Ebenezer Scrooge economics.

I am tired of being told by the BBC and other news organisations that full shops at Xmas is “good thing”. It’s not: it means more consumption, more carbon dioxide emissions and so on.

Full shops are allegedly good because that implies more jobs, and with unemployment too high – well, more jobs must be good outcome surely.

There is actually a far better outcome, as follows. Unemployment is defined as wanting a job and not being able to find one. The better outcome and better way of reducing unemployment would be people choosing to work fewer hours and accepting a lower standard of living.

How often do you see statistics on the latter variable on the news?

And now I’m off to indulge in some unnecessary consumption.

Mish criticises Kucinich’s bill.

Mish’s criticisms of Congressman Dennis Kucinich’s “abolish the Fed” bill are a bit harsh in places.

This bill abolishes the Fed and gives Congress the right to create new money. The bill outlaws fractional reserve banking, an aspect of the bill that Mish agrees with. So do I.

Mish says:

“Neither sound money nor the free market comes from printing money into existence. Arguably the only thing worse than the Fed printing money out of thin air is Congress printing money out of thing for the purpose of full employment and/or any other absurd ideas Congress has.

The last thing we need, the very last thing we need is Congress lending money into existence to pay the bills or to do anything it wants for any reason. Those looking for hyperinflation can find the roots of it in that bill.”

Now what does “sound money” actually mean? Like most ultra reasonable sounding phrases, it is near meaningless.

If by “sound money” one means keeping the money supply growth at a level that aims to maximise employment without causing excess inflation, then there is nothing wrong with “printing money into existence”. In fact “printing money into existence” has been going on ever since the Greenback first appeared.

Also, this bill does not give Congress the right to create money to fund any old form of spending proposed by any old politician. It proposes setting up a “Monetary Authority” to control money creation. Now isn’t that the fundamental flaw in the bill? That is, it just replaces the Fed with a “Monetary Authority”.

Mish’s final paragraph reads:

“All things considered, and in spite of horrendous flaws, it may be a plus that someone has actually submitted a bill in Congress to end Fractional Reserve Lending. Now all we to do is throw away the entire rest of the bill and let Ron Paul draft a proper bill ending FRL as the central idea.”

Agreed.

Monetary union requires political union?

I’m tired of that cliché. Hong Kong and various mid American countries use the US dollar or have their currencies pegged to the dollar. Same went for Argentina between 1991 and 2002. To call these countries a political union is obvious nonsense.

As this article in the Financial Times suggests, giving peripheral European countries an easier escape from the Euro might be a better option than forcing them to stay in and endure years of austerity.

Are Canadians are suckers for moral hazard?

As Walter Bagehot pointed out in “Lombard Street” (published in 1873), booms and recessions are a regular cycle. That is, irrational exuberance goes too far, which leads to a crash, followed by a slow recovery. Memories are short, so after a few years of recovery, no one thinks the inevitable new bout of exuberance can possibly be irrational, so the cycle starts again.

To say that memories are short in Canada looks like being an understatement: they haven’t learned the lessons of the recession WE ARE STILL IN! The Bank of Canada seems to be buying junk mortgages like there’s no tomorrow. See Mish.

Is the natural rate of interest really zero?

There is a widely accepted phrase amongst advocates of Monetary Theory (MMT) that the “natural rate of interest is zero”, e.g. see Mitchell here and here. Or for a more concise exposition of the zero interest rate idea, see Mosler. I support MMT, but I’m not enthusiastic about this natural rate idea.

By the way, the word “government” will be used below to refer to “government and central bank combined”.

One possible sense of the phrase “natural rate of interest” is something like “the free market rate” or “the rate that would prevail assuming no attempt by government to influence the rate”. In other words this is the rate that arises just from the relationship between those who want to be net borrowers and those who want to save up, and be net lenders.

The phrase “natural rate” is used differently in MMT: the phrase is used to help explain what happens when government creates and spends money (i.e. does not borrow or tax to fund the spending). The effect is a drop in interest rates. And the rate can, according to MMTers drop to zero. In the words of Mosler (p. 539), “Our main point is, in nations that include the USA, Japan, and others where interest is not paid on central bank reserves, the “penalty” for deficit spending and not issuing securities is not (apart from various self-imposed constraints) “bounced” government checks but a zero percent interbank rate, as in Japan today.”

