Adair Turner: “It’s private debt that got us into this mess”.

That’s what he says 4 minutes into this interview. Well true, but whose fault is that? Well it’s partly the fault of Mr & Mrs Average who want government to stand behind or subsidise the private debt creation process. That is, Mr & Mrs A. want government to stand behind the money they’ve deposited in private banks.  So in effect, Mr & Mrs A. want private banks to be subsidised. And politicians can always win votes by subsidising whatever Mr & Mrs A. want to see subsidised.

To expand on that, “loans create deposits” as the saying goes. That is, when a private bank extends a loan and the borrower spends the relevant money, that money inevitably ends up as someone else’s deposit. And private banks, quite naturally, want to maximise the size of their businesses: that is they’ll expand the total volume of loans and deposits as far as they can.

So if governments stand behind deposits, they are effectively subsidising the private debt creation process.

Of course, if we abolished the too big to fail subsidy and other bank subsidies, the size of the private bank industry would shrink, the effect of which would be deflationary. But that’s easily made up for by having the government / central bank machine create and spend money into the economy. And that’s “debt free” money, as Positive Money calls it. That way Mr & Mrs A. (and indeed firms and corporations) would have a bigger stock of money, and thus wouldn’t NEED TO borrow so much: i.e. the total amount of private debt would shrink.

H/t to Positive Money, plus please note that the above views are my own: they haven’t been officially endorsed by PM, though as far as I know the above is fully compatible with PM policy.

Scott Sumner’s strange claim that the fiscal multiplier is zero.

He has made that claim in numerous blog posts, but this one is typical, and it’s entitled  “For the 247th time, the fiscal multiplier is roughly zero.” The 247 is presumably there to patronise dimwits like me and others who don’t agree with him. Anyway, let’s examine Sumner’s argument.

His reason for saying that the fiscal multiplier is zero is set out in the first two sentences of his post: “Keynesian economists have never been able to accept my assertion that the fiscal multiplier is roughly zero because the Fed steers the (nominal) economy.  There’s a mental block on their part…”

Well now a very good analogy to the latter argument can be made with those cars with two steering wheels and designed for learner drivers. The learner controls the car most of the time, but the instructor can take over by using the other wheel (e.g. in an emergency). Now you could say that the learner is not in control in that the instructor has the power to negate what the learner does. But does that mean that what the learner does is pointless or has no effect? Does it mean that really it’s the instructor who is “steering the nominal path” of the car (to use Sumner’s phraseology)?

Well in the case of a learner who is clued up, the instructor wouldn’t interfere. And in that case it’s the learner that is driving the car. It’s amazing that I need to spell this stuff out, isn’t it?

Same applies to monetary and fiscal policy. If fiscal stimulus is implemented, and the central bank thinks that stimulus is desirable, then the central bank won’t negate it. So in that case that particular bout of fiscal stimulus will work. Indeed, during the recent crisis, central banks (much to the surprise of Sumner, perhaps) AUGMENTED fiscal stimulus by cutting interest rates.

Which is better: monetary or fiscal stimulus?

That of course all leaves the question as to which is better: monetary or fiscal stimulus. My answer to that is that PURE monetary policy (i.e. relying just on interest rate adjustments or QE) is not a good idea. My reasons are here, here and here.

National debt is not deferred tax.

Debt-phobes are fond of telling us that national debt is deferred tax. While household name economists make plenty of blunders, they don’t seem to make the “deferred tax” mistake. That is, it’s second raters who make this mistake: e.g. Pete Peterson, Niall Ferguson and Alan Reynolds.

Let’s take a period over which US debt as a proportion of GDP declined substantially. In 1948 the proportion was 90% and in 1986 the proportion had halved. See this table.

Now how much tax was collected to pay back those creditors? Er…. None! In fact quite the opposite: the US debt rose in that period from $252bn to $2,125bn. Put another way, far from anyone having to pay tax of bring about that reduction in the debt relative to GDP, quite the opposite occurred. That is, taxpayers were EXCUSED paying about $2,000bn in tax in that period because the US government funded $2,000bn of its spending from extra borrowing rather than tax.

The above sort of “second raters” will be baffled. How can this be? Well the answer is that far and away the biggest way in which national debt is reduced is INFLATION!!!!!!

I.e. national debt is not deferred tax: it’s deferred robbing of a country’s creditors via inflation. And if you can rob your creditors, then why not? Go for it!!

Even in the decade or so after WWII when the debt fell faster relative to GDP than in any other decade, the debt in terms of dollars stayed more or less constant. I.e. no taxpayers were called on to bring about that substantial reduction in the debt.

Conclusion.

Of course, the above is not to suggest that governments can stop collecting tax altogether and instead, fund their expenditure from borrowing. But the basic point I’m making is that the “deferred tax” crowd (Peterson Institute, Niall Ferguson, etc) are a bit simple: they’ve much to learn if the want to understand the tax versus borrowing question.

As a start, I suggest they get to grips with Modern Monetary Theory.

Robert Skidelsky seems to be frightened of deficits.

Hot on the heals of the inane drivel coming from Summers and Krugman on the subject of secular stagnation, Skidelsky has now weighed in with the view that given a lack of investment opportunities and near zero population growth, there may be only source of the demand we need to bring full employment, namely “continuous fiscal deficits”.

As he puts it, “In this situation, full employment could be maintained only by running continuous fiscal deficits.” So what’s the problem with that, if Skidelsky is actually saying there is a problem there? And that’s not clear, but the suggestion seems to be that there’s a problem.

More clarity please, Prof. Skidelsky.