Monday, 16 January 2017
The Pigou effect is the fact that in a perfectly functioning free market, and given some sort of shock which causes a recession, wages and prices will fall, which increases the REAL VALUE of money, base money in particular. That increases the value of private sector liquid assets, will induce the private sector to spend more, which cures the recession.
Incidentally, not only does the real value of the stock of base money rise: so too does the real value of government debt. But as Warren Mosler (founder of Modern Monetary Theory) pointed out, government debt can be seen simply as a term account at a bank called “government”. That is, government debt is almost indistinguishable from base money (a point also made by Martin Wolf). Base money and government debt are both assets as viewed by the private sector.
The reason the Pigou effect does not work very well in the real world is Keynes’s famous “sticky downwards” point: that is, given deficient demand for labour, the price of labour DOES NOT FALL very much and for the simple reason that if it does you tend to get strikes, riots and so on. The year long coal miners’ strike in the UK in 1926 nicely illustrated that.
The Pigou effect might seem arcane, give that it does not work too well in the real world, but it’s actually quite important. Reason is thus. It is generally accepted in economics that free markets product an optimum outcome, or tend to maximise GDP, unless market failure can be demonstrated. E.g. it is normally accepted that governments should not interfere with the market in apples unless for example it can be shown that apple growers have set up a cartel and artificially raised the price of apples, in which case government intervention is justified. That is, government should punish the cartel ring-leaders and restore something like a genuine free market in apples.
Something similar applies to the Pigou effect: that is, since the Pigou effect works in a hypothetical and ideal free market, it is a guide to what sort of policies will maximise GDP in the real world, and more on that below.
Wren-Lewis takes issue with the Pigou effect in an article entitled “Why the Pigou Effect does not get you out of a liquidity trap”. His first salvo against the Pigou effect is thus.
“The Pigou effect is when the authorities keep the current stock of money constant, and falling prices mean that its real value increases. The idea is that at some point people feel sufficiently wealthier that they spend more, which adds to demand. For this to work, we have to assume that the nominal stock of money will remain unchanged, unaffected by falling prices. Now you might say fine, let’s assume that. But if you do, you might also agree that the fall in prices is temporary. Simple neutrality implies that if you hold the money stock constant, falling prices today will mean higher prices tomorrow.”
As you’ll see, there is not much difference between my definition of the Pigou effect and Wren-Lewis’s. The only slight difference is that he says (first half of the above quote) that the nominal stock of money has to stay CONSTANT. Actually the Pigou effect would still work (or not) given a small annual increase or contraction of the nominal stock of money.
Indeed, the latter point is more than just a theoretical point: in an economy on the gold standard, a fall in prices would equal an increase in the real value of gold, which would induce gold miners to dig up more gold. So in that scenario, the Pigou effect would increase BOTH the nominal stock of money and real value of each unit of that money.
But to repeat, the latter point is a minor one, so I won’t dwell on it any further.
Wren-Lewis then says (second half of the above quote):
“Now you might say fine, let’s assume that. But if you do, you might also agree that the fall in prices is temporary. Simple neutrality implies that if you hold the money stock constant, falling prices today will mean higher prices tomorrow.”
Eh? Why “might” I agree that the fall in prices is “temporary”? I’m baffled.
In common with others who accept the Pigou effect would work in a perfectly flexible free market (I assume), it strikes me the Pigou effect works as follows.
1. Assume demand is deficient. 2. Prices fall and the real value of the stock of base money rises. 3. Given a larger stock of money in real terms, people tend to spend more (as the empirical evidence confirms). 4. The most reasonable and simple assumption is that the real value of the stock of money continues to increase until the additional demand brings the fall in wages and prices to a halt, and that point equals an equilibrium which is maintained until some sort of new shock knocks the economy off equilibrium again.
So where does Wren-Lewis get his “higher prices tomorrow” from? Following straight on from the above quote, he continues:
“But we have already established that in that case you do not need a Pigou effect, because higher inflation tomorrow at the ZLB will mean lower real interest rates, and you get the demand stimulus the good old real interest rate route. Furthermore, if people understand that prices will rise, they are not really wealthier in an intertemporal sense, because their extra real money balances will be inflated away. If you like, they save their extra real money balances today to pay for future inflation taxes.”