I beg to differ: it could be that full employment in some countries is attained (because of the additional spending) BEFORE interest rates reach zero! Of course the above zero interest point may well be valid in Japan. But the Japanese are ultra enthusiastic savers: they are willing to lend their government very large sums at zero or near zero rates of interest. Spendthrift Anglo-Saxons and PIG countries are different.

Now that all might seem to be contradicted by events since the recent credit crunch. That is, interest rates have dropped to near zero even in Anglo-Saxon and some other countries, yet those countries certainly do not have full employment: put another way, in these countries, a zero or near zero rate of interest coexists with a feeble rate of exit from the recession.

The answer to this contradiction is that governments have not JUST being net spending: they have engaged in quantitative easing (QE). And QE is a policy which aims specifically at reducing interest rates, with additional consumer spending being very much of a side show. Another aim of QE is to boost asset prices: nice for the rich and asset owners generally, but this again is not the same as directly putting purchasing power into the hands of the average consumer / citizen.

So which is the better policy: QE or extra net spending? Well the basic purpose of the economy is to produce what consumer / citizens want. Thus the better policy is net spending because this puts more purchasing power into consumer / citizens’ pockets.

Of course additional net spending can mean extra government spending AND/OR reduced taxation. And it is arguable that extra government spending does not equal putting additional purchasing power into consumer / citizens’ pockets. On the other hand, additional purchasing power IS put in their pockets in the sense that citizens vote at election time for government to act as citizens’ agent and do some spending on behalf of citizens: e.g. spend money on schools, the police and so on. So let’s just say the phrase “put purchasing power into consumer / citizens’ pockets” is being used in a broad or “dual” sense here.

To put the latter point another way, and summarise, the distinction being made here is between two policies. The first is to increase both traditional consumer spending (e.g. on cars, houses, etc) plus traditional government spending (e.g. schools, the police, etc). The second policy, that is QE, is to drop interest rates and boost asset prices.
At the time of writing, the weaknesses of putting much of the emphasis on QE have been layed bare: we have (at least in the U.S.) record low interest rates and a feeble recovery from the recession.

So my favoured policy in a recession is to have government do more net spending, and let the market determine the interest rate – or at least have “net spend” as the main anti recessionary tool, with interest rate adjustments being a minor and supplementary tool. That was more or less what Abba Lerner advocated, except that he though bureaucrates and politicians were someow good judges of the optimum the interest rate for the purposes of optimising the total amount of investment.

Keynes also advocated the above “extra net government spending” idea, but not in such a blatant or bold manner as Lerner.

Afterthought (18th Dec). To summarise, “the natural rate of interest is zero” is a bit of a non statement, for the following reasons. Given falling unemployment and no deliberate attempt by government to influence interest rates, full employment may be attained at least in some countries before interest rates reach zero. And if demand is then raised still further, inflation ensues. In this scenario the “zero interest rate” scenario is an irrelevance: it should be avoided.

So perhaps the above quote from Warren Mosler should be rephrased and toned down, and the phrases “natural rate” and “zero” should be avoided. The above quote reads “the “penalty” for deficit spending and not issuing securities is not . . . bounced government checks but a zero percent interbank rate…” . Instead, it should simply read, “the penalty of deficit spending and not issuing securities is not bounced government checks but a reduced interest rate”.

What did the Fed do with $9 trillion?

Fed Inspector General can’t explain what happened to $9 trillion. The first two thirds or so of this clip deals with a ONE trillion sum. Then they move on to the nine trillion.

(I got this from Brenda Rosser in the comments section here: http://economistsview.typepad.com/economistsview/2010/12/roubini-fiscal-follies.html#comments)

QE does not equal printing money.

QE is often equated with printing money. This is nonsense.

Let’s start with the QEing of government bonds near maturity. These bonds are widely regarded as, and accepted as a very near equivalent of cash in the world’s financial centres. Thus QEing these bonds is about as earth shatteringly irrelevant as swapping $10 bills for $20 bills. Giving someone two $10 bills in exchange for a $20 bill does not constitute “printing money” and nor does QEing short term government bonds.

As to QEing longer term government bonds or private sector bonds, things are a little more complicated. Let’s start by defining the word money and the phrase “print money”.

There are numerous definitions of the word money, but one definition is “a very liquid asset”: that is, an asset which is readily accepted as a means to pay for less liquid assets like cars, houses, and so on.

