RALPHONOMICS

Fractional reserve causes artificially low interest rates.

2012-01-27T01:36:00.000-08:00

The argument put here for thinking that fractional reserve causes artificially low interest rates is a much expanded version of the argument I put here.

But first, let’s be clear on the various possible money regimes, of which four are thus.

1. A commodity based regime where the commodity based currency (e.g. gold coins) are the only form of money. In this regime, the gold coins are also the monetary base.

2. A commodity based regime where commercial banks build a pyramid of credit on the monetary base.

3. A fiat monetary base without commercial banks building a pyramid of credit on the base. This is the sort of regime that most present day advocates of full reserve want.

4. A fiat monetary base regime where commercial banks build a pyramid of credit on the base (which is the regime in most countries nowadays).

A fiat base regime.

Let us assume fiat base regime and that the base is large enough to ensure full employment, but not so large as to cause excessive inflation. (The full employment assumption is dropped a few paragraphs hence.)

As the economic text books explain, people and firms hold money for two motives: the precautionary and the transaction motive. Assuming everyone aims to keep these two stocks constant, then lenders can lend only by forgoing consumption. Thus the rate of interest charged by lenders will reflect the pain involved in this forgone consumption. And the advantage of that is that (at least at the margin) the benefits of any investment are equal to the cost in terms of the pain involved in forgoing the consumption needed to make the investment possible.

At any rate, let’s say that rate of interest in our hypothetical “monetary base only” economy is 5% for essentially risk free loans.

Enter commercial banks.

Now let us assume that commercial banks enter the scene. What banks do, amongst other things, is to offer loans (normally on the basis of collateral, of which property is the most common form). But no one needs to forgo consumption for a bank to lend, or so it would seem! Thus the bank will be happy to lend at a lower rate than those who forgo consumption in order to lend. A bank takes the title deeds of someone’s property, creates money out of thin air, and lends it to the person concerned.

Or as Murray Rothbard put it (and putting himself in the shoes of a banker) “I can charge a lower rate of interest than savers would. I don't have to save up the money myself, but can simply counterfeit it out of thin air.” (BTW: I don’t normally agree with Austrians!)

Let’s say banks can cover their costs by lending at 2%.

Some people are FORCED to reduce consumption.

Next, when the borrower spends what they have borrowed, the effect is inflationary (given the above full employment assumption). Hence government has to withdraw some monetary base to compensate, e.g. by raised taxes. Thus the reduced consumption that must take place to make room for the borrower to spend is FORCED onto those paying extra taxes.

So the net effect is that commercial bank created money displaces central bank money. Friedman alludes to this sort of effect when he says, “Private promises to pay the monetary commodity are as good as the monetary commodity itself – so long as they command widespread confidence that they will be fulfilled – and far cheaper to produce, since the issuers can meet possible demands for redemption by keeping on hand an amount of the monetary commodity equal to only a fraction of their outstanding promises. A pure commodity standard therefor tends to break down.” (That’s in Chapter 1 of his book “A Program for Monetary Stability”).

He goes too far in saying the “commodity standard breaks down”: the gold standard did not break down for the reason given by Friedman: it “broke down” because of a POLITICAL decision. However, and to repeat, Friedman alludes the sort of effect described here.

Anyway, commercial banks certainly will try to induce an economy to make maximum use commercial banks’ money and minimum use of the monetary base.

And this tussle between the two forms of money was played out in dramatic fashion when Abraham Lincoln issued green backs to fund his side in the American civil war. Commercial banks didn’t like it. See here, in particular the paragraph starting, “Abraham Lincoln. From this we see….”

Expansion of commercial bank loans versus a steady state.

The above way in which some consumers are FORCED to reduce consumption so as to make room for an EXPANSION in commercial bank loans must be distinguished from the scenario where commercial bank loans are NOT EXPANDING.

In the latter scenario, commercial bank loans presumably have no effect on demand because the creation of new loans is balanced by the repayment of existing loans.

But there is a permanent effect of allowing commercial bank credit or money creation, which is that interest rates are permanently reduced: they become sub-optimum.

After all, it is profitable for borrowers to borrow at 2% and invest in something that brings a 3% or 4% return. That beats all those investments that had to make a minimum of 5% return. Also a very significant proportion of borrowers take their “return” in kind: that is, when people borrow to buy a house, the return is the utility or satisfaction derived from living in a house (or owning a house rather than renting one).

Let’s assume some unemployment.

Full employment was assumed above. Let us now assume excess UNEMPLOYMENT. Here, there are two ways of raising demand. 1, expand the monetary base. 2, expand the amount of private bank lending.

The logic of the former is thus. The BASIC PURPOSE of an economy is to provide what the consumer wants. Thus given excess unemployment, the obvious and best solution is to give the consumer more that the stuff that lets the consumer have more of what they want: i.e. give the consumer more money. (Plus, public spending needs to be expanded by the same proportion as consumer spending expands if the economic expansion is to be politically neutral – that is, not biased towards the public or private sector.)

As regards expanding the amount of private bank lending, whence the assumption that resources are best allocated by such an expansion? That makes as much sense as assuming that given excess unemployment, it’s just spending on the military or education or airports that should be expanded.

Moreover, if stimulus is effected by giving the consumer more money and expanding public spending, THERE IS NOTHING TO STOP consumers or public sector entities from using the additional funds at their disposal to borrow more, where and when they see fit.

A new equilibrium.

The net effect of introducing commercial banks is that a new equilibrium arises. It is NOT an equilibrium at which at the margin the benefit derived from investments equals the pain or disutility of forgone consumption. It is an equilibrium at which at the margin the benefit derived from investments equals the costs to commercial banks of creating credit / money. (At least that’s my theory!).

The borrower’s property IS forgone consumption.

There might seem to be a flaw in the above argument, as follows. It was argued above that the private bank creates money / credit without any consumption being forgone. But it could on the face of it be argued that the borrower DID HAVE TO forgo consumption to acquire the property used as collateral to back the loan. The answer to that is that the property is not CONSUMED during the “lend and eventually pay back” process. Put another way, the lender does not forgo the results of the saving which was needed in order to purchase the property.

By the way, I’ve assumed above that all loans are backed by collateral in the form of property, as readers will have noticed. While this is the biggest single type of collateral, obviously there are other forms. And some loans are based on no collateral at all. However that does not change the argument much.

Full reserve’s big hitters.

And finally, please note that we full reservers have some big hitters on our side. William F. Hummel is one. Irving Fischer and James Tobin also favoured full reserve according to Mervyn King – see p.16 here. Plus there is Milton Friedman and Mike Shedlock.

Bibliography – or rather a list of other works on this subject and why I think they are flawed.

Brown, Ellen Hodgson. “The Web of Debt”. This is a full length book which argues against fractional reserve. It’s full of historical detail, but it says nothing about fractional reserve bringing artificially low interest rates, far as I can see.

Huerta De Soto, Jesus. “Money, Bank Credit and Economic Cycles”. This is a full length book which argues against fractional reserve. It is available online. It has “Austrian” written all over it.

Given the length of the book, it is short on good IDEAS. For example he devotes the FIRST THREE CHAPTERS to arguing that fractional reserve breaks legal principles. Well there is a simple answer to that. The important question relating to any activity is WHETHER ON BALANCE IT BRINGS BENEFITS. If it does, and in doing so, a legal principle is broken, then it’s the legal principle than needs amending, not the activity that should be banned.

Selgin, George. “Should We Let Banks Create Money?” Selgin is an advocate of fractional reserve, and his book is far better than Ellen Brown or Huerto de Soto’s. The book is well thought out, and sets out a detailed step by step argument.

On his p.97 Selgin DOES ADDRESS the artificially low interest point, and argues that commercial bank created money will not be inflationary if there is a DEMAND for that extra money. Agreed.

But Selgin then argues that if commercial banks lend too much, that results in creditors (i.e. those who deposit money in banks) holding more money they want, which according to Selgin means banks have to pay excessive rates of interest to persuade them keep their money there. (Exactly this phenomenon, incidentally, is spelled out by Warren Mosler in his hypothetical “parent, children and business card” economy.)

However there is a flaw in Selgin’s argument, as follows. Why should commercial banks be bothered if depositors find themselves with too much cash? The excess cash has an inflationary effect (as mentioned above), but that won’t bother banks too much. As far as commercial banks are concerned, inflation is a problem for government and central bank.

Moreover, if I can borrow at 2% rather than 5% to fund some project, I can afford to pay my suppliers a better price than someone doing a similar project and borrowing at 5%. Now if you are a supplier, and you already have your preferred stock of cash, and you spot the generous prices I’m offering for your product, you’ll just abandon those you currently supply, and take up my offer instead. Alternatively, you might opt to expand your business and supply BOTH me and your original customer. As to what you will do with the extra cash: well that’s not difficult: you’ll spend it on wine women and song – or something like that! And that will raise demand.

This is not to suggest that fractional reserve leads to instant hyper-inflation: clearly it does not. Amongst other reasons, that is because of the well known fact that if any INDIVIDUAL bank expands its lending much faster than its rivals, it is in trouble.

In fact the pace at which commercial bank money in the UK over the last few decades has grown in prominence compared to central bank money has been very leisurely.

The M0/M4 ratio declined from about 16% in 1969 to about 3.5% in 2000 (see here). Incidentally that decline in the importance of M0 is not explained to any great extent by the reduced use of physical cash. Physical cash as a proportion of M0 decline from around 10% in 1970 to roughly 2% in 1997 (see Chart 1 here – you’ll have to do your own calculations to check this).

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Former Archbishop of Canterbury backs cuts in welfare.

2012-01-25T02:29:00.000-08:00

One of the main arguments he puts is that Britain's national debt is too high, and that cutting welfare payments would reduce the debt.

Like about 90% of those who sound off on the subject of the debt and deficit, he doesn’t get the distinction between micro and macroeconomics: a major blunder. He is clearly not being divinely inspired.

So for about the hundredth time, I’ll explain the distinction.

A micro economic entity, like a household or firm, can certainly cut any deficit it has by cutting expenditure. Unfortunately, if a government does the same, it causes a drop in demand and a rise in unemployment: an outcome presumably not favoured by his grace.

Moreover, in that a deficit is required for stimulus purposes (i.e. employment raising or employment maintaining purposes) it is daft to even aim to cut the deficit.

But that’s not to say the debt and/or deficit cannot be cut. Reason is that the debt and deficit are partially structural in nature: that is they exist thru pure simple failure by politicians to collect enough tax. And that part of the deficit / debt is easily cut. To do so, proceed thus.

1. Print money and pay off creditors – and probably the best way to do so is to cease rolling over debt.

But that alone would probably be too inflationary. So (step 2), get some of the money for debt repayment / deficit reduction via extra tax. As long as the deflationary effect of the tax equals the inflationary effect of the money printing, there is NO NET EFFECT.

But that’s not to say that cutting the debt is necessarily desirable. Britain is currently borrowing at a negative real rate of interest far as I can see. We’re ripping our creditors off. So let’s carry on – that’s what I say. At the very least, there is no great urgency to cut the debt.

The former archbishop’s views on welfare dependency may well be valid. But his views on the deficit and debt are flawed.
Clerics – Christian, Buddhist, Jewish, Hindu, Muslim, Zoroastran, Druid, etc etc - please keep to your holy books, and don’t express views on subjects you haven’t studied.

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Employer of last resort on the 1970s - two articles.

2012-01-24T06:26:00.000-08:00

The first is by Milton Friedman. It’s stronger on rhetoric than cold impartial analysis, to put it politely. And the second concerns Denmark.

I re-produced these via optical character recognition from hard copy, so expect typos.

“Humphrey-Hawkins” by Milton Friedman, Newsweek, 2nd Aug, 1976.

A centerpiece of the Democratic fall campaign is the "Humphrey¬Hawkins Full Employment and Bal¬anced Growth Act of 1976." Support of that bill has become the litmus test of the true-blue Democratic faith of every candidate from Jimmy Carter to the aspirant for dogcatcher.

The present expanded version of the Humphrey-Hawkins bill em¬braces the earlier Humphrey-Javits bill. It proposes to establish a process of long range economic planning to achieve "a full-employment goal ... consistent with a rate of unemploy¬ment not in excess of 3 per centum of the adult Americans in the, civilian labor force, to be attained within not more than four years after the enactment" of the act, as well as a long list of other goodies.

ADAM SMITH'S' CRITIQUE

The best critique of this bill that I have come across was published 200 years ago in that great book, "The Wealth of Nations" by Adam Smith-" the original Adam Smith, not the cur¬rent impostor who has had the effrontery to adopt that, pseudonym.

Wrote Smith: "The statesman, who should attempt to direct private peo¬ple in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so danger¬ous as in the hands of a man who had folly and presumption enough to fan¬cy himself fit to exercise it."

Has any contemporary political writer described Hubert Humphrey more concisely?

Not to put too fine a point on it, the Humphrey-Hawkins bill is as close to a fraud as has ever served as a cam¬paign document. It is full of pious promises but contains no measures capable of fulfilling those promises. It would not reduce unemployment but simply add to government employ¬ment and reduce private employ¬ment, in the process making us all poorer and very likely igniting a new inflationary binge.

How can such a bill do otherwise? Easy enough to say that the govern¬- ment will be the employer of last resort. But where does the govern¬ment get the money? Ultimately, from you and me, by hook or by crook. If it spends, we don't. If it employs people, we don't.

Of course, people on welfare could be re-labeled "civil servants assigned to home duty," thereby reducing re¬corded unemployment without addi¬tional spending. But to do more - and Humphrey-Hawkins promises to do far more - requires more government' spending. The extra spending could be financed by higher explicit taxes In that case, taxpayers would have less to spend and would hire fewer people. The extra spending could be financed by higher borrowing. In that case, the lenders, or the borrowers outbid by government, would have less to spend. Government employ¬ment would replace employment in building homes or factories. Finally, the government could print the mon¬ey, which would tax us indirectly via inflation. We would have more pieces of paper to spend but could buy less. For a time, that could mean more government spending without less private spending, but surely by now we have learned that that is a fool's paradise that would not last.

Is anyone so naive as to suppose that the government jobs created will be more productive than the private jobs destroyed?

VISIBLE GOOD, INVISIBLE HARM

Why do democrats believe that Humphrey-Hawkins is such potent political soothing syrup? Do they have such a low opinion of the intelli- gence of the American people? I do not think so. It is for a very different reason – one that is for me a source, of so many harmful government policies: the visible vs. the invisible effects of government measures.

People hired by government know who is their benefactor. People who lose their jobs or fail to get them because of the government program do not know that that is the source of their problem. The good effects are visible. The bad effects are invisible. The good effects generate votes. The bad effects generate discontent, which is as likely to be directed at private business as at the government.

The great political challenge is to overcome this bias, which has been taking us down the slippery slope to ever bigger government and to the destruction of a free society.

“Why Hanstholm has no jobless youngsters”. Times article by Christopher Follett, 16th Dec 1980.

Reduced fishing quotas have hit the Danes, the biggest North Sea fishing nation, hard. leaving chronic unemployment, particularly among young people in the age group 18-25, in their wake.

Thanks, however, to a unique local initiative, Hanstholm, Denmark's third largest North Sea fishing port (and number one for its idustrial fisheries), situated on the remote north west coast of Jutland, has almost totally eradicated youth unemployment.

The Conservative dominated local town council of Hans tholm decided simply to forbid youth joblessness in 1979 by refusing - as it can under Danish law - to put young people on unemployment benefits or social welfare and creating employment for them instead. After its first year of operation Hanstholm's iob creation scheme is still enthusi¬astically backed by local union representatives, employers, and last but not least, by the young themselves, who would otherwise earn 90 per cent or more of their wages (in some case even more) in unemployment benefits and/ or social aid if they were on the dole.

With' a population of 6,000, Hanstholm, like most of depressed north Jutland, suffered from above average youth unemployment before the council stepped in. Unemployment in Denmark is among the worst in the European Community at present with 200,000 or nearly 8 per cent idle. Of this figure, young people make up 75,000 or nearly 40 per cent and the Danish government's latest economic forecasts foresee a further dramatic increase in coming years.

