obsession with “balancing the books” at the national level despite plenty of evidence that this obsession is based on various myths.

The obsession seems to have its origins in the “stagflation” of the 1970s when the oil crisis of 1973 ushered in inflation, high unemployment and reduced growth. This combination was unusual and intractable.

Inflation was suddenly enemy number one and it led to the preference for interest rate targeting (monetary policy) rather than taxing and spending (fiscal policy) to manage the economy. Even better, an “independent” central bank should set the policy interest rate, not the elected government as in former times, as the latter might try to appease voters rather than make the “right” technical decisions.

The upshot was that central governments were advised to constrain their spending and balance their budgets – yet taxation became a dirty word as it was perceived as acting as a brake on private investment, private spending, and growth in general. How do you balance your budget and reduce taxation? Maybe sell some public assets like Qantas and the Commonwealth Bank?

Money was seen as something the private sector created via its hard work and astute business decisions. The central government, with allegedly no money of its own, was parasitic as it taxed away wealth and then spent it like a drunken sailor without the prudence of a market-disciplined mindset.

Further, the rich were both essential and noble because they were funding the government, and everyone else, because they paid more tax and employed the workers.

As central governments usually ran budget deficits, and sold bonds in a perceived borrowing operation, economists claimed this public debt would lead to more inflation, higher interest rates, more taxation, and less money for the private sector to borrow due to the “crowding out” effect as governments borrowed more and more from a limited pool of funds.

And heaven forfend if the government decided to start “printing money” as we would end up like Zimbabwe, Argentina or the Weimar Republic!

The notion that balanced budgets are ultimately necessary, even at the federal level, is easy to argue because it is a seductively simple formula and we are all familiar with spending limits imposed by our household budget, business budgets or state government budgets. How could the Australian Government be any different? Money doesn’t grow on trees – and look at, say, Greece.

Without the discipline of a balanced-budget constraint, how would the federal government know how to limit its spending? On the other hand, Japan’s government debt is the highest globally at 250% of GDP (Australia is 50%) and things seem relatively OK in Japan.

We are now very familiar with the claim that the government is “spending taxpayer money”, or “wasting taxpayer money” (or the government is “investing” if you approve of the spending).

This post-1970s mindset is now usually called neoliberalism — although resting on neoclassical foundations — and has been helped along by the World Bank, International Monetary Fund, credit-rating agencies, the OECD, the media, and most university economic departments.

However, a minority of economists say most of the assumptions outlined above are wrong, ideological, and without evidence. By contrast, they cite a body of evidence going back 5000 years to the invention of money to show that central governments (sometimes monarchs) created money from nothing — as a kind of points system — and that government spending must logically precede taxation (and bond sales).

In such discussions, it is important to focus on the evidence rather than simply concede to a majority, who may or may not be correct.

The minority view is that:

• Central governments have a monopoly on currency creation via central bank computer keystrokes (despite private-bank money creation for loans).
• They spend first, via their central bank, and tax second to destroy some of the money supply – so federal taxes cannot fund federal spending.
• Prudent central government spending is not determined by deficits or surpluses, but by many factors in the economy, including total spending (public and private) and available real resources.
• Any given fiscal balance, whether deficit or surplus, can be too big or too small, depending on many factors.
• Government bond sales (so-called borrowing) are optional and probably unnecessary.
• If bonds are sold, the government can always control the bond interest rate (which could be zero) or buy the bonds back whenever it wants – so-called quantitative easing.
• Government should set the policy interest rate low (called the “cash rate target” in Australia), as a high interest rate can fuel inflation and benefits the rich more than the poor.
• It follows that governments like Australia can run prudent (non-inflationary) deficits indefinitely as there is no debt generated that has to be paid back out of limited funds.
• An Australian Government surplus is always matched by a non-government deficit of the same size in the same period – and vice-versa (called the “ sectoral balances”).
• Not all national governments have their own currency (e.g. Greece) and some borrow in foreign currencies so different rules can apply to different nations.

I will discuss some of the important implications of this in part 2.