Well the fact that one does not “need” a particular solution to a problem does not prove that solution doesn’t work. Taking your foot off the accelerator in a car will slow the car down because it requires energy to make the engine revolve at a speed faster than ticking over speed, and that energy can only come from taking kinetic energy from the car as a whole: i.e. slowing it down. However, the fact that one does not “need” that method of slowing the car down because one can always use the brakes does not prove that taking you foot off the accelerator won’t slow the car down, (my dear Watson).
Then in the second half of the latter quote, Wren-Lewis invokes Ricardianism: that’s (roughly speaking) the idea that peoples’ income rises, they do not spend their increased income because their income is determined just by what they perceive their life-time earings to be. Put another way, Ricardianism claims that households ignore what are possibly temporary increases or falls in income and instead go in for a large amount of “lifetime income smoothing”.
Now the only people who seriously believe that are people with PhDs in economics. I.e. anyone with a grain of common sense knows that when people come by windfall increases in income (e.g. when they win a lottery) they spend a significant amount of that windfall. Indeed the empirical evidence supports that.
Or as the Nobel laureate economist Joseph Stiglitz put it, “Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense”. Or as the Cambridge economist Ha Joon Chang put it “Unfortunately a lot of my academic colleagues not only do not work on the real world, but are not even interested in the real world.”
Towards the end of his article, Wren-Lewis says, “We can sum this up rather neatly, as Willem Buiter did with the aid of lots of maths, by saying that what matters is the terminal stock of money, not its current value. The government can only make people feel wealthier by printing money if people believe that the increase in its real value is permanent.”
Well the first flaw there is that Buiter (like Wren-Lewis) assumes the validity of Ricardian equivalence, which everyone (apart from economics PhDs) knows is largely nonsense.
Next, Wren-Lewis says (to repeat), “The government can only make people feel wealthier by printing money if people believe that the increase in its real value is permanent.”
Well sure! And in the simple Pigou effect scenario set out above where a shock requires an increase in the real value of the stock of money, that increase IS PERMANENT – unless and until some new shock comes along.
Buiter and Wren-Lewis do not succeed in denting the Pigou effect, far as I can see. And there is another very simple point that supports the Pigou effect, as follows.
The purpose of economic activity is to produce what people want. So if there is insufficient economic activity, i.e. not enough of “what people want” is being produced, then the solution would seem to be to give people more of what they need to purchase what they want, i.e. MONEY!!!! That is, a good solution to a recession is tax cuts and increases in social security payments.
And given that when it comes to what people want, they normally express a desire for having about a third of their income come to them in the form of public spending, any cure for a recession should include some of the new money being used to increase in public spending.
Sunday, 15 January 2017
Krugman recently wrote a short article making the entirely reasonable point that large deficits are OK in a recession, but that come the recovery, one needs to be more careful with deficits.
That produced a storm of protest from people, who can loosely be called “progressive”, e.g. here, here, here, and here.
One of the objections to Krugman’s article was that in saying a large deficit would crowd out private investment, Krugman invoked the loanable funds idea.
Well, not so fast. The fact of saying that an excessively large deficit will crowd out private investment does not prove one is invoking the loanable funds idea. One could equally well be invoking Scott Sumner’s “monetary offset” idea: the idea that when a central bank spots what it thinks is an excessively large deficit, it will raise interest rates so as to counter that excess. And that rise in interest rates will of course crowd out some private investment.
Incidentally, Sumner is far from the first person to tumble to the point that an independent central bank on spotting what it thinks is an excessive deficit will raise interest rates to compensate. But Sumner is a keen advocate of the idea, so I thought I’d give him a mention.
So my conclusion, at least as regards the charge that Krugman invoked the loanable funds idea is: case not proven.
Thursday, 12 January 2017
Godfrey Bloom, former UK Independence Party Member of the European Parliament, exhorts us to read his allegedly insightful book on banking in the tweet below.
See my aide memoire on the Magic of Banking https://t.co/Xy8hZcQabE everyone & await my new book on money— Godfrey Bloom (@goddersbloom) October 30, 2016
40 years in the city, I'm the man https://t.co/AwZ1qg4BWe
Godfrey Bloom also has a habit of assuring us that he is “always right” or words to that effect. So clearly we all have much to learn from him (ho ho). E.g.:
This is my whole point— Godfrey Bloom (@goddersbloom) January 11, 2017
Oxford academics are consistently wrong.
The BBC must start using people who are consistently right.