Depressingly, youth unemployment has doubled in Denmark in the past year alone. In the Hanstholm project, the jobs created for the young are mainly geared to the important local fisheries industry. Instead of buying in fish boxes and crates from outside, as many other Danish ports tend to do, the youth of Hanstholm now make them themselves.

The first year's production amounted to an impressive 80,000 crates, more than were needed locally. The excess was, profitably sold to visiting foreign fishing vessels, earning useful foreign exchange for the hard pressed fishing community. Other created jobs undertaken by the youth of Hanstholm the manufacture and repair of toys for local schools, gardening, carpentry, painting, recycling projects.

In addition the local town council absorbs many of the otherwise idle youth. Paying wages of 40 kroner (£2,90) an hour, as agreed with the unions. Hanstholm Kommune (council) estimates that the scheme is costing it a maximum 3m kroner (£215,000) a year, putting an extra 2 per cent on the local rates.

According to Mr Niels Graversen, the councillor in charge of the Hanstholm youth project, over 92 percent of the first year's "intake" of around 150 young people found work afterwards.

"The scheme has obvious advantages for all involved, the employers, the unions, the young and the town as a whole", Mr Graversen says.
"Young people who have taken part in our programmes, which vary in duration, gain a sense of fulfilment and achievement and are, in our experience, eventually more attractive prospects to potential employers than unemployed youths who have never had any work experience at all."

The only criticism to be heard from Hanstholm town council is against the Danish Social Democratic government in Copenhagen, which, it feels, does not give sufficient incentive to local authorities to carry out job creation schemes, While a Danish local authority is automatically refunded one half of its outgoings on unemployment benefits by the state, funds spent on job creation schemes are not reimbursed at all, creating an anomaly with which the Danish bureaucracy has not yet caught up.

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Central banks should do some fiscal.

2012-01-22T13:37:00.000-08:00

This paper by a professor of computer science, Russ Abbott, suggests that the Fed should have to right to alter sales taxes and payroll taxes. H/t to Scott Sumner. To download, click on the “One click download” phrase top centre. The paper is less than 1,000 words.

One advantage of this system, as the author points out (and as I pointed out here), is that implementing stimulus (or “anti-stimulus”) by monetary policies alone is distortionary: for example interest rate adjustments work only via entities that are significantly reliant on variable rate loans. (Technical problem: that link just above may take you to the end of the comments on the blog post linked to.)

In contrast, adjustments to a sales tax and/or payroll tax affects well over half of all households, and are thus less distortionary.

Politicians.

An obvious problem is that those economically illiterate politicians will balk at having some of their power removed.

However any politicians who make this objection are being illogical in that they conceded long ago that decisions on how much the economy needs speeding up or slowing down should be taken by central banks. Thus the only question is exactly how central banks should do this: monetary means alone, or monetary plus a bit of fiscal.

If politicians want to retain the right to control fiscal WITH A VIEW TO CONTROLLING STIMULUS, then they are saying the decision as to what stimulus an economy gets should be split between two bodies: central bank and a body of elected politicians. And that is PLAIN DAFT. As I pointed out here, you might as well have a car with two steering wheels one of them controlled by husband and the other by his wife in the middle of a marital breakdown.

Political neutrality.

A fault in Abbot’s proposal is that it is not politically neutral. That is, if stimulus is needed, only the private sector would be boosted under Abbot’s proposal. And that is a serious fault because it gives ammunition to the politicians who will claim their right to make political decisions is being diluted.

However, there is a very simple remedy namely to arrange for both public and private sectors to be boosted by the same percentage when stimulus is needed. To illustrate, given a need for stimulus, the central bank could cut the sales tax and/or payroll tax by enough to give an X% boost to the private sector over say the following two years. PLUS the central bank could tell politicians they can expand public sector spending by X% over the same period.

In short, the above “central banks do some fiscal” policy needn’t have ANY EFFECT WHATEVER on politicians’ control of the most basic political decisions that any country takes. These are first, what proportion of GDP is allocated to the public sector, and second, how public sector spending is split between education, the military, law enforcement, and so on.

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Government borrowing is pointless.

2012-01-21T06:44:00.000-08:00

Note: the word government is used here in the sense “government and central bank combined”.

The main and valid reason for any entity to borrow arises where the entity spots a legitimate or profitable way of spending money but happens to be short of cash. For example if a business thinks a new machine makes sense, but it doesn’t have enough cash to buy the machine, then borrowing is clearly a legitimate option.

But governments have a near inexhaustible source of cash: the taxpayer. And that applies to governments which issue their own currencies (monetarily sovereign governments) and those which don’t (e.g. Eurozone counties).

Monetarily sovereign countries of course have an additional source of cash, namely that they can print the stuff – though clearly they have to watch inflation when doing so.

Borrowing spreads costs across generations?

One popular excuse for borrowing to fund capital projects is that it spreads to cost across the generations: the generations that will benefit from the expenditure. That argument does not stand inspection. See blog post here. (Clicking on that link may take you to the end of the comments on that blog post - sorry.)

Borrowing means the rich pay?

Another popular excuse for government borrowing is that the funds will inevitably come from the rich, thus there might seem to be a re-distributive element here. There are several flaws in this argument.

1. The rich are not made any worse off: they get government bonds in exchange for their cash. And not only that, but the rich will presumably withdraw a finite amount of lending to the less-well off to fund lending to government.

2. To the extent that the rich DO NOT withdraw loans to the less well-off, what economists call an “injection” takes place. That is aggregate demand is raised. Indeed this is just the standard Keynesian “borrow and spend” remedy for deficient demand.

So if the “borrow so as to re-distribute” policy is carried out on an “all else equal” basis, then it is not legitimate to count the above apparent injection merit as a merit in the re-distribute policy.

3. There is a limit to how long the “borrow so as to re-distribute” policy can go on for before it results in government debt as a proportion of GDP rising to ridiculous levels.

Borrowing with a view to stimulus.

If stimulus is required, then as mentioned above, governments CAN implement the classic Keynsian borrow and spend policy. But what’s the point of government borrowing something (i.e. money) which it can produce in limitless quantities any time? It’s plain daft.

Indeed as Keynes himself and Milton Friedman pointed out, having government just print money and spend money it in a recession (and/or cut taxes) is a perfectly viable alternative to borrowing.

As Keynes put it “the public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money.” See 5th paragraph.

Re Friedman, see p.250, paragraph starting “Under the proposal…”.

So why do governments borrow?

Political cowardice of course!!!! Or put another way, it’s a way of buying votes.

Taxpayers tend to notice tax increases. But they are less likely to blame governments for any interest rate rise that comes from more government borrowing. Indeed, the latter sort of interest rate increase does not even necessarily take place because lenders may make up for their increased lending to government by tightening up on lending criteria to other borrowers rather than actually raising interest rates. In fact the latter phenomenon is taking place right now: interest rates are at near record lows, but small and medium size businesses are complaining about difficulty in getting loans.

Borrowing so as damp down demand.

There is one possibly valid reason for government borrowing, as follows.

Suppose a government borrowed nothing, but it thought that demand and inflation were becoming excessive. Such a government could simply announce it was willing to borrow at above the going rate of interest. That would withdraw money from the private sector, which would be deflationary.

However, this is not “borrowing” in the normal sense of the word. Normally when any entity borrows it is so as to spend the funds borrowed. The above anti-inflation trick would very definitely not involve government spending the relevant funds.

Smoothing tax receipts.

The money received by governments during the year varies from one month to the next, which might seem like a reason to borrow during the months when receipts are low. But why borrow when governments can print money at will? Because the result would be inflationary? Nope.

Entities due to pay a large chunk of tax in X months time will be perfectly well aware that this liability is in the pipe line. Assuming they have the cash to hand, they think very carefully before spending that cash.

Thus a government which has constant spending needs thru the year and erratic tax receipts does not need to borrow in the “lean” months. It can perfectly well print and spend money in the lean months and balance that by having taxes exceed spending in other months.

No government borrowing would cause a shortage of private sector net financial assets?

A possible objection to the above argument is that zero government borrowing would leave the private sector short of net financial assets, which might cause paradox of thrift unemployment. The answer to that is the clearly government must supply the private sector with the net financial assets that the latter wants, but this can be done with cash instead of government debt. Indeed, this is exactly what Friedman advocated in the paper linked to above.

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P.S. (22nd Jan) – Controlling interest rates. If government does not borrow, it loses control of interest rates, except to the extent mentioned under the heading “Borrowing so as to damp down demand” above. In short, government would be able to RAISE interest rates, given excess demand and inflation, but it would not be able to lower them, given a recession. Does this matter? I think not and for several reasons.

1. Abba Lerner did not advocate adjusting interest rates with a view to adjusting demand. (He DID ADVOCATE adjusting interest rates, but NOT so as to control demand.) See end of p.39 – start of p.41 here.

2. There is a long list of weaknesses in interest rate adjustment as a means of controlling demand. See here and here.

3. Warren Mosler, as far as I can see, advocated a regime quite similar to the one set out above: that’s a regime where government does not adjust interest rates. See here, final four paragraphs in particular.

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Mind boggling stupidity from the IMF and The Times.

2012-01-20T01:20:00.000-08:00

This IMF report argues that Japan needs to cut its national debt (h/t to Warren Mosler).

I’ve been thru the report, and no reasons are given for for Japan cutting its debt other than a selection of catchy and fashionable phrases like “fiscal sustainability”.

Other fashionable phrases, all of which have been debunked in Modern Monetary Theory literature abound in this report: the confidence fairy is there, as might be expected.

There is no appreciation of the fact that if Japanese citizens are happy to hold this debt at very low interest rates (and it’s very largely Japanese nationals rather than foreign nationals who hold Japanese debt), that indicates a desire by Japanese nationals to hold a relatively large quantity of net financial assets. And if those assets are not provided, you get paradox of thrift unemployment.

So if Japan heeds the IMF’s advice and unemployment rises in Japan in the next five years, we know who to blame: the IMF.

As Bill Mitchell has said time and again, the IMF is not fit for purpose and should be closed down. (Coincidentally Bill’s post today is yet another of his broadsides against the IMF.)

The Times.

This Times leading article is an inspiration. It claims that the solution for Britain’s economic ills is more investment.

As anyone who has got a quarter of the way thru a basic introductory economics text book knows, building a car plant capable of producing a thousand cars a week will not raise demand for cars by so much as one car per year. Though there are some apparent flaws the latter argument, which the gullible always fall for, as follows.

1. There is the fact that all investments are to some extent what economists call an “injection”, i.e. investments tend to increase aggregate demand. But raising demand is easy: just ask anyone who has got a quarter of the way thru a basic introductory economics text book.

2. There is the fact that really worthwhile investments can raise exports (cited by The Times). You knew that was coming didn’t you?

The problem there is that in this recession everyone else has had this brainwave. Obama thinks the U.S. can grow on the back of exports, and Germany is exhorting other European countries to be more like Germany and export more.

But you don’t even need to have OPENED a basic introductory economics text book to see the flaw in that one: it’s a zero sum game.

3. If the car plant is much more efficient than existing car plants, it will raise overall demand for cars, which might sound desirable. Trouble is that (apart from the above mentioned injection point) there is no reason to suppose aggregate demand rises in consequence. Thus the increased demand for cars will be at the expense of demand for other stuff. Net effect: zero.

In short, if inflation permits, why not just raise demand? Businesses invest when demand for their products warrants an investment. Businesses large and small do not need Times leader writers or bureaucrats or politicians to tell them when to invest and what to invest in.

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Government as employer of last resort.

2012-01-16T05:53:00.000-08:00

This is a summary of the arguments for allocating ELR people to EXISTING employers rather than to specially set up schemes or “employers” as was the case with the WPA in the 1930s.

The “factors of production” quandry.

If an ELR scheme employs little permanent skilled labour, capital equipment or materials, that will keep costs down, but it will tend to result in inefficiency. (See any basic introductory economics text book on the optimum combination of different factors of production.)

On the other hand, if an ELR scheme involves more normal ratios of the above factors of production, the scheme becomes indistinguishable from a normal or regular employer: in effect, ELR people are subsidised into work with regular employers.

So ELR employees might as well be subsidised into work with EXISTING regular employers (along the lines of CETA).

At NAIRU, ordering up other factors is inflationary.

The above argument is backed by another argument, as follows. If unemployment is above NAIRU (or the “natural level” or the “inflation barrier” level, or whatever you call it) the best cure for unemployment is a straight rise in demand. Therefor the niche for ELR is in dealing with “at or below NAIRU” unemployment. But in that scenario you cannot order up the above “other factors of production” to supply an ELR scheme because the regular economy is already at capacity – the result would be inflation. Thus allocating ELR people to specially set up schemes along the lines of the WPA is in a logical check mate. It’s caught between a rock and a hard place.

Anti-fraud measures.

But if ELR people ARE allocated to existing employers, as suggested above there is a problem, namely how to dissuade employers from using the subsidised labour to displace regular labour. The answer is to call the employer’s bluff: that is, place a time limit on how long a ELR person can stay with a given employer (as was done – not very well in my opinion – under CETA).

The time limit could be a SPECIFIC time limit, but even better would be to allow public employment agencies to remove ELR labour from any given employer randomly, or when such agencies think they’ve spotted an ELR vacancy with some other employer where the ELR employee would be more productive. That way, the employer is forced to claim the ELR subsidy only in respect of the employer’s LEAST productive employees: the employees which the employer does not mind losing. (No employer wants to lose PRODUCTIVE employees).

Employers could of course claim the subsidy in respect of a PRODUCTIVE employee and then on hearing that that the employee was about to be removed, cease claiming the subsidy. But that ruse is easily dealt with: either remove the employee anyway, or allow the employer to keep the employee, but make the employer repay the previous month or two’s worth of subsidy money.

The latter system WOULD result in a relatively fast turnover of ELR people, but that’s arguably quite beneficial. The unemployed are those who cannot find a suitable job. They are people who by definition in many cases are going to have to acquire new skills and find a new work environment. Thus giving them experience of a variety of new and different work environments would help them decide which to go for. Many millionaires started their careers with a series of dead end jobs.

The macroeconomics.

Does the macroeconomics of the above system stand inspection? I think so….

As unemployment falls, the marginal product of labour falls: that is the unemployed become increasingly unsuited to vacancies – until the point is reached where too many employers, rather than take labour from the dole queue, spend increasing amounts on advertising for staff. And that in effect means poaching staff from other firms, which bids up the price of labour, which equals inflation.

Thus the inflation / unemployment trade-off is improved if employers can be persuaded to take on relatively unsuitable employees. That’s employees who are not TOTALLY UNPRODUCITVE, but employees who employers would not take on but for the ELR subsidy.

“Existing employer ELR” = free market.

Note that the above system is similar to a totally free and unregulated labour market (a scenario which in theory involves zero unemployment). A totally free labour market involves no minimum wage laws, no state sponsored unemployment insurance, etc. And in this scenario, the unemployed – to a greater extent than is currently the case – would take temporary and relatively low paid unproductive jobs pending the appearance of something better.

In short, the above system (if it works) would gain the advantages of a totally free labour market without the social costs.

Private sector ELR more inflationary than public sector?

It is commonly assumed that public sector ELR requires no increase in demand, thus it must be less inflationary than private sector ELR. Not true.

If the idea set out above under the heading “The Macroeconomics” works to perfection, the only net effect of introducing “existing employer ELR” is to induce employers (public and private) to marginally expand their workforces by taking on a few more less skilled people, while NOT INDUCING employers to order up more capital equipment, materials, etc.

In that case, neither public sector ELR nor private sector ELR has any inflationary effect.

Alternatively, it could be that employers ARE INDUCED to order up some more capital equipment and materials, and the effect would certainly be inflationary. But let’s have a fair comparison between public and private sectors here: let’s compare a public and private sector employer where the RATIOS of different factors of production employed are the same. On that assumption, there is no reason to suppose the private sector employer will order up MORE CAPITAL EQUIPMENT etc. than the public sector employer.

Thus there is no difference between the two sectors, inflation-wise.

Bureaucratic costs.

But having said all that, as Cullen Roche and John Carney have correctly suggested recently, the bureaucratic costs of any ELR system could exceed the benefits.

