Monday, 27 June 2011
First the laugh. The World Bank has just appointed Lehman’s Global Head of Market Risk Management as they went into bankruptcy to the position of Vice President and Treasurer. Hat tip to Billyblog. As Bill Mitchell author of Billyblog rightly asked, “Did they also interview Bernie Madoff?”
Graph of the day.
I like this, which I saw at the Schwartz Centre for Economic Policy Analysis site. It clearly shows different components of effective demand. Note the collapse in household investment (bottom line) between 2007 and 2010.
Saturday, 25 June 2011
As Bill Mitchell has pointed out numerous times, the IMF is made up of incompetents.
Simon Johnson in this article has a great idea for reducing the deficit and/or debt (DD): it’s to wait till the recovery really gets underway, and then pair down the DD in earnest. The crucial paragraph in his article is the penultimate one, which I’ve re-produced just below in purple.
The best way to bring the debt-to-G.D.P. ratio under control is to limit future spending increases and augment revenue while the economy continues to recover. In particular, health care spending needs to be credibly constrained but doing this properly would mean limiting health care costs as a percentage of G.D.P. — proposals that just push costs from government onto companies and individuals are not appealing.
There are several flaws in this argument.
First, deficits INVARIABLY decline in a recovery, and may even turn into surpluses. To that extent, Johnson is simply advocating the inevitable.
Indeed, taking an ideal scenario (a rather extreme one by today’s chaotic standards) governments would pitch their deficits at a level which resulted in almost no recessions or booms. That is, given for example a sharp decline in household spending because households are worried about the loss in value of their houses, government would ideally step in and keep demand more or less constant by running a deficit.
In this ideal scenario, DDs would decline in a recovery to an even great extent than they already do. But would there any point in cutting the DD by any MORE than was happening anyway? The answer is “NO”: because the result would be a totally unnecessary slow-down in the recovery.
Public spending cuts do NOT reduce public spending!
Next, the second sentence of Johnson’s above paragraph trots out the tired old nonsense that a way of reducing DDs is to cut government spending (he cites health care).
The flaw in this idea is that such cuts raise unemployment, which in turn increases spending on the automatic stabilisers, like unemployment benefit. In fact there is even evidence that public spending cuts actually RAISE public spending!
The above bit of nonsense is popular with those who have not grasped the difference between macroeconomics and microeconomics. A microeconomic entity (like a household or business) CAN reduce its deficit by cutting expenditure or raising income. A government which is a macroeconomic entity CANNOT.
But what a government CAN do – at least to cut the DD - is simply to reverse the process that brought the DD into being. And what brings a structural DD into being is failing to collect enough tax to cover spending. Reversing that consists of raising taxes and paying off the debt.
And of course the knee jerk reaction to the “increased taxes” idea is that living standards will suffer: there will be “austerity”. Now this is a strange claim, for the following reasons.
When a country INCURS a structural DD, no one ever claims the effect is wildly STIMULATORY (although my guess is that actually is somewhat stimulatory). That is, a structural deficit occurs simply because politicians fail to collect enough tax to cover spending (with a view to making themselves popular and winning votes).
So when the process is REVERSED, there is equally little reason to suppose the effect is deflationary or that it involves austerity.
However, it may well be (as mentioned above) that the effect of incurring and paying back a structural DD is indeed somewhat stimulatory and deflationary, respectively. But that’s not a problem. Anyone who has studied economics for a year or more knows how to give an economy a boost, or conversely, damp down economic activity. Adjusting interest rates is one possible tool (not one that I personally like, but that’s another story).
Thus Johnson’s claim that health care spending must be reined in so as to cut the DD is nonsense. And if you want empirical evidence to support this, look at Sweden: it devotes much more of its GDP to public spending that the US, yet it has a much smaller DD.
Incidentally, I am NOT, repeat NOT advocating a bigger public sector for the US or any other country. The size of a country’s public sector is a POLITICAL decision: one that has NOTHING to do with a country’s DD.
Afterthought, 18th July 2011. Simon Johnson's understanding of economics is also questioned here.
Friday, 24 June 2011
The excuses for not raising demand and reducing unemployment are a wonder to behold. Economist Michael Spence has an article in the Wall Street Journal today with a series of these excuses.
He starts his article by claiming that the root cause of current high unemployment levels are structural. So the collapse of various banks three years ago and the credit crunch had nothing to do with it? The sharp rise in unemployment just after those bank collapses was entirely coincidental? “God first makes mad those he wishes to destroy”, as the saying goes.
Spence then claims that employment in non-tradables will not rise because of “government budget woes”. Strange then, that Sweden manages to devote a much larger proportion of GDP than the US to public spending, while having a much smaller debt and deficit than the US. America’s political right just can’t work this one out because they are thick.
And before some right wing thicko accuses me of advocating an expanded public sector, I’m not. I’m concentrating on the ECONOMICS. The decision as to what size the public sector is, is a political decision, not an economic decision - a distinction with which citizens of the US seem to have much more of a problem than citizens of Europe.
Spence then points to the blindingly obvious fact that several large less developed countries are getting their act together, improving their levels of education and so on. This means they now compete more effectively with skilled Americans. And from this he concludes that the only solution is for the US to spend more on education, infrastructure and so on. The flaw in this argument is as follows.
Where a country has a comparative advantage, the relevant products will tend to be exported.
But if that comparative advantage is lost, the relevant products will no longer be exported. What of it? The UK used to have a massive comparative advantage in steel shipbuilding: it used to build HALF the world’s steel ships. Then other countries caught up.
