Friday, 6 March 2015

Bank capital is expensive? LOL.

Those who supply equity to a bank (or indeed ANY corporation) run a bigger risk that those who fund a bank via DEBT (e.g. bonds, or in the case of banks, deposits). Thus equity providers or “shareholders” understandably require a bigger return on capital that bond-holders.

A plausible but in fact flawed conclusion often drawn from the above is that if bank capital is raised, the cost of funding banks will rise. The flaw in that argument is that if the proportion of a bank’s funding that comes from equity is raised at the expense of debt , then the risk per share or per shareholder declines pari passu. Thus altering the latter proportion should have NO EFFECT whatever on the cost of funding banks (as pointed out by Messers Miller and Modigliani).

However the Modigliani Miller theory has been criticised, and one very popular criticism is that the tax treatment of debt is not the same as the tax treatment of equity. For example, the UK’s main official response to the bank crisis, the “Independent Commission on Banking” (ICB) claimed in para A.3.46 that:

“First, the returns on debt are deductible from taxable profits, whereas the returns paid to shareholders are not. More equity therefore means banks pay more tax – a cost to the banks but not, in the first instance, to society.”

Well hopefully you’ve spotted the glaring flaw in that ICB argument. It’s that tax is an ENTIRELY ARTIFICIAL imposition. Tax bears no relation to, and tells us nothing about REAL COSTS, which is what those concerned with bank regulation ought to be concerned with.

To illustrate, if red cars are taxed more heavily than cars painted with a different colour, does that mean that the REAL COST of making or running a red car are higher than the cost of making or running a car with a different colour? Of course not. The average six year old ought to be able to work that out.

Indeed, the ICB sort of admits to the irrelevance of its tax point when it says “More equity therefore means banks pay more tax – a cost to the banks but not, in the first instance, to society.” Yes quite: that is, there’s no “cost to society”.

But what’s that about “in the first instance”? The hint, or the implication is presumably supposed to be that actually THERE IS some sort of cost: in the “second” instance, so to speak.

So what is this mysterious “second instance” cost? Well the ICB doesn’t tell us.

This would be hilarious if the consequences (credit crunches, excess unemployment etc) were not so serious.

Given the high stakes involved here (getting bank regulation right versus making a hash of it), it’s tragic than I need to point to a glaring and simple error like the above, isn't it?


Another “glaring and simple error” comes shortly after the above one (in para A3.50), where the ICB claims that raising bank capital requirements just in the UK would lead to what might be called “regulation evading arbitrage”, that is, banking activity shifting to foreign banks where capital regulations are more lax.

Well the flaw in that argument is that ANY FORM of regulatory imposition on UK banks will tend to lead to the latter form of arbitrage, if other countries do not impose similar improved regulations. Thus the “arbitrage” point is not a weakness SPECIFICALLY in higher bank capital ratios.

As to other alleged weaknesses in the Modigliani Miller theory which the ICB points to, I’ll deal with those hopefully in the near future.

Provisional conclusion.

Messers Modigliani and Miller were right. As a result, bank capital can be raised just as high as we like, even to 100% (as advocated by supporters of full reserve banking). The result will not be to raise the cost of funding banks.

Moreover, where a bank is funded entirely by equity, it’s next to impossible for it to go insolvent, which greatly reduces the chance of, and severity of credit crunches. Thus even a large increase in bank capital DOES INCREASE bank funding costs somewhat, those costs may be insignificant compared to the CATASTROPHIC costs of banking crises like the one we had five or so years ago.

Thursday, 5 March 2015

What’s the optimum amount of national debt?

I’ll argue below that the optimum amount is “none”. And for those interested in science, there’s something appealing about simple answers to complex questions. E=MC2 was an example of that sort of simple answer. Moreover, Milton Friedman and Warren Mosler also argued for  “zero debt”, so I’m in reasonably good company. (Re Friedman see para starting “Under the proposal..” and for Mosler, see his 2nd last para). Anyway, down to business.

National debts have risen over the last five years or so as a result of dealing with the recession. The standard and not very clever response from most economists is approximately as follows.