P.S. The above system probably occurs to some extent anyway in that as unemployment rises, there is an increased tendency to work on the black market while continuing to claim unemployment benefit.

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Think(?)tank advocates shorter working hours as cure for unemployment.

2012-01-15T00:21:00.000-08:00

OMG & WTF: The New Economics Foundation (NEF) is advocating shortening the working week to about 20 hours as a way of reducing unemployment! Not that one again!!!

To be fair, the NEF do advocate a number of other advantages to a shorter working week, such as reduced stress and reduced consumption of the world’s scarce resources. I have no quarrel with that. Indeed Jesus, 2000 years ago, and Buddha six hundred years before that were advocating people should be less concerned with worldly wealth. Perhaps they were right.

The NEF’s (hopefully temporary) departure from sanity would not matter if the rest of the world was clued up as to the basic flaw in the “shorter working week as a cure for unemployment” myth. Unfortunately it’s not.

Certainly the above Huffington article doesn’t get it, nor does this respectable economics tutorial site.

Even Robert Skidelsky, an economist I normally greatly respect, seems to have fallen for this nonsense.

The fallacious lump of labour fallacy.

The most popular rebuttal of the shorter working week argument is to cite the so called “lump of labour” fallacy. Personally I find the lump of labour fallacy very muddled and unconvincing. Here is just one reason.

The lump of labour argument normally accuses advocates of the shorter working week of assuming (to quote Wiki) that “the number of hours of labour per day that are demanded by the market is constant”.

Well it’s blindingly obvious that advocates of the shorter working week are NOT MAKING that assumption. To illustrate, suppose the entire workforce of a country cuts working hours from 40 to 20 hours a week, and let’s say unemployment is at the maximum it has reached in the US in the last three years: about 10%.

Let’s also make the over-simple assumption that the aim is to reduce unemployment to zero.

Achieving this end in the above hypothetical scenario quite clearly DOES NOT require there to be a CONSTANT demand for labour hours. Indeed, if there were such a constant demand, then demand would be far too high!!! Here’s the maths.

The original number of hours worked involved 0.9 of the workforce working 40 hours. 0.9 x 40 = 36. The new number of hours will be 100% of the workforce working 20 hours. 1.0 x 20 = 20. Thus the new total demand for labour hours needs to be 20/36 = 0.55 of the original total number. QED.

Conclusion: the lump of labour fallacy is itself fallacious!

The real flaw.

Now for the real flaw in the shorter working week argument.

The REAL flaw in in the shorter working hours is not actually a hundred miles from the above Wiki one, and it is thus. The shorter working week argument assumes aggregate labour supply can be reduced relative to aggregate demand for labour with no inflationary consequences. Now if that’s the case, then aggregate demand for labour can presumably be increased relative to aggregate labour supply with no inflationary consequences! In short, if the objective is to reduce unemployment, why not just bump up demand?

Note that what I called the “real flaw” in the shorter working week argument is actually the same as the Wiki argument, but put in more general terms. I.e. the Wiki argument is a PARTICULAR CASE of my “real flaw”.

Anyway, if you are convinced, then read no further. But for those who want a more detailed explanation, read on.

More details.

As unemployment falls it becomes increasingly difficult for employers to find the types of labour they want. And when it falls far enough, too many employers resort to poaching staff from other firms rather than take labour from the ranks of the unemployed.

This poaching may be conscious or it may be entirely unconscious. E.g. the more difficult it is to find specific types of labour from the dole queue, the more an employer is likely to spend on advertising for such labour, which inevitably tends to draw a labour from other firms, all of which tends result in the price of labour rising too fast in nominal terms, and that equals inflation.

That lack of the right type of labour on each local labour market is a simple statistical phenomenon: that is, the smaller the number of unemployed, the less the likelihood of any given employer being able to find the labour they want from the dole queue.

Now if one cuts working hours, that has NO EFFECT WHATEVER on the likelihood of employers being able to find the labour they want from the dole queue at any given level of unemployment. Ergo NAIRU or the “natural level of unemployment” or the “inflation barrier level of unemployment” to paraphrase Bill Mitchell remains exactly where it was.

I’ll put that differently just to clarify. If at unemployment level X, the last plumber disappears from the dole queue in a particular town when everyone is doing 40 hours a week, then the last plumber will also disappear from the dole queue at exactly the same level of unemployment when everyone does 30 or 20 hours a week. (That assumes of course that the PATTERN of demand for labour on each local labour market remains unaltered by the working hours reduction: i.e. I’m assuming that the demand for plumbers RELATIVE TO the demand for other skills remains unaltered, which is not a wildly unrealistic assumption.)

Conclusion: shortening the working week does absolutely nothing to improve the unemployment / inflation trade-off. Therefor unemployment will be
unaffected.

Immigration raises labour supply – shock horror.

A curious feature of those who advocate a shorter working week is that my hunch is they are the same sort of people who claim that immigration does not raise unemployment: (left of centre / liberal / politically correct, etc).
So they’re saying that in the case of immigration, increasing aggregate labour supply DOES NOT raise unemployment, but were we to increase labour supply by increasing the working week from say 20 hours to 40 hours, that WOULD INCREASE unemployment. A slight self-contradiction there, I think.

____________

Afterthought (same day): Here’s Tim Worstall’s take on the NEF. Tim Worstall’s blog is worth following. His style is very sarcastic, abusive and witty. He uses three and four letter words with regularity. But he does understand economics, so I keep an eye on his blog with a view to knicking his ideas and presenting them as my own :-). Imitation is the sincerest form of flattery.

Afterthought (22nd Jan). I said above that cutting working hours has no effect on the “likelihood of employers being able to find the labour they want from the dole queue”. On second thoughts, reducing working hours involves those who work for employment agencies (private and public) ALSO reducing their working hours. Such agencies will thus devote less time per week to each of their customers. Thus the above mentioned “likelihood” will DETERIORATE. Hence reduced working hours will actually RAISE unemployment all else equal.

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Got two minutes to waste? Here’s some info on the economics of the oldest profession.

2012-01-14T01:58:00.000-08:00

Hans, a German tourist, is in Orlando, Florida for his holiday. One evening he heads for the red light district and enters a brothel.

The madame in charge allocates a young woman to him and they sit talking for a minute. Then Hans whispers something in the woman’s ear. She jumps up and says, “Certainly not”, and walks off.

Madame sees this, and decides that Hans’s unusual requirements could perhaps be met by a more experienced woman. So she allocates a more experienced woman to Hans.

They sit talking for a minute. Then Hans whispers something in her ear. She jumps up screaming and runs away.

Madame is now intrigued and decides to do the honours herself. So she sits down beside Hans and offers her services. They talk for a minute. Hans is now embarrassed at being rejected by the two previous women. So he then says in an especially quiet and subdued whisper: “Can I pay in Euros?”.

An argument for private sector JG.

2012-01-13T03:41:00.000-08:00

The electorate votes for a public sector which it thinks is of a size such that the marginal product of labour in both private and public sector is the same. (For a definition of marginal product, see ** below).

I.e. we all want a public sector of a size such that shifting a small amount of labour from one sector to the other makes what we believe to be little difference to our overall well-being. Thus any argument on the relative merits of public and private sector JG must proceed on the basis that the marginal product of labour in both sectors is the same, before JG is set up.

Now if JG is created JUST in one sector (say the public sector), the marginal product of labour in that sector will decline to below that of the private sector: not what the electorate presumably wants. And this phenomenon is reinforced by the fact that public sector is not good at employing the less skilled.

Thus, if the rules governing how public and private sector employers hire JG labour are the same, GDP is maximised for a given total number of JG employees.

Existing employers versus “specially set up schemes”.

Let’s assume JG is confined to the public sector. There is then a choice between allocating JG employees to EXISTING public sector employers or creating what might be called “specially set up” schemes. The latter were more or less what the WPA in the 1930s consisted of.

The advantage is using EXISTING employers is that it largely disposes of a big problem that afflicts the whole JG idea, namely what might be called the “skill mix” problem.

This problem was referred to by Malcolm Sawyer in a paper on JG. See under the heading “Functional Finance and ELR” in his paper.

The skill mix problem is as follows. If unemployment is well above NAIRU, much the best way of bringing down unemployment is a straight rise in demand, not JG. Therefor the real niche for JG is in dealing with “at or below NAIRU” unemployment. (Incidentally, I’m using the acronym NAIRU in a very loose sense: if you prefer “natural level” or Bill Mitchell’s “inflation barrier” idea, that’s OK by me. I’ve never had much interest in the differences between these quite similar ideas.)

So let’s assume unemployment is at NAIRU. Of course no one knows with any great accuracy what level of unemployment corresponds to NAIRU. But that doesn’t matter: the purpose here is to set up a JG system which is perfect IN THEORY, and that’s worth doing. The real world is one big mess compared to the world of theory, and JG in the real world might be such a mess that it’s not worth implementing. But that’s another matter.

Getting back the skill mix problem, the big problem facing an economy at NAIRU is the difficulty employers have in finding the types of labour they want on each local labour market. Thus any “specially set up” JG scheme (which by definition gets its labour exclusively or almost exclusively from the ranks of the unemployed) will have a skewed labour force: in all probability it will be biased towards the less skilled.

However, that problem is ameliorated if JG people are allocated to EXISTING employers. To illustrate, an employer with what the employer regards as a perfect mix of different skills can probably cope with a few more less skilled people if the price is right – i.e. if those additional less skilled people get the JG subsidy.

** The Oxford Dictionary of Economics defines “Marginal product” as “the extra output that results from a small increase in an input….”. Thus the marginal product of labour in a particular firm or sector of the economy is the extra output obtained from employing one extra person (or person hour) in that firm or sector.

Afterthought (same day): John Carney also refers to the skill mix problem.

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UK graduate, Cait Reilly, objects to her new JG job.

2012-01-12T11:38:00.000-08:00

Subsidised temporary employment is not a bad way of dealing with unemployment. The advocates of Modern Monetary Theory tend to call this form of employment “Job Guarantee” (JG).

The story in brief is thus. A graduate already doing volunteer work for a museum was told she’d have to work instead in a shop - stacking shelves and sweeping floors. (h/t to Mark Wadsworth)

The graduate didn’t like the shelf stacking assignment, so she’s suing the government department that allocated her to it.

What the graduate has going for her (seems to me) is that she was ALREADY doing something useful. So why the need to re-allocate her?

On the other hand, there is much to be said for private sector JG: the empirical evidence is that those who do private sector JG have more successful subsequent employment histories than those doing public sector JG. See here.

Plus there is a good argument for not allowing JG employees to stay with a given employer for too long: it tempts employers into abusing the system - that is employing people who are in reality normal productive employees on a subsidised basis. (For more on this, see under heading “11. Fraud and other rules governing TES” here.)

The graduate complained she was being forced to do “futile, unpaid labour”. Invalid argument: she was doing unpaid labour anyway!!!!! As to whether the shop work was “futile”, she may have thought that as a graduate, stacking shelves was beneath her dignity, but other than that, the work was certainly not futile: she was doing something that paying customers actually want – helping run a shop that supplies goods that ordinary people want. Moreover, the shop concerned (Poundland) caters for the less well off – not millionaires.

So my judgement is thus. If Ms Reilly has only been in the museum job for two or three weeks, have that job registered as an official JG job, and let her stay there for two or three months. On the other hand if she’s already been in the museum job for two or three months, she’ll have gained some valuable “museum experience”, and it’s time for to move on and see something of the less effete, brutal world of commerce.

_________

Stop press: Cait Reilly puts her side of the storey.

The economics of immigration: nonsense in The Guardian.

2012-01-12T04:36:00.000-08:00

The hardcopy version of this Guardian article on immigration has a truly inspiring couple of sentences in extra bold type just beside the article. Plus the extra bold couple of sentences have oodles of blank space just above: so Guardian journalists / editors must think the two sentences are unusually profound.

The two sentences say, “GDP goes up with immigration. So if you’re asking what’s ‘best for Britain’, in the politician’s terms, that’s your answer.”

Well it’s pretty stark staring obvious that the more people there are in a country, the larger is GDP. And that’s true even if the new arrivals are far less productive than existing inhabitants (which they aren’t: the two groups are roughly speaking equally productive).

Exactly what the advantage of more car parks, factories, housing estates, etc is for one of the most heavily populated countries in the World, I’m not sure. You certainly won’t find any explanation in this Guardian article.

This apparent inability of Britain’s political left to work out the different between changes to GDP and changes to GDP per head has been going on for some time.

The government’s submission to the House of Lords enquiry into immigration in 2007 (when Labour were in power) is also based on the above bit of nonsense. On p.11 of this work, they cite a paper produced by the National Institute of Economic and Social Research (NIESR). But if you look at the small print of the NIESR paper, you find that it also simply makes the banal point that increasing the population increases GDP.

And we pay taxes to fund the NIESR!

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The effect of temporary subsidised employment on employability.

2012-01-10T10:42:00.000-08:00

Temporary subsidised employment (TSE), like the Job Guarantee, and the training that is often associated with TSE hopefully raises or at least maintains the employability of those concerned. But is this the actual effect?

These two studies done in Switzerland claim that TSE in the private sector produces significant benefits. In contrast, the benefits of public sector TSE are not as good. As to training, the benefits are not as good as private sector TSE.

TSE does not seem to bring benefits for those with a good chance of finding work anyway (not a big surprise, I suppose).

The above two categories “private sector TSE” and “public sector TSE” do not capture the actual nature of the various TSE schemes in Switzerland with 100% accuracy. But they are a more or less correct characterisation. Anyone interested in precise definitions will have to look at the papers.

1. “A Microeconometric Evaluation of Active Labour Market Policy in Switzerland”
http://ideas.repec.org/p/iza/izadps/dp154.html

2. “Does Subsidised Temporary Employment Get the Unemployed Back to Work?”
http://ideas.repec.org/p/iza/izadps/dp606.html

Some other bits of empirical evidence are as follows.

3. Booth, A.L., Francesconi, M. and Frank, J. (2000), ‘Temporary jobs: Who Gets
Them, What Are They Worth, And Do They Lead Anywhere?’ Discussion Paper 00/54, Institute for Labour Research, University of Essex.

http://dtserv1.compsy.uni-jena.de/ws2005/wisosoz_uj/25747702/content.nsf/Pages/5FC6494774878700C1257125005FB932/$FILE/Booth,%20Alison%20L.%20%20Francesconi,%20Marco%20%20Frank,%20Jeff%202001%20Temporary%20Jobs%20%20Who%20Gets%20Them,%20What%20Are%20Th.pdf

This paper showed that those prepared to do temporary jobs (not necessarily subsidised jobs) fared better in subsequent employment histories than those not prepared to do temporary jobs. This effect was more marked for women than men.

4. Calmfors, L., Forslund, A. and Hemstrom, M. (2002), ‘Does Active Labour Market Policy Work? – Lessons from the Swedish Experience’, Institute for Labour Market Policy Evaluation, Uppsala.
http://www.ifau.se/upload/pdf/se/2002/wp02-04.pdf

This confirms the Swiss finding that TES – i.e. “learning by doing” – yields better results than formal training.

5. Bolvig, I., Jensen, P. And Rosholm, M. (2003), ‘The Employment Effect of Active
Social Policy’, Discussion Paper 736, Institute for the Study of Labour (IZA), Bonn.
http://ftp.iza.org/dp736.pdf

This pretty well confirms the above studies, with the surprising additional claim that training actually IMPAIRS employability.

______________

Afterthought (11th Jan). Here is another paper by Calmfors & Co with a more pessimistic take on the benefits of TSE and similar labour market programs. Title of paper: “The effects of active labour market policies in Sweden: What is the evidence?”. See:

http://mitpress.mit.edu/books/chapters/0262012138chap1.pdf

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I love Mervyn King (in a Platonic sort of way).

2012-01-08T23:13:00.000-08:00

Mervyn King, governor of the Bank of England said, “If there is a need for genuinely safe deposits the only way they can be provided while ensuring costs and benefits are fully aligned, is to insist such deposits do not coexist with risky assets.” Quite right.

He also said, “Of all the many ways of organising banking the worst is the one we have today”. Right again.

