Wednesday 16 July 2014

Simon Wren-Lewis versus MMT.




Simon Wren-Lewis claims we should try stabilise the debt at some proportion of GDP, whereas MMT says we shouldn't aim for any specific amount of debt: that is, the debt should be whatever level is need to bring full employment. Let’s examine that question.
Examples of SW-L’s claim are for example here, where he says “fiscal policy should be all about debt stabilisation”. And here he says, “….maintaining a 3% deficit would stabilise the debt to GDP ratio at 75% of GDP. I think that is still too high, and for various reasons it is good to plan for a steady fall in the debt to GDP ratio over the next few decades.”
Now the big problem with that idea is as follows. The private sector, as MMTers keep pointing out, desires some amount of savings in the form of base money and in the form of national debt (which is simply base money that pays interest). Plus it’s highly unlikely that the desired level of that form of saving will remain constant (or remain “stable”) over time. That is, it’s beyond dispute that the private sector has outbursts of Alan Greenspan’s “irrational exuberance” from time to time.  
So what happens when the desired level of savings RISES? Well Keynes gave the obvious and simple answer to that: we get so called paradox of thrift unemployment. That is, if people desist from spending (an activity that results in jobs being created or maintained), and instead switch to saving, then unemployment rises.
Now in that situation it’s completely fatuous to stick to some pre-determined amount of base money and debt. All that will happen is that unemployment rises.
To summarise, if the objective is to maximise numbers employed within the constraints posed by inflation, then government is JUST FORCED to adjust the total amount of base money and debt. In other words it’s plain fatuous to try to stick to some pre-determined level of base money and debt.

Interest on the debt.
And as to the debt-phobes who worry about the interest that government (i.e. taxpayers) pay on the debt, the answer to that little problem is that a government that issues its own currency can pay any rate of interest it likes on it’s debt, as various MMTers have pointed out. Puzzled? You don’t know how to cut the interest paid on the debt? Well it’s easily done: just put into reverse the process whereby the debt arose in the first place. It goes like this.
Governments are always tempted to spend more than they collect in tax. So to counterbalance the inflationary effect of that “policy” (to give it an unduly flattering name), governments induce the private sector to abstain from spending that excess stock of base money by attracting the money back into government coffers, and the “inducement” is of course the interest offered on that money.
So to reverse the process, the state just needs to print money and buy back the debt (i.e. implement QE), and as to any inflationary effects, deal with that by raising taxes.

Why pay interest on the debt at all?
Given that the state can pay any rate of interest on its debt that it likes, you might be wondering what the point is of paying any interest at all. That is, why not reduce the rate to zero?
Well that’s exactly what’s advocated by a leading MMTer, Warren Mosler – see 2nd last paragraph of his Huffington article "Proposals for the banking system" here. And Milton Friedman advocated the same “zero interest rate” policy. See paragraph starting “Under the proposal..”in his paper "A Monetary and Fiscal Framework for Economic Stability", American Economic Review, 1948. See here.
In fact the whole process of incurring debt is raving bonkers (not to put too fine a point on it). The “debt incurring” process in practice consists of the following. The state spends an excessive amount of its money into the private sector (net of taxes) and thus has to bribe the private sector not to spend that money, which is nice for those with cash to spare, but not so nice for taxpayers who in practice pay for the above “bribe” (i.e. interest).
Instead of spending an excessive amount net of taxes, wouldn’t it be simpler to simply raise taxes? Well yes it would. So why don’t governments do that? Well the reason was explained very succinctly by David Hume over 200 years ago.  As he put it, “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government.”

8 comments:

  1. I'm not sure I follow Ralph. Offering higher interest bearing savings accounts is in no way "bribing" the dollar holders not to spend. The Dollar holders are not spending (consumer purchases) that money whether or not savings accounts at the CB are available. They are investing their savings, and if they can't invest them in savings accounts at the CB (as QE demonstrates) they will save them in other locations. Either way the statement that CB savings accounts are a bribe to not spend money is deeply flawed.

