Krugman questions Modern Monetary Theory.

Krugman questions Modern Monetary Theory (MMT). But he does not really attack its FUNDAMENTALS. He simply attacks the claim put about by the more irresponsible MMT advocates, namely that “deficits are never a problem”, to quote Krugman.

For example, Bill Mitchell is one of the leading lights of MMT. He claims that deficits will be the NORM. But he does not say that a country should run a never ending deficit or that it doesn’t matter how big the deficit is.

And Abba Lerner, the founding father (if there is one) of MMT said (p. 39), “The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money……” Note the word “withdrawal”. I.e. is saying that sometimes a surplus rather than a deficit is in order. I.e. his is not is not saying governments should run a permanent deficit, or (put another way) that it should permanently “issue new money”.

And on p.40 he says “In applying this first law of Functional Finance (FF), the government may find itself collecting more in taxes than it is spending, or spending more than it collects in taxes.” In other words he is saying that under FF / MMT, government may run a deficit OR a surplus.

And here, Krugman asks what happens if we have a 6% deficit at full employment, and govt cannot counteract the inflationary consequences because it has lost access to the bond markets. There are several answers to this point.

First, it requires some irresponsible behaviour for a country to lose access to bond markets. Such a country is probably heading for disaster whether it adopts MMT or any other policy.

Second, if a government cannot withdraw money from an economy by voluntary means (i.e. the bond market) it can always resort to brute force: i.e. raise taxes!

Third, a situation where fiscal policy is having too large a stimulatory effect, which is counteracted by an entirely different policy (i.e. monetary policy) is daft, as I pointed out here, here, and here.

So Krugman is saying that given a situation which is daft in several respects, MMT might not work. Well, that’s true. But likewise, if a car driver tries to drive his car with ten times as much alcohol in his blood as is allowed by law, there is liable to be an accident. That does not prove that cars a bad idea.

Abba Lerner’s flawed ideas on interest rates.

Note: this post replaces a post entitled “Abba Lerner’s interest rate mistake” (15th Dec 2010) because I made a mistake in the latter post (details below). I’ll delete the latter post in due course.

_______________

The first two sentences of a paper by Stephanie Bell say “In 1943, Abba Lerner wrote an essay entitled Functional Finance and the Federal Debt. The essay elucidates, in just fourteen pages, the principles that Lerner believed should guide the government's budgetary policies.”

I basically agree with Lerner’s paper, but not with a point he makes about interest rates. By the way, while his essay consists of only fourteen pages, I’ll use the page numbers from the journal in which the essay appears (38 – 51). Also, I’ll use the word “government” in reference to “government and central bank combined”.

There is a paragraph at the bottom of Lerner’s page 40 which starts “The second law of Functional Finance is that the government should borrow money only if it is desirable that the public should have less money and more government bonds…This might be desirable if otherwise the rate of interest would be reduced too low . . . and thus induce too much investment, thus bringing about inflation.”

(In the above mentioned 15th Dec post I thought Lerner was advocating interest rate adjustments so as to optimise the amount of investment: in fact, as the above quote makes clear, he advocated such adjustments so as to control inflation. Doh!)

Anyway, why did Lerner think that adjusting interest rates is desirable as a means of controlling inflation when he has just advocated adjusting government net spending as a method of controlling demand and inflation? (See bottom of his p. 39)

Adjusting interest rates almost certainly influences inflation: e.g. if an economy is near capacity and inflation looms, then raising interest rates will presumably result in a finite reduction in investment spending which in turn will reduce inflation. But the important question, which Lerner does not address, is why do we need two tools to do one job? Having two tools doing one job is not really consistent with the Tinbergen principle.

If the two tools have obvious and different merits and demerits, then there could be a case for using both. For an example of a demerit, interest rate adjustments are probably distortionary in that they work only via entities that are significantly reliant on borrowed money. Plus such adjustments exacerbate fluctuations in demand for capital goods, which is not a clever move, because it is precisely instability in the demand for capital goods (via the so called “accelerator”) which is one of the main causes of instability for the economy as a whole.


Fiscal policy can act quickly and needn’t be distortionary.

In contrast, changes in government net spending needn’t be distortionary: e.g. a payroll tax change influences the spending habits of ALL employees, and that is a big proportion of the population. Hence the effect should be fairly non-distortionary.