According to Spence’s crazy logic, the UK should have busted its guts and spent billions subsidising steel production, ship-building and so on.
The policy which actually makes sense when comparative advantage is lost is simply to cease exporting the relevant products, and turn to the next best form of economic activity. And that may involve exporting, or it may not. It really doesn’t matter.
If the next best products happen not be exportable, then obviously the balance of payments suffers and the currency depreciates. But what of it? The British pound fell by 25% in 2008. Scarcely anyone in the UK has noticed. It’s been nice for exporters who have taken on more employees. Otherwise, the UK population has been completely unmoved by this massive non-event.
Spence then claims the US needs to “aim to help raise savings rates so we can finance our own investment”. What, so with interest rates at an all-time record low there is some problem funding investments? And with US corporations sitting on all time record piles of cash they can’t work out how to fund investments?
As I said, God first makes mad….
Tuesday, 21 June 2011
The Public Sector Borowing Requirement (PSBR) is one huge nonsense. This world is full of emperors with no clothes. That is, farces which are so big that no one notices them.
PSBR is a term that has rather fallen out of use in the UK. But alternative terms with the same meaning are still used. Anyway I’ll stick with “PSBR”.
The PSBR is defined by the Financial Times Lexicon as “The term used in the UK for the government's budget deficit in a particular fiscal year. It refers to the fact that the deficit (the excess of spending over revenue) is made up by government borrowing. The amount that a government has to borrow in a particular period of time to cover the difference between the money it gets from taxes and the amount it spends.”
The first reason to be suspicious of the whole PSBR concept, as defined above, is that it applies microeconomic thinking at a macroeconomic level. That is, everyone knows that if a microeconomic entity, like a business or household, has a deficit of £X for the year, then it must borrow £X (assuming it has no cash to spare). But macroeconomics is a different world.
SOMETIMES microeconomics works at the macroeconomic level, but not in this case. Reasons are as follows.
When government wants to boost the economy, a popular method is Keynsian “borrow and spend”. That is government borrows £Ybn and spends £Ybn. And that supposedly raises aggregate demand. That is, the effect of “borrow and spend” is alleged to be stimulatory.
There are actually good reasons for thinking this policy works. One is that the net effect, taking the above example, is that private sector net financial assets rise by £Ybn. That is government borrows £Ybn from the private sector and spends same (i.e. channels the £Ybn back into the private sector). Plus government gives bonds worth £Ybn to those it has borrowed from. Net result: the private sector is up by £Ybn.
Noticed the farce yet? If not, read on.
Now if government runs a deficit of £Zbn, then applying microeconomic thinking, and the above FT definition, it needs to borrow £Zbn. Put another way, if government did NOT borrow the £Zbn and simply printed £Zbn of new money to make good the tax shortfall, the results would be inflationary (assuming the economy was at capacity).
So the purpose of borrowing the £Zbn is to give a demand reducing effect that cancels out the demand increasing effect that would arise from simply printing and spending £Ybn.
But wait a moment. In the case of Keynsian borrow and spend, the effect is supposedly the OPPOSITE! That is, the effect of “borrow and spend” is supposed to be demand increasing!
Of course where borrow and spend is supposed to be demand reducing, government could let interest rate crowding out do its worst: that is, it could let interest rates rise as a result of said borrowing. But given the disagreement amounts economists as to the extent of the crowding out effect, it is hard to say what the effect would be.
Conversely, when the aim of borrow and spend it to RAISE demand, government could intervene and make sure interest rates DON’T rise, or even lower them (and no doubt governments normally do this). But in either scenario, why bother with the concept “PSBR” at all? From the above argument, it would seem that it is interest rate adjustments that do the crucial work. So why not just adjust interest rates as required and forget all about the PSBR?
Indeed, even interest rate adjustments are a farce, if the arguments I put here are correct. That is, the real work is done by having government print and spend money (or the reverse, that is, rein in money via extra taxes, and “unprint” or extinguish money).
Or as Abba Lerner said, the important point about an item of tax or spending or anything else, is the EFFECT. The actual figures – in particular the effect on the size of the deficit or surplus or the PSBR is irrelevant.
Monday, 20 June 2011
Looks like Sweden is aiming for a balanced budget (hat tip to Marc Robinson).
As I’ve pointed out more than once on this blog, any country which aims for inflation of around 2% will need to run a significant deficit just to prevent its monetary base and national debt declining relative to GDP at 2% a year. If it doesn’t have that deficit, private sector saving desires may not be met, which may mean paradox of thrift unemployment.
Friday, 17 June 2011
Note dated 26th Oct 2011. The article below is 2,700 words. I put a slightly longer and hopefully better version (3,300 words) online on about 25th Oct 2011.
I’m tired of being told “we must consolidate the debt, but too fast a pace of consolidation would hinder the recovery”.
This message comes from numerous “authorities” who should know better, including the IMF, a long list of Britain’s academic elite, and William Dudley of the New York Fed. (For some directions to the relevant paragraphs in their pronouncements, see references at the end.)
The phrase “fiscal consolidation” is defined in the Financial Times online Lexicon as a reduction in the deficit but not the debt. In contrast, the OECD defines it as reducing both.
This disparity is not important for the arguments below because these arguments apply regardless of whether a country wants to reduce just its deficit, or both deficit and debt (DD).
As implied above, the argument here is that the pace of consolidation is largely independent of stimulus or attempts to adjust aggregate demand. To explain this, it is necessary to divide the DD into two parts: the structural DD and the part of the DD that results from stimulus. These two are significantly different, and I’ll start with the structural DD.