People like me. https://t.co/JRfCBXgzz1
Anyway, I thought I’d have a look at his book which is entitled “The Magic of Banking”.
I do like Bloom’s politically incorrect views and tweets. His political nous is way superior to that of self-styled “political commentators” who write for broadsheet newspapers. However, his ideas on banks are not well thought out.
First, he is obsessed by inflation. For example on p.2 there is a chart (see below) showing a one year period during the worst of the German inflation in the early 1920s. (Actually p.2 is part of the foreword and is written by someone else, but that chart couldn’t possibly have been inserted without Bloom’s approval).
Now that’s a bit like having a picture of the Titanic sinking at the start of a book on ships designed to persuade readers that ships are not safe. I shouldn’t need to point this out, but shipbuilders, ship owners, etc are well aware of the dangers of crashing ships into rocks, icebergs and so on. That’s why they spend large amounts on navigation aids, and on training ship captains, navigators etc. It is also why rocks are marked by buoys and so on (gasps of amazement).
Likewise in the case in banks and economics generally, we’re all aware of the dangers of excessive inflation. That’s why most governments have an inflation target of around 2% (more gasps of amazement).
Bloom also seems to have a problem with basic maths. That is, on p.14 there is another chart showing the exponential increase in the money supply between 1960 and 2010 with the heading “How can this continue?” Well the answer is that given ANY level of continuous year after year inflation (2% or whatever) there will be an exponential increase in the money supply and an exponential fall in the value of money.
As to how that can continue, the answer is “very easily”. As Bloom rightly points out, dollars are now worth a less than tenth of what they were worth before WWI. But what of it? We just have very roughly ten times more dollars, and dollars continue to perform the function they have always performed, namely obviating the inefficiency of barter.
A hundred years from now, dollars will be worth a tenth or less of what they are worth now, but what of it? The problem eludes me.
Certainly money is no use as a form of LONG TERM saving. But that’s not its main function. Its main function is to avoid the inefficiencies of barter, which it does very well.
Apart from the above flawed points on inflation, Bloom’s work is not too bad up to p.17, but then serious mistakes appear on that page. He claims that bank bailouts at the height of the recent crisis cost taxpayers “trillions”. As he puts it:
“Trillions of dollars, pounds and Euro’s just put on account for future generations to somehow pay off. Such is the enormity of the debts and the cost of servicing them that it is inconceivable they can be repaid.”
Well first, the “trillions” figure is a mile out. EXACT figures for the bailout are hard to come by, and presumably because the revolving door brigade wants to obfuscate and muddy the whole question as to exactly what the bail out cost. However, far as I can see, the maximum amount the Fed loaned out at any one time was around one trillion dollars, while the AVERAGE amount loaned out over the 18 months of the worst of the crisis was around $600bn. That’s according to the chart in an article by Mick West entitled “Debunked: The Fed “gave away” $16 trillion…”
Moreover, all of that one trillion was paid back, so in that sense there was no cost for the taxpayer. However, there WAS a cost for the country as a whole in that there was a gross mis-allocation of resources. That is, instead of lending money to private banks at Walter Bagehot’s famous “penalty rate”, the actual rate was near zero. I.e. the loans were sweetheart loans.
The normal rule in free markets is that resources go to whoever bids the most for them. And a bunch of corporations who bid nothing for loads of lovely money are pretty obviously not the most commercially viable corporations or borrowers in the country. I.e Main Street would have paid good money for some of that freshly printed central bank money.
That horrendous national debt.
Also on p.17, Bloom falls for the popular myth that the national debt is out of control, and we’re on the verge of bankruptcy. Bloom is clearly unaware that the debt in the UK as a proportion of GDP is nowhere near where it was just after WWII or in the middle of the 1800s.
Think I’ve had enough of this nonsense. I can’t be bothered reading any further.
Wednesday, 11 January 2017
Republicans spent the last eight years or so crying wolf about the deficit (pretty obviously so as to knobble Obama). Then, before the new Republican president, Trump, is even sworn in, Republicans (Trump in particular) say the deficit for some strange reason no longer matters.
Put another way, Republicans are more than happy to shaft the unemployed if that helps them in turn to shaft Democrats. And this is nowhere near the first time this blatant dishonesty in relation to the deficit has happened: regular as clockwork over the last fifty years, when Republicans come to power, the deficit (which they claim to disapprove of) goes thru the roof.