The big problem in using deposits (made safe thanks to the taxpayer) to fund risky investments is that this is a subsidy of commerce. And it is a HUGE subsidy.

That can be put another way. If you invest directly in shares in corporation X and it goes bust, you lose some or all your money. But if you put money into a bank account, and the bank uses your money to buy shares in corporation X, or makes a loan to the corporation and it goes bust plus the bank goes bust, you are safe. You keep your money.

It’s a free lunch! And of course the taxpayer pays for the meal.

Two types of bank account.

My favourite solution to this problem is to require depositors to come clean: make them choose between two alternatives. First they can have 100% safe accounts, or second, they can have what might be called “investment accounts” (for want of a better phrase).

Money put into safe accounts would NOT be invested in anything remotely risky: perhaps it could be deposited at the central bank. Those accounts would have a government guarantee, but they’d earn little or no interest.

In contrast, money in investment accounts WOULD BE invested in commerce, mortgages, etc. A decent rate of interest would probably be earned, but there would be no taxpayer funded rescue if the bank went belly up.

Regulation is simplified.

The beauty of the above system is that bank regulation is simplified. As regards investment accounts, there’d be no more need for more regulation than applies to the stock exchange. If you buy shares it’s largely a case of “buyer beware”: same principle would apply to those wanting investment accounts.

As to safe accounts, the money has to be lodged at the central bank, or perhaps invested in government stock. That is dead simple. It is easy to check up on and audit.

Would lending would be constrained?

An apparent problem with the above system is that if a significant proportion of depositors opt for safe accounts, then funds available for banks to lend might seem to be reduced, which might seem to constrain economic growth. And banks can be relied on to shout this argument from the rooftops. (You can tell how concerned banks are about economic growth from the wonders they’ve done for economic growth over the last four years – ho ho.)

Anyway, the answer to the above economic growth argument is that if you implement a taxpayer funded subsidy for any activity (bank lending to business, or anything else), that activity will expand. And conversely, if the subsidy is withdraw, then the activity will become less popular.

However to argue that constraining loans by banks constrains economic activity is nonsense in that there are alternative ways of funding businesses: shares, bonds, etc. Thus to the extent that the latter funding methods made up for reduced bank lending, there would be no reduced funding for businesses.

But even if total funding for businesses did decline, that in no way stops government boosting aggregate demand when appropriate and maintaining full employment (in as far as governments have the competence to do this - and clearly they are not 100% competent in this regard.)

Moreover, where total funding for business DID DECLINE, it is false logic to argue that GDP declines. That reduction in total funding for business, if it occurred, would simply result from the withdrawal of an unjustified subsidy.

And subsidies DISTORT ECONOMIES and lead to a GDP REDUCTIONS. So unless someone can prove that there is market failure which leads to a sub-optimum amount of funding for business, then any reduction in such funding as a result of withdrawing the above subsidy will lead to AN INCREASE IN GDP, not a DECREASE.

Put another way, there is an OPTIMUM amount to be invested in any business or in a nation’s entire business sector. The amount invested can be too much as well as too little. Untill someone shows that the above subsidy is justified because of market failure, the assumption must be that removing the subsidy will result in us moving from excess investment to something nearer the OPTIMUM.

Now bankers: get out of that one.

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The cure for excessive and irresponsible lending is to encourage more lending (ha ha).

2012-01-06T23:01:00.000-08:00

Let’s celebrate the New Year with a good laugh at the imbecility of those in high places.

We have a credit crunch caused by excessive and irresponsible borrowing and lending, and the response of the authorities is – roll of drums – to cut interest rates and implement QE so as to encourage more borrowing and lending.

You couldn’t make it up. I’ve said that before. But I intend saying it again . . . and again . . . . and again.

Economics is complicated, and it’s easy to get bogged down in the details and lose sight of the bigger (and hilarious) picture.

If the cure for imbibing a poison is to take more of the poison, how about forcing those with lung cancer to smoke 50 cigarettes a day? Please leave more suggestions along these lines in the comments section. I like a few laughs every day.

Note that Modern Monetary Theory (MMT) would not have made the above mistake. That is, in a recession, MMT advocates simply creating new money and spending it into the economy (and/or cutting taxes). MMT, far as I can see, has little to say about interest rates.

Abba Lerner, often seen as the founding father of MMT, certainly advocated the above “create money and spend it” policy. Unfortunately he also advocated tinkering with interest rates, NOT as a means of influencing demand, but on the grounds that the authorities have a better idea as to what the optimum rate of interest is than the market. I think he was wrong there.

Politicians and bureaucrats know better than the market as to what the optimum rate of interest is? I’d love to see the evidence. I think Lerner went wrong there.

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National debt is not normally a “burden” on future generations.

2012-01-04T03:23:00.000-08:00

There’s been much debate recently on the net as to whether debt is a burden on future generations. It was sparked off by Krugman, who claimed that basically a burden cannot be imposed by the current generation on future generations. I agree (see here and here).

But see also: Noah Smith, and three Worthwhile Canadian Initiative posts, here, here and here. The debate seems to be inconclusive.

When trying to solve a problem, always cut out the extraneous, i.e. reduce the problem to its simplest form. Then add the extraneous if you like afterwards.

So let’s take a desert island with a few people living on it. Assume the island economy enjoys full employment and that for a currency, they use Cowrie shells. Assume “government” consists of a periodic meeting of islanders. Plus we’ll assume a closed economy to start with.

They decide one day that the island needs a pier for its fishing boats. So government borrows from those who feel like lending. Plus government imposes a tax on all islanders to fund interest on the bonds (and repayment of capital, if the bonds are to have a limited life).

The pier is built.

Now how does this impinge in the next generation? Well assuming bond holders donate their bonds to their offspring, there is no overall burden for the next generation because the children of bond holders inherit bonds (i.e. the right to receive interest and/or repayment of capital), while others inherit the obligation to pay taxes to fund interest on the bonds (and/or repayment of capital).

The assets and liabilities inherited cancel out. So as far as debt and bonds go, there is no net burden for future generations.

Moreover it is a plain impossible for any sort of “burden” to be endured in say 2030 that contributes to the building of the pier in 2012. To cut down a tree in 2030 and use the timber to build a pier in 2012 involves time travel, and that’s not on.

Inheriting investments.

Having said bonds as such do not cause a net cost or benefit for the next generation, the next generation do of course inherit the pier. So overall, far from their being a “burden” on the next generation, there is a BENEFIT for the next generation.

However, the latter “benefit” depends on government spending money on an investment, like a pier, rather than on a consumption item, like increased pay for the island’s police. In the latter case, there’d be no burden or benefit passed to the next generation.

Debt owed to foreigners.

An exception to the “no burden” rule occurs where government spending is funded by foreigners (As pointed out by R.A.Musgrave, in the American Economic Review in 1939. He is no relation.)

Obviously if the pier is built by people from some nearby island, who then demand repayment of the debt in X years time, then that is a real burden on the debtor island in X years time.

Pensions.

Another exception proposed by Nick Rowe, which I find unrealistic, would occur if the oldies in each generation managed to get youngsters to work extra hours and buy bonds off the oldies. (See Nick’s hypothetical “apple economy” here).

This actually occurs to some extent with pensions. That is, many people store up wealth (perhaps including government bonds) during their working life. They then effectively sell the bonds to younger people on retirement in that youngsters are storing up wealth to fund their own retirement. However, absent government bonds, people would make provision for their retirement ANYWAY. They’d just use different assets and/or they’d go for pay as you go schemes, or “unfunded” schemes as they are sometimes called.

The “different assets” obviously have a similar “getting youngsters to pay” effect as selling government bonds to youngsters. Same goes for pay as you go pension schemes, that is, in the case of these schemes, at any point in time, youngsters fund the pensions of oldies.

So when government incurs extra borrowing, there will be no burden on the next generation unless the effect of the extra borrowing is to increase the AGGREGATE amount that people decide they want by way of pensions. And personally I don’t see extra government borrowing having much of that sort of effect.

The interest less than GDP growth argument.

Another superficially attractive argument that features in the above mentioned debate arises out of the possibility that GDP growth exceeds the interest that government pays on bonds.
Suppose interest is simply added to the debt. And assume that the bonds are very long term – i.e. centuries before maturity. In this scenario the liability that the bonds represent will ultimately decline to a negligible portion of GDP.

From this it might seem that a government can borrow in 2012 and distribute goodies to its population, while the “payback” is essentially non-existent. It looks like a free lunch for people in 2012. (Incidentally, much the same superficially attractive argument applies where inflation erodes the value of bonds to near nothing in ten or twenty years time.)

The flaw in that argument is of course that stuff produced in 2012 and distributed by government cannot be produced other than by blood, sweat and tears expended in 2012 (or earlier).

There is no free lunch here.
______________

P.S. (23rd Jan). This argument has now gone viral. It’s generating more heat than light I think. It may well be what sparks off World War III. See the following:

http://www.angrybearblog.com/2012/01/educating-dean-baketr.html
http://consultingbyrpm.com/blog/2012/01/krugman-almost-renders-landsburg-and-me-speechless.html#comment-31742
http://shewingthefly.com/2012/01/22/taking-the-biscuit-paul-krugman-edition/#comment-745

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Employer of Last Resort, buffer stocks and price anchors.

2012-01-03T01:24:00.000-08:00

The folk who advocate having government as employer of last resort (ELR) often claim that ELR employees form a “buffer stock”, which works in the same way as the physical buffer stocks that governments sometimes maintain to iron out fluctuations in the price of physical commodities.

The alternative to ELR is unemployment, and of course both the unemployed and ELR employees act as a buffer stock – in that the buffer stock analogy has any substance, which I don’t think it does.

As regards preventing sudden FALLS in the price of labour, does the above so called buffer stock achieve this? The answer is “no”, because it’s very difficult to get the price of labour to fall: as Keynes rightly pointed out, “wages are sticky downwards”.

As regards INCREASES in the price of labour, does the alleged buffer stock prevent an excess rise in wages given excess aggregate demand? Nope.

In fact wages and prices can rise much faster than is acceptable long before the so called buffer stock runs out. Which makes the so called buffer stock very different from conventional buffer stocks. That is, as long as government has a finite stock of some commodity in its buffer stock, it can sell that stock and ameliorating price increases. The same does not apply to the ELR or unemployed so called buffer stock.

Thus the whole buffer stock analogy is flawed.

Are ELR employees a better buffer stock than the unemployed?

Well there is bound to be a FINITE difference between the two, but I doubt the difference is significant.

For example it can be argued that ELR employees are more employable than the unemployed because the former have their work habits maintained, plus they may learn or at least maintain skills while doing ELR work. But there are flaws in that idea.

First, as regards the idea that the unemployed lose or partially lose the ability to turn up to work on time because of a year or two’s absence from formal employment, one has to wonder how teenagers manage to enter the labour market, given that they have never in their lives had to turn up day after day, 50 weeks a year at some place of work. Same goes for women who take fifteen years off work to raise kids, and then re-enter the labour market.

However, the evidence is mixed here. Webster claims the unemployed are not “scarred” by their period in unemployment. Others claim there is a scarring effect.

Second, it is questionable on the face of it whether the sorts of activities that ELR typically involves are a good preparation for regular jobs. At worst, ELR consists of street sweeping and leaf raking, which are clearly not a good preparation for regular work. And indeed, this “on the face of it” conclusion is backed by some evidence.

A study of Swiss temporary subsidised work found that temporary subsidised jobs with EXISTING private sector employers DID improve subsequent employment histories for those involved. In contrast, the subsequent employment histories of those doing the above typical ELR jobs was ACTUALLY IMPAIRED by such employment. (Note, incidentally, that I’ve advocated temporary subsidised jobs with EXISTING employers, public and private, on this blog over the last few days.)

Third, the chance of skills being maintained while doing ELR work is not good. This is because people are unemployed PRECISLY BECAUSE there is a surplus of their particular type of labour or their skill in their neighbourhood.

I.e. if there is an excess supply of plumbers in town X, an ELR scheme will be hard pressed to find large amounts of plumbing work in the town that really needs doing.

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Why do ELR proponents always advocate public sector type work?

2012-01-02T09:40:00.000-08:00

About fifty million people throughout history have tumbled the fact that there are an infinite number of public sector type jobs that the unemployed could to: sweeping the streets, maintaining public parks, etc.

These advocates of having government act as employer of last resort (ELR) nearly always advocate PUBLIC SECTOR type work, rather than PRIVATE SECTOR type work. And there is an appealing logic here, namely that the output of the public sector is GIVEN AWAY rather than SOLD. Thus demand does not need to be raised to create said public sector type jobs. (At least that is presumably the logic employed: the logic is rarely spelled out.)

That would seem to mean that there cannot be any inflationary effect from said public sector jobs. Unfortunately there is a flaw in that argument, as follows.

If unemployment is above NAIRU, or the “natural level” or the “inflation barrier” level, as Bill Mitchell calls it, a straight rise in demand is far preferable to any sort of ELR job. So let’s concentrate on the scenario where ELR really comes into its own, that is where unemployment is at or below NAIRU.

If an ELR scheme involves just the ex-unemployed and no other factors of production like permanent skilled labour, capital equipment or materials, it will be hopelessly inefficient. On the other hand, the scheme CANNOT order up the latter “other factors of production” (OFP) from the regular economy, because if the economy is at NAIRU, no extra demand is permissible.

So ELR is in a bind. At least it is certainly in a bind if it takes the form of schemes which consist of new or “specially set up” employers, as was the case with WPA – the main “make work” scheme in the U.S. in the 1930s.

Alternatively, an ELR scheme CAN consist of allocating the unemployed to jobs with EXISTING public sector employers (as was the case with the Comprehensive Employment and Training Act (CETA) system in the 1970s). But there is a problem here, which is that public sector employers are under similar cost cutting and output maximising incentives as the private sector. That is, if a public sector employer can cut costs by hiring subsidised ELR people and have them replace staff that the employer actually has to pay for, then the employer will be tempted to do so. Indeed, this abuse occurred to some extent under CETA.

Thus it is necessary to have rules in place governing the system (as indeed was the case with CETA). And those rules need to ensure as far as possible, that those taken on under ELR would not have been hired but for ELR. Of course the latter objective can never be attained with perfection, but as long as the objective is more or less hit, then the benefits of ELR will hopefully outweigh the costs.

Now if the above rules ensure that public sector employers are induced to expand output by taking on ELR people (rather than order up more of that inflationary OFP) then presumably the same rules applied to private sector employers will have the same result: that is private sector employers, if offered ELR employees on the same conditions as they are available to public sector employers, will expand output (given an increase in demand) by taking on ELR people rather than by ordering up more of that inflationary OFP.

Ergo there is no reason to confine ELR to the public sector.

QED.

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My quibble with the vice-president of the ECB’s speech.

2012-01-01T12:15:00.000-08:00

Warning: this post is a bit technical, semantic and arcane.

Vítor Constâncio, vice-president of the ECB makes the following claim:

“Central bank reserves are held by banks and are not part of money held by the non-financial sector, hence not, per se, an inflationary type of liquidity. There is no acceptable theory linking in a necessary way the monetary base created by central banks to inflation.” (Hat tip to Mike Norman.)

I have no quarrel with Constâncio’s attack on the idea that boosting bank reserves boosts bank lending, which is the basic point he makes here. But I don’t fully agree with the above quote from C’s speech.

When bank reserves rise by $X, the amount deposited in commercial banks will most likely rise by the same amount, all else equal. To illustrate, suppose $Y of my govt bonds are QE’d. I get a cheque for $Y from the central bank. I deposit the cheque at my commercial bank, and the latter deposits the cheque at the central bank. Net result: bank reserves rise by $Y and deposits at commercial banks rise by $Y.

The only exception would be where the govt bonds QE’d are bonds owned by some commercial bank.

The result of the above “$Y” operation is that private sector net financial assets do not rise, but they DO BECOME more liquid. In addition, having a central bank buy govt bonds is the classic way of enforcing an interest rate reduction, and it is generally agreed that interest rate reductions are stimulatory, (and if the stimulus goes too far, inflationary.) So, contrary to C’s claims, there certainly are transmission mechanisms via which a rise in reserves could be inflationary.