The structural deficit and debt.
The structural DD arises simply from a failure by politicians to collect enough tax to cover public spending. That is, they borrow instead of taxing.
Since there is no intention to give the economy any stimulus (or anti-stimulus) here, the deflationary effect of the borrowing ought to equal the stimulatory or “inflationary” effect of the spending (had that spending not been covered by tax or borrowing). At least, the two will be the same if those implementing the deficit know what they are doing.
Thus disposing of a structural DD is child’s play: just reverse the process that brought it into being. I.e. the debt needs be paid back. That is, taxes need to be raised and creditors paid off. Those tax increases would NOT mean “austerity”. Reason is that, as mentioned above, incurring a structural DD does not involve stimulus, thus reversing the process would not involve “anti-stimulus” or austerity. Put another way, there would be no reduction in GDP, total numbers employed, etc. At least that is certainly the case with a closed economy. Open economies are slightly different, and I’ll deal with them below.
As to where some stimulus DOES inadvertently result from incurring a structural DD (and I think this DOES happen to some extent), this is not a problem. It means that an exact mirror image of incurring the DD would involve an anti-stimulatory or demand reducing effect. But countering the latter demand reducing effect is not difficult: anyone who has studied economics for more than a year knows how to raise demand. For example, some of the money for the debt buy back could come from the printing press (as is the case with QE).
Having said that GDP, numbers employed etc remain unaltered, it is of course it is not ESSENTIAL to aim for this “everything stays the same” outcome. It would be possible to mix some stimulus with the DD reduction process. But to keep things simple, I’ll stick with the “everything remains constant” assumption.
And for any readers who are puzzled as to how taxes can be raised while all the above factors remain constant (especially take home pay), the explanation is that the effect of the debt buy-back would be to raise pre-tax incomes, while tax would nullify that increase.
So that’s the structural DD gone. Vanished. A few apparent problems associated with this cure for the DD will be dealt with below, but the stimulus DD will be considered first.
The stimulus DD.
Making a reduction in the stimulus deficit an objective is COMPLETELY BALMY.
The purpose of a deficit is to raise aggregate demand where there is a shortfall in AD (for example when indebted households rein in spending because they find the value of their houses falling dramatically compared to their debt – ring any bells?)
So long as the latter shortfall in demand persists there is NO POINT in trying to reduce the stimulus deficit.
But if such a deficit lasts a relatively long time, that might appear to involve an unacceptable expansion in the debt.
The answer to the latter non-problem is that as Milton Friedman, Keynes and others pointed out long ago, a deficit does NOT HAVE TO BE FUNDED BY DEBT. That is, a deficit can be funded EITHER by increased debt, OR it can be funded by expanding the monetary base.
There isn’t actually a huge difference between the two: that is, monetary base and government debt both appear on the liability side of a central bank’s balance sheet. Moreover, a chunk of government debt is simply a promise by government to pay the holder of such debt some money on a particular date. As to where that date is in the NEAR future, (i.e. where the debt is near maturity) there is virtually no difference between the two.
Given this rather small difference it is reasonable to ask whether it is worth turning debt in to monetary base. Well, one good reason is that the world is full of panic stricken folk who think an expanding debt means the end of the world. So keeping these folk happy is no bad idea.
Second, as I explain here, the traditional arguments for having governments run into debt do not stand inspection.
The stimulus debt.
As pointed out above, given inadequate demand, government should feed financial assets to the private sector (bonds or money). In other words, given inadequate demand, the stimulus DEFICIT should not be reduced.
However, if over recent months or years a stimulus deficit has accumulated in the form of bonds or “national debt”, there is nothing wrong with reducing or “consolidating” that debt in the sense of converting the bonds to cash. In other words the buy-back proposed here can perfectly well extend to the stimulus debt.
There is a minor problem involved in doing this, namely that simply “doing a QE” on such debt (i.e. printing money and buying it back) might be too stimulatory, and thus too inflationary. But the solution to this little problem was referred to above, namely that the funds for buying back debt can come from the printing press or alternatively from extra tax. The former is stimulatory and the latter has the opposite effect, that is it is “anti-stimulatory” or “demand reducing”.
So mix the two in the right proportions, and you get a neutral effect. That is, no effect on GDP, numbers employed, and so on.
Apparent problem No.1: distributional matters.
I’ll now consider a few apparent problems with the above DD reduction ploy.
The first apparent problem is that the ploy might benefit the asset rich (holders of government debt) at the expense of the average tax payer. Well the answer to that is that in principle, matters and policies relating to wealth and income distribution should not be mixed up with matters relating to DDs.
For example, when governments expand a deficit, the prime aim is NOT to re-distribute income or wealth (although given the less than perfect competence of governments, some inadvertent re-distribution probably does take place normally). Likewise, when the process is reversed, assuming it is reversed in a competent manner, there ought not to be any significant distributional effects. I.e. if changes to the income tax and social security system are needed to counter-balance any distributional effects of reversing a DD, then so be it. That is not a big technical or economic problem. (As to the politics, that’s a different matter!)
So let’s move on to the next problem.
Apparent problem No 2: a large monetary base expansion would be inflationary.
Laugh out loud!
The monetary base in the US just has expanded by an astronomic and unprecedented amount: it’s TREBBLED IN THE LAST TWO YEARS!!!! And where’s the hyperinflation?