This all supports the idea put by Positive Money, the New Economics Foundation and Richard Werner that decisions on the SIZE OF the deficit should not be in the hands of politicians. I.e. decisions on the size of a stimulus package should not be in the hands of politicians.
In contrast, it’s fair enough for obviously political decisions, like what % of GDP is allocated to public spending to remain with politicians.
Sunday, 8 January 2017
It’s normal practice for the brainless lefties who write for the Guardian to accuse those who want less immigration of hating foreigners (xenophobia). Indeed, that accusation has appeared in The Guardian (and indeed other supposedly “intelligent” broadsheet newspapers) about a thousand times, without so much as the beginnings of an attempt to substantiate the accusation.
In fact the accusation is VERY DIFFICULT to prove since it has hard to prove MOTIVE, though the latter point will be way beyond the comprehension of the aforesaid brainless lefties. How do you prove someone wants less immigration because (1) they hate or fear foreigners rather than (2) because they want to preserve their country’s traditions, way of life, identity, etc? It’s near impossible!
Moreover, the idea that for example members of the UKIP hate foreigners is a bit hard to square with the fact that UKIP members go abroad for their holidays like every one else, and mix with those ghastly foreigners.
And what’s that Nigel Farage doing making friends with Donald Trump? Doesn’t Nigel Farage realize Trump is a foreigner…:-) The Guardian really needs to fill us in on that one.
And one more nail in the “nasty leftie” claim that opponents of immigration hate foreigners is that when Tibetans say they want to preserve their country’s culture, identity and so on, lefties go all dewy eyed. But that’s just the millionth example of lefties having one set of rules for people with white skin and a different set for those with brown skin. And unless you’re as dim as a Guardian journalist, you’ll have noticed that that preferential treatment for brown skinned people is a form of racism.
Anyway…academics. I’ve just discovered that a group of academic economists were into this dimwit “hate foreigners” nonsense in the run up to the Brexit vote. That’s in an article entitled “Immigration brings both benefits and costs…” published by “Critical Macro Finance”. The article starts:
“If UK voters decide to leave the European Union, it will be for one reason above all. From the outset, nationalism bordering on xenophobia…”.
Of course to be strictly accurate, the authors don’t actually accuse anyone of xenophobia: they accuse them of “nationalism bordering on xenophobia”. But that’s just weasel words, far as I’m concerned. Moreover, the authors accuse Brexiteers of being motivated PRIMARILY by “nationalism bordering on xenophobia”. Thus the authors are clearly pulling out every stop to give the impression that Brexiteers hate or fear foreigners without actually saying so.
Don’t think I’ll bother to acquaint myself with any more of the amazing insights published by “Critical Macro Finance”
Thursday, 5 January 2017
I last commented on this idea around two months ago here.
But just recently another article has appeared on this subject, entitled “Steve Keen: rebel economist with a cause” published by ‘Financial Review’.
This latest article contains a LITTLE extra information on the all important DETAILS on how this jubilee will work. The information is not nearly enough, but I’ll comment on it anyway.
To recap, Keen’s basic idea is that government prints loads of money and gives it to debtors on condition they use it to pay down their debts. But Keen recognises that that involves a big windfall for debtors and nothing for creditors. So he proposes putting that right by printing even more money and giving that to creditors.
There is of course a glaring flaw in all this, namely that (to put it figuratively) simply printing tons of $100 bills and giving them to everyone is inflationary (assuming the economy is already at capacity). I’ll come back to that point later.
But as already intimated, the Financial Review article does at least contain a few more details on how this debt jubilee might work. To quote:
“Keen believes there needs to be a reset of private debt levels via a "people's quantitative easing" – effectively, a government bailout of households – to something more in the order of 50-100 per cent of GDP, from around 120 per cent now.”
So now it seems that Keen is contemplating a more modest jubilee. For example, on the basis of the latter percentages, debt as a percentage of GDP might decline from an existing 120% to 100%. That’s far more modest than wiping out all mortgages, as originally proposed. However, that doesn’t actually stop the whole idea being nonsense, and for the following reasons.
Suppose half the country are debtors (mortgagors) and half are creditors. Also assume the aim is to cut the debt of the average debtor by $X. Also assume the economy is already at capacity.
So….government prints $X per debtor and dishes $X out to each debtor, who in turn passes the money on to a creditor. Plus government prints yet more money and gives $X to each creditor.
