Friday, 16 December 2016

The free market’s cure for a recession is a helicopter drop.

In a perfectly functioning free market and given a recession, wages and prices would fall in terms of dollars, pounds etc, which would increase the real value of the stock of money (base money in particular) which in turn would encourage spending.

In the REAL WORLD, the market is very far from perfectly free: in particular and to use Keynes's phrase, “wages are sticky downwards”. In other words, try cutting wages, and you’re likely to get strikes, if not riots.

That increase in the value of most people’s stock of money is known in economics as the “Pigou effect” after the economist Arthur Pigou.

Note that it’s the value of the stock of BASE MONEY (i.e. central bank issued money) which rises but not the value of the stock of COMMERCIAL BANK issued money that rises. At least in the case of commercial bank money, for each dollar of money there is a dollar of debt: reason is that commercial banks create or “print” money when they grant loans, as the opening sentences of a Bank of England article explains.  It’s often said that commercial bank money “nets to nothing”, which is true. (The BoE article is entitled “Money creation  in the modern economy”).

In other words base money is a net asset as viewed by the private sector, and by government spending departments, city authorities, etc. In contrast, commercial bank issued money is not a net asset.

In addition to the value of the stock of base money rising in a recession in a totally free market, the value of government debt also rises. Reason is that that is also a net asset as viewed by holders of that debt.

However, as MMTers (Warren Mosler in particular) pointed out some time ago, government debt is pretty much the same thing as base money. That is, the only thing government owes to holders of that debt is base money (when the debt matures). I.e. government debt can well be regarded as a deposit or term account at a bank called “government”.  Martin Wolf, chief economics commentator at the Financial Times, also made that point a year or two ago. As he put it “Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year JGBs yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny…”. (That’s in an article entitled “Warnings from Japan for the Eurozone”).

It could perhaps be argued that if the real value of the stock of government debt rises, that might induce government to REDUCE its spending. But that would be a very irrational thing for a government to do: that would just raise unemployment. What’s the point of that?

Moreover, it is very debatable as to whether so called government debt really is a debt. Reason is that government is free to grab any amount of that “debt” (aka base money) off the private sector whenever it wants. That’s the equivalent of someone being able to walk into the bank which gave them their mortgage and grabbing wads of £10 notes so as to pay off the “debt” they owe the bank: a strange sort of debt that would be.

In short, government debt can well be regarded as an asset as viewed by holders of that debt, but not as a liability of government. As Warren Mosler put it, government debt and base money are like points in a tennis match: first they are produced from nowhere, second, they are assets as viewed by players, and third, they are not liabilities as viewed by the umpire.

Having said that the free market’s cure for a recession is a helicopter drop, that’s not quite accurate in that under a helicopter drop (pun there if you like) there is a choice as to who gets the free money. And most of us would not regard those already in possession of a pile of money as being the first priority. Nevertheless, in a helicopter drop free market style, a very WIDE RANGE of entities find themselves in possession of more spending power, (to repeat) including some central government departments, city authorities, etc.

Interest rate adjustments.

It is often assumed that the free market’s main cure for a recession is to cut interest rates. (See here for discussions as to what extent central bank interest rate adjustments are actually a REACTION to market pressures rather than the basic cause of interest rate cuts in a recession.)

No doubt interest rates do fall of their own accord in a recession, but it would not be very logical of the free market if that were the free market’s MAIN reaction to a recession: reason is that borrowing based expenditure does not account for more than a smallish proportion of total spending (in both the public and private sectors).

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