Friday, 17 May 2013
In this paper, Jan Kregel addresses the following problem.
It’s desirable for obvious reasons for governments to back bank deposits, or at least to guarantee some minimum amount of those deposits. Unfortunately, this gives rise to moral hazard: it induces banks to behave more recklessly. And second, that guarantee inevitably involves subsidising what is in effect commerce.
That is, if you invest direct in the stock exchange, a buy to let property or whatever, there are no government guarantees for you in case your investment goes wrong, and rightly so. On the other hand, if you place money in a bank, and the bank makes a series of bad loans or investments in firms large or small or in mortgages and it goes wrong, the taxpayer comes riding to your rescue.
As Kregel puts it, “It would thus seem impossible to design a truly fair deposit insurance scheme that eliminates the inherent moral hazard….”
Well actually Positive Money, Prof. Richard Werner and the New Economics Foundation solved that one some time ago. See here.
Thursday, 16 May 2013
The overgrow school children who play the part of politicians are often mesmerised by anything resembling “toys for boys”: whether its advanced technology trains, boats or planes. And of course a common reason they advance, with a view to being able to play with a new toy, is the idea that making the toy “creates jobs”.
Certainly the job creation excuse has been pushed for all it’s worth in the case of the HS2 rail project being proposed in the UK.
A near identical, and equally daft phenomenon occurs in the US, where Republican politicians regularly claim that expanding the deficit so as to spend more on the military will create jobs, whereas expanding the deficit so as to spend more items not approved of by the political right apparently has no job creation effects at all.
If public spending on trains creates jobs, then presumably spending public money on education, health and the dozens of other items on which government spends money should also “create jobs”.
In fact, given that public spending has risen from about zero percent of GDP to near fifty percent over the last 150 years, unemployment should have vanished long ago.
But amazingly, unemployment is about the same as it was 100 or 150 years ago.
Now if you’re an economically illiterate politician who gets mesmerised by toys for boys, you’ll be baffled.
In contrast, and for those of us who understand economics, the reason why expanding public spending fails to have any effect on unemployment is simple enough, and is as follows.
Anyone with a pre-university qualification in economics can tell you how to expand demand and raise employment. And it makes very little difference what the extra money is spent on: it can be public sector items or private sector items.
But in either case, the big obstacle is inflation. I.e. raise demand far enough, and inflation kicks in.
Now assuming unemployment is as low as it can go without causing excess inflation (which is where it should be), the NET INCREASE in spending so as to get HS2 going is just not allowable. That is, any such spending will have to come out of taxes, which in turn will reduce spending on other items.
The net effect on “jobs” will be zero.
Wednesday, 15 May 2013
As Bill Mitchell (Australian economics Prof.) has pointed out a dozen times, the political left is too dumb to do anything more than ape the economic illiteracy of the political right.
But if the political left really seriously wants those “radical” and “progressive” policies it claims to want, but doesn’t have the guts or the brain to advocate, they could try the following two.
1. Nationalise the money production process.
There are various problems with letting private banks create money - or “lend money into existence” as the saying goes. One is that private bank money creation is pro-cyclical. That is they lend like there is no tomorrow just when they shouldn’t: in a boom. And they fail to lend just when we want them too, as you can hardly fail to have noticed over the last two or three years.
So why give them the freedom to lend money into existence at all? They only make a mess of it.
2. Stimulating an economy by stuffing the pockets of the rich (QE) is just brilliant, isn’t it? I mean that’s got “socialism” written all over it, I don’t think.
Moreover, we’ve been in a BALANCE SHEET RECESSION for the last few years. And the people with seriously impaired balance sheets are households who have taken on too much debt. So to get the private sector spending, stimulus should be channelled into the pockets of ordinary households, no the pockets of the rich.
I don’t favour of debt jubilees: that is artificial assistance for those in debt, paid for by those who have acted responsibly. But certainly stimulus directed at ordinary households would have more effect than stimulus directed at the rich.