“The word debt has negative overtones, so debt must be bad. Plus we obviously need to reduce the extent of anything bad. Ergo the debt should be reduced to about where it was prior to the recession” Indeed that’s been pretty much the response of the IMF and OECD – except that they refer to debt reduction with a technical sounding phrase to make themselves sound important: they refer to “fiscal consolidation”.

Well the fact that some country’s national debt used to be say 50% of GDP and then rises to 75% is not a reason to return to 50%. The important question is: what’s the OPTIMUM amount of debt? The new “post recession” optimum could be 10%, or it might be 70%. Who knows?

 As I’ve pointed out several times before, the concept “optimum” seems to be beyond the comprehension of almost every economics commentator including economics professors at the world’s top universities (no names mentioned). Makes you wonder what’s inside their skulls: brain cells or something else.

Anyway, four plausible but actually flawed arguments for government borrowing are considered below. They’re as follows.

1. Government should borrow to fund public investments like infrastructure.

2. Borrowing makes it possible to spread the cost of public investments across generations.

3. Letting those with cash to spare lend to government is a good idea.

4. Borrowing provides government with money with which to implement stimulus.

1. Borrowing for infrastructure.

It’s often argued that governments should borrow to fund infrastructure and similar investments, whereas TAX should be used to fund CURRENT spending. And that sounds sensible: after all, households and firms often borrow to fund investments, like buying a house, factory or office block.

However, the idea that investments should ALWAYS be funded by borrowing is nonsense:   there’s no point whatever in borrowing if you happen to have more than enough cash to spare. No one in their right mind borrows to buy a car if they’ve more than enough cash lying idle. And governments have a near inexhaustible supply of cash, namely the taxpayer.

Of course politicians are often RELUCTANT to raise taxes to fund investments. Reason is that politicians can normally ingratiate themselves with voters by cutting taxes, increasing borrowing and leaving it to some poor sucker in ten years’ time to sort out the resulting debt. Or as David Hume put it 250 years ago:

“It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker's shop in London, than to impower a statesman to draw bills, in this manner, upon posterity.”

But the fact remains that governments have a near inexhaustible supply of cash: the taxpayer. Thus the excuse for borrowing, namely that “I don’t have enough cash” just won’t wash in the case of governments.

2. Spreading the burden across generations.

A second plausible reason for borrowing is that since the benefit of a long term investment is enjoyed by more than one generation, each generation should carry some of the cost, and that can be done by making people in fifty or a hundred years’ time responsible for some interest and repayment of some of the capital sum. (This argument takes some time to dispose of – you have been warned!)

The basic problem with the later “generation” argument, is that it involves time travel: that is, it assumes for example, that people in 2050 can make a real sacrifice and for example produce steel and concrete to help build a bridge which is put up in 2015. That’s clearly impossible: it involves time travel.

Put another way, if government in 2015 borrows $X to build a bridge, then all the person hours and other real resources needed to build the bridge have to be produced and consumed in 2015 (or earlier). As to the bonds issued by government in respect of the bridge, those are purchased by one set of people who pass them on to their descendants, plus another set of people inherit the liability to pay taxes to fund the interest and repayment of capital on those bonds. Thus on balance, the next generation makes no net sacrifice.

Foreign debt .

There are two apparent flaws in the above “time travel” argument. The first is that where debt is held by foreigners, that’s a genuine debt for the country as a whole. I.e. it really is possible to borrow from foreigners so as to fund a bridge built in 2015. Then in 2050 or whatever comes payback time, and the country has to make a real sacrifice to pay back those foreigners.

However, against that “foreigner” point, there’s the fact that national debt of country X held by people in country Y will to some extent be cancelled out by national debt of country Y held by people in country X. Also, the amount owed to foreigners (e.g. by the US to China) is determined by factors TOTALLY UNRELATED to how much infrastructure investment the US is doing. Thus the whole “foreigner” point is pretty irrelevant.

The Nick Rowe theory.

Another weakness in the above time travel argument (put by Nick Rowe) and which doesn’t in fact stand inspection is as follows.

