Thursday, 28 April 2016
The world is awash with deluded individuals who think that government debt is comparable to the debt of a household or firm: something that is bad, bad, bad. And allegedly that government debt needs to be reduced or paid off as soon as possible.
Reason for that delusion is that the word “debt” has negative overtones, and the overtones of a word are all that most people consider: that is, considering the ACTUAL NATURE of government debt is too much like hard work.
To be more exact, government debt is an asset as viewed by those who hold that debt (i.e. private sector entities like households). I.e. government debt is a form of saving. Thus we might as well scrub the phrase “national debt” and rename it “national savings”. If we did that, the above people would immediately conclude that the more “national savings” there are the better.
So where does the truth lie on that “savings – debt” scale? Well the answer is that “national debt / savings” is neither good nor bad: the reality is that for any given situation (level of inflation, unemployment, etc) there is an OPTIMUM amount of “debt / savings”, as advocates of Modern Monetary Theory (MMT) have been trying to point out for a long time.
It’s thus good to see Narayana Kocherlakota publish a Bloomberg article recently advocating more government debt – in flat contradiction of the conventional view that the debt should be reduced. (Incidentally, Kocherlakota is former president of the Minneapolis Fed and is an economics prof at the University of Rochester.) However, not even Kocherlakota’s analysis is without flaws, so I’ll run thru it.
In his 3rd para (starting “How is the US government..”) Kocherlakota argues that because interest on US national debt is lower than it was ten years ago, that therefor that rate of interest must be too low.
To put it politely, that’s not a brilliant piece of logic: if the speed of your car is less than it was two minutes ago, does that prove the speed is now too low?
Put another way, the fact that something is less now than it was recently is completely irrelevant. The IMPORTANT point is this: what’s the OPTIMUM amount of any variable (debt, car speed, etc)? Unfortunately as I’ve pointed out over and over, the concept “optimum”, simple as it is, is way beyond the comprehension of about 99% of the population.
Well according to MMT, which I agree with, the optimum amount of national debt is not too difficult to determine, at least in theory. It goes like this.
Debt as viewed by debt holders is an ASSET. In fact national debt is simply a form of term account: it’s a chunck of money on which government pays interest (as distinct from physical cash, on which government pays NO INTEREST).
And the bigger the stock of those paper assets (debt and base money) held by the private sector, the more the private sector will spend, all else equal. Thus the OPTIMUM amount of that stock is simply the amount that induces the private sector to spend at a rate that brings full employment. Easy.
Another related question (mentioned above) is this: what exactly is the OPTIMUM rate of interest to pay on the debt? (Apologies for using that word “optimum” again!)
Well there’s no real reason to pay any interest at all! Milton Friedman advocated an abolition of government debt: i.e. he advocated that the only liability of the state should be base money. To be more exact, there’s no reason for government AS CURRENCY ISSUER to pay any interest. In contrast, there might be a reason for government AS OPERATOR OF INFRASTRUCTURE investments to pay interest, but even the arguments there are not good, as I’ve explained elsewhere.
Having said that, I wouldn’t rule out the use of interest rate adjustments altogether: obviously they’re a useful tool to use in emergencies. But basically, and to repeat, there aren’t any BRILLIANT arguments for paying interest on government liabilities year in year out.
Later in the above mentioned 3rd paragraph, Kocherlakota says (in reference to the fact that interest on government debt is at record lows) “This means that the price is near record highs, suggesting that the U.S. government's supply of such safe investments is falling far short of demand.”
Well demand for anything (revelation of the century this) depends on the price. All Kocherlakota is saying is that if interest on the debt was higher, there’d be more demand for it. You don’t say?
That ignores the more important and more basic question dealt with above, namely: what’s the OPTIMUM level of interest on the debt? Like I said, the concept “optimum” is beyond the comprehension of 99% of the population.
Kocherlakota continues, “In other words, we're starving the world of desperately needed financial safety.”
No we’re not: households and other entities are free to stock up on whatever amount of US dollars they want. At least they’d certainly have that freedom in an MMT regime. However, they WOULDN’T necessarily get any or much interest on that stock. And why should they? That is, why should one lot of people (primarily the less well off) have to pay taxes to fund interest for those who choose to amass a big pile of government debt or cash?
Given the number of errors in the opening hundred words or so of Kocherlakota’s article, I can’t be bothered with the rest of it. It just isn't too clever.
Tuesday, 26 April 2016
Sir John Vickers was chairman of the main British investigation into the 2007/8 bank crisis. That investigation’s official title was the “Independent Commission on Banking” – also referred to as the “Vickers commission”).