That can all be put another way – sort of – as follows. The only reason that (quoting C) “central bank reserves are not part of money held by the non-financial sector” is that very few private sector entities are allowed to have accounts at central banks: that is, most private sector entities have to employ commercial banks as agents when those entities come by some central bank money (as in the case of QE). But that is a feeble argument for saying that private sector non-bank entities don’t hold or possess central bank money.

So how should C have phrased the above quoted two sentences? I think he should just have said something like “An increase in bank reserves as such does not encourage extra bank lending”. And that’s it. In trying to broaden the point too much and include ideas about “no acceptable theory linking in a necessary way the monetary base created by central banks to inflation” he tripped up.

He should have me as his speech writer – then he’d REALLY trip up.

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Unproductive employees.

2011-12-31T03:41:00.000-08:00

As unemployment declines, the suitability of each succeeding person hired for vacancies also declines. That is because the fewer the unemployed, the less the likelihood of finding someone suited to any given vacancy.

In other words, as unemployment declines the marginal product of labour also declines.

When “suitability” declines to the point where the output of those hired does not cover the minimum wage / union wage / going wage, etc etc, employers tend to resort to consciously or unconsciously poaching each other’s staff. The result is that the price of labour is bid upwards, and inflation kicks in.

The latter problem could be ameliorated by inducing employers to take on relatively unsuitable staff with the assistance of a subsidy.

As to how to identify the “unsuitable”, that is not too difficult. Just let employers claim the subsidy in respect of any employee/s they like, but for a limited period. On expiration of the subsidy for any specific individual, if the employee is GENUINELY unsuitable, the employer will be happy to let them go. In contrast, if the allegedly unsuitable employee is in fact relatively productive, the employer will keep the employee and will be bluffed into paying the full wage.

There are numerous ways employers could game that system, but its not too difficult to think of anti-gaming rules to counteract the gaming.

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Malcolm Sawyer and government as employer of last resort.

2011-12-30T00:51:00.000-08:00

Internet discussion about having government act as employer of last resort (ELR) has flared up in the last week amongst advocates of Modern Monetary Theory. So I thought I’d set out a brief summary of a paper by an opponent of ELR: Malcolm Sawyer (Prof of economics at Leeds University in the UK).

His paper is 14,000 words, so some people might prefer something a bit shorter: the summary below is about a tenth as long. This summary is bound to be inaccurate in some respects. Don’t expect perfection on this blog.

The headings below are the actual headings used in Sawyer’s paper. After each point, I’ve put a brief comment of my own.

Functional Finance and ELR.

i) The value of output from ELR jobs is inherently low, because given full employment, a range of “normal” or regular jobs would exist which are regarded as being more worthwhile than ELR jobs. I.e. given full employment a proportion of (or all ELR) jobs are abandoned, and the relevant labour moves to regular employment.

My answer to that is: “OK, but ELR jobs are still arguably better than nothing.”

ii) Sawyer then divides unemployment up into the usual categories, frictional, structural and demand deficient. Plus he makes the conventional point that where demand deficient unemployment is at a minimum (or if you like, at “NAIRU”), frictional and structural factors are the obstacle to further unemployment reduction. That is, employers cannot find the skill mix they want.

This means that if ELR is used to deal with unemployment when unemployment is a NAIRU, then ELR has a skill mix problem.

My answer to that: “True. That’s one reason I advocate offering the unemployed temporary subsidised places with EXISTING employers, rather than ELR.” See here.

Finance and Money.

i) Sawyer sets out one of the basic ELR claims that used to be put by advocates of Modern Monetary Theory (though they’ve gone quite on this point in recent years.) This is that the costs of ELR can be funded essentially by printing money, and then controlling inflation by the sale of government bonds. But as Sawyer rightly points out, the money printing idea leads to a never ending expansion in the amount of “money plus bonds” relative to GDP, which is unsustainable.

ii) Sawyer’s next point, to quote, is “…why restrict the form of government expenditure in this way?” In other words if employment can be expanded simply by printing money, why not print money and use such money to create extra regular or normal jobs?

My answer: “Good point. In other words, the whole idea that money printing can fund ELR is nonsense, as advocates of Modern Monetary Theory now seem to have conceded.”

Costs of ELR proposals.

i) Under this heading Sawyer points out that some estimates of the cost of ELR include just the cost of labour! He claims that the costs of materials, capital equipment and permanent skilled labour are likely to double the costs.

My answer: “Good point.”

ii) Sawyer then gives another reason for costs being underestimated, namely that ELR would actually draw people into the labour force.

My answer: “What of it? This involves employing those who have given up looking for work, and are thus not classified as “unemployed”. There is nothing wrong with employing members of this “hidden unemployed” category.”

Are the Jobs Available?

i) Sawyer claims that ELR jobs need to be jobs which “do not require much skill or which use skills which are widely available in the population (e.g. literacy, ability to drive). Second, the job leads to the production of useful output, but the output is not necessary in that the output is only forthcoming when aggregate demand is low and the ELR jobs are required. Even work on capital projects (which has often been used to provide jobs at times of high unemployment) would not fit the ELR requirements. Apart from logistical problems of speeding up or slowing down capital projects depending on the state of aggregate demand, much of the work on capital projects is skilled work for which wages are usually significantly above the minimum wage. Jobs such as those in education, health service, personal social services, and care would not be good candidates for ELR jobs. Such jobs may well provide valuable public services and could be expanded as part of mainline public expenditure. But they do not provide examples of jobs which can be undertaken at the basic wage and only undertaken when there is a low level of demand in the economy, generating requirements for ELR jobs.”

My answer: “Good point.”

ii) Sawyers says, “ELR jobs have to be provided virtually instantaneously, for if they are not then someone requiring an ELR job would be unemployed (in reality if not in name). If the capital equipment, material inputs, and supervisory labour for a job are not immediately forthcoming (or standing idly by), then this job cannot be "switched on" to meet ELR job requirements.” And having capital equipment and skilled labour “standing idly by” is a waste of resources.

My answer: “Good point. That’s one reason temporary subsidised jobs with existing employers are better than ELR: the capital equipment (and skilled labour) is already there.”

iii) Next, Sawyer says “an ELR job which did draw on material inputs to a significant degree would generate demand (for those materials) in the non-ELR sector.”

My answer: “Quite right. And that’s one flaw in the claim that ELR is non-inflationary. Or put another way, to create ELR jobs with any sort of respectable output, materials and capital equipment have to be withdrawn from the regular economy. The advocates of ELR never quantify this destruction of regular employment when computing the output of ELR jobs: they just sweep this problem under the carpet.”

iv) Next, Sawyer points to the fact that unemployment can be particularly high in particular geographical areas, or suddenly rise in such areas because of the closure of a local large employer. As he points out, while there may be an argument for having a SMALL proportion of the population doing ELR type work over the country as a whole, having a LARGE proportion doing same in high unemployment areas would tend to result in pointless types of work.

My answer: “Valid point.”

ELR, Underemployment, and Unemployment.

i) Sawyer claims that if the wage on ELR type work exceeds the value of the output on such work, then the relevant employees are making a “net claim” on the rest of the economy.

My answer: “Not a good criticism. The alternative is to have the relevant people unemployed, in which case their “net claim” is probably LARGER!”

ii) Training. In the para starting “To illustrate the significance of these figures…” Sawyer gets the point (not appreciated by many ERL enthusiasts) that there is clash between on the one hand the relatively fast turnover of the unemployed and presumably equally fast turnover of ELR employees, and on the other hand, the requirement that any half decent training on ELR schemes has to last for a considerable or specific period. That is, money spent on a training course that pupils abandon half way thru, is money that is largely wasted.

This deficiency has been substantiated by empirical studies done around Europe over the last twenty years which shows that straightforward subsidised work produces better results than training on ELR schemes.

iii) Next, Sawyer points to the fact that ELR employees have to be available at a moment’s notice for mainstream jobs, which would lead to inefficiencies on ELR projects.

My answer: “True, but that is not a desperately strong criticism since peripheral or relatively unskilled employees in mainstream employment also tend to leave at a moment’s notice.”

ELR, the NAIRU, and Inflation.

i) Where ELR is voluntary, its attractions for those partaking must be superior to the attractions of unemployment. Ergo the RELATIVE attractions of regular employment are reduced. To this extent, NAIRU under ELR (sometimes called NAIBER) will be higher than in the absence of ELR.

My answer: “Correct. I tumbled to this point decades ago as did the Swedish labour market economist, Calmfors, who entitled the effect “Calmfor’s Iron Law of Active Labour Market Policy. The only way round this problem is to introduce what might be called a “workfare” element into ELR: i.e. “do this job else your unemployment benefit gets cut”.

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Vickers does not separate safe from unsafe bank activities.

2011-12-19T22:17:00.000-08:00

Roll of drums, fanfare, etc. It’s just been announced that the Vickers proposals on banking are to be implemented in the UK. And everyone thinks that safe banking activities will be separated from unsafe activities. Well people believe whatever they’re told, I suppose.

Vickers actually puts both risky and non-risky activities inside the much vaunted “ring-fence”, when the whole object of the exercise is to separate the two.

For example, it is generally thought that money deposited in banks by small depositors like you and me should be 100% safe (though that idea is flawed, as I’ll explain below). So these deposits are inside the fence. But so too are loans to small and medium size enterprises: clearly not an entirely safe activity! But it gets worse. The report is not even clear on whether deposits from and loans to large companies should be inside or outside the fence. (1st paragraph on p.12).

Or as Jill Treanor, the Guardian’s City editor put it, “The commission is vague about whether banking to large companies should be in or outside the ring-fence.”

If Vickers & Co could not make up their mind on that basic and simple point, why did they even publish their report?

Loans and equity: how different are they?

As regards separating so called investment banking from other bank activities, there is another problem, which is that the line between “investing” in a company and “lending” to a company is very blurred. To illustrate, a loan which is last in line for reimbursement in the event of bankruptcy and/or where the so called interest is related to profits is very close to “investing” i.e. taking an equity stake. Lawyers will have a field day here.

So it’s no surprise that there is an article on the Legal Recruitment site entitled, “Vickers review puts lawyers centre stage”.

Or as Martin Jacomb, former chancellor of the University of Buckingham put it in the Financial Times, “The ring-fencing proposal involves much detailed regulation.”

Why did Vickers get in this muddle?

Why, if the object of the exercise is to separate the safe and risky, does Vickers mix them up inside their famous ring fence? The explanation lies in a piece of economics which the Vickers & Co clearly did not grasp. And this revolves round what they call “trapped deposits” (e.g. see p.277). I’ll explain.

Deposits, or at least some of them, need to be safe. At the same time, lending out money is clearly not 100% safe. Thus there is an absolutely fundamental conflict between safe deposits and lending.

If one solves this problem with excessive restrictions on the types of loan that banks can make with “safe deposit money”, the relevant money is liable to become what Vickers calls “trapped”. And this, according to Vickers, would reduce the supply of credit (paragraph A3.29).

Well obviously it WOULD reduce the supply of credit, all else equal. But (and this is the point that Vickers does not get) if restrictions are put on the way money can be used, there is nothing to stop a central bank / government expanding the money supply to compensate for this.

Indeed, central banks have massively increased the supply of central bank created money (monetary base) in response to the crunch. Perhaps Vickers & Co weren’t aware of this.

But that all raises a question, namely what is the point of expanding the money supply and then putting restrictions on how money can be used? Answer is that it enables us to get a clear distinction between money that is supposed to be 100% safe and money which the possessor of said money wants to have invested, and which in consequence is not 100% safe: exactly what Vickers & Co aim to do but fail to do.

Or in the words of Mervyn King, “If there is a need for genuinely safe deposits, the only way they can be provided . . . is to insist such deposits do not coexist with risky assets”.

Quite right. I.e. what we need is a system under which those who deposit money in banks have a choice. If they want 100% safety, that’s fine: but they cannot at the same time reap the benefits of having their money invested in a less than 100% safe manner. That involves a free lunch, and someone somewhere pays for that free lunch: cross subsidisation is involved.

Alternatively, if depositors want their bank to lend out their money, nothing wrong there. The money is being put to good use, so depositors can get a decent rate of interest. But they cannot at the same time ask for 100% safety. And since their money has been locked up in some business or a mortgage, they cannot ask for instant access to their money either.

We have a choice. Face reality, which will dispense with cross-subsidisation. Or second, we can live in la-la land where we indulge in the belief that we can have our cake and eat it. But the result is cross-subsidisation.

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Peter Schiff, Paul Krugman, and the baby-sitting co-op.

2011-12-17T00:46:00.000-08:00

Peter Schiff, the well known loudmouth tries to refute the idea behind Paul Krugman’s baby sitting co-op article. (Hat tip to Stefan Karlsson.)

Schiff begins with about twenty or thirty insults before getting to the crux of the argument. That together with Schiff’s loud and excitable voice makes me suspect that Schiff’s real skill is getting drunk and picking fights with fellow drinkers, rather than economics.

Schiff then claims the babysitting coop failed because too many coupons were issued: complete nonsense! At least there is nothing in Krugman’s article about the co-op failing for this reason. (Although the average mentally retarded six year old has doubtless worked out that if excess amounts of money/coupons are issued, there will be a problem, i.e. inflation.)

Schiff then claims that a fundamental flaw in the baby sitting co-op is that baby-sitting hours are priced the same regardless of whether it’s a weekday, weekend, New Year’s Day, etc etc. Perhaps Schiff or anyone else can explain why this “same price regardless” system applies to millions of products in every economy round the world, and without any big problems.

Of course “price discrimination” as economists call it, and as is explained in introductory economics text books, makes sense and is profitable for vendors as long as the administration costs are not too high. But this discrimination is not essential for an economy to function.

The one area where Schiff is half right is his claim that escaping recessions that result from bubbles simply by printing money will lead (if history is any guide) to another bubble sooner or later. Problem with that argument is that most of the human race have worked that one out, and no thanks to Schiff: that’s why we are busy tightening up bank regulations! Doh!

To spell that out in detail for the benefit of people with Schiff’s non-existent knowledge of economics, it was excessive and irresponsible borrowing that contributed to (or were the basic cause of) the credit crunch. Hence the need for tighter bank regulation.

But then it is precisely right wingers, like Schiff who tend to oppose more regulation, and left wingers like Krugman who tend to back tighter regulation.

The irony will be way above the head of Schiff the loudmouth.

________

Correction, 18th Dec: Krugman’s Slate article DID SAY that the co-op issued too many tokens, but DIDN’T SAY that the co-op collapsed for this reason.

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Economics Professors who don’t realise central banks can print money.

2011-12-16T11:12:00.000-08:00

This might sound bizarre, but there are numerous so called professional economists who don’t understand that central banks can print money.

To be more exact, these economists, if asked “Can central banks print money?” would probably answer “Yes”. But they then proceed to write articles based on the assumption that central banks CANNOT print money. It’s weird. (I’ll deal with their articles in detail below.)

Indeed, Modern Monetary Theory (MMT) is little more than an attempt to push the above point, namely that given excess unemployment, it’s a good idea for a government / central bank machine to print money and spend it. As Abba Lerner, arguably the founding father of MMT rightly pointed out, “Fundamentally the new theory, like almost every important discovery, is extremely simple. Indeed it is this simplicity which makes the public suspect it as too slick......What progress the theory has made so far has been achieved not by simplifying it but by dressing it up to make it more complicated and accompanying the presentation with impressive but irrelevant statistics.”

Quite. In addition to the “public”, universities are full of academics who won’t believe anything unless a hundred words are used where one will do. Those academics don’t like simple solutions to problems: that might put them out of work. And their own job security takes precedence over reducing unemployment or reducing poverty.

Article No 1: Financial Times leader.

This leading article in the FT argues that Britain’s debt ought to be reduced, or at least the rate of increase slowed down. And the reason given is old shibboleth that doing so impresses “investors” (3rd para) and enables Britain to borrow at relatively low rates.

As regards borrowing and spending for stimulus purposes what's the problem if "investors" don't want to lend? Whence the assumption that a monetarily sovereign country needs to borrow when it can perfectly well print money? See what I mean? The article assumes it is not possible to print.