Rowe argued that the bonds issued by government at one point in time can be sold by bond owners in their retirement to younger working people. And the latter can in their retirement sell to the next generation, and so on. That way one can pass the cost of government spending down the generations.

The flaw in that argument is that different generations actually engage in the latter sort of “passing the buck” activity ANYWAY as part of pension provision.

Pensions can be funded or unfunded. The former involves saving up and investing in assets, like government bonds. In contrast, an UNDFUNDED pension scheme invests in nothing: youngsters at any given point in time simply pay taxes or make a payment in some other way which is passed straight to pensioners living at the same time.

Now on the very reasonable assumption that people ALREADY HAVE the pension provision that they want, they’re not going to want EVEN MORE pension provision just because government builds a series of bridges and highways.

Thus I suggest the Nick Rowe theory doesn’t dent the basic argument I’m putting here, which is that the “spreading the burden across generations” argument does not stand up.

3. Why not let people lend to government if they want to?

A third plausible argument for government borrowing is thus. If people (particularly those with cash to spare) want to lend to government, why not let them?

Well the problem with that argument is as follows.

The basic point of the tax and borrowing that funds public spending is to supress PRIVATE spending. That is, assuming the economy is at capacity, if government is going to spend $Xbn more, then the private sector must spend $Xbn less, otherwise we get excess spending and excess inflation.

Now the idea that because £Xbn of extra tax is extracted from the private sector, that therefor the private sector will spend $Xbn less, is a gross over-simplification. What the private sector will do is certainly to spend SOMEWHAT less, but it won’t cut its spending by as much as $Xbn.

And in the case of borrowing, the relationship between borrowing and subsequent cuts in spending by the private sector is even more feeble. In particular, if private sector entities lend to government because they have money to spare, money they’d have left idle in the event of not lending it to government, then the cut in private spending that results from that money being loaned to government will be near non-existent.

(Incidentally, you should have noticed that lending to government (macroeconomics) is very different to lending to a microeconomic entity like a household or firm. In the case of the latter two it’s simply a case of getting hold of the right amount of cash. In the case of lending to government, it’s a case of SUPRESSING private spending by the right amount)

4. Borrow to fund stimulus.

As Keynes pointed out, governments can escape recessions by spending EITHER printed money OR borrowed money. So which is best?

Well I’m darned if I can see the point of BORROWING. The purpose of stimulus is to increase demand. But borrowing has a deflationary or “demand reducing” effect. So borrowing in order to obtain the money to implement stimulus is a bit like throwing dirt over your car before washing it.

John Cochrane (professor of economics at Chicago) pointed to the problems involved in borrowing money in order to effect stimulus. Cochrane went too far in suggesting that borrowing COMPLETELY negates the desired stimulatory effect. But even so, and to repeat, doing something anti-stimulatory when you’re trying to implement stimulus is a strange thing to do.


I probably haven’t TOTALLY DEMOLISHED the case for government borrowing above, but I’ve thrown plenty of cold water over the idea.

So my provisional conclusion is that governments ought to aim at borrowing nothing. Put another way, Milton Friedman was right to say that the only liability issued by the government / central bank machine should be boring old cash, or “base money”.

But that’s not to say that there will NEVER be a case for some borrowing. For example if there’s a serious outbreak of Greenspan’s “irrational exuberance” and inflation looks like rising too far and it looks like fiscal measures won’t rein in the exuberance, there’d be no harm in government or central bank wading into the market and offering to borrow money at above the going rate of interest, and raising taxes so as to pay for that interest.

But note that that is not “borrowing” in the normal sense of the word. Borrowing in the normal sense of the word (e.g. borrowing in order to fund the construction of a house) involves the LOAN or TRANSFER of real resources from the lender to the borrower. In contrast, in the case of the above “anti irrational exuberance” so called borrowing, there is no transfer of real resources. All that happens is that TOKENS commonly known as “money” are removed from private sector pockets so as to cut down on private sector consumption.

So all in all, the case for government borrowing in the normal sense of the word “borrow” looks very feeble. Looks like David Hume was right 250 years ago: the REAL motive for government borrowing is that it enables politicians to ingratiate themselves with voters.