The fact that in practice changes in government net spending often ARE distortionary and/or take time to implement is irrelevant.

Distortion often arises because for example politicians lobby for their favourite and bizarre bits of pork every time there is money available with which to purchase pork. But it would be perfectly feasible to have SOME fiscal changes (e.g. payroll tax adjustments) which are relatively free of distortionary effects.

Moreover, such distortionary effects as ARE inherent in a payroll tax change can be rectified. For example, as just mentioned, a payroll tax change affects only those in work, which leaves out for example pensioners. But this defect is easily enough rectified in countries with a state pension scheme by temporarily changing the state pension. Indeed, this sort of measure is already operative in the U.K. in that pensioners get a variable Winter fuel allowance, depending on how cold the Winter is.


Speed.

A similar point applies to the SPEED with which fiscal changes can be made. It is perfectly reasonable to spend months if not years debating some fiscal changes before they are implemented. The issues involved can be complicated. But that is irrelevant. The important point is that, again, it would be perfectly feasible to have SOME fiscal changes that can be altered quickly when the need arises. Indeed, the U.K. changed its sales tax (VAT) twice during the recent credit crunch.


Possible merits in interest rate adjustments.

As to a possible merit in interest rate adjustments, it might be that interest rate adjustments work QUICKER than fiscal adjustments, in which case there would be a case for using both tools. To illustrate, given a sudden need to boost demand, interest rates could be dropped so as to obtain a QUICK change to aggregate demand, while changes to government net spending (fiscal changes) could be implemented at the same time and would eventually take over the “work” done by interest rate changes.

But the evidence seems to be that interest rate changes do not work all that quickly. At least according to the Bank of England, such changes take about a year to work. See 8th para here.

As to how quickly fiscal changes work, the evidence seems to be “quickly”. At least where a fiscal change results in a change in employees’ take home pay, one would expect some sort of effect almost immediately: that is if the average employees’ take home pay rises by $X in say mid June, I would expect at least SOME of that extra to be spent before the end of June.

And the evidence supports this. The following studies indicate that roughly a half of tax rebates or other windfalls are spent by households within about six months. See here, here, here, and here.


Other problems with interest rate adjustments.

Apart from the fact that interest rate adjustments do not work quickly, such adjustments have other problems, two of which are as follows.

First, in the absence of government interference with interest rates, there is presumably some free market rate of interest. And this rate, in the absence of market imperfections, will maximise GDP. Thus there are costs associated with such interference.

Second, central bank instigated changes in interest rates seem to have no effect on rates charged by credit card operators.


Conclusion:

Abba Lerner was wrong to advocate TWO tools for controlling demand and inflation: changes to government net spending AND interest rate changes. That is, the main tool which he advocated, changing government net spending ALONE ought to do the job, though perhaps there’d be nothing wrong with having interest rate changes as a back-up, and second best tool, for use only in emergencies.


Afterthought – 6th April, 2011. On second thoughts, the claim that Lerner thought government should adjust interest rates so as to bring the optimum amount of investment does not seem to be so stupid after all: David Colander in “Functional Finance, New Classical Economics, and the Great Great Grandsons” also seems to have thought that this was what Lerner though, though Colander does not cite any sources to back up his claim. See his p.2, item No.2 under the heading “The Rules of Functional Finance”.

Anyway, the big flaw in the idea that governments should fiddle with interest rates so as to bring the “optimum” amount of investment is that it assumes politicians and bureaucrats actually know what this optimum is. The idea is laughable. Moreover, even if interest rates are a percentage point or two above or below this mysterious “optimum”, it simply means we would get very slightly less or more than the optimum amount of investment. The effect on living standards and GDP would be minimal.

Fiscal or monetary measures on their own are distortionary.

Apart from the reasons for combining fiscal policy (FP) and monetary policy (MP) given here, I’ve just thought of another reason: each of the policies on its own is distortionary.

A fiscal policy (FP) measure typically consists of government increasing spending by £X and covering that with £X of additional borrowing. A monetary policy (MP) measure typically consists of changing interest rates or quantitative easing: both the latter involve government in buying or selling its own bonds to the market. “Combining” the two consists of the government / central bank machine creating an extra £X and spending it. Alternatively, if inflation looms, it might be appropriate to do the opposite: have the government / central bank machine raise taxes, rein in money and “unprint” or extinguish the money.