Anyway, it’s nice to see John Vickers in his latest publication come round to something nearer to what I’ve been advocating for some time. In the ICB report, he and his committee advocated a very small increase in bank capital ratios, and on the grounds that a big increase in capital ratios would impose costs on banks.
The flaw in that idea was set out by the two Nobel laureate economists, Franco Modigliani and Merton Miller in their “Modigliani Miller” theory (MM), which shows that capital ratios have no effect on funding costs, a theory which the ICB dismissed.
If high capital ratios do increase costs, it’s strange that corporations’ capital ratios are all over the place: everything from about 20% to 90%. Google has ratio of 90% and is doing just fine, far as I know.
At any rate, in his latest work, John Vickers is far more at ease with much higher capital ratios. He cites Anat Admati with approval - she advocates a capital ratio of 25 to 30% (p.6-7).
The Modigliani Miller Theory.
MM is one of those beautifully simple theories, a bit like E=MC2 which just grabs you by the throat – at least for those who understand it, it’s beautiful. Unfortunately as is the case with most simple theoretical insights, the theory then induces a collection of time wasters and hangers-on to jump on the band wagon and advocate a series of changes to, or criticisms of the original theory which are basically just a waste of ink and paper.
It’s the same with religion: original thinkers like Jesus and Buddah produce something worthwhile. But they’re followed by theologians, hate preachers etc who end up trashing the religion.
In the case of MM, the most popular criticism of it is that the tax treatment of capital and debt is not the same, thus MM supposedly does not work out in the real world as per theory. The flaw in that idea is that tax is an ENTIRELY ARTIFICIAL imposition, thus for the purposes of calculating REAL COSTS AND BENEFITS, it should be ignored.
Vickers critises that alleged “tax” weakness in MM, and rightly so (p.7).
He then says “The other main reason why banks and their shareholders are averse to equity funding – whether by new issuance or retained earnings – is that, by reducing insolvency risk, it has benefits that flow to creditors and are not fully appropriated by the shareholders themselves.11 Reducing too-big-to-fail risk, which falls on the public as contingent creditor if it happens, is a prime instance of this effect. More bank equity reduces the likelihood and scale of public bail-out. So long as there is any prospect of bail-out, debt funding is effectively subsidised relative to equity funding.”
So to summarise, Vickers seems to be saying that the two main criticisms of MM are invalid. Well I’ll drink to that!
A 100% capital ratio.
But having advocated substantially higher capital ratios, Vickers than says “None of this is to say that banks should be entirely funded by equity, which would eliminate bank deposits and the liquidity services that they provide.”
John Vickers must know (or perhaps he doesn’t) that that’s nonsense. Under a 100% capital ratio system (or “100% reserves” as Milton Friedman called it), the state aims to supply the economy with whatever amount of money is needed to keep the economy operating at capacity. Thus the idea that “bank deposits” vanish, is just nonsense. The main difference is that under 100% reserves, those deposits are kept in a totally safe manner, whereas under the existing system, they’re put at risk.
Another point about banking which John Vickers still apparently doesn’t understand (not that many other people do) is thus.
It’s blindingly obvious that if banks (or more generally, entities that lend) have to fund themselves entirely out of equity, that that will raise the cost of funding those banks, and that in turn will have a deflationary effect. The John Vickers of this world then jump to the conclusion that VERY high capital ratios are damaging.
Well the simple solution to that little problem or “non problem” is stimulus – to put it bluntly, having the state print money and spend it and/or cut taxes. There is no limit to the amount of stimulus that can be implemented that way (as pointed out by Mosler’s law). Thus any deflationary effect of high bank capital ratios is a total and complete non problem.
Put another way, there is a choice between two alternatives. The first involves relatively low bank capital ratios, relatively small amounts of base money in the hands of households and high levels of household debt. Second, we can have high bank capital ratios, a larger amount of money in the hands of households and lower household debts.
As I explain in this work, the second option resembles a free market more closely than the first, thus the second is the GDP maximising option.
Monday, 25 April 2016
I had a discussion with George Selgin recently on this topic in the comments here.
My basic point was that when there’s a need for stimulus, there is no particular reason to impart stimulus via more borrowing, lending and investment than there is to impart it by artificially increasing the production and sale of ice-cream, lollipops, cars, education or any other narrow selection of goods. Thus interest rates should be left to market forces, as should the price of most items.
Milton Friedman argued that government should not interfere with interest rates. See para starting “Under the proposal..” here.
Warren Mosler advocated the same. See final two paras here.