As Keynes and Milton Friedman pointed out, a deficit can be funded EITHER by borrowed OR printed money.

And as regards the structural deficit/debt, much the same applies: that is a monetarily sovereign country can just print its way out of trouble. Of course the printing could prove too inflationary, but that’s no problem: all that is needed is some sort of DEFLATIONARY measure, like increased taxation, to counter the inflationary effect. Net effect: zero. That is, the debt comes down, while demand and employment remain unaffected.

2. Jeffrey Sachs.

At the end of the second paragraph of this article by Sachs, he claims, “Keynesian thinking presumes that the financial markets will readily buy government bonds to finance the stimulus.” Complete bo**ocks! Keynes made it perfectly clear that deficits can be funded EITHER BY BORROWED OR PRINTED MONEY!!!!!

Re Keynes, see 2nd half of 5th paragraph here.

And Sachs was the youngest ever “Professor of Economics” at Harvard. Apparently studying economics is not a requirement for the latter post.

3. Willem Buiter.

In this article, Buiter makes the bizarre claim that “The U.S. like every country that has independent monetary authority, when it has an unsustainable fiscal situation, has two options. One is default, right, and the other . . . . is inflation.

Bo**ocks again! There is a third option: just stop borrowing and go for whatever combination of 1, increased tax / reduced public spending, and 2, printing is suitable.

Buiter is actually half aware of the fact that central banks can print when he says, “Permanent monetisation of the vast deficits anticipated in the US and the UK would be highly inflationary.” Well of course! But that’s just a man of straw argument. It takes the print idea to an absurd extreme.

In contrast, the above mentioned COMBINATION of printing and tax increases would not, if implemented in a competent manner, cause excess inflation.

4. Jared Bernstein.

In this article, Bernstein claims, “As I’ve stressed throughout, debt is not just important—it is an essential tool of economic growth.”

NO IT IS NOT. Friedman set out a monetary system in which there is NO GOVERNMENT DEBT AT ALL!!!!!!! Warren Mosler advocates a similar system.

Re Friedman, see paragraph starting “Under the proposal…” (p.250) here.

Bernstein sits on the Congressional Budget Office's advisory committee, but as far as I can see from the summary of his career on Wiki, he has never studied economics. As I said above, a knowledge of economics does not seem to be an essential requirement when appointing people to jobs where you’d think a knowledge of the subject is essential. And the poor and unemployed pay a heavy price for this.

Bernstein incidentally also trots out the old myth that if government makes worthwhile investments, that justifies the borrowing needed to fund such investment. Bo**ocks again. Bernstein needs to read a paper by Kersten Kellermann on this subject.

_____________

Afterthought – 17th Dec. Re the final paragraph above, perhaps I should have added that the most fundamental reason that any entity borrows to make an investment is that it does not have the necessary cash available. E.g. if you want a £15k car and have well over £15k in the bank it probably won’t make sense for you to borrow £15k.

And governments have an almost limitless source of cash available: the taxpayer. Thus the most basic reason for borrowing to make an investment does not make sense in the case of governments. But of course there are other relevant points to consider, as Kellermann explains.

Afterthought (22nd Dec). There is another example of the “central banks can’t print” thinking in an article by Robert J. Samuelson in the Washington Post.

Samuelson is not a professional economist, but he is influential all the same. He claims in his article that “Standard Keynesian remedies for downturns — spend more and tax less — presume the willingness of bond markets to finance the resulting deficits at reasonable interest rates.”

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Draghi believes in the confidence fairy!

2011-12-15T08:21:00.000-08:00

Contratulations to Andrea Terzi for highlighting the fact that Mario Draghi, president of the European Central Bank believes in the confidence fairy. He also seems to believe (equally ridiculous) that Europe can export its way out of trouble.

For the uninitiated, the “confidence fairy” is a somewhat sarcastic name given to a common belief amongst economic conservatives, namely that a stiff dose of fiscal responsibility will result in such a surge of confidence in a country, that its problems will be solved in short order.

Yes, you can see the beneficial effects of the confidence fairy in Greece – I don’t think.

But it gets better: Draghi also thinks employment will rise in Europe if Europe becomes more competitive. Er . . . that will just destroy jobs elsewhere in the world won’t it? Or more likely, the result of increased exports from Europe to the rest of the world will raise the value of the Euro relative to other currencies which will bring trade between Europe and the rest of the world back into balance. The words “back”, “where” and “started” spring to mind.

Still, if you are captain of a sinking ship, I suppose you have to sound cheerful. Though what good that does, God knows. Being realistic would do more good, I’d have thought.

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The Fed made a profit out of TARP?

2011-12-14T07:20:00.000-08:00

The crooks and swindlers that make up the elite in the U.S. like to claim that the Fed made a profit out of TARP. The claim is of course nonsense. But it’s important to be clear as to why.

The institution which issues a nation’s currency – i.e. the institution which has the right to engage in seignorage – can hardly avoid making a profit. That is why – gasps of amazement – it is profitable to turn out one’s own $100 bills, £20 notes, etc.

Even if one only LENDS OUT bundles of $100 bills at interest, rather than turning them out and refusing to ever take them back, there is still profit to be made on the interest. And that is where part of the Fed’s “profit on TARP” comes from.

However, the money lent out could equally well have been lent to households, small businesses, local government, etc etc. Thus the fact a profit was made by lending TARP money to large banks and the well-connected is not a justification for lending to banks and the well connected.

PLUS, the money lent out under TARP was lent at a ludicrously low rate of interest: a huge misallocation of resources.

Indeed, the fact that central bank makes a so called profit from lending is not even an argument for lending, since the money created could just as easily be spent directly into the economy: on education, infrastructure, etc. Alternatively, the new money could be used to reduce taxes.

This raises the question as to what is the best way to allocate “new money”.

The new money CAN BE USED to increase lending. For example, the new money itself can be lent out, as was the case with TARP. Alternatively the new money can be used to ENCOURAGE new lending: by reducing interest rates or implementing QE.

But whence the assumption that economic expansion is best implemented via more borrowing rather than a straight increase in spending? Do the authorities (or the crooks and swindlers) ever have any EVIDENCE that increased borrowing is preferable to a straight increase in current spending? Of course not: most of them are too stupid to realise that the question even needs asking.

Moreover, a straight increase in current spending will AUTOMATICALLY lead to increased borrowing and investment where those concerned think borrowing and investment is warranted. Firms making widgets are far better judges of whether it makes sense for them to borrow and make an investment than the crooks, swindlers and morons that make up the elite.

And it’s not just the PRIVATE SECTOR than can decide for itself when investment is warranted: public sector entities like local government or highway authorities are equally capable of making “borrow and invest” decisions.

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Modern Monetary Theory in England 1,000 years ago?

2011-12-13T01:58:00.000-08:00

There is some dispute as to EXACTLY what Modern Monetary Theory (MMT) consists of. But I’ll assume it’s the idea that in a monetarily sovereign country the government / central bank machine can simply create money and spend it into the economy as appropriate (and do the reverse if inflation looms).

This idea seems to have been in operation in England in the 1,100s. See 5 minutes into this video clip:

This piece of history also supports Chartalism. Chartalism (if I’ve got this right) is the idea that the state’s money derives its value and dominance from the fact that the state imposes taxes, which are payable only in the state’s money. Thus private sector entities HAVE TO get hold of the state’s money in order to pay taxes.

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MMT and Positive Money ideas in the Financial Times.

2011-12-12T07:04:00.000-08:00

Letter in today’s Financial Times which is very much in line with Modern MonetaryTheory (MMT) and Positive Money’s ideas, namely that in a recession the government / central bank machine should simply create new money and spend it into the economy (and/or cut taxes).

The letter goes off the rails at one or two points, I think, but it’s good to see MMT and Pos Mon ideas out there.

In contrast to the above ideas, the authorities’ response to a credit crunch brought about by excessive and irresponsible borrowing was to cut interest rates and implement QE so as to encourage more borrowing. You couldn’t make it up, could you?

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Bank subsidies are partially YOUR fault !!!!

2011-12-11T00:20:00.000-08:00

The UK’s Independent Commission on Banking (ICB) estimated the too big to fail subsidy that UK banks get as being worth well over £10bn a year. That is roughly £150 a year for each UK inhabitant. So why does this subsidy arise?

The answer lies partially in a piece of chicanery which suits banks and suits everyone who deposits money in banks – that’s you and me. This is that we want our money to be 100% secure: that is we want government (i.e. taxpayers) come to the rescue when a bank goes bust. While at the same time we want the benefits and interest that comes from engaging in commercial activity: i.e. letting banks lend on our money in a less than 100% safe manner. We want to have our cake and eat it.

Mervyn King described this process as “alchemy”. Quite right. “Chicanery” . . . “alchemy” . . . either word will do me.

He also said, “If there is a need for genuinely safe deposits, the only way they can be provided…..is to insist such deposits do not coexist with risky assets”. Right again.

One solution to this problem is to make depositors come clean: that is, force them to be honest and say whether they want their money to be 100% safe, or whether they want it invested, in which case it will NOT BE entirely safe. In other words we need two basic types of account which for want of better words I’ll call “safe” accounts and “investment” accounts.

Safe account money would NOT BE invested, hence it would earn little or no interest, but it WOULD be “instant access”. Just to make sure this money is 100% safe, it could be deposited at the central bank. In contrast, investment account money WOULD earn significant interest, but it would not be instant access, plus there would be no taxpayer funded recompense if the relevant bank went bust.

As a result, there’d be little need for any bank subsidy. As regards safe money, that would be safe (absent blatant criminality). And as to investment account money, there’d be no government rescue if the bank went bust.

The above “two account” system would not of course ENTIRELY dispose of all the risks posed by banks: banks could still pose a systemic risk. But the two account system would certainly help. Moreover, the “too big to fail” problem can be mitigated by preventing any one bank growing too big.

The two account system might seem to constrain private banks’ freedom to lend (though of course under fractional reserve they have a large measure of freedom to create money out of thin air and lend it out when they see fit). Alternatively, under full reserve, the two account system would certainly seem to constrain banks’ freedom to lend. And indeed the ICB fell hook line and sinker for this “constraint” argument.

But any such constraint is not a problem, because the central bank can easily expand the monetary base to compensate for any such constraint.

The main solution advocated by the ICB was to increase banks’ capital. The problem with that is that shareholders are not saints: they want a commercial return on capital. So the cost of that extra capital is inevitably passed on to bank customers – depositors and those borrowing from banks.

So the ICB solution amounts to a game of pass the parcel, with the net result being not vastly different to the two account solution, in that the cost of the risk that investment inevitably involves is dumped onto depositors and those borrowing from banks. The weakness in the ICB solution is that depositors who are prepared to take a risk are not fully rewarded for doing so: part of the “reward” is donated to those who want to indulge in the above mentioned chicanery or “alchemy”.

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No nativity scene in DC.

2011-12-08T22:41:00.000-08:00

Subject: Supreme Court rules no Nativity scene in DC

Date: Wed, 9 Nov 2011 11:06:34 -0800

The Supreme Court has ruled that there cannot be a Nativity Scene in the United States' Capital this Christmas season.

This isn't for any religious reason. They simply have not been able to find
three Wise Men in the Nation's Capitol.

A search for a Virgin continues.

There was no problem, however, finding enough asses to fill the stable.

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The Euro will fail.

2011-12-08T06:41:00.000-08:00

Assuming Euro leaders DO MANAGE to get some sort of fiscal union agreed, what of it? That fiscal union will in effect be much the same as the current arrangement, in that it will involve imposing austerity on uncompetitive countries. And the austerity will have to last years before such countries become competitive, by which time they’ll either have been reduced to anarchy or will have opted to leave the EZ.

And COMPETITIVENESS is the CRUCIAL point, as Martin Wolf explains, not deficits or debts. That’s why I advocated an instant devaluation of periphery currencies here in September. The latter solution would be expensive and difficult to organise, but it’s the least bad solution, I think.

Expect long boring articles in newspapers making the above point in the months and years to come.

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LSE “professor” of economics doesn’t know what a structural deficit is.

2011-12-07T02:19:00.000-08:00

According to Professor John Van Reenen, Director of the London School of Economics’s Centre for Economic Performance, “The UK currently has a structural deficit of around 8.8 per cent of GDP. But this has not been due to some unfunded spending splurge since 1997, but rather because Britain has just suffered the deepest recession since the 1930s.”

Hang on . . . . . a structural deficit is a deficit (or part of the total deficit) which is NOT attributable to a recession!

At least Reuters defines and structural deficit as “The portion of a country's budget deficit that is not the result of changes in the economic cycle. The structural deficit will exist even when the economy is at the peak of the cycle.”

And Wiki’s definition is essentially the same: “a structural deficit exists even when the economy is at its potential”

The Financial Times Lexicon’s definition is slightly different, not that this will be any solace for the Professor. The FT definition is “A budget deficit that results from a fundamental imbalance in government receipts and expenditures, as opposed to one based on one-off or short-term factors”. This of course amounts to the same thing as the Reuters and Wiki definition if by “short-term factors” one means “cyclical” or “credit crunch induced”. But the FT definition could be clearer on this point.

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Willem Buiter is not 100% clued up.

2011-12-06T10:37:00.000-08:00

Builter has written an article claiming the prospects for growth worldwide are near non-existant. (h/t to Credit Writedowns.)

Buiter says amongst many other things that “The US also may be technically able to use fiscal expansion to stimulate demand, but even if markets continue to be tolerant, political gridlock makes it impossible.”

That implies that there is a problem if “markets” become intolerant, which is certainly a popular view. But Buiter fails to tell us what the problem is (probably because he can’t).

If “markets” won’t to lend to a monetarily sovereign country, like the US, other than at high rates of interest, what of it? If such a country wants to implement some stimulus, it can fund the stimulus by printing money rather than by borrowing it, as Keynes and Milton Friedman pointed out.

In contrast to stimulus deficits or debts, there are structural deficits, and debts. If structural debt needs to be rolled over, no problem: structural deficits, by definition, do not impart stimulus. Ergo abolishing a structural deficit, or paying off a structural debt involves no “anti-stimulus” or any of that dreaded “austerity”. At least that’s the case if one goes by the Reuter’s and Wiki definition of “structural”. And the Financial Times Lexicon definition isn’t all that different.

For more on this, see: http://mpra.ub.uni-muenchen.de/34295/1/MPRA_paper_34295.pdf

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“In the Black Labour”: are fiscal conservatism and social justice compatible?

2011-12-05T00:17:00.000-08:00

This paper entitled “In the Black Labour” published by “Policy Network” leaves room for improvement. It argues that the political left in Britain should be fiscally conservative so that the left gains credibility with voters. (h/t to Stumbling and Mumbling).

Advocates of Modern Monetary Theory, Bill Mitchell and Rodger Mitchell in particular often rail against the way in which self-styled “progressives” have adopted the economic illiteracy of the political right. Mitchell and Mitchell are correct. (The two Mitchells are not relatives, by the way.)

The “black Labour” paper is of course correct to say that the political left in the UK needs to come clean with voters as to what it intends doing about the deficit and debt. But it is wrong to say (p.4) that “one option might be a commitment to deliver a surplus on the public finances towards the end of a concrete timescale such as the lifetime of a single parliament.”

Any country or political party which “commits” itself to a surplus at some point in the future needs to study some economics.

First, there is a very simple reason why most governments will run deficits most of the time (which in practice is what they have actually done over the last century or more). The reason is this. Given the 2% inflation target, the monetary base and national debt will contract in real terms at 2% a year unless they are topped up. Assuming for the sake of simplicity that both are to remain constant as a proportion of GDP, they’ll have to be topped up every year. And that “topping up” can only come from a deficit.

And not only that, but assuming some sort of economic growth in real terms, even more “topping up” will be needed to keep the base and debt constant as a proportion of GDP. That’s quite a lot of deficit.

Second, as Keynes correctly observed “look after unemployment, and the budget will look after itself”. Put another way, “committing” oneself to a particular level of deficit or surplus five years hence is PLAIN DAFT. If there is a fit of irrational exuberance, a surplus will be in order. Conversely, if the private sector continues to act in a conservative fashion, i.e. continues to deleverage and save (save up money, that is), then a deficit will be in order.