Distortion.

Let’s take MP first. Raising interest rates is type of MP, but this works only via entities that engage in a significant amount of borrowing or lending, and that is distortionary.

QE is a monetary policy. But it works mainly via boosting asset prices, that is, it works only via the rich, and that is distortionary. In fact it is worse than that: it’s near disastrous because of the low propensity of the rich to spend extra income (or capital gains). Indeed more than one article has been published recently claiming that the current US high unemployment levels are largely attributable to the rising inequlity.

Now let’s take FP. Some FP measures are relatively undistortionary, e.g. a payroll tax change. Granted a payroll tax change is distortionary in that works only via those in work, e.g. pensioners are left out. But that is not much of a distortion because about half the population goes out to work.

Plus the latter sort of defect could easily be rectified in countries with a state pension, and by temporarily altering the state pension. (The state pension in the U.K. is “temporarily altered” in Winter to help pensioners (and others) if it is sufficiently cold.)

But if a payroll tax reduction and pension increase are funded by increased government borrowing, a distortion creeps in: the increased borrowing raises interest rates, and as pointed out above, interest rate changes are distortionary.

Therefor FP changes should be implemented in a “monetarily neutral environment”. Or put another way, MP and FP should be combined, if distortions are to be minimsed.


Conclusion.

The above is another argument that supports Abba Lerner’s “money pump” and Modern Monetary Theory. That is, in a recession, the government / central bank machine should simply increase its net spending.

.

Credit rating agencies doubt Britain’s AAA rating – shock, horror.

Credit rating agencies: don’t you love them? They’re the folk who were giving all and sundry tip top ratings just weeks before the credit crunch hit. They are the people who Warren Buffet totally ignores.

The two agencies Moody’s and Fitch have recently expressed doubts about Britain’s AAA rating, which in turn will allegedly make it more expensive for Britain to borrow.

The flaws in this argument are as follows. (Incidentally, the arguments below are relevant to a country, like the UK, which issues its own currencies: the arguments are different for countries in common currency areas, like the Eurozone.)


The first reason for government borrowing.

Governments borrow for various reasons, but two reasons are of relevance here. First there is borrowing as a substitute for tax. That is, if government collects less in tax than it spends, it normally has to make up the difference by borrowing. (Incidentally, the AMOUNT such a government needs to borrow will almost certainly be nowhere near the tax shortfall. It may be more, or it may be less. Any idea that the two DO need to be equal is to apply micro economic, or bookkeeping ideas to a macroeconomic entity: government. But that’s a point I won’t dwell on here.)

Anyway, the purpose of this borrowing by the government of country X is to bring about a deflationary effect which cancels out the stimulatory effect of the tax shortfall. That being the case, what is the use of borrowing from abroad? Reducing the spending power of entities (households and firms) outside country X will not have much effect on the amount such entities spend INSIDE country X. In contrast, reducing the spending power of DOMESTIC entities WILL significantly reduce their spending inside country X.

In other words to cut down on the amount spent by entities in country X, money must be borrowed from those domestic entities: borrowing from those entities tends to cut down on the money they have available to spend inside the country X.

So in this scenario, if foreigners fail to lend to country X (contrary to the claims of credit rating agencies) no harm is done!

As to reluctance by DOMESTIC lenders to lend to a government, what of it? Such a government, if it cannot persuade domestic lenders to lend, can just grab money off its population by force: it’s called TAX. Perhaps the rating agencies haven’t heard about tax.


The second reason for borrowing: stimulus.

A second reason for government borrowing is the well known Keynsian “borrow and spend” policy which allegedly brings stimulus. But there is a problem here: crowding out. That is, the fact of borrowing tends to raise interest rates, which in turn discourages private sector economic activity.

So what do governments do to prevent any such “discouragement”? They buy back government bonds with a view to making sure interest rates DO NOT rise. Indeed, where stimulus is required, such a government is likely to buy back MORE bonds than are needed simply to prevent interest rates rising: the government is likely to buy back enough bonds to actually get interest rates to FALL.