To be more serious, there are some very good reasons for this lack of serious inflation. First, additions to the money supply are not inflationary till they are spent, and spent in sufficient volume and speed to cause excess demand and thus inflation. (David Hume, the Scottish philosopher pointed this out 250 years ago. It would be nice if we’d learned something about economics in the last 250 years, would’nt it?)
But wait a minute: an increase in demand IS THE SOLUTION TO THE PROBLEM! In other words it is not possible to get serious inflation without first “solving the problem” (i.e. the recession). Of course the tricky bit is to avoid overshooting the solution, to coin a phrase. But certainly in principle, it is not possible to get excess inflation without having first “solved the problem”
Second, as to the idea that this additional money might cause inflation a few years down the line, that is a feeble point, and for two reasons.
First, increases in demand and thus inflation can perfectly well occur EVEN WITH NO INCREASE IN THE MONEY SUPPLY AT ALL. For example a big increase in consumer confidence, i.e. a willingness by consumers to go into debt and a willingness by banks to lend to them would cause a rise in demand. Indeed, this was the source of a sizeable portion of many countries’ aggregate demand prior to the recession.
Perhaps the “anti money supply increase” brigade can tell us what they propose doing with the money supply given that inflation can arise ABSENT any money supply increase. Do they advocate abolishing money altogether?
Of course, expanding the monetary base raises the RISK of inflation in a few years time to a finite extent. But that should not be difficult to deal with: there are a host of anti-inflationary measures that every government has at its disposal. One of these measures is simply to reverse the above “money printing”. I.e. raise taxes, rein in money and “unprint” it, or extinguish it.
Any additional tax imposed for the latter reason would not, repeat not, mean austerity or “hindering the recovery” in any way. The sole purpose of such taxation is to remove money from the private sector, which, were it left in the private sector would cause excess inflation. And inflation REDUCES living standards rather than increases them. I.e. tax, paradoxically, can improve living standards.
Second, as to the idea that banks will lend money just because they have loads of it sitting in idle accounts, LOL yet again. Right now, as I write, banks ACTUALLY ARE sitting on larger than ever reserves, while not lending it out with any great enthusiasm. And apart from the latter evidence, there are some simple theoretical reasons that explain why banks do not automatically lend out “idle” money, as follows.
Any bank with its head screwed on, lends where it sees a PROFITABLE LENDING OPPORTUNITY, not when it happens to have money in idle accounts. Likewise car hire firms do not hire out cars at any old bargain basement price just because they have cars lying idle.
Indeed, as long as banks see profitable lending opportunities, banks will lend EVEN IF THEY HAVE INADEQUATE RESERVES!!!!! In short, the amount that banks have in idle accounts or reserves, is one big irrelevance. For more on this, see here, or Google “banks are capital constrained not reserve constrained”. Or see here.
And if by any chance it turns out that banks do lend simply because they have money in the kitty, that just proves they are incompetent. And that is a good reason for tighter bank regulation, not an argument against letting households have the amount of money they feel comfortable with, which in turn should bring full employment. Given the numerous crooks and incompetents running banks, personally I’d favour much tighter bank regulation that Basle III.
Third, one daft aspect of the idea that “money supply increases cause inflation” is that those who promote this view never tell us what the OPTIMUM amount of money per person should be. This is exactly the same as saying that ANY increase in speed for a car on a particular stretch of road will be dangerous, without saying what the OPTIMUM speed is (i.e. where the best trade-off is as between reduced journey time and danger).
In contrast, a very clear idea has been set out above (hopefully) as to what the optimum amount of money should be: whatever brings the maximum level of demand that is consistent with acceptable inflation.
Apparent problem No.3. Permanent low interest rates.
Buying back debt as advocated here is similar to QE. And the large scale and long lasting “QE” operation advocated here possibly implies low interest rates for an extended period, but this is not a problem. Far from being a problem, there are actually good arguments for the current zero or near zero interest rates to become a permanent feature. First, see two of Warren Mosler’s works: here and item No.3 under the heading “Proposals for the Federal Reserve” here.
Second, as far as stimulus is concerned, it makes no sense for a government which wants to do some Keynsian “borrow and spend” to pay any interest for the money borrowed. That is, what is the point of paying for the privilege of borrowing something (money) which you can produce yourself at no cost?
Third, one of the few valid reasons for government debt (or monetary base) is that this provides the private sector with the net financial assets it wants. Put another way, without such assets, one gets “paradox of thrift” unemployment. But in demanding such assets, private sector entities do not do society as a whole any favours. Thus there is no reason to reward such private sector entities.
Put another way, the attitude of government to private sector entities which threaten to go into saving mode and cause unemployment unless they have the savings they want should be “OK, here are the savings you want, but there is no reason taxpayers should be burdened with paying you interest, so you’re not going to be rewarded for demanding these savings”.
Should we abolish interest rate adjustments?
The above argument, of course, implies abandoning attempts to adjust aggregate demand by adjusting interest rates. That is, the implication is that it is the quantity of money that should be adjusted not its price (though of course adjustments to the quantity will inevitably impinge on the price).
This idea may be novel, but there are actually a host of weaknesses in the idea that interest rate adjustments are a good idea, which I set out here.
Apparent problem No.4: balance of payments effects.
Let’s start with the stimulus part of the deficit. QE has lead, particularly in the US, to funds quitting the country in search of better returns elsewhere. And this in turn will have depressed the dollar relative to other currencies.
Given that what is proposed in this article is QE writ large, is there a problem here?
The answer is that ANY form of stimulus depresses the value of a country’s currency. That is, the alleged “problem” here is not unique to the policy advocated here.