That elementary lesson in deficits and debts will doubtless leave a lingering doubt in the minds of the fiscally conservative, namely that if the deficit persists, then the debt will on the face of it continue to rise. Well the answer to that is as follows. If the markets continue to be willing to purchase debt at a rate of interest that is equal to or less than the rate of inflation, then more fool the markets. The UK (or any monetarily sovereign country) can continue to sell the markets bum steers – I mean debt.

Alternatively, if the markets want a significantly positive rate of interest, then we just stick two fingers up at the markets and fund the deficit with printed money rather than borrowed money. As I’ve said dozens of times on this blog, both Keynes and Milton Friedman pointed out that a deficit can be funded with EITHER printed money OR borrowed money: whichever is most appropriate.

Presumably I’ll have to point this out another trillion times before the message gets thru.

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QE: Mervyn King versus Andrea Leadsom.

2011-12-04T10:24:00.000-08:00

Battle of wits between, on one side, Mervyn King governor of the Bank of England plus another BoE official, and on the other side, UK politician Andrea Leadsom. I’ve tried to summarise the exchange of views below. Or for the video, see here (starting at around 43 minutes. (Put your cursor on the bar just below the “movie” to bring up the slide bar which enables you to start half way thru the “movie”.)

Summary.

Ms Leadsom tries to establish that when a central bank buys government bonds in the market (as under QE) and then sells them back at a lower price, the central bank makes a loss. Mervyn King and friend give evasive and suspiciously complicated answers.

Using conventional accounting, obviously the central bank makes a loss. But there is really no such thing as a central bank making a profit or loss: the job of a central bank is simply to feed money into the economy in a recession, and withdraw money when inflation looms.

When a central bank is trying to impart stimulus (as under QE), it is arguably a positive benefit if it “makes a loss”: in doing so, it feeds more money into the economy than if it made a so called profit.

The far more serious question is this. Should central banks be feeding money into the pockets of the wealthy: those who hold government bonds? That is, shouldn’t the government and central bank (considered as a single unit) feed money into Main Street during a recession, rather than into Wall Street?

So Mervyn King’s response to Ms Leadsom should have been “What if the BoE does make a loss: so much he better”. And Ms Leadsom’s accusation should really have been “What in God’s name do you think you are doing enriching the already stinking rich people who work in the City of London, rather than boosting every British high street?”.

Least that’s the way I see it.

_________________

Afterthought (same day). Warren Mosler made the point that a central bank should be likened to the umpire in a game of tennis: that is, someone who dishes out points (money) as appropriate. As Warren explained, those “points” do not come from anywhere. And the umpire in a game of tennis does not “lose” anything by awarding points. Put another way, the umpire does not “make a loss” as a result of awarding points.

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Tony Blair oozes sincerity and displays his ignorance about the Euro.

2011-12-03T10:14:00.000-08:00

Pretty boy Tony Blair expresses his views about the Euro in this interview. Unless you are seriously short of anything useful to do, don’t bother watching it. He simply makes the point that Euro politicians have REACTED to events rather been IN CHARGE of events, and this has induced markets to bet against the Euro and its periphery in particular.

Well I think everyone, including inmates of mental institutions have worked that out.

Which raises the question as to why the Wall Street Journal bothered publicising the interview. Well the answer is that if you are a journalist working for a newspaper, you can’t go wrong commissioning an article or publicising an interview with a big name – even if the big name is obviously senile or hopelessly ignorant.

In contrast, if someone has some seriously original or intelligent ideas about some economic problems, it’s best to give them a wide berth. Dean Baker spends much of his time pointing to the appalling nonsense that appears in some of America’s leading newspapers.

Such a pity.

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Krugman doesn’t fully understand Europe.

2011-12-02T03:21:00.000-08:00

Krugman is not up to his usual high standards in this article. He claims the EZ’s problem is insufficient demand.

Well demand is OK in the core countries. Inflation is near the 2% target, so while demand could be bumped up a little perhaps, it cannot be increased dramatically.

The big problem is the uncompetitive periphery. If demand for the EZ is increased enough to bring full employment in the periphery, that means excess inflation in the core. And Germans wouldn’t like that.

I.e. the central problem, missed by Krugman, is the disparity in competitiveness.

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Academia at its worst.

2011-11-30T10:49:00.000-08:00

The words of Prof. Bryan Caplan:

"I've been in school for the last 35 years - 21 years as a student, the rest as a professor. As a result, the Real World is almost completely foreign to me. I don't know how to do much of anything. While I had a few menial jobs in my teens, my first-hand knowledge of the world of work beyond the ivory tower is roughly zero.

I'm not alone. Most professors' experience is almost as narrow as mine. If you want to succeed in academia, the Real World is a distraction. I have a dream job for life because I excelled in my coursework year after year, won admission to prestigious schools, and published a couple dozen articles for other professors to read. That's what it takes - and that's all it takes."

Words of Dean Baker (director of the Centre for Economic Policy Research):

“If we ask why economists would believe something about the world that seems to fly in the face of evidence, my answer would be that it is the easiest path for them. The vast majority of economists have no interest in upsetting the apple cart. They wanted to be economists because it is a relatively well-paying and prestigious profession. The way you move ahead in the profession is you repeat what the people who are more prominent than you are saying. This carries no risk. If they are right you can share in the glory. If they end up being wrong, then you have the “who could have known?” excuse.”

Dean Baker again:

“In elite Washington circles, ignorance is a credential.”

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Positive Money and what proportion of the money supply is created by commercial banks.

2011-11-29T03:33:00.000-08:00

Positive Money advocates full reserve banking. So do I. So I support Pos Mon both financially and with my time. But I disagree with them on a couple of points.

What proportion of money is created by commercial banks?

Pos Mon (and the New Economics Foundation) claim that 97% of money is created by private banks rather than the Bank of England. This figure is based on the fact that 3% of money is physical cash (£20 notes etc).

If monetary base came only in the form of the above cash, then the argument would be valid. But the reality is that a significant portion comes in the form of book keeping entries, or (as is the case nowadays) entries in computers. As far as I can see this amounts to about another 3% during normal times. In contrast, during the current recession, the monetary base in the UK and elsewhere has been significantly expanded.

For example, in the US the base as a proportion of M2 rose from about 12% at the end of 2000 to 27% in Oct 2011. For the figures, see here and here.

The “book keeping entry” portion of the monetary base is not of course strictly speaking in circulation. But nor can it be said to be private bank created.
The process by which this portion of the monetary base comes into existence (using QE for the purposes of illustration) is thus. The Bank of England (BoE) creates money and buys Gilts from X – (person or institution). The latter gets a cheque for the value of the bonds sold. The cheque is deposited at X’s commercial bank and X’s account at the commercial bank is credited. And the commercial bank presents the cheque to the BoE, who credit the commercial bank’s account in the BoE’s books.

The net result is that the money supply is expanded, NOT as a result of any private bank’s money creation activities, but as a result of the BoE’s money creation activities. And the only reason X is not a direct holder of monetary base is that the BoE does not create accounts in its books for anyone apart from very large institutions, like commercial banks. But in effect, X holds monetary base: it’s just that a commercial bank acts as agent for X at the BoE.

Are we reliant on debt for our money supply?

Another claim made by Pos Mon is that we are reliant on debt (owed to banks) for our money supply. The above 97% figure would certainly seem to support this view.

On the other hand, given a about of deleveraging, such as we have had recently, and a consequent contraction of privately created money, it is clear that central banks step in and make up for the contraction of privately created money with an expansion of central bank money (monetary base).

This phenomenon is nicely illustrated by the 2nd chart on page 2 of this Credit Suisse paper.

So are we really “reliant” on privately created money for our money supply? I suggest not. I suggest that what is going on is as follows.

The typical household with a mortgage will be in debt to the mortgage provider to the tune of very roughly £20,000 to £60,000 with only perhaps £1,000 or so in the bank. In other words the average household with a mortgage sees fit to have an amount of debt which is large compared to the amount of debt free money it chooses to hold.

Those households with £20 – 60,000 of debt will of course be balanced by other households or institutions with equally large amounts of cash to spare.
Incurring debt so as to get a roof over one’s head is largely a VOLUNTARY choice, since the alternative and debt free method of getting a roof over one’s head is to rent. Indeed, this ties up with law of reflux and the real bills doctrine which state that each private sector entity incurs the amount of debt it WANTS, or regards as appropriate, or regards as best suiting its needs.

To summarise, commercial banks provide what might be called a “debt transfer” service. Those debts are widely regarded as “good” because they are backed by respected institutions: large banks. Thus these debts are a form of money.

AS IT HAPPENS, these debts provide the economy with nearly as much money as it wants or needs. But if the population were particularly keen on incurring NO DEBT, the money supply would not shrivel up: the central bank would just step in and issue the amount of money required to keep the economy ticking over.

Do we “rent” our money supply?

Pos Mon, or at least a proportion of Pos Mon minded folk, promote the idea that because people pay interest on debt, and because that debt is a form of money, that therefor we “rent” our medium of exchange. I disagree.

The rent paid here is the rent paid by debtors to creditors. If the creditor is NOT A BANK, chances are that the debt does NOT become a form of money. Money is anything widely accepted in payment for goods and services. For example, where firm A supplies firm B with goods, a debt is than owed by B to A. And part of the agreement between the two may involve interest to be paid by B to A if B is late in paying for the goods. But this debt is not a form of money because it is not easily transferable: it is not widely accepted in payment for goods and services.

And borrowing, lending, debts, etc would continue after the introduction of full reserve, as Pos Mon admits. Put another way, if you have money in your bank account, you are, to that extent, a creditor. But you don’t pay “rent” for the privilege of possessing this money do you? Quite the reverse: other than during the very low interest rates that currently obtain as a result of the credit crunch, you probably get some interest. I.e. the bank PAYS YOU!!!!

Conclusion: debtors normally pay interest to creditors, but posessors of the money created by commercial banks do not pay rent to such banks for the privilege of being supplied with a medium of exchange.

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Ron Paul, Bernanke and can money for capital investment come from the printing press?

2011-11-28T00:21:00.000-08:00

Youtube clip of Ron Paul interviewing Bernanke.

Ron Paul asks whether money for capital investment can come from the printing press – see 1min 30 secs into the interview. Bernanke does not give a straight answer. The answer is thus.

If an economy is at capacity, and the government / central bank machine (GCBM) prints money and distributes it to commercial banks, who then lend it to firms doing capital investment, that investment expenditure will raise demand, which in turn will raise inflation. That effectively robs those who are not in receipt of GCBM largess, and those robbed are forced to forgo consumption.

Thus the REAL RESOURCES for the capital investment come from those robbed. And that is a pretty random selection of the population, and an illogical way of organising the reduction of consumption needed to fund capital investment.

If the economy is below capacity.

In contrast, if the economy is BELOW capacity, the additional demand may well not exacerbate inflation too much. But robbery still takes place. That is GCBM allocates the “right to control resources” (i.e. money) to a few chosen institutions (i.e. banks). That is money that could have been simply spent into the economy, and/or used to cut taxes (as advocated by Modern Monetary Theory and by this lot.

If GCBM can show that the amount of investment is sub-optimum, i.e. that there has been market failure, then artificial assistance for investment could be justified. But of course GCBMs have never demonstrated this: that would be too much like hard work.

____________

Hat tip to Dr Mike Heywood. I got the link to the above Youtube clip from an email that Dr Heywood distributes about once a week. This email contains what he thinks are interesting economics articles, and a selection of economics / politics related cartoons. Contact: mike@mikehaywoodart.co.uk.

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Government should not subsidise bank loans.

2011-11-27T02:28:00.000-08:00

It’s been announced in the last 48 hours that the UK government intends underwriting a few billion of loans by banks to businesses, which to the innocent will sound a good idea.

But why should government subsidise bank loans to businesses? There are alternative sources of funding for businesses: issuing shares or obtaining loans from non-bank institutions (or in the case of small businesses, loans from family members or friends).

Siemens in Germany are very much into the “firm to firm” lending business. Are they entitled to a subsidy, and if not, why not?

Moreover, the whole bank lending business already receives an ASTRONOMIC subsidy: that’s the too big to fail subsidy plus the £85,000 per account guarantee provided by government (i.e. taxpayers). The too big to fail subsidy alone was estimated by the Independent Banking Commission as being worth well over £10bn a year (about £150 per UK resident per year). See p.130 here.

As the ICB righly say (p. 8) “The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers.”

Government should stop tinkering with the dozens of levers that they think control the economy and concentrate on approximately one lever. As advocated by Prof Werner, Positive Money, the New Economics Foundation, government should just create new money and spend it into the economy when needed (and/or cut taxes). Modern Monetary Theory advocates the same.

Or as Simon Jenkins put it, “Governments can worry about borrowing, lending, inflation, fiscal rectitude, whatever until the cows come home – but without demand there is recession.”

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Germany fails to sell debt.

2011-11-24T20:55:00.000-08:00

The recent failure of Deutschland to sell its debt stems does not stem the market thinking Deutschland is not credit-worthy. The very idea is absurd. The problem derives from suspicious as to whether the Euro will survive. Who wants to own bonds denominated in a currency that might cease to exist in a few months?

The solution is for the ECB to act a bit more like a normal central bank / government and create and spend money into the Euro economy. This comes to much the same thing as the Euro distribution long advocated by Warren Mosler (see para starting “The ECB would create…”).

Or have I missed something?

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Today’s Financial Times leading article on deficits and debt is clueless.

2011-11-23T04:43:00.000-08:00

The article starts:

It is now clear that curbing Britain’s public debt is going to be much harder than the coalition government originally predicted. While David Cameron admitted as much earlier this week, official confirmation will come next week with the publication of the Office of Budget Responsibility’s report on the state of the UK’s public finances. While disappointing, this does not undermine what still appears to be a sensible plan. The problem for the government is that weaker actual and potential growth has made the task of reining in the deficit much harder than forecast.

Now why would “weaker growth” result in “reining in the deficit” being “much harder”? Reason is that weak growth necessitates a bigger deficit, or to be more exact, weaker growth requires more stimulus, which itself requires a bigger deficit.

But what’s wrong with such a deficit? If the private sector fails to spend, the remedy is to have government spend more (and/or cut taxes so that the private sector is encouraged to spend more). So what’s wrong with such a deficit – the fact that it results in more debt?

POPPYCOCK! As both Keynes and Milton Friedman pointed out, a “stimulus deficit” can be funded EITHER by borrowed money OR printed money. If interest rates are round about zero, there is no harm in borrowing more. But if interest rates become significantly positive, then all government needs do is to go for the print option. So there is no problem there.

But the next sentence of the FT article is bizarre. It says,

Chancellor George Osborne’s hopes of eliminating the current structural deficit by 2014-5 now look impossible.

Well as made clear above, the part of the deficit that may have to expand if weak growth persists is NOT THE STRUCTURAL DEFICIT. It’s the stimulus part of the deficit.

Put another way, the structural deficit is the part of the total deficit which has no influence on growth.

Or as the Reuters definition puts it “The portion of a country's budget deficit that is not the result of changes in the economic cycle. The structural deficit will exist even when the economy is at the peak of the cycle.”

Wiki says much the same: “a structural deficit exists even when the economy is at its potential”

(There are actually a number of other and silly definitions of the phrase “structural deficit” out there. I may do a post on this, as well as contacting the authors of those definitions.)

Now if the structural deficit has no influence of growth, it follows (by definition) that removing this part of the total deficit will have no “anti-growth” effect, i.e. no “anti-stimulatory” effect!

So if it’s the structural deficit and debt that the FT is talking about, it is untrue to say that, “curbing Britain’s public debt is going to be much harder” because of poor growth figures.

As to the actual mechanics of reducing the structural deficit without harming growth, see here.

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87 countries have left currency unions since 1945.

2011-11-20T05:49:00.000-08:00

John Redwood says 87 countries have left currency unions since 1945.

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A hopeless defence of fractional reserve banking in the Financial Times.

2011-11-17T01:09:00.000-08:00

Ben Dyson of Positive Money authored an article in the Guardian earlier this week attacking fractional reserve banking. This blog article at the Financial Times authored by Izabella Kaminska responded. The latter’s attempt to demolish Dyson’s arguments are hopeless.