In short, “borrow and spend” is a bit of a farce: the beneficial effect of “borrow and spend”, to a significant extent, actually comes from having the “government / central bank machine” PRINT money and spend it!

Now what do foreign lenders have to do with this? They are completely irrelevant! That is, if government X wants to create new money and spend it, then as far as that government is concerned, foreign and domestic lenders can go hang.

Having said that the stimulatory effect of “borrow and spend” to some extent comes from the creation of new money, it should of course be said that those who think crowding out is a minor problem claim that the stimulatory effect comes from “borrow and spend” per se. Well now, to the extent that this is true, what difference does it make whether the government borrows from domestic sources or from abroad? If foreigners are not willing to lend, government X can raise interest rates and borrow a bit more from domestic sources.

And according to the “crowding out isn’t a problem” brigade, the deflationary effect of any such interest rate increase is more than outweighed by the stimulatory effect of having government spend the money it has borrowed. Personally I find that unrealistic, but never mind. The important point is that whatever assumptions are made about crowding out, foreign lenders are irrelevant.


Does borrowing from abroad have no effect at all?

Having poured cold water on the idea that any particular country needs to borrow from abroad, this is not to say that borrowing from abroad as a substitute for borrowing from domestic sources has no effect at all. It has a significant effect on living standards in country X. That is, borrowing from abroad will temporarily raise the value of the country X’s currency on the foreign exchange markets.

It is always dangerous to extrapolate from the micro economic to the macroeconomic, but in this case the effect of a country borrowing from abroad is very similar to the effect of a household borrowing. The effect is a temporary rise in living standards: that is, the day of reckoning is delayed. Sooner or later, the loan must be repaid, and when it is, it hurts. That is, during the repayment process, there is a dip in living standards which (ignoring interest payments and inflation) will be equal to the above mentioned temporary boost to living standards.


Conclusion.

For the government of a country that issues its own currency, the willingness of potential lenders, foreign or domestic to lend to it, is well nigh irrelevant.

Why separate monetary and fiscal policy?

The phrases “monetary policy” and “fiscal policy” are a boon for economics commentators who want to sound important. These commentators, or at least 99% of them simply accept the status quo, namely that the two policies should be separate. They rarely consider the possibility that the two should be merged.

Blind acceptance of the status quo is of course a common human weakness. No doubt 99% of those living in ancient Egypt accepted that spending a large portion of GDP on building million ton pyramids was a good idea.


The current bizarre set up.

The separation of monetary policy (MP) and fiscal policy (FP) arises to a significant extent from the bizarre way in which governments get extra monetary base into private sector hands, which is thus. 1, Treasury borrows from the markets to fund extra spending and issues government bonds to those it has borrowed from (which is so called “fiscal”). 2. Then the central bank creates new money, and buys up the bonds (which is so called “monetary”).

It would of course be much simpler for the “government / central bank machine” to simply create money and spend it, where stimulus is needed. And where inflation looms, i.e. dose of deflation is needed, it would be simpler for the “machine” to do the opposite, i.e. raise taxes, rein in money and “unprint” or extinguish money.

Indeed Keynes approved of the latter sort of policy, while Abba Lerner advocated it more openly than did Keynes.


Would merging be too much of an upheaval?

As mentioned above, an important reason for keeping MP and FP separate is the they happen to be naturally separated under our current (and illogical) institutional arrangements. That is, central banks are responsible for MP, and elected representatives are responsible for FP.

But there is a big flaw in this arrangement. This is that both MP and FP influence aggregate demand, thus the current set up involves two bodies being responsible for influencing demand: you might as well have a car with two steering wheels, each of the controlled by different people.


The printing press.

Conventional folk (i.e. the above mentioned 99%) will doubtless answer the latter point by claiming that the current set up at least keeps politicians’ hands off the printing press. Well it doesn’t! At least, to all intents and purposes it doesn’t, and for the following reasons.

The problem with irresponsible use of the printing press is that it leads to excessive demand, which in turn leads to excessive inflation. But as just pointed out, and as is generally accepted, FP influences demand! Thus even though politicians cannot print actual currency units (US dollars in the US), they can get as near as makes no difference: that is, they can issue debt, and debt equals the promise to pay currency units to holders of such debt at some point in the future. Indeed, government debt, particularly debt which is near maturity is accepted as money in the world’s financial centres.