That is, given excess unemployment, a country will normally be better off reducing that unemployment, even if there is a slight drawback in the form of its currency losing value.
As to the structural part, QE certainly leaves debt holders with spare cash, and a proportion of those will lodge their cash abroad, which means a finite devaluation of the currency of the country concerned. And that means a standard of living hit, i.e. austerity.
On the other hand the pound Sterling was devalued by 25% or so in 2008 and any standard of living hit has been negligible compared to the standard of living reduction being experienced by European periphery countries.
Moreover, the greater the number of countries with allegedly excessive debt that implement the above policy at the same time, the less the incentive for former debt holders to shift money from one country to another, thus the less will be the changes in living standards of one country relative to another.
Dudley: see para starting “As discussed earlier….”
IMF: see para starting “The policy advice to advanced economies….”
Note: The above last section “Apparent problem No 4…” was re-written on 25th Sept 2011.
Thursday, 16 June 2011
Stephen Roach is a Yale University academic and non-executive chairman of Morgan Stanley Asia. He devotes a Financial Times article to the point that US consumers are not spending.
Yes, well most of us tumbled to the fact this was bound to happen when heavily indebted households saw the value of their houses plummet two or three years ago.
Roach, of course does not have a solution to the problem, other than suggesting we sit around for years on end waiting for consumers to deleverage.
In contrast, leading MMTer Warren Mosler has been trying to spell out the solution for a long time now. Namely a payroll tax reduction: that feeds stimulus direct into household pockets.
But the political and Wall Street elite would hate to see money flowing into peasants’ pockets. The former want it flowing into their own pockets. That wouldn’t matter too much if they actually spent it on something: butlers, chamber-maids, servants, yachts, you name it.
But they don’t: they use the money boost stock market prices or take the money out of the US altogether in search of better returns around the globe.
Perhaps the elite will finally be happy when the peasants are chopped up into little pieces and turned into dog food.
Tuesday, 14 June 2011
Government debt forms a significant portion of peoples’ savings in many countries – whether that debt is held directly by individuals or indirectly in the form of a pension funds and so on.
Obviously people can put SOME savings into housing, the stock market or other assets. But suppose this is not enough to satisfy the population’s desire to save – should government then have to go into debt to supply the savings that the population wants? This question is of particular relevance, given that it can be argued, as I do here, that the conventional justifications for governments going into debt do not stand inspection.
The answer is that if the stock market etc are not enough to fulfil the populations’ “savings desires” government will just HAVE to go into debt, else we’ll get “paradox of thrift” unemployment. That is, if the population does not have enough savings, it will just store up money: an activity which reduces demand and causes unemployment. And money (or monetary base to be more exact) is at least nominally a form of debt – owed by government to the holder of monetary base.
As an alternative to storing up monetary base, the population can of course store up something very similar to monetary base, something that is normally seen as “genuine” government debt: e.g. Treasuries in the US or Gilts in the UK.
But if interest is paid on any of this debt (monetary base, Treasuries, etc), AND if there really is no other good reason for governments being in debt, then we have the ridiculous situation where one section of the population, taxpayers, have to make a sacrifice just to ensure that another section, i.e. savers, have what they want.
The solution to this problem is to let the monetary base and/or government debt expand to the point where savings desires are satisfied, but offer zero or very near zero percent by way of interest on government debt. And as we all know, this is more or less the situation in Japan.
Monday, 13 June 2011
Austrians think recessions are good in that they dispose of mal-investments.
The flaw in this Austrian argument is thus.
First, there are businesses or investments which are only just viable during a particular boom, and which will fail come a recession, but which will get their act together, and become much more profitable in the long term. Having a recession that wipes out these businesses is pointless.
Second, there are businesses like the above but which will remain only just viable when the economy is at capacity. These businesses are clearly “bottom of the class” They are the businesses that we least need. But what of it? As long as pay their way (only just), why get rid of them?
Third, there are businesses which will go from bad to worse. These will fail even if demand is kept at the maximum level that is consistent with acceptable inflation. That is, a recession is not needed to get rid of these businesses.
Conclusion: recessions do get rid of mal-investments, but recessions involve throwing babies out with the bathwater: bathwater which will be disposed of anyway. Therefore recessions achieve nothing.
Sunday, 12 June 2011
This is a nice study by the above two authors. They look at the UK national debt and deficit figures since the early 1900s, and show that the effect of “fiscal consolidation” is counter intuitive. That is, attempts to pay back debt are self-defeating: they result in a rising debt.
As they say, “The empirical evidence runs exactly counter to conventional thinking. Fiscal consolidations have not improved the public finances.”
Also Anne Pettifor’s blog looks interesting.
Afterthought (12th June): The claim by Chick and Pettifor that attempts at what is now called “fiscal consolidation” are self-defeating might seem to clash with the claim I have made on numerous occasions, e.g. here, namely that the debt can be reduced or abolished by printing money and buying the debt back (to over simplify a bit). In fact there is no clash. C & P refer to cutting public spending (or raising taxes) and using the money to pay off the debt. In contrast, my proposal is to leave public spending and taxes more or less untouched (but not entirely untouched) and basically pay off the debt, to repeat, with “new” or “printed” money. These are two very different scenarios.
Saturday, 11 June 2011
A recent speech (1) by William Dudley, president of the New York Fed is mostly quality stuff, but he seems to be unaware that reducing national debts, or at least preventing them expanding, is quite easy.