Wednesday, 4 March 2015

Kenneth Rogoff discovers quantitative easing.

Kenneth Rogoff (along with his side-kick Carmen Reinhart) has given more academic credibility to austerity world-wide than just about anyone else over the last five years. First there were his dire warnings about the lack of growth in countries with a debt/GDP ratio of more than 90%. It then turned out that that claim was based on a spread-sheet error.

Apart from that, he has had numerous articles over the last five years in the Financial Times and other publications warning of the horrors of what he calls the “debt overhang”. The word “overhang” has a sort of menace, and for those into propaganda and psychology rather than logic, the psychological overtones of words are much more important than reason.


Quantitative easing.
However, there was always a huge problem with the “debt overhang” theory: any old fool of a government can make its national debt disappear in a puff of smoke by simply printing money and buying the debt back, a process called “quantitative easing”. The result of QE is of course that base money replaces debt.

So Rogoff, as soon as he opens his mouth on the subject of QE which he does in this recent article, faces an obvious problem.

That is, he has two options. One is to claim that the impending disaster that stems from the “debt overhang” is equally applicable to base money. The second is to say that the impending disaster vanishes in a puff of smoke. But to admit to the latter is to say that an impending disaster can be removed by something as simple as printing more dollar bills, pound notes etc, which in turn implies the “disaster” claim is nonsense.

So his only LOGICAL course of action is to go for the first option, i.e. argue that replacing the “debt overhang” with the “base money overhang” solves nothing.

So is he sufficiently sure of his “dreaded overhang” claims to say out loud that QE simply replaces the debt overhang with an equally bad “QE induced overhang”? Well no. Rogoff in the above article basically just waffles and exudes hot air. He doesn’t say anything that the average Financial Times or Wall Street Journal doesn’t already know.

He does however go a small way towards the above mentioned only logical option, namely claiming that QE in no way reduces the “overhang” problem. He says “Why doesn’t the government just finance its entire debt at zero interest? Wouldn’t that free up public funds for other uses and save the taxpayers a lot of money? Yes, but here’s the rub: As the composition of government debt shifts to more short-term debt, the public finances become more exposed if some external factor drives up global interest rates. If all debt were very short-term and interest rates unexpectedly rise, taxpayers would suddenly face vastly larger interest costs as the debt gets rolled over at higher rates.”

OK, let’s examine the latter claim, and let’s assume just to keep things simple that government funds itself with ULTRA short term zero interest debt: i.e. plain simple old cash, or “base money” if you like.

Now suppose, horror of horrors, that “interest rates unexpectedly rise”. What of it? Rogoff claims “taxpayers would suddenly face vastly larger interest costs”. Whaaaaat?

How can government or “taxpayers” face higher interest costs when they aren’t borrowing anything? Rogoff’s claim is laughable.

In the case of closed economy (to keep things simple) those holding excess amounts of cash might easily try to dump or spend away some of their cash. That would result in excess demand. But that’s easily enough dealt with, at least in theory, by raising taxes and “unprinting” the money collected.

Depending on exactly which taxes are raised, there could be POLITICAL problems involved in doing that: certainly voters don’t like increased taxes. But to repeat, there’s no problem in THEORY. Moreover, the UK cut and then substantially increased its sales tax (VAT) in the recent recession, and scarcely anyone noticed. There wasn’t a single riot, demonstration or anything of the sort.

And a further point is that the economic illiterates in Congress and other elected bodies around the world are constantly pushing for a balanced budget or even a budget surplus. Thus they shouldn’t object to a request by the central bank and treasury to raise taxes, and/or cut government spending in some way or other.


Open economies.
Having assumed a closed economy above, there is of course the question as to what happens in an OPEN economy, particularly one where large volumes of its debt and currency are held overseas.

If interest rates world-wide rose substantially, obviously foreign holders of zero interest yielding dollars would dump them to some extent in search of yield elsewhere. That would cause the dollar to decline relative to other currencies. But the dollar has RISEN substantially over the last year or two, which has hit US based exporters. Obviously a panic and large scale dumping of dollars would be disruptive, but modest scale dumping wouldn’t do much harm.