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    1. The higher the interest that the CB or state offers you for lodging your money with them, the more money you’ll lodge with them, surely?

      “If they can't invest them in savings accounts at the CB (as QE demonstrates) they will save them in other locations.” I more or less agree, except that I’d say “if money cannot be invested with the CB it will EITHER be invested elsewhere, OR it’ll be spent on consumer items.” Either way, when the state raises interest rates, it has the desired effect: the private sector spends / invests less, and the state can spend / invest more.

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  2. I have to disagree here too:

    "The higher the interest that the CB or state offers you for lodging your money with them, the more money you’ll lodge with them, surely?"

    Not at all, if interest rates are higher at the Fed, then that means they are even higher at commercial banks and the money market. Its not:

    Fed raises rates higher than other savings account rates.

    Its:

    Fed rates are always below other savings accounts rates and when the Fed raises its rates, all rates increase, leaving largely unchanged the relative rates for different types of savings accounts.

    Now higher rates at the Fed may change the relative calculation between saving in different classes of assets or opportunities. Logically, it would be much harder to beat the interest rate at the Fed in the stock market if the FFR was 15% vs 0%. But thats the difference between personal logic and intuition and empirical reality, sometimes they don't mesh.

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    1. “if interest rates are higher at the Fed, then that means they are even higher at commercial banks and the money market”. No – and the reason is that a private sector investment has to EARN its keep, whereas the state (i.e. CB plus government) can pay any rate of interest it likes on the money it borrows,and SIMPLY GRAB the necessary funds to pay interest from taxpayers.

      Put another way, when the Fed raises rates, no doubt the main effect (as you suggest) is to raise rates for other borrowers. But a proportion of those borrowers (the least viable) just won’t be able to compete with the state and its dominant position: they’ll cease borrowing / pay back loans, and the relevant lenders will lend to the state instead.

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  3. "OR it’ll be spent on consumer items."

    No, there is absolutely no reason to think that the current owners of T-securities would ever consume enough real goods and services to cause an inflationary problem. Just look at who actually has their money in savings accounts at the Fed:

    http://www.npr.org/blogs/money/2013/10/10/230944425/everyone-the-u-s-government-owes-money-to-in-one-graph

    And then tell me who it is you think is in danger of spending their savings on consumer items.

    SS?
    The Fed?
    China?
    Japan?
    Federal Retirement and disability?
    Military retirement?
    Mutual Funds?
    State and local Govts?
    Banks and credit unions?
    state and local Govt pensions?
    Insurance companies?
    Private Pensions?

    The only plausible groups would be Individuals, corporations and others and they have less than 6% of total money on deposit in Fed savings accounts, and they would never spend 100% of it in any event, so the practical amount is so small as to be irrelevant, which of course was my point originally.

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    1. Fair point: clearly the large majority of any money NOT LOANED to the state will get loaned out or invested elsewhere rather than be spent on consumer items because the large majority is held by pension funds, China, etc rather than by individuals. But that doesn’t alter my basic point which is that if the Fed / state reduces the reward for lending to the state, then savers will tend to spend on investment items elsewhere.

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    2. Fair point: clearly the large majority of any money NOT LOANED to the state will get loaned out or invested elsewhere rather than be spent on consumer items because the large majority is held by pension funds, China, etc rather than by individuals. But that doesn’t alter my basic point which is that if the Fed / state reduces the reward for lending to the state, then savers will tend to spend on investment items elsewhere.

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  4. You are either ignoring my point or missing it.

    Savings accounts, savings accounts, savings accounts.

    The money you earn from your bank on your term savings deposits is always higher than a similar duration term account at the Fed.

    A 6-month Chase CD will just always pay more than a 6-month T-bill because thats what it means to add a risk premium onto the risk free rate.

    Therefore it doesn't matter for term savings accounts what the FFR is. In 1992 with a 5% FFR, a 6 month Chase CD paid more interest than a 6 month T-bill, just like it does during ZIRP.

    Which is to say that your entire premise of term savings accounts at the Fed bribing people to not spend their money is wrong.

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