In other words stimulus should come in the form of expanding the output of as wide a range of goods as possible. The only exception to that might come if a recession is caused by a dramatic and irrational fall in the output of some particular set of goods or services, in which case subsidising the output of that set of goods could be justified.
It could be argued that the recent recession was sparked off by a “dramatic and irrational fall” in bank lending. Well the fall was certainly dramatic, but it’s not clear that it was “irrational”. What happened was that banks realized that a significant proportion of their loans were no good, and cut back on such lending: entirely rational!!
To put it more bluntley, the crises was sparked off by excessive and irresponsible lending, and the solution advocated by all those clever professional economists was to cut interest rates so as to encourage more lending: the phrase "raving bonkers" springs to mind.
Another potential excuse for interest rate adjustments is that the lag between the decision to impart stimulus and stimulus actually arriving might be shorter in the case of interest adjustments than other forms of stimulus. Or the PREDICTABILITY of the effect of interest rate changes might be better. But that doesn’t seem to be the case.
So why do we have interest rate adjustments? Well probably the main reason is that we don’t want politicians having the last word on stimulus, i.e. we don’t want politicians in charge of the printing press. So we have a system under which politicians CAN IMPLEMENT SOME STIMULUS: they can borrow more and spend more. Economists are generally agreed that that’s stimulatory assuming the central bank arranges for interest rates to remain stable: i.e. arranges for the extra lending not to push up interest rates.
But note that the ultimate say on stimulus under that system rests with central banks.
Actually the evidence seems to be that if politicians DO HAVE access to the printing press (i.e. have the last word on stimulus) the results are not too bad – with Robert Mugabe being the obvious exception. That is, the evidence seems to be that there isn't much to choose between independent and non-independent central banks. See the first chart here.
However, and to repeat, the consensus is that independent central banks are better because the last word on stimulus is then in the hands of professional economists rather than politicians, thus central banks have to be given some sort of tool or weapon to actually impose their will, and what better than control over interest rates?
But the obvious problem there is the one set out at the start of this article above, namely that interest rate adjustments are a defective tool. So how do we get round that apparent contradiction? Well it’s not too difficult. In fact the solution was set out in this work a few years ago.
The solution (assuming we’re going to have some sort of independent committee of economists have the last word on stimulus), is to have such a committee determine BOTH monetary AND fiscal stimulus. Whether that committee is based at the central bank or the treasury doesn’t matter too much. Those who want the committee kept as far away from politicians as possible will want it based at the central bank of course.
As to how we actually combine monetary and fiscal stimulus, that’s easily done: just fund the extra public spending or tax cuts that make up a stimulus package from new money issued by the central bank. I.e. when there’s a need for stimulus, just have the state print extra money and spend it or cut taxes.
As to whether a stimulus package consists primarily of more public spending or more tax cuts, that’s clearly a POLITICAL decision which should stay with politicians. And that’s exactly what’s advocated in the above work: that is, the committee of economists decides on the SIZE OF stimulus package, while POLITICIANS decide whether the package consists mainly of extra public spending or mainly of tax cuts.
And finally, having poured cold water on interest rate adjustments, I wouldn't rule them out altogether in an emergency. But they're certainly not my first choice.
Thursday, 21 April 2016
This is a 400 word summary of this work (see top of the column just to the left).
There’s no question but that private banks create or print money under present arrangements. See the opening sentences of this Bank of England article for confirmation of that point.
To answer the question in the above heading, let’s consider an economy where the only form of money is base money, i.e. government / central bank issued money. I’ll refer to government and central bank combined as “the state”.
The more base money the state spends into the economy, the bigger the private sector’s stock of base money. Given that the more money people have, the more they are likely to spend, at some point, giving a rising stock of base money, that will at some point induce the private sector to spend at a rate that brings full employment. Moreover, that arrangement will result in some sort of natural or free market rate of interest.
Assume also that private banks can act as intermediaries between lenders and borrowers, but they can't actually CREATE money.
Assume also that the state does not borrow anything. Given the large amounts that states or governments currently borrow, that might seem an unrealistic assumption. In fact several economists have advocated a “zero borrowing” regime: e.g. Milton Friedman (see para starting “Under the proposal..”). Also see the final two paras of this article by Warren Mosler.
Now suppose private banks are allowed to create money out of thin air and lend it out. Those private banks can easily undercut the going or free market rate of interest for the simple reason that it costs nothing to create / print money. (In contrast, to the extent that banks INTERMEDIATE, lenders have to endure the pain of actually EARNING money and then abstain from spending it so as to transfer that money to borrowers.)
The result of that extra lending will be excess demand, thus the state will have to curtail demand somehow. One option is to raise taxes and “unprint” the base money collected. In that case, households and firms are robbed of money in order to enable private banks to create the stuff.