The horrendous “debt overhang” problem about which Rogoff makes so much can be made to disappear in a puff of smoke by simply printing money and buying back the debt, i.e. QE. Thus the alleged problem is non-existent. Obviously that increase in the money supply could be inflationary (though in practice QE hasn’t proved all that inflationary). But to the extent that IT IS inflationary, that is easily dealt with simply by raising taxes and/or cutting public spending and unprinting the money collected.

And assuming the DEFLATIONARY effect of that unprinting is equal to the INFLATIONARY effect of the QE, then the net effect is zero. I.e. GDP would remain the same. Of course equalising those two effects would be difficult to do with TOTAL precision in the real world. But in principle there is no problem there: certainly no “debt overhang” problem.

Friday, 27 February 2015

Without debt there’d be no money?

Summary.     If it were true that without debt there’d be no money, then it would be impossible to have an economy where there was money but no debt. In fact such an economy is perfectly possible. People would just deposit collateral at banks and have their accounts credited with $X, $Y or $Z and with a view to conducting day to day transactions. That WOULD GIVE RISE TO VERY SHORT TERM debts in the sense that the amount in each person’s account would rise above and fall below $X, $Y or $Z for short periods (e.g. there’d be a rise when people got their salary). However, there’d be little point in banks charging interest on those short term debts. Plus in such an economy there’d be no LONG TERM debts like mortgages, which is what advocates of the “without debt there’d be no money” idea really have in mind.


When commercial banks grant loans (i.e. create debt) they create money. That point has been explained by the best economics text books for decades and is confirmed in the opening sentences of this Bank of England publication.

You might conclude from that that without debt there’d be no money. Indeed, the latter claim is often made by those advocating a change to the bank and monetary system.

If the latter claim were true, it would follow that it would be impossible to have a system where there was money but no debt. Of course that’s a bit of a hypothetical system or society, but a culture where no one wished to go into debt is certainly a theoretical possibility: i.e. everyone would want to pay cash on the nail for everything. So let’s examine such a hypothetical society to see if it’s possible for commercial banks to supply a form of money without anyone going into debt .

Incidentally, CENTRAL banks create or issue a form of money which can well be argued to be “debt free”, but let’s ignore central banks: we’re concerned here just with COMMERCIAL banks.

A barter economy.

So, let’s start with a barter economy where a commercial bank or series of commercial banks set up in business. They offer some wondrous new stuff called “money” to anyone banks regard as credit worthy (perhaps because they’ve deposited collateral or perhaps not). The actual units making up that money doesn’t matter: make it an ounce of gold if you like, and each unit is called a “dollar”.

And let’s say just to keep things simple that EVERYONE in this hypothetical society (including employers) wants $1,000 to enable them to do day to day transactions in a more efficient manner than under barter. So $1k is credited to everyone’s account.

Now at that stage, i.e. before any spending starts, is there any debt? The answer is “no”. Or to be more accurate, there are two equal and opposite debts: first, banks owe everyone $1k in that money in your current / checking account is a debt owed to you by your bank. Second, there’s a debt owed by everyone to their bank: that’s everyone’s undertaking to repay the $1k to the bank at some stage. (That “equal and opposite” scenario is actually set out in economics text books: it’s not some strange new invention of mine.)

So, before any spending starts, there is no net debt. That is, no REAL RESOURCES or goods and services have moved from one person to another or from people to banks or from banks to people. All that’s happened is that some book-keeping entries have been made.

Physical cash.

As to physical cash (dollar bills, pound notes, coins etc), bank customers might want some of that. But there again, creating and issuing paper notes involves virtually no consumption of REAL RESOURCES: printing bank notes costs next to nothing.

Incidentally, I have of course assumed that commercial banks ARE ALLOWED to issue their own bank notes, an activity that was stopped in the UK in 1844.

Spending starts.

As soon as spending starts, remember that any money leaving one person’s account arrives someone else’s account (or in someone else’s wallet in the case of physical cash). Thus the AVERAGE stock of money possessed by citizens in this society always remains at $1k.