Dyson argues against the right of private banks to create money. The first five or so paragraphs of Kaminska’s article respond by pointing out that economists realised a century or more ago that private banks do this. Thus Dyson’s point, according to Kaminska is old hat.

The answer to that is that Dyson does not claim to be revealing anything that most economists are not already aware of. As Positive Money’s literature points out time and again, the object is to educate the PUBLIC. (I could cite ignorant economists who quite clearly DO NOT get Dyson’s point, but I don’t want to be cruel.)

Second, in the paragraph starting “Having staggered…” Kaminska claims that Positive Money “plans to end evil debt everywhere”. Wrong again. The advocates of full reserve banking (including Positive Money) are well aware that borrowing and lending will always take place. What advocates of full reserve object to is (amongst other things) the fact that fractional reserve exacerbates instabilities.

That is, during a boom, asset prices rise. It was primarily property prices in the run up the recent credit crunch, and in the late 1920s it was primarily share prices. This price rise makes assets better collateral to back further lending. That further lending boosts asset prices still further. And so on.

Third, and credit where credit is due, Kaminska claims that the whole full versus fractional reserve argument is complex. Agreed.

And finally, Kaminska makes the bizarre claim that “Without debt, after all, you can’t have money.” Oh yes? What about a commodity based currency, like gold coins? If I have some gold coins, exactly where is the “debt” associated with these gold coins? Answer: the debt does not exist!

And it’s not only commodity based money systems that involve debt free money. In our existing fiat money system, monetary base is effectively debt free. Of course monetary base IN THEORY has an associated debt: a debt owed by the central bank to holders of monetary base. Those £20 notes (which are part of the monetary base) have imprinted on them the phrase “I promise to pay the bearer on demand the sum of £20”. But of course that is meaningless: try going along to the Bank of England and demanding £20 of gold (or anything else) in exchange for your £20 note. You’ll be told to shove off.

In short, there is no debt associated with monetary base.

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A flaw in Nominal GDP targeting.

2011-11-16T02:44:00.000-08:00

There was a debate on NGDP targeting on Winterspeak’s site recently. One point missing (I think) from that debate (perhaps because it was too obvious) was as follows.

Advocates of NGDP claim that if the authorities concentrate EXCLUSIVELY on inflation, they’ll pitch aggregate demand too low when inflation has a significant cost push element.

As David Beckworth (probably the main high priest of NGDP) says,

“Inflation is the result or symptom of underlying shocks to aggregate demand (AD) and aggregate supply (AS). Monetary policy, however, can only meaningfully influence AD so that is where its focus should be. This cannot happen with strict inflation targeting because it requires the central bank to respond to any change in inflation, regardless of whether it is caused by AD or AS shocks.”

Well the answer to the latter point is that the authorities JUST DON’T concentrate exclusively on inflation: that is, the DO LOOK at the reasons behind inflation.

For example, Britain’s government and central bank think that the current excess levels of UK inflation are to a significant extent cost push and temporary. They are thus doing nothing too drastic to bring down this inflation to the 2% target within the next six months.

I don’t have any big objections to NGDP targeting: I just think it’s merits are exaggerated.

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Dennis Kucinich tells banks what they can do with themselves.

2011-11-15T05:12:00.001-08:00

One minute clip:

http://www.youtube.com/watch?v=VaF_MZVWM3E

(Hat tip to Richard Shelley)

Krugman confuses fractional reserve and maturity transformation.

2011-11-05T00:48:00.000-07:00

I have plenty of respect for Krugman, but he goes off the rails in this article, in which he tries to defend fractional reserve. Near the start there are two paragraphs which read as follows (in italics):

Like a lot of people, my insights draw heavily on Diamond-Dybvig (pdf), one of those papers that just opens your mind to a wider reality. What DD argue is that there is a tension between the needs of individual savers — who want ready access to their funds in case a sudden need arises — and the requirements of productive investment, which requires sustained commitment of resources.

Banks can largely resolve this tension, by offering deposits that can be withdrawn on demand, yet investing most of the funds thus raised in long-term, illiquid projects. What makes this possible is the fact that normally only some depositors want to withdraw funds in any given period, so it’s normally possible to meet those demands without actually having liquid assets backing every deposit. And this solution makes the economy more productive, providing more liquidity even as it allows more productive investment.

The latter process, transforming short term deposits into long term loans, is not fractional reserve: its called “maturity tansformation” (MT). Fractional reserve is the process whereby the private bank system holds a relatively small amount in the form of cash relative to its deposit lilabilities: in other words the private bank system can create and lend out money.

But since Krugman introduces MT to the argument, let’s examine it. It would certainly seem to bring benefits on the basis of the Diamond-Dybvig argument. But the first flaw in this argument is that it equates money (which is nothing more than numbers in computers) with REAL SAVINGS. Real savings are of course not just numbers in computers: real savings consist of houses, office blocks, machinery, etc.

Thus trying to make maximum use of our stock of money is senseless because numbers can be added to computers at no cost anytime. Or as Milton Friedman put it in Ch3 of his book, “A Program for Monetary Stability”, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.”

So MT achieves nothing. That is, from the perspective of an individual bank it is profitable. But from the perspective of the country or economy as a whole, it’s a zero sum game.

Moreover, MT amounts to “borrow short and lend long”: an inherently risky strategy which brought down Northern Rock and hundreds of other banks over the centuries. Indeed, Krugman admits as much. He says:

The problem, of course, is the vulnerability of such a system to self-fulfilling panics: if people believe that a bank will fail, everyone will in fact want to withdraw funds at the same time — and because the bank’s assets are illiquid, trying to meet those demands through fire sales can in fact cause the bank to fail.

This then leads to the need for policy: deposit insurance and/or lender of last resort facilities to head off bank runs, and bank regulation to reduce the moral hazard from these explicit or implicit guarantees.

Quite. Put another way, MT is so risky that some sort of compulsory insurance is required to underwrite it. Ideally this insurance should be funded by those taking the risk (which to some extent in some countries it is). Unfortunately, insurance in most countries also comes in the form of the taxpayer funded implicit too big to fail subsidy. And that’s a blatant misallocation of resources.

Banks cannot be defined?

Krugman then claims that it is near impossible to define a bank, plus he points to the large shadow banking industry. This leads him to conclude that controlling fractional reserve is near impossible.

The first problem here is that I suspect the shadow banking industry does not engage in much fractional reserve. I suspect it’s main activity is connecting large lenders with large borrowers. That’s not fractional reserve.

In contrast, there is nothing to stop the shadow bank industry doing MT. And doubtless the latter helps explain the run on the shadow bank industry that contributed to the credit crunch.

Fractional reserve involves the CREATION OF MONEY. And money is defined as anything which is WIDELY ACCEPTED in payment for goods and services or settlement of debts. Now if I am some unheard of outfit claiming to be a bank and I want to do what large banks do, i.e. create money out of thin air and credit the account of someone applying for a loan, and that person then draws a cheque on me, the person who is given the cheque is unlikely to be happy with “payment” that consists of having their account at some “unheard of outfit” credited. The latter outfit could be me or some other shadow bank. They’re probably going to want their account at some large, respectable outfit credited.

Conclusion: it is difficult for shadow banks to do fractional reserve.

And even to the extent that shadow banks do do fractional reserve, I totally fail to see the difficulties in having government keep tabs on them. If government can keep tabs on every household with a view to extracting income tax from households, then where is the problem in keeping an eye on the smallest shadow bank which probably has a turnover fifty times that of the average household?

Government (at least in the UK) keeps tabs on, or tries to keep tabs on, one man band loan sharks who prey on poorer neighbourhoods.

And finally, the turnover of the shadow banking industry has risen sharply in recent years and is now about the same size as the official banking industry. If so called “bank regulators” are to be anything more that unproductive bureaucrats shuffling pointless bits of paper, then they are just going to have to get to grips with the shadow bank industry.

The scourge that is unemployment.

2011-11-03T10:21:00.000-07:00

Fractional Reserve.

2011-11-03T02:19:00.000-07:00

Once upon a time there was an economy with a central banker called Ab Lerner. He spent money into the economy at a rate that brought full employment (and occasionally raised taxes and withdrew money when the population was gripped by irrational exuberance).

He didn’t want to operate bank accounts for households and businesses, i.e. “private sector entities” (PSEs). That function was performed by Lloyd Bankfiend, the commercial banker.

Each PSE wanted a stock of money to meet its need to make transactions, plus some extra money against a rainy day: the so called precautionary motive for holding money. Each PSE kept pretty well to its “transaction and precautionary” stock of money.

That in turn meant that no PSE could borrow unless some other PSE took the deliberate decision to forgo consumption and save money.

PSEs wanting to borrow sometimes borrowed direct from other PSEs, and sometimes they borrowed via Mr Bankfiend.

Mr Bankfiend only lent money that had been deliberately deposited with him in savings accounts rather than current or checking accounts.

The rate of interest in this economy was determined by market forces, that is, it was determined by the relationship between borrowers and lenders. That in turn optimised the amount of borrowing and lending and investment. Reason was that at the margin, the benefits of borrowing (e.g. the return on capital that businesses could obtain by making investments) was equal to the pain or disutility suffered by those abstaining from consumption so as to save.

Then one day Mr Bankfiend had an idea. “Why”, he said to himself “do I bother waiting for people to deposit money with me before crediting the accounts of those who want to borrow?”

He couldn’t think of a reason for not doing this. So next day when people came in applying for loans, and after making sure they had adequate incomes and net assets, Mr Bankfiend just clicked his computer mouse and credited the accounts of the borrowers.

The big advantage of this for Mr Bankfiend was that he collared the interest paid by the borrowers without having to pass any of it on to those who had put money in deposit accounts at his bank. Or as Murray Rothbard put it, fractional reserve bankers “can charge a lower rate of interest than savers would”.

But of course there is no such thing as a free lunch. The going rate of interest dropped, which meant that lenders (i.e. those with deposit accounts) lost income, while Mr Bankfiend gained.
Moreover, interest rates were no longer at the level at which costs and benefits at the margin were equalised. As a result GDP fell.

To make absolutely sure he retained this easy source of income, Mr Bankfiend paid the election expenses of various politicians so as to make sure they didn’t interfere with his new source of income.

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P.S. 28th Jan 2012. There is a much more detailed version of the above argument here.

Workfare.

2011-11-01T01:47:00.000-07:00

An economy consists of a labour force of twelve people and two firms. Demand is enough to employ ten people (including the two employers). So there are two unemployed.

Wages are sticky downwards, but prices are flexible. Government is too incompetent to raise aggregate demand. What do do?

One solution is to tell the two unemployed individuals that if they want to continue receiving benefits they have to turn up at an employer’s premises and work part time.

The availability of this new source of free labour would induce the employers to cut the price of their products by enough to raise output by enough to keep the two unemployed people busy. That’s Say’s Law (I think).

That’s not as good as providing full time work for the two unemployed people (assuming they want full time work). But it’s better than having them full time unemployed.

Note that even if unemployment is at NAIRU in this economy (or at the “inflation barrier” as Bill Mitchell calls it), the above system would still work – at least to some extent. Reason is that at NAIRU, employers do not take on the unemployed because of the latter’s unsuitability. So if the employment subsidy involved here makes up for this unsuitability, employment would rise.

QED.

Why can’t everyone have a printing press?

2011-10-31T03:06:00.000-07:00

Quotes from “Creating New Money”, by Joseph Huber and James Robertson.

“The cost to the state of issuing new money is only the cost of
producing banknotes and coins. The cost to the banks of issuing new money is virtually zero. The state receives public revenues from issuing cash, but banks make private profits. The benefits of the money system are therefore being captured by the financial services industry rather than shared democratically.” (p. iii)

“Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves.” (p. 31)

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Afterthought (1st Nov). More information about James Robertson here. (Hat tip to Gillian Swanson).

“Where Does Money Come From”?

2011-10-30T11:26:00.000-07:00

I’ve just read / skimmed thru this recently published book (published by the New Economics Foundation, London). It does what it claims to do on the front cover, that is it is “A guide to the UK monetary and banking system”. But there are so many references to bank and money systems in other countries, that the book is arguably a guide to bank and money systems in general.

This book explains the numerous deficiencies in the existing system, but does not propose any particular remedy: that is not the aim of the book. Bits of the book that stuck in my mind (because I’m an MMTer) were thus.

1. Warren Mosler’s “parents, children and business cards” hypothetical economy is briefly explained on p.34.

2. The book accepts that the text book model of banking where banks are constrained by their reserves is out of date.

3. The section headed “Is cash a source of ‘debt-free’ money” (p.66) left me scratching my head. This section claimed that “some monetary analysts have concluded that there are two ‘money supplies’. Firstly a supply of cash, created by the Bank of England and injected into the economy by being lent to commercial banks, and secondly a much larger supply of bank-created money created as banks make loans to and buy assets from businesses…” The authors then try to play down the difference between the two sorts of money, for example by pointing out that commercial bank created money is backed by the state: up to £85,000 per account in the UK (but check the small print before assuming your money is safe!).

In effect the authors play down the distinction between what MMTers call “vertical” and “horizontal” money. However, this attack on the latter distinction is half hearted and not very successful.

But there is much more to this book than the above MMT oriented points.

Incidentally in a separate publication, the publishers (New Economics Foundation) and one of the co-authors Prof.R.A.Werner advocate a basic MMT idea, namely that in a recession, the government / central bank machine should simply create new money and spend it into the economy. See:

http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

Why on earth does the EFSF want to borrow from China?

2011-10-29T20:41:00.000-07:00

The Eurozone (EZ) is contemplating bailing out Greece and possibly other indebted periphery countries. Banks holding those countries’ bonds may also be bailed out.

But the EFSF is contemplating getting some of the money for this exercise from China. The EFSF evidently does not understand monetary sovereignty.

That is the European Central Bank can print any number of Euros for bail out purposes any time it wants. As to how inflationary that would be, that is moot. If the indebted countries acted responsibly and continued with their deflationary policies (which are intended to make them more competitive) they would not go on a spending spree.

Likewise the banks which were relieved of their toxic sovereign debts would arguably not go on a spending spree either. Banks on both sides of the Atlantic have had their fingers burned recently as a result of the irresponsible borrowing they indulged in in the run up to the credit crunch. Give a chance they will certainly make the same mistakes again, but not in the next two or three years. Walter Bagehot a hundred and fifty years ago pointed to the never ending cycle of irrational exuberance followed by busts, followed by a few years of recovering from the hangover, followed by the next round of irrational exuberance.

And in the US and UK, bank bail outs have not led to excessive bank lending: quite the reverse.

But even if indebted countries and banks DO GO ON A SPENDING SPREE, Europe (if it gets its act together) ought to be able to take deflationary countermeasures. And this of course is where the real “core countries subsidising PIGs” effect arises. That is, core countries have to rein in demand so as to enable PIGs to spend.

And finally (and to add insult to injury) borrowing from China does not solve the above “spending spree” problem. That is, if indebted countries and banks are going to go on a spending spree with freshly printed Euros supplied by the European Central Bank, they’ll almost certainly do the same with freshly supplied money coming from China.

Greek style austerity is not necessary.

2011-10-27T04:06:00.000-07:00

Britain’s former premier, John Major, has a good article in today’s Financial Times. However he makes a mistake when he says in reference to Euro periphery countries, “because they cannot devalue their currency, they must devalue their living standards and promote reforms that enhance efficiency.” Not true!

As I pointed out here, individual Euro countries MOST CERTAINLY CAN to all intents and purposes devalue their currencies: they just need to cut their wages, pensions, etc. And contrary to John Major’s suggestion, this does NOT result in a big drop in living standards because the bulk of the cost of stuff consumed in most countries is the cost of labour in that country.

Moreover (also contrary to John Major’s suggestions) periphery countries DO NOT need to become more efficient. As long as they do a “devaluation / wage cut” of the right amount, they can perfectly well remain inefficient. Indeed I quite like the idea of a variety of different lifestyles and levels of efficiency round Europe. If Greeks and Spaniards want to take three hour lunch breaks, sitting in the sun, that