It is deficits that cause debts to rise, and (as pointed out by Keynes (2) and Milton Friedman (3)) funding a deficit with new money rather than via debt is a perfectly acceptable option. That means the deficit can continue, but the debt declines or at least ceases to grow.
The relevant passage from his speech is as follows (in green and italics).
However, the large size of the fiscal deficit and the rapid increase in the country's federal debt-to-GDP ratio means that this is not sustainable for much longer.
Standard deficit terrorist stuff. He then continues:
Ultimately, the composition of economic activity in the United States needs to be rebalanced. There are two issues here. First, the consumption share of GDP may still be too high. Second, the need for U.S. fiscal consolidation implies that there will have to be offsetting increases in investment and the U.S. trade balance as the recovery proceeds.
To illustrate this second point consider the following accounting identity:
The public sector balance + the private sector balance = the current account balance
Right now the identity holds as roughly:
-10 percent of GDP public sector balance + 7 percent of GDP private sector balance = -3 percent of GDP current account balance.5
If the public sector balance must over time move from around -10 percent to around -3 percent to stabilize the federal debt-to-GDP ratio at tolerable levels, then the private sector balance and the current account balance must move by roughly 7 percentage points of GDP to take up the slack.
The first flaw in this argument is Dudley’s suggestion that the deficit cannot continue because the debt is too large. The answer to that is that, to repeat, a deficit can perfectly well be funded by new money rather than by debt.
Put another way, debt reduction should not be an important or central economic objective. The main economic objective is keeping total numbers employed as high as is consistent with acceptable inflation.
The deficit should be whatever is needed to attain the latter objective. And then, having decided on the deficit, there is the question as to whether to fund it via debt or new money. And the arguments for funding via debt are thin on the ground (and more on this below).
The deficit might need to last another five years.
If households want to continue deleveraging or saving up dollars for the next FIVE YEARS, that does not mean as per Dudley logic that the US government has to go ever deeper into debt. The US government can simply print dollars to supply households with what they want.
Indeed, the present rate of deleveraging will have to continue for another five years or so if households want to reverse the leveraging they undertook between Jan 2005 and Jan 2008. At least that is the case if the first chart here is any guide.
Moreover, since it is money that households are after, it is eminently reasonable to fund the deficit via cash rather than debt.
Central bankers shouldn’t worry about private sector investment.
Dudley then says:
“Assuming that the consumption share of GDP still needs to fall over the medium term, the adjustment in the U.S. private balance will have to occur primarily in terms of rising residential or business fixed investment.
There does seem to be room for business investment to expand significantly when firms become more confident in the economic outlook, provided that the United States remains a competitive location for investment. But residential investment is unlikely to climb very much for some time given the chronic overhang of unsold homes.
If these two sectors cannot take up all the slack created by necessary fiscal retrenchment in the years ahead—as seems likely—then the U.S. trade balance will need to improve as well. This implies that emerging market economies (EMSs) will no longer be able to rely on expanding U.S. demand as a key driver of their own economic growth.”
In other words he is saying that if the injection by the public sector into the private sector ceases, some other injection (and investment is all he can think of) must take its place. Well the flaw in this argument is that, despite what it says in economics text books, injection can take the form of demand for consumer goods just as much as investment goods. Indeed, there is not even a sharp dividing line between the two: is something that lasts one year a consumer good or an investment good? What about two years . . three years?
Put another way, if demand by the US private sector for US private sector produced stuff expands or speeds up sufficiently, the injection from government can just cease. Period. Full stop. As to how this extra demand by the private sector breaks down as between consumer and investment goods – who cares? We don’t need central bankers worrying about that. The free market can sort that out for itself.
Thus the idea that a smallish demand for investment goods necessitates reducing the flow of dollars out of the US to EMEs does not add up. Put another way, if EMEs want to save up dollars, let them! Of course Uncle Sam will have to print dollars to supply EMEs with the dollars they want. And would require a continued but smaller deficit. But that’s not a problem.
In fact, being able to churn out bits of paper with “$100” printed on them (to put it figuratively) and exchange those bits of paper for real goods and services is great. Even better, the value of the bits of paper can be degraded by inflation. Wish I could do that! Put yet another way, anyone in the position to do some seigniorage can make good money. That’s what banks do, and if the US gets its act together, it can be the world’s banker for a few years yet before the Yuan becomes the world’s reserve currency.
Why fund a deficit via debt rather than with new money?
The first nonsensical aspect of funding via debt is that it amounts to asking to become indebted to other countries. That is, foreigners can buy one’s national debt. E.g. China holds a big chunk of U.S. debt.
Now there is nothing wrong with a microeconomic entity like a household or firm borrowing from abroad. But there is a problem when government does this, which is as follows.
Where government collects insufficient tax to cover its spending, it has to borrow instead. And the purpose of the borrowing is to provide a demand reducing effect to counteract the demand increasing (and possibly inflationary) effect that would come from just printing money to cover the tax shortfall.
But if a country borrows from abroad, it is debatable as to how much of a demand reducing effect there is. Certainly if some foreign entity brings money into the debtor country SPECIFICALLY to lend to the debtor government, there is no demand reducing effect at all! That leads to the farcical situation of the debtor country paying interest to the foreign entity, and then having to borrow as much again from domestic entities so as to get the demand reducing effect!
Of course in the real world, things aren’t that simple. For example the dollars that China allocates to US national debt are (at a guess) dollars that China would be holding anyway as a result of China’s export fetish. Nevertheless, capital moves freely across national boundaries nowadays. And you can be sure that as soon as some country announces a desire to borrow, potential lenders around the world take a look at what’s on offer.