As to the phrase “print money”, this is normally understood to mean the creation and distribution of MORE money with no corresponding reduction in the amount of assets which are “near money”. To illustrate (and to use the above example of QEing short term government bonds) creating $X out of thin air and using the $X to buy and tear up $X worth of short term government bonds certainly NOT the same as creating $X out of thin air and distributing the $X to the population (e.g. via a tax reducution or a helidrop).

In the latter case (e.g. a tax reduction), private sector assets RISE by $X. In contrast, in the former case (QEing) the value of private sector assets remain constant, or very nearly CONSTANT. That is a BIG DIFFERENCE! And since the “QE equals money printing” brigade cannot see the difference, the conclusion is that they can’t see an awful lot.


Printing versus printing and distributing.

I said above that money printing equals the creation AND distribution of more money. It could be argued that the distribution element is not a necessary part of the definition. For example, if I print a million tonnes of £20 notes and stash them down a disused coal mine and don’t tell anyone what I’ve done, that is still “money printing” isn’t it? Perhaps it is. But the above senseless “stashing” operation will have no effect whatever on demand, inflation or anything else (apart from temporarily increasing the demand for paper and ink).


QEing private sector bonds.

QEing private sector bonds and longer term government bonds is a little different from QEing short term government bonds, which as noted above is little different to swapping $20 bills for $10 bills.

Assuming a fair price is paid for “long term / private” bonds, then no money printing takes place in the sense that the value of private sector assets remains the same. On the other hand, the liquidity of a portion of those assets certainly IS improved: in the extreme case, hard to dispose of bonds are turned into cash, which is a very definite improvement in liquidity.

The EXTENT of money creation here is hard to estimate. It is certainly nonsense to claim that QEing $Y worth of these bonds equals the printing and distribution of $Y worth of new money. But SOME money HAS been created in that extra liquidity has been created. I’ll leave it to others to quantify this!

Martin Wolf is wrong to back low interest rates.

Martin Wolf in the Financial Times attacks the idea that low interest rates are unfair to older people (who tend to be lenders / savers). This article is not up to Wolf’s usual high standards.

His first argument is that older people have benefited from “huge capital gains in their houses”. Completely irrelevant! Not everyone owns a house: some rent. And second, the gain in value of one’s house is no benefit, unless one trades down to more humble accommodation. And third, some peoples’ houses are worth far more than others, plus some people have more than one house!

Martin Wolf’s argument above is a bit like arging that men should pay a higher rate of tax than women because men tend to earn more. The way to a more equitable distribution of post tax income is INCOME TAX. The sex of individual taxpayers is irrelevant.

If there is something wrong with large capital gains on large houses or second homes, then fine: introduce a tax on those gains. Though any such tax (and thus Wolf’s point about house price increases) is rendered somewhat irrelevant by the fact that at least in the U.K., capital gains tax is payable on second homes, plus the value of everyone’s main residence is included in estate valuations for inheritance tax purposes when they die.

Wolf then argues that given excess debt, excessive leverage and weak financial sectors, low interest rates will help profligate and irresponsible lenders and borrowers rectify their mistakes. Well it’s not the job of pensioners (or anyone else) to subsidise or come to the rescue of the irresponsible.

Walter Bagehot advocated, quite rightly, that where a bank is in trouble, the central bank should provide TEMPORARY assistance based on QUALITY collateral and at PUNATIVE rates of interest. If the bank cannot produce quality collateral or pay those punative rates, then it does not just have a temporary liquidity problem: it is bust. Bankrupt. It should be closed down.

Of course politicians HATE taking the latter bull by the horns. It means disruption, which might lose them votes (but benefit the country in the long term). “Kicking the can down the road” is so much more appealing for politicians. And there is another bonus, at least in the U.S.: the irresponsible lenders who are rescued with taxpayers’ money then continue contributing to said politicians’ campaign funds.

Subsidies for the irresponsible are themselves irresponsible.

Martin Wolf then claims that “with higher rates, house prices would fall further, unemployment would rise, more loans would default and banks would fall back into difficulties.”

The idea that higher rates of interest have to lead to higher unemployment is nonsense. Of course it is perfectly true that ALL OTHER THINGS BEING EQUAL higher rates MAY lead to higher unemployment: certainly adjusting interest rates is a popular way of supposedly regulating aggregate demand.

However there are plenty of authorities who have questioned the effects of interest rates on demand and hence on employment levels. For example, the Radcliffe Report in the U.K. in 1960 concluded that interest rates were a poor way of regulating demand.