Incidentally, to keep things simple, I’ll assume from now on that all transactions are done by check or debit card rather than physical cash.

Also bear in mind that assuming everyone has enough regular income (wage, pension, etc), to enable them to pay their way, the balance on their account will on average over a few months or a year remain at $1k. That is the balance will tend to rise above $1k on receipt of their wage, and then fall below $1k over the next 30 days assuming wages are paid monthly.

But where’s the long term debt? There isn't any!

There are of course a series of SHORT TERM debts: i.e. if someone spends $X they’re temporarily in debt to the tune of $X. But assuming that  citizens of this country are just after money or LIQUIDITY, i.e. enough money to day to day transactions, the latter individual’s bank balance will be $X ABOVE $1k as often as it is BELOW $1k.

Charges made by banks.

In the above scenario, banks would clearly have to charge for ADMINISTRATION costs, e.g. the cost of checking up on the value of collateral. Indeed in the real world, there is often a “set up fee” or something of that description charged by banks when arranging a mortgage. As to INTEREST, there’s not much point in banks charging interest because banks would owe each customer money as often as customers owe banks money. Of course banks COULD CHARGE interest to those whose bank balances fell below $X, but then people would by the same token be justified in demanding interest from banks when the balance on their accounts was ABOVE $X.
Certainly if banks WERE TO charge interest, the NET AMOUNT of interest over the year charged by banks would be zero. (Incidentally, I’m assuming there that any interest charges are what might be called “genuine interest”, that is a charge for money owed, as distinct from administration costs)

Long term debts.

In contrast to the above SHORT TERM debts, there are LONG TERM debts, like mortgages which very definitely DO INVOLVE interest. And it’s that sort of debt that people have in mind when they claim that “without debt there’d be no money”. But as I’ve just hopefully demonstrated, those sort of long term debts are not needed in order for commercial banks to create money. And as to any interest that is charged on short term debts, that doesn’t make much sense. So the payment of interest is not needed either,  for commercial banks to issue a form of money.

Moreover, long term loans tend to be matched by long term deposits, i.e. so called “term accounts” (maturity transformation apart). And so called “money” in term accounts is often not counted as money (depending on the exact length of the term). Thus even the claim that long term loans create money is questionable.

Thursday, 26 February 2015

Lawrence Summers’s “secular stagnation” is complete nonsense.

Summary.    Secular stagnation is the idea that even at zero interest rates, it’s possible an economy does not achieve full employment. Ergo negative interest rates are needed, but implementing the latter is difficult. Ergo it’s conceivable there is no escape from excess unemployment.

The truth is that as Keynes pointed out and as MMTers keep repeating, it doesn’t matter how reluctant businesses are to invest or how reluctant households are to spend, if the state simply increases and carries on increasing the amount of money spent and fed into household pockets, the point must eventually come where households react by  spending enough to bring full employment. And until household spending rises far enough, there is no theoretical limit to the latter public spending.

As leading MMTer Warren Mosler put it in his “Mosler’s law” which appears at the top of his blog: “There is no financial crisis so deep that a sufficiently large tax cut or increase in public spending cannot deal with it.”


Summers first proposed his secular stagnation idea in a speech at an IMF conference in 2013. Mostly it’s incoherent nonsense far as I can see, but if Summers is saying anything at all, I go along with the summary of his speech set out by Gavyn Davies in the Financial Times. As Davies puts it in his 2nd and 3rd paragraphs, the theory is that demand can decline to such an extent that even a zero interest rate won’t solve the problem, thus a NEGATIVE rate is needed, and allegedly because cutting interest rates “has been the only means available to boost demand”.

Now the first flaw there is that cutting interest rates is most certainly not the “only means available to boost demand”. That is, if a zero rate doesn’t bring full employment, the state can simply print money and spend it, and/or cut taxes. The effect of that is to boost household cash balances, and (if the increased public spending option is taken) to increase employment in all the usual public sector areas: education, health, infrastructure repair, law and order, defence and so on.