A second daft aspect of funding a deficit via debt rather than new money is this. Regardless of whether a government borrows from domestic or foreign entities, what’s the point in a government borrowing money, and paying interest for the privilege, when it can produce such money itself for free anytime? That is as daft as a dairy farmer buying milk in a shop when there is a hundred gallon tank of milk outside the farmer’s back door.
Money printing causes inflation?
The rest of this post explains why money printing does not necessarily exacerbate inflation. So readers who know why additional money does not necessarily mean inflation can stop reading here.
The fact that governments can and do print money does not of course mean they can print it willy nilly. On the other hand the idea that money supply increases necessarily lead to increased inflation is also nonsense. For example the U.S. monetary base has TREBBELED in the last two years: totally unprecedented. But inflation, just as many of us predicted, remains at a level that is very near the post WWII average. Plus the big money is not betting on increased inflation in the near future, if the yield on various Treasuries is anything to go by.
So how much money can be printed before inflation is exacerbated (either straight away or in a few years) and how should such money be allocated? Well the answer to that question can be explained to a fifteen year old in about five minutes. The answer is thus.
New or printed money will only exacerbate inflation if and when it gets spent in serious quantities and at a serious speed. I.e. if the money just sits in deposit accounts or under mattresses, it has no effect.
Money in banks is not always loaned out.
As to the idea that a money supply increase when it is plonked in bank deposit accounts will be loaned out and thus cause a rise in demand and/or inflation, well that idea flies in the face of both the evidence and the theory.
As to the evidence, banks currently have record reserves: which they are not lending out with any great enthusiasm!!!
As to the theory (and this explains WHY banks are not lending freely) banks lend when they see viable lending opportunities: for example businesses with bulging order books. Put another way, given a healthy level of aggregate demand, banks will lend. (Incidentally, this point highlights the absurdity of rescuing Wall Street rather than Main Street, and then expecting instant recovery as a result.)
So how much money should be printed? Well how about the government / central bank machine printing money and allocating the new money between private and public sectors in the ratio that these sectors currently form as a proportion of GDP: roughly two thirds for the private sector and one third for the public sector.
So as regards the latter, government just prints money and spends it on the usual public sector items: schools, law enforcement, etc.
As the regards the private sector, the new money needs to go to the ultimate source of all demand: the consumer. A payroll tax reduction would do the job.
And wouldn’t you know it – one of the leading lights of Modern Monetary Theory, Warren Mosler (4), has been advocating a payroll tax reduction since the recession began.
Unfortunately the incompetents actually in charge have allocated new money (via QE) to the people LEAST likely to spend it: bond holders, i.e. the rich: a shambles!
As to HOW MUCH money to print and distribute, there are no sure answers to this, and for the simple reason that households’ behaviour is not all that predictable. Nor is the behaviour of businesses, politicians, or any other group. In other words the effects of a deficit funded by new money are just as uncertain as the effects of a deficit funded by borrowed money. Either policy can lead to excess demand and thus inflation, or to too little demand and thus excess unemployment.
So how about just carrying on with the current deficit, funded with new money rather than borrowed money, and see what happens? If inflation looms, that can be controlled by “unprinting” money: that is, for example raising taxes and extinguishing the money collected.
1. Dudley: http://www.newyorkfed.org/newsevents/speeches/2011/dud110607.html
2. Keynes: http://www.scribd.com/doc/33886843/Keynes-NYT-Dec-31-1933
(2nd half of 5th para).
3. Friedman: http://nb.vse.cz/~BARTONP/mae911/friedman.pdf (p.250)
4. Mosler: http://www.hardassetsinvestor.com/videos/1868-warren-mosler-payroll-tax-holiday-needed.html?showall=&start=1
Friday, 10 June 2011
Bond holders in the Bank of Ireland who got a mouthwatering 13.75% for years complain about haircuts!
Even had these creditors of the Bank of Ireland received a more normal return on their investment, I wouldn’t have given a hoot if their entire investment had been wiped out. That’s free markets for you. Or it used to be: nowadays, the rich aren’t allowed to lose money. The latter is a privilege reserved for the poor or those with less good political connections.
Hat tip to Mark Wadsworth.
Wednesday, 8 June 2011
Here is a paragraph from a speech by Bernanke (in italics). If you dose off half way thru (and I wouldn’t blame you), you could skip to my less than flattering comments below.
Of course the head of a central bank holds a politically sensitive position, thus when reading their material it is necessary to read between the lines. Possibly Bernanke is just saying (in convoluted language) “we’ve got to do something about the deficit". At the same time, possibly he actually means what he says here:
The prospect of increasing fiscal drag on the recovery highlights one of the many difficult trade-offs faced by fiscal policymakers: If the nation is to have a healthy economic future, policymakers urgently need to put the federal government's finances on a sustainable trajectory. But, on the other hand, a sharp fiscal consolidation focused on the very near term could be self-defeating if it were to undercut the still-fragile recovery. The solution to this dilemma, I believe, lies in recognizing that our nation's fiscal problems are inherently long-term in nature. Consequently, the appropriate response is to move quickly to enact a credible, long-term plan for fiscal consolidation. By taking decisions today that lead to fiscal consolidation over a longer horizon, policymakers can avoid a sudden fiscal contraction that could put the recovery at risk. At the same time, establishing a credible plan for reducing future deficits now would not only enhance economic performance in the long run, but could also yield near-term benefits by leading to lower long-term interest rates and increased consumer and business confidence.