And Scott Sumner, Prof of economics at Bentley University (U.S.A.) thinks likewise.

But more important than the questionable effects of interest rates in regulating demand is the above “other things being equal” point. The flaw in Martin Wolf’s argument here is as follows.

Suppose we were to adopt what might be called the above purist Walter Bagehot approach and keep interest rates relatively high. And let’s also assume that high interest rates DO curtail demand. The result – no question about it – would be raised unemployment.

However, interest rates are not the only factor determining employment levels! That is, there are well known ways of boosting demand (and employment) other than adjusting interest rates. E.g. an unfunded deficit with the additional or new money channelled into household pockets would raise demand: pretty much what Keynes advocated, as did Milton Friedman.

To summarise, we could perfectly well go for higher interest rates, and compensate for any demand reducing effects by boosting demand by other avenues.

Would a common fiscal policy solve Europe’s problems?

Note dated 14th Jan 2011. This post has been rather superseded by a post dated 14th Jan 2011.

The current conventional wisdom is that it would. I’m not convinced.

Suppose there had been some sort of centralised European fiscal authority between say 2000 and 20008. Would those running it have nipped PIG type problems in the bud? That is, would they have spotted that anything was wrong before the credit crunch arrived and it was blindingly obvious to everyone that something was wrong? Where ARE these geniuses with better forsight than everyone else?

And even if these geniuses exist, there is another and somewhat technical problem, as follows.

A major problem with common currency areas occurs, as is now widely appreciated, where the competitiveness of constituent countries diverge. Where such countries each have their own currency, those who have lost relative competitiveness can devalue. In a common currency area they allegedly cannot do this.

Well actually they could, though doing so is complicated and messy. The way to do it, assuming an X% devaluation is required, is to cut all wages in the country concerned by X%. As is the case where a country with its own currency does an X% devaluation, the X% wage cut does cut living standards, but not by anything near X%. This is because the wage of natives of the country concerned forms a significant part, and usually the vast bulk, of the cost of goods and services consumed in the country concerned.

Now presumably what is meant by “common fiscal policy” is something resembling what is currently taking place in Ireland, but in slow motion. In other words the minimum wage, social security benefits, and a few other items are cut, allegedly well before the problems we now see materialise.

But cutting those two items plus a few more, is nowhere near the same as cutting ALL wages. Presumably the idea is that cutting the above two items will eventually result in wages drifting downwards (at least relative to wages in more competitive countries). But the “drifting down” is bound to take several years. The relevant country will have to endure a long period of deflation and unnecessary unemployment in the meantime.

A better alternative would be to cut employers’ contribution to any payroll tax (National Insurance contribution in the U.K.). That would reduce the cost of employing people, which in turn would reduce the cost of the relevant country’s exports and possibly rectify the balance of payments position.

The political right is barking mad.

As Scott Sumner says, when inflation was 4.1% and unemployment below 5% in 2007 the political right favoured stimulus. Now that inflation is 1.2% and unemployment near 10%, they think stimulus will be inflationary.

They really are totally and completely barking mad.

The multiplier is totally irrelevant.

There are a thousand articles, chapters in books, papers, etc which discuss the relative merits of different forms of economic stimulus, with particular emphasis on the multiplier effects of each. For example there is the tax cut versus increased public spending debate. An recent article by Prof Michael J.Boskin is just one example.

But the multiplier or “bang per buck” argument is also dragged into other areas, for example the relative merits of different employment subsidies.

However the entire argument over mulitpliers is TOTALLY IRRELEVANT because given a relatively low multiplier, the additional dollars needed to create a given number of jobs is not a REAL cost. That is, producing the extra dollars ex nihilo required by a relatively low multiplier form of stimulus does not cost anything in REAL TERMS. All that is required is a book keeping entry.

For example, the multiplier in the case of tax cuts over the next year or two could be unimpressive because a significant proportion of households have had their fingers burned during the credit crunch. As a result they may NOT want to buy houses, or anything else, with BORROWED money. Instead, they may want to buy stuff with SAVED money.

But where does this additional stock of money come from? There is only one source: a government deficit. But that deficit, assuming it accumulates as extra monetary base rather than extra national debt, does not COST anything in real terms to produce. To put it bluntly, printing money does not cost anything.

This point is intuitively obvious to advocates of Modern Monetary Theory. I would be nice if professors of economics, like Boskin, were similarly clued up.