Why does it take someone on the political right like me, to tell the political left what to do?
Tuesday, 14 May 2013
Osborne, along with finance ministers in other leading countries, have been completely fooled, hood-winked and out-smarted by private banks.
Since the crisis erupted, various worthy committees have, as we all know, been set up to re-examine bank regulation (Basel III, Vickers, etc). And the net effect of those committees has been near enough non-existent. In particular, the 3% equity to gross asset ratio (henceforth “capital ratio”) has not changed.
As for the UK, George Osborne could not even bring himself to adopt the 4% ratio advocated by Vickers: Osborne reduced that to 3%.
So what reasons do George Osborne and his fellow dimwit finance ministers round the world have for sticking to 3%? Well it’s the nonsense promulgated by private banks, and swallowed hook line and sinker by Osborne & Co that equity finance for banks is expensive. So, increase the extent to which a bank is funded by shareholders, and the cost of funding the bank rises – or so private banks will tell you. And those increased costs would be passed on by banks to borrowers, which would discourage borrowing and thwart economic growth: certainly the last thing we need when trying to escape a recession – so private banks will tell you.
And for the naïve, private banks seem to have a point. That is, the return demanded by bank shareholders is indeed higher than the return demanded by depositors. But there is a whapping great flaw in that argument, pointed out by Franco Modigliani and Merton Miller. It’s a desperately simple flaw, and it goes like this.
Shareholders demand a higher return than depositors because shareholders are first in line for a hair cut when a bank is in trouble. Put another way, shareholders carry a risk.
But – and this is crucial – the total amount of risk involved in running a particular bank which makes loans of a given quantity and type is a GIVEN. It’s fixed - regardless of what adjustments one makes to capital ratios. I.e. adjusting capital ratios has NO EFFECT on the total risk involved. Ergo adjusting the ratio has NO EFFECT on the total charge that shareholders or “risk bearers” will make for carrying said risk.
In short, adjusting capital ratios has no effect on the cost of funding a bank.
Not convinced? Well you might like to know that there are successful lending institutions in Britain where the ratio is WAY ABOVE 4%. How big do you think it is? 10%? 40%? Nope: it’s a whapping great 100%!!!!!
Those lending institutions are mutual building societies. Those institutions don’t have formal shareholders: they just have depositors. Thus depositors are in effect the shareholders, as Mervy King rightly pointed out. As King put in reference to those depositors “in a mutual organisation they are, in effect, the shareholders.”
But amazingly, and to repeat, mutual building societies manage to compete with private banks. Now that will baffle George Osborne. But it shouldn’t baffle anyone who has read and understood the above paragraphs.
And if you don’t believe the above paragraphs, then you might like to read discussion paper No 31 published by the Bank of England External Monetary Policy Unit’s discussion paper No.31, entitled “Optimum Bank Capital”. The authors conclude by saying that the very low capital ratios that have obtained in recent decades have arisen because “most regulators and governments seem to have accepted the view that “equity capital is scarce and very expensive” – which in some ways is a proposition remarkable in its incoherence….”.
Friday, 10 May 2013
First, I do like this chart which shows the – er – amazing benefits of the 2009 cut in base rates in the UK. More specifically, the base rate plunged, and the result? Rates charged by commercial banks, etc to borrowers went up.
Re the chart, hat tip to economicshelp.org
Next, Brad DeLong and Laura Tyson give five reasons why it used to be thought that monetary policy alone could deal with recessions.
All five reasons are thoroughly defective. The reasons copied straight from their paper are as follows (in brown), followed by my comments in black.
1. The problem of legislative confusion: Legislatures that were told that expansionary policies which led to cyclical deficits in downturns were good might have difficulty retaining the other important lesson that structural deficits which led to perpetually rising debt-to-GDP ratios were bad. Better, it was thought, to keep the legislative process focused on “classical” considerations of the benefits and costs of spending programs and taxation levels.