The end result is that both debtors’ and creditors’s net assets rise by $X, so they’ll go on a spending spree! Enter hyperinflation, stage left. What to do?
Well government can of course nullify the latter “inflationary effect stemming from increased household net assets” by increasing taxes on every household to the tune of $X.
But wait a moment…..that puts us back where we started! The whole exercise is a farce!
Better bank regulation.
In the Financial Review article, Keen also advocates tighter bank regulation, e.g. in the form of limiting loans to some multiple of the rental value of a property. That would be an ALTERNATIVE to a jubilee, presumably.
Well my first problem with that is that bank lending in Keen’s native Australia (the country he is primarily concerned with) is already fairly tightly regulated compared to elsewhere (though admittedly I’m not the world’s expert on that).
Second, there is a much simpler solution, which is to abolish fractional reserve banking and replace it with full reserve. Under the latter, anyone making a silly loan bears the full cost of any disaster that ensues, rather than taxpayers bearing the cost. I.e. under full reserve, there is no need to regulate lenders at all (which regulation is arguably pretty ineffective anyway). That is, lenders can do what they want, just like people can by whichever shares they want on the stock market. If those shares turn out to be worthless, there is no taxpayer funded rescue, and quite right. Same should apply to people who make silly loans.
The latter is a very simplified descripton of how full reserve would work. But I’ve set out more detailed descriptions elsewhere.
Of course that still leaves a problem to which Keen rightly alludes, namely that given a collapse in house prices and lending, there is a big deflationary effect. But the latter problem is easily dealt with via standard stimulatory measures (e.g. interest rate cuts, government budget deficits, etc).
Tuesday, 3 January 2017
Having spent about ten years, a lot of time and money pushing the case for full reserve, I’m pleased to see the above book, which was the Financial Times economics book of the year in 2013, also supports the idea.
However, arguing the case for full reserve is not the central objective of the book: as the title implies, the book is a history of money, and it goes right back to the beginning. I.e. it covers ancient Mesopotomia, ancient China, Greece, Rome, etc. It then moves on to Europe in the Middle Ages and on up to the present day.
It’s only near the end that the author, having considered the numerous problems associated with money, concludes that the best system is full reserve – quoting in particular (far as I remember) Milton Friedman, Irving Fisher and Lawrence Kotlikoff.
The book is brilliant: it combines readability with scholarship. For example there are about 200 items in the bibliography / references section. The book (at about 120,000 words) is also (at a guess) a bit longer than the average book.
Ancient Rome’s credit crunch.
If you want a taste of the author’s style before buying, here is a short passage describing Rome’s credit crunch.
“In such an extensively monetised economy, it is hardly surprising that the Romans were also well acquainted with another familiar feature of modern finance: the credit crisis. Occasionally, the simi¬larities with the modern age are nothing short of eerie. In AD 33, the Emperor Tiberius' financial officials were persuaded that the recent boom in private lending had become excessive. It was decided that regulation must be tightened in order to extinguish this irrational exuberance. After a brief review of the statutes, it was dis· covered that none other than the father of the dynasty, Julius Caesar, had in his wisdom instituted a law many decades before specifying strict limits on how much of their patrimony wealthy aristocrats could farm out in loans. He had, in other words, introduced a rigorous capital adequacy requirement for lenders. The law was clear enough: but not for the first time in history, industrious lenders had proved remarkably skilled at circumventing it. Their ingenious evasions, the historian Tacitus reported, 'though continually put down by new regulations, still, through strange artifices, reappeared.
Now the emperor decreed the game was up: the letter of the old dictator's law would be enforced. The consequences were chaotic. As soon as the first ruling was made, it was realised with some embarrassment that most of the Senate was in breach of it. All the familiar features of a modern banking crisis followed. There was a mad scramble to call in loans in order to comply. Seeing the danger, the authorities attempted to soften the edict by relaxing its terms and announcing a generous transitional period. But the measure came too late. The property market collapsed as mortgaged land was fire-sold to fund repayments. Mass bankruptcy threatened to engulf the financial system. With Rome in the grip of a credit crunch, the emperor was forced to implement a massive bailout. The Imperial treasury refinanced the overextended lenders with a 100-million sesterces program of three-year, interest-free loans against security of deliberately overvalued real estate. To the Senate's relief, it all ended happily: credit was thus restored, and gradually private lending resumed."
Update: This article also appears on the Seeking Alpha site.