Moreover, the temptation to go mad with the latter form of “almost money printing” is currently a major problem: that is, numerous countries have been piling up debt at an alarming rate recently.


Re-arranging government and central banks’ responsibilities.

And not only that, but if MP and FP WERE merged, that would or could involve a much more effective way of keeping politicians’ hands off the printing press (the money printing press AND the debt printing press). That is, central banks could be responsible for strictly technical matters, in particular whether demand was too high or too low, and thus whether government net spending needed reducing or increasing. While elected politicians could be responsible for the strictly political stuff, that is for example the proportion of GDP grabbed by government and the MAKE UP of government spending.


The advantages of a merger.

One major advantage of merging the two policies is that there is a huge amount of argument amongst economists as to which policy is better AND which elements of each policy work and which don’t. For example the crowding out argument looks like going on till the end of time.

In contrast, under a “merged” policy, it doesn’t make much difference which element of the policy does the real work. For example if government reduces employees’ contribution to a payroll tax, does the effect come from the employees’ increased take home pay, or from the fact that their net financial assets are boosted? Well it doesn’t matter too much: as long as at least ONE of the latter effects works, the policy as a whole will work.


The big problem: politicians' and economists' egos.

In practice, there are two major obstacles to merging MP and FP, both of them psychological or political.

The first has to do with the fact that the merged policy involves increasing the monetary base from time to time. As Lerner righly pointed out, this produces a knee jerk reaction: inflation.

That is that about 99% of the population, including economists who should know better, think that the mere fact of increasing the money supply is inflationary. That is they think that if someone prints a billion tons of $100 bills and hides them down a disused mineshaft, that somehow inflation will go thru the roof.

Put another way, only a very small portion of the population (economists included) can work out that additional money only has an effect WHEN IT IS SPENT. Given that most economists cannot work this simple point out, one has to wonder whether economists know anything about economics.


The second problem: tinkering with the controls.

The second problem is that both economists and politicians love tinkering with the buttons and levers that control the economy. That is, as soon as politicians are elected, they cannot resist the temptation to tinker, even though their qualifications for operating the controls are non-existent. (To some extent, politicians cannot be blamed for this because electors vote for politicians who appear to be "doing something", even when what they are doing is totally fatuous.)

As to economists, five thousand economists worldwide would be out of a job if it became generally accepted that tinkering can be drastically reduced.

Abba Lerner’s “Functional Finance” (aka Modern Monetary Theory) involves merging MP and FP, and as he pointed out, what puts most people off Functional Finance is its sheer simplicity. Or in his own words, functional finance is “too logical”. The ego’s of self styled technical experts are severely dented if someone demonstrates that most of the technicalities are a waste of time. That is, technicians would rather bamboozle the public with irrelevant technicalities than solve any of the world’s major problems, like unemployment.

Or as Lerner put it (p.39), functional finance “like every important discovery, is extremely simple”. And on the above point about the need to massage the egos of professional economists, Lerner points out (p.39) that “what progress the theory has made so far has been achieved . . . by dressing it up to make it more complicated, and accompanying the presentation with impressive but irrelevant statistics.”


Afterthought, same day 24th March 2011.

For more on the subject of national debt being little different to currency units (e.g. dollars) see Mike Norman.

What is the optimum size of the banking sector?

Those concerned with Basle III seem to be under the illusion that the optimum size is the maximum size that is consistent with a low chance of systemic collapse. Those holding this view have forgotten their basic economics.

The optimum size is actually the size that maximises GDP. And that will be obtained when there is fair competition between banks and the other sources of funding for borrowers. Plus there needs to be fair competition between commercial banks, when they seek capital, and other firms (in the non-bank sector) when THEY seek capital.


Walter Bagehot.

Surprising as it may seem, Walter Bagehot’s dictum that central banks should in emergencies lend on the basis of good collateral and at penalty rates does not meet the above criteria. Reasons are as follows.

First, the criterion “good collateral” is ridiculously vague, which makes it open to corruption. That is, thanks to the desire by politicians to kick cans down roads, and (at least in the US) to have bankers fund politician’s election campaigns, what “good collateral” and “penalty rates” actually translates into is “toxic collateral” and “near zero interest rates”. In effect this equals subsidies for commercial banks.
Moreover, even if commercial banks offer good collateral, my response, if I were a central bank governor, would be “OK, if the collateral is so good, why don’t you just sell it, and raise the cash you need that way?”