Alternatively, and given that interest rates will have been reduced by the above lending out of freshly produced money, the state can raise interest rates again. It can do that by offering interest to base money holders with a view to inducing them to deposit money with the state. That money is then no longer in circulation, hence the deflationary effect.
But that involves robbery again: that is, taxpayers are robbed in order to pay interest to those with an excessive stock of base money.
Conclusion: a system under which private banks create money is a defective system.
Saturday, 2 April 2016
The letter claims among other things that had the UK’s proposed restrictions on immigration been in force when those economists chose some time ago to migrate to the UK, then the effect would have been “deeply damaging to the competitiveness of the UK science and research sectors and to the wider economy.”
So economists make a big contribution to a country’s “research sectors and to the wider economy” do they? Given that so called “professional” economists are currently having difficulty working out how to raise inflation (something that Robert Mugabe knows how to do without even trying) it’s a wonder so called “professional” economists manage to tie their own shoe laces.
While I have personally been inspired by some economists (as many of them amateurs as professional) I don’t remember having read anything remotely interesting by the above fifteen, with the exception perhaps of William Buiter. Had they never entered the UK, the UK would have lost nothing, far as I can see.
Moreover (and this may be news to the above fifteen individuals), culture is very much international and has been for a long time. That is, new ideas thought up in say Argentina are round the World in a flash thanks to the internet. (Perhaps the above fifteen aren’t connected to the internet).
Thus it doesn’t make a big difference exactly WHERE in the world talented researchers are located. I personally communicate every single day with people in the US, Canada, Australia, mainland Europe etc while being based in Britain.
And to add insult to injury, culture has traveled around the world in a flash for a very long time: Bach and Mozart’s music traveled round the world on some amazing stuff called “paper” soon after being composed. Perhaps the above fifteen don’t know what paper is.
And the final nonsensical element in the above letter is it’s opening sentence which reads, “The UK Home Office is in the final stages of a radical policy shift, aimed at reducing dramatically the number of non-European Union economic migrants who have the opportunity to settle in the UK.”
Well the problem there is that half the signatories of that letter are not “non-Europeans”: e.g. William Buiter hails from Holland.
Wednesday, 30 March 2016
I like this picture from Lars Syll’s blog. It summarises much of Modern Monetary Theory.
In particular, government debt is an asset, as viewed by the private sector. The more paper assets the private sector has, the more it will tend to spend and the lower will unemployment be, all else equal.
So think twice before advocating a cut in the debt. If REAL interest on the debt (i.e. interest on the debt after adjusting for inflation) is around zero, the just leave it alone. In contrast, if government is paying any significant amount of REAL interest on the debt, then fair enough: reduce it.
Friday, 25 March 2016
Steve Keen and many others keep trying to scare us with charts like the one below showing the rise in private debts over the last twenty years or so.
One reason for not being scared is that interest rates have dropped significantly over that period. Thus (surprise, surprise) people and firms borrow more.
As to what would happen if interest rates rose again, well if they rose at the same gentle pace that they’ve declined over the last twenty years, that wouldn’t be a problem. In contrast, given a SUDDEN rise in interest rates, obviously there’d be problems: some mortgagors would go bust, as would some banks which had loaned too much to high risk borrowers.
That would cut aggregate demand, but that’s easy enough countered with standard stimulatory measures. Of course many governments and members of the economics profession are too dumb to realise we have the power to counter recessions. But at least in theory, recessions are easily countered.
As to banks going under, well small banks in the US are covered by the FDIC.
As to larger banks in the US, and non-insured banks elsewhere, the fact of banks going under being a cause of macro economic problems just proves the idiocy of our existing bank system. The solution is full reserve banking. Under that system, it’s plain impossible for banks to go insolvent, though it’s perfectly possible for them to see a sharp fall in their share prices, resulting perhaps in being taken over.
And finally, I’m still waiting to hear some FUNDAMENTAL THEORETICAL reason for thinking debts are too high. But never mind: I can come to the rescue there. I set out a basic and very simple reason for thinking debts are too high here. The reason is that the debt creation process is subsidised by taxpayers!!
How’s that for simplicity? To be more exact, I argue at the above link that money creation (aka money printing) by private banks is subsidised, and given that for every $ of that form of money there is a $ of debt, it follows that in subsidising private money printing, we’re subsidising debt creation.
So…if we abolish private money printing (which is what full reserve banking involves), the result is something nearer the optimum amount of debt, plus we’re more likely to avoid bank problems giving rise to macro economic problems.
What more do you want?