And if the latter policy is implemented in robust enough form and for long enough, then household cash balances must at some point induce households to spend enough to bring full employment.

Indeed, the latter is exactly what we’ve done over the last three years or so. That is we’ve implemented fiscal stimulus (i.e. have government borrow and spend (and/or cut taxes)), then we’ve had central banks print money and buy government bonds: that’s called “Quantitative Easing”. And that comes to the same thing as having government and central bank, i.e. “the state”, print money and spend it and/or cut taxes.

Perhaps Summers hasn’t heard of QE. Or if he has, it seems he doesn’t understand the basic central bank book keeping entries involved when central banks do QE.

Two years later: 2015.

Having briefly sumarized Summers’s ideas as of 2013, we’re now in 2015 and he seems to have learned nothing in the meantime. In this speech given a few days and entitled “Reflections on Secular Stagnation” he says:

“Go back to basic Keynesian economics, and imagine that the point where the IS curve coincides with full employment involves a nominal interest rate that is lower than the attainable nominal interest rate. In that case, the creation, the printing of more money will be unavailing in generating economic growth.”

What on Earth is he talking about? Robert Mugabe didn’t find the “IS curve” any problem when he was printing and churning out ludicrously large amounts of money. It would be nice if Harvard economists had the same grasp of this subject as Robert Mugabe, wouldn’t it? (As I pointed out here some time ago).

And later in his speech of a few days ago he says:

“Secular stagnation is the phenomenon that the equilibrium level that savings are chronically in excess of investment, at reasonable interest rates.”

Well obviously it’s possible there is a decline in the amount that firms want to invest, and obviously its also possible there is a rise in the desire by households to save – in particular save MONEY rather than save in the sense of acquiring bigger houses, newer cars, etc. But the solution is easy: GIVE PEOPLE MORE MONEY!

Of course if the latter process goes too far, then excess inflation ensues. But until that point is reached or looks as though it’s about to be reached, there’s nothing wrong with simply printing money and expanding public spending and/or cutting taxes.

Tuesday, 24 February 2015

Alexander Apostolides’s amazingly clever article on banking.

This article by AA seems to have impressed sundry people in the Twittersphere, e.g. see here and here, but not me (e.g. see my critical comment after the article). Anyway, with a view to resolving this, I’ll run through the article in detail.

The article is 650 words in length, and the first 450 simply make the point (scarcely believable this) that the bubonic plague in Europe and the Turkish invasion of Cyprus in 1974 were traumatic events for Europe and Cyprus respectively, and that such events can be turning points for countries concerned.  Well I bet you didn’t know that…:-) I could add that the Norman invasion of Britain in 1066 was a similar turning point, and I could point to other turning points, but I don’t want to bore you to death.

Now in view of the above 650 / 450 numbers, astute readers will notice that that only leaves 200 words in which to say something about banking. Given that banking is a complicated subject, the chance of anything original being said in 200 words is slim. But let’s give AA the benefit of the doubt and examine the 200 words.

The paragraph after the above stuff on the bubonic plague says “The bail-in of 2013 is another such juncture. In March 2013, the unprecedented step of punishing depositors for the mistakes of bankers and their regulators will permanently alter the economic infrastructure of the island.”

Well OK. But deploring the bail in of ordinary depositors is easy. Wooley minded lefties will approve of that.  But unfortunately that leaves unanswered the question as to exactly WHO SHOULD be bailed in: i.e. who should pay for bank failures? AA doesn’t tell us.

You could argue that the latter sentence of his suggests that “bankers and their regulators” should foot the bill for bank failures. Unfortunately “bankers and regulators” just don’t have access to the ENORMOUS SUMS needed to bail out large banks. So AA’s weeping and wailing on behalf of depositors isn't much use.

Moreover (and I very much doubt AA knows this) one proposed solution to the question as to how to deal with our obviously dysfunctional banking system ACTUALLY INVOLVES bailing in a particular type of depositor. That proposal is part and parcel of full reserve banking. But that’s far too complex a point to deal with here.

Vested interests.