And the latter question is particularly apt, given that commercial banks, certainly during recessions, normally do not lend other than on the basis of collateral that can actually be sold for an amount that raises enough cash to cover the loan. For example about two thirds of mortgage deals in the UK currently require a deposit of at least 20% or so.

In short, if banks can borrow on the basis of so called “good” collateral which can’t, er, actually be sold for the amount it is supposedly worth, whey can’t everyone else? To repeat the point made above, unless there is a level playing field as between banks and everyone else, GDP will not be maximised.


Outlaw 100% mortgages?

It is clear from NINJA mortgages and the credit crunch in general that banks are incapable of fulfilling one of their central functions: distinguishing between credit worthy and non credit worthy customers. Either that, or they cannot be bothered making the distinction because they know the state will rescue them when they go belly up: an implicit subsidy.

We thus need some sort of simple rule which prevents banks making use of the latter subsidy. One possibility is to disallow money used from state backed deposit protected accounts for anything more than say 80% mortgages. Those wanting mortgages would still be free to seek 100% mortgages, but they’d have to get the remaining 20% from non state backed sources.


Reduced bank lending does no mean reduced GDP.

The objection raised ad nausiam by banks to any constraints on their activities is that this will reduce the amounts they lend and hence reduce “economic growth” or GDP. Politicians fall for this nonsense hook, line and sinker every time.
Clearly requiring banks compete on a level playing field with other firms WILL constrain bank’s activities, lending in particular. And without any compensatory measure, this WOULD reduce GDP.

However, what is to stop the government / central bank machine implementing stimulatory measures to make up for the reduced lending? Absolutely nothing!

The net effect would be more economic activity that had absolutely nothing to do with banks. For example more businesses would be funded by their owners, owners’ family and friends than by banks. Plus more firms would be funded by share issues than by bank loans. That is, the world can manage very nicely, thank you very much, with a much reduced banking sector.

Indeed bank assets and liabilities in the US and UK have expanded by a factor of about ten over the last fourty five years or so relative to GDP (see Haldane, Chart 1, p. 24). Yes, you read that right: TEN! And to what benefit? Economic growth has not improved as a result.

In fact economic growth (at least in the form of improved living standards in the UK over the last five years or so) has been next to non existent: that is, worse over the last five years or so than at any time since WWII.

What is the ECB doing with its monetary base?

I first saw this chart on Prof David Beckworth’s blog. The chart is a strange one. The vertical axis is the monetary base in trillions of Euros, and the horizontal axis is time, ranging from Feb 1999 to Feb 2011. Anyone got any explanations?

You’d have thought the cautious ECB would not want to expand the monetary base (in nominal terms) faster than the real expansion of the Euro economy (say 2% a year) plus the target rate of inflation (say 2%). That means roughly 4% ( 2 + 2 = 4%). But the rate of expansion on the chart is well over 10%.

My explanation is that while central banks are supposedly in charge, prior to the credit crunch, commercial banks were forcing an expansion of several developed economies and their monetary aggregates (based on dodgy collateral – property prices). The ECB could have reined in this expansion by raising interest rates to unprecedented levels, which would have stifled activity in non-property sectors. But what they actualy chose to do was join the party, and expand the monetary base.

What would have been really smart on the part of the ECB (and other central banks) would have been to spot the property bubble, and curtail loans based on property. But that would probably have been politically impossible because of howls of anguish from home buyers.

I think Steve Keen said that prior to the crunch, the tails were wagging central bank dogs.

.

Inflationary expectations are irrelevant.

In trying to predict inflation in the near future, the important factors to consider are current wage increases, current raw material price increases and current factory gate price increases.

Expectations are irrelevant, except in that they influence the above three factors. For example, inflationary expectations seem to have risen in the U.K. recently, but this does NOT seem to have led to a faster pace of wage increases. At least not according to the evidence that I’ve found – see here, here and here.

What seems to be happening (at least to some extent) is that the average Brit has read or heard that prices are rising a bit faster than a year ago, and thus “expects” the trend to continue for several months or a year or two. But at the same time, the average Brit is not pushing hard for significant wage increases.