No doubt most of us agree that the legislature should concentrate on the strictly political matters, like what proportion of GDP should be allocated to public spending and how that should be split between education, defence and so on. But that doesn’t preclude fiscal stimulus: the degree of fiscal stimulus can be decided by a fiscal council or some other independent committee of economists, while the above mentioned “political matters” remain untouched. E.g. if a fiscal council cuts taxes and raises public spending by the same proportion and with a view to imparting stimulus, then the proportion of GDP allocated to public spending remains untouched.
Moreover, it is easy to build in an element of variability into sales taxes for example: indeed, VAT has been altered three times in the last five years in the UK without a full vote in the House of Commons. Likewise an element of variability could easily be built into social security benefits, payroll taxes, etc.
2. The problem of legislative process: Legislatures are, by design, institutions that find it very difficult to make decisions quickly. Central banks, by contrast, can move asset prices in an hour. Fiscal policies that take effect this year as a result of decisions made by a legislature last year based on information from two or three years ago would seem to guarantee sub-optimal economic outcomes.
Total confusion here.
First, even assuming that central banks can take decisions quicker by a few weeks or months AND ASSUMING that fast acting fiscal councils are not possible, the “in an hour” point is irrelevant. The IMPORTANT question is the TOTAL LAG as between the decision to act and the eventual effect. And in that lag for both fiscal and monetary policies seems to be around a year. So if it takes a fiscal council a month longer to act than a central bank, that is near irrelevant.
Next, whence the assumption that decisions on fiscal stimulus are based on “information from two or three years ago” but decisions on monetary stimulus are based on more recent information? The “information” will be EXACTLY THE SAME in each case: the most important pieces of information being whether unemployment is rising or falling and ditto for inflation.
3. The problem of implementation: Public bureaucracies have limited capacities to ramp-up or ramp-down their spending levels quickly without incurring substantial waste. The larger the fiscal-policy intervention to balance aggregate demand, the less likely the intervention would be well timed, well designed and well executed.
Obviously there are areas where “ramping up or down” involves waste. A classic example is one of the most popular proposed forms of anti-recessionary spending, that is infrastructure. It’s normally impossible to get infrastructure projects going quickly, plus if anti recessionary spending is concentrated on just one area (infrastructure or whatever), the requisite skilled labour probably won’t be available.
However, there shouldn’t be any of the above waste if stimulus is spread over the entire economy or a large portion of it, as occurs when taxes or benefits are adjusted.
Moreover, adjusting interest rates suffers from exactly the problem mentioned above: namely concentrating stimulus on one or two narrow areas of the economy. That is, cutting interest rates concentrates stimulus on capital expenditure (assuming interest rate cuts work as they are supposed to, which looks doubtful if the above chart is any guide). As mentioned above, big increases in demand for PARTICULAR PRODUCTS care likely t o run into the above mentioned shortage of skilled labour problem.
4. The problem of rent-seeking: In a world where we fear that the structure of government already leads to policies favoring too-many politically-powerful winners at the expense of politically-weak losers, an additional excuse to undertake fiscal projects and programs that would not meet conventional societal benefit-cost tests is not welcome.
Rent seeking is a problem that occurs where corporations can bribe politicians into allocating government spending to PARTICULAR projects or forms of spending. In contrast, fiscal committees or similar are NOT CONCERNED with specific projects or similar. Fiscal committees are concerned with changes to tax or spending which do not impinge to any great extent on one project or area of the economy.
5. The problem of superfluity: Monetary policy was strong enough to do the job. Fiscal policy was simply not necessary.
The fact that something is “strong enough to do a job” is not a good reason for supposing it’s the BEST TOOL for the job. In particular, monetary policy is DISTORTIONARY (as mentioned above) in that it concentrates stimulus on capital spending.
An Abrams tank is “strong enough” to plough a field. But it’s not the best tool for the job, is it?
And to cap it all, monetary policy, as DeLong and Tyson correctly point out becomes a feeble implement at the zero bound.