Anyway, then comes the final section of AA’s article which is entitled “Vested resistance to change” and consists of 140 words. AA basically makes the point that vested interests stand in the way of bank reform. Well I never! Is there anyone who hasn’t worked that out?

And AA’s final paragraph reads “Like the peasants in the day of the Black Death, society at large should not tolerate efforts of interest groups to stop the root-and-branch reform of the institutions that led Cyprus to this crisis.” Well everyone will drink to that: just another statement of the obvious.

And the real irony there is that several people, who claim to be left of centre and “radical” (to use the fashionable word) favor patching up the existing banking system rather than implementing root and branch reforms. But as Bill Mitchell has pointed out ad nausiam, the political left worldwide is incapable to doing anything much more than aping the economic illiteracy of the political right. I.e. lefties are far from innocent when it comes to backing vested interests.

But as regards banking, the CRUCIAL question, the $64k question is: exactly what should “reforms” consist of? Dodd-Frank & Co in the US have got bogged down in horrendous complexity in trying to answer that question.  AA doesn’t tell us or even make any suggestions (apart from his dislike of depositors being bailed in).


Alexander Apostolides’s article doesn’t amount to much.

Monetary offset is a joke.

One of the central ideas, if not THE CENTRAL idea of Market Monetarism is so called “monetary offset”. Scott Sumner is one of the World’s leading proponents of monetary offset, if not THE leading proponent. He explains the idea in an article entitled “Why the Fiscal Multiplier is Roughly Zero”.

Monetary offset according to Sumner is the idea that fiscal stimulus is very ineffective (as the title of his article implies) and THE REASON apparently is that if the fiscal authorities implement too much stimulus, the monetary authorities (i.e. the central bank) will “adopt a more contractionary monetary policy in order to prevent inflation from exceeding their 2 percent target.”

Now anyone with a grasp of economics ought to be able to spot the flaw in that idea. Incidentally I’ve put the relevant passage from Sumner’s article below under the heading “Sumner’s own words” and in italics. And of course readers wanting an even more detailed look at his ideas are free to read his whole article.

Anyway, for the benefit of readers who haven’t spotted the flaw, I’ll spell it out, and in fact the flaw can be illustrated very nicely by reference to a car, as follows.

Suppose one person has control of the accelerator (fiscal policy), and someone else controls the brakes (monetary policy), obviously one of the things the “brake controller” will do is to apply the brakes if the “accelerator controller” has stepped on the gas too much and the car is exceeding the speed limit.

Sumner’s conclusion from the latter is that the accelerator (fiscal policy) is near useless, because if too much of it is applied, the brake controller will slow down the car. Well hopefully most readers will by now have seen the flaw in the argument.

The flaw of course is that an accelerators is a good way of controlling a car’s speed. There’s nothing inherently wrong with accelerators. And the fact that drivers sometimes to too fast and need to apply the brakes is not an argument against accelerators.

Moreover, the idea that if inflation looks like getting excessive, that the central bank will apply the brakes is not exactly an original idea. Everyone including the average taxi driver knows central banks do that. I.e. there is no need whatever or a gradiouse new theory called “monetary offset”.

Monetary offset is nothing more than a verbal sleight of hand. It’s for people who don’t like fiscal policy, but can’t find any serious flaws in fiscal policy.

Sumner’s own words.

“Why has the effect of fiscal stimulus been so meager in recent years? After all, interest rates in the United States have been close to zero since the end of 2008. The most likely explanation is monetary offset, a concept built into modern central bank policy but poorly understood. We can visualize monetary offset with the Keynesian aggregate supply and demand diagram used in introductory economics textbooks. If fiscal stimulus works, it’s by shifting the aggregate demand (AD) curve to the right. This tends to raise both prices and output as the economy moves from point A to point B, although in the very long run, only prices are affected. Now let’s assume that the central bank is targeting inflation at 2 percent. If fiscal stimulus shifts the AD curve to the right, then prices will tend to rise. The central bank then must adopt a more contractionary monetary policy in order to prevent inflation from exceeding their 2 percent target. The contractionary monetary policy shifts AD back to the left, offsetting the effect of the fiscal stimulus. This is called monetary offset.”