Indeed, this has been going on for several years now. That is, real wages have not increased for the last five years or so, thus employees for that period have quite clearly not been pushing for “inflation plus X%” wage increases, which is what they pushed for during the serious bout of inflation in the 1970s.

In short, expectations are irrelevant.

The arrogance behind Project Merlin.

U.K. banks are allegedly not lending enough to Small and Medium size Enterprises (SMEs). Project Merlin is an agreement between the UK government and banks under which banks promise to lend a minimum sum to SMEs per year (amongst other things).

The first nonsense here is that if one believes in free markets, as the UK government claims to, why is govt interfering with bank’s decisions on who are creditworthy customers? After all, this sort of decision is supposed to be one of the basic skills of banks.

The second nonsense is the assumption that bank loans are the best or only way of funding SMEs. If an economy is being held back because of lack of lending for what are genuinely profitable projects, interest rates would be forced up. But there is no evidence of this happening.

Conclusion so far: if an economy is operating below capacity, the best solution is the obvious one, namely to raise demand. That, amongst other things, will make lending more profitable. As to whether it is large banks, small banks or other entities that do the lending, well that absolutely nothing to do with government.

As to evidence that that borrowing from non-bank sources is a substantial source of funding for SMEs, a recent survey by the Forum of Private Business found that financial support from friends and family to jump from 10% of their total funding in 2010 to 45% in 2011*.

But SMEs realise (as does everyone) that with govt nowadays grabbing about half GDP, there is plenty of profit to be had from sucking up to politicians as opposed to doing anything useful. That’s why most SMEs probably back Merlin (at the same time and holding their noses, no doubt).

Given the nonsensical logic behind Merlin, why did this “project” arise in the first place?

One factor is that is that banks are trying to repair their balance sheets, and a part of this exercise consists of being more cautious about lending than prior to the crunch: probably a good idea in view of the grossly irresponsible lending that took place prior to the crunch and caused the crunch.

Second, it does the egos of the London based elite (bankers and politicians) no end of good to see regional businesses come to them cap in hand for money rather than see such businesses find other sources of finance. The same arrogance is evident in the US: politicians there prefer to hand out taxpayers’ money to Wall Street than to Main Street. Wall Street in turn funds the election expenses of politicians. The elite looks after the elite.

* Source: Sunday Times Business Section article entitled “Don’t trip up over loans close to home”, 6th March 2011.

.

The inefficiency of U.S. medical treatment.

Health and medical expenditure in the U.S. seems to be double that of most other developed countries. Yet life expectancy is no better in the U.S. than in the latter countries. Amazing. Or perhaps its all down to lifestyles: too much calorie intake in the U.S.

See chart here or (the original source), p. 111 here.

(Hat tip to Larry Willmore author of “Thought du jour”)

.

The European Court of Justice’s strange ideas on male and female driver insurance.

The European Court of Justice (ECJ), in their infinite stupidity, recently decided that car insurance firms cannot charge women less than men, despite the fact that women are safer drivers than men.

The flaw in the Court of Justice’s decision stems from their non-grasp of economics, and for the following reasons.

GDP is maximised where prices reflect costs. If there are social reasons for thinking prices should NOT reflect costs (and that is sometimes a legitimate claim) it’s up to society as a whole or GOVERNMENT to alter the price via taxes or subsidies. That is, cross subsidisation between men and women or between any other two groups only makes sense if it can be shown that one group involves social costs AND the other group involves social benefits.

We don’t use taxes on alcoholic drinks to subsidise non-alcoholic drinks.

The ACTUAL reasons for the ECJ’s decision are plain as a pike staff: politics, fashion and the new religion – political correctness. “Discrimination” is a cardinal sin in the eyes of this new religion. And the morality of religious folk is often deplorable. For example Shia Muslims are scum of the earth in the eyes of many Sunnies. And non-Muslims are scum of the earth in the eyes of many Muslims.

Thus discrimination in any shape or form must be outlawed – unless of course the ECJ did some detailed research into matter, and proved that there are significant social “benefits” of having more young male drivers on the roads causing death and destruction.

Plus the idea that the ECJ did some detailed research, and proved that there are social benefits in having fewer women able to drive (and thus, in some cases find work) is laughable.

.