First, as regards “fiscal drag”, the latter is simply the tendency as GDP rises in money terms (as distinct from real terms) for more people to pay more income tax. This “fiscal drag” phenomenon goes on ALL THE TIME!!!! It happens regardless of whether there is a recession or no recession. It happens whether there is a deficit or a surplus. So why on earth does Bernanke mention it? Presumably just to pad out his speech with important sounding phrases like “fiscal drag”. (Incidentally, beware of the Wiki definition of fiscal drag. It’s wrong. It’s nice to see this definition contains an MMT phrase, “net savings desires”, but it’s much more important to get definitions right.)
Next, Bernanke tells us that a “sharp fiscal consolidation” would reduce demand, which is allegedly a “dilemma”. (By the way, the phrase “fiscal consolidation” sounds important, doesn’t it?)
Anyway, he has the solution for this “dilemma”. (Thank God for that). He says “The solution to this dilemma, I believe, lies in recognizing that our nation's fiscal problems are inherently long-term in nature.” Complete bunk!
At least half the deficit derives simply from the fact that a bunch a school children in Congress are squabbling about taxes, public spending, and related matters. And no one will agree to a decent tax increase unless they get their favourite toy. (That’s the so called structural deficit.)
This “dilemma” could be resolved in 24 hours if members of Congress just grow up and recognise that public spending ought to be funded by tax. The increased taxation that would resolve this “dilemma” would NOT, repeat NOT result in any standard of living hit for US citizens, despite the fact that large numbers of economic illiterates in high places think that some sort of pain or austerity WOULD flow from such tax increases. Reason is as follows.
If government (aka school children) decides to collect $X less in tax than is needed to cover public spending, then on the face of it, government has to borrow $X. (Actually that’s not strictly correct: what government needs to do is borrow an amount such that the demand reducing effect of the borrowing equals the demand increasing effect of $X worth of spending. But I won’t bother with strict accuracy on this point.)
Thus if government increases tax tomorrow by enough to cover all government spending, there’d be NO EFFECT on living standards, GDP, total numbers employed, etc etc. In short, there is no “austerity” or “pain”.
Conclusion so far: in as far as the deficit derives from the above childish behaviour, the “fiscal problems” are not, as Bernanke claims, “inherently long-term in nature.” Rather, the problem is political, and given an outbreak of common sense, could be solved in 24 hours. How long the problem persists is a POLITICAL JUDGEMENT. It could be short term or it could be very long term. But the problem is not “inherently long-term”.
As distinct from the extent to which the deficit derives from childishness, the deficit partially derives from stimulus. Here again, the so called problem is not inherently long-term nor does it make sense to “quickly to enact a credible, long-term plan for fiscal consolidation.” That is because the stimulus part of the deficit is a REACTION to the recession and the latters’ severity and duration (or it should be). I.e. the remedy needs to last as long as the disease lasts.
Tuesday, 7 June 2011
Hard on the heels of the 150 US right wing economists who can’t distinguish between their own personal political views and economics, a group of 52 UK left wing economists and academics have chirped up. The confusion of issues by these 52 individuals is just as bad as in the case of the above 150.
The “52” claim to be concerned about “sustainable growth” and deficit reduction. They don’t say which of the policies they advocate address which of the above two objectives. Anyway they advocate a “green new deal”. Presumably the “green new deal” helps bring about “sustainable growth” – that’s assuming the word “sustainable” is being used in the environmental sense.
Well now, the statement that a “green new deal” will help address problems “sustainable” in the environmental sense is true by definition, isn’t it? It’s a non-statement.
Moreover, why address matters “environmental” and “deficit” in the same letter or article? The two are entirely separate subjects. I.e. had the recession never happened, and we were currently enjoying full employment and no deficit, environmental issues would be just as important. In fact they’d be slightly MORE important because we’d be burning up more of the world’s scarce resources.
As to “targeted industrial policy” (more or less central economic planning), it may well be that the free market’s performance can be improved by having bureaucrats and politicians take major economic decisions (though I doubt it). But this has nothing specifically to do with deficit reduction or the recession. That is, if a bit of “targeted industrial policy” improves things, it will have this beneficial effect recession or no recession – and deficit or no deficit.
Next the 52 want a clamp down on tax avoidance. Same again: nothing specifically do with the recession or the deficit. That is, if it is relatively easy to catch tax avoiders, then fine – let’s go for it. But this will apply, presumably, at full employment.
And finally, the 52 want “real financial reform, job creatiohttp://www.blogger.com/img/blank.gifn, "unsqueezing" the incomes of the majority, the empowerment of workers and a better work-life balance.”
That’s so vague it’s hardly worth commenting on. As to “job creation”, who can argue with that? What are the 52 going to advocate next: apple pie and mother’s milk? The $64k question is EXACTLY HOW TO CREATE JOBS!!!! DOH!
The moral is: if you want to learn to think, don’t go to university :)
Afterthought, 21st June 2011. When I wrote the sentence just above about universities failing to teach students to think, I thought that was a joke. But it seems there is evidence to back this point.
Wednesday, 1 June 2011
150 economically illiterate economists have petitioned Obama to cut public spending. Apparantly is will cure America’s economic ills.
The flaws in this argument are basic, simple, glaring and elementary.
1. If a low level of public spending is essential to a healthy economy, how come some European counties enjoy similar living standards to America, while having levels of public spending relative to GDP that are double that of the U.S.?
2. The decision as to what level of public spending a county has is a POLITICAL decision. It is the basic political difference between left and right. It is a decision that is made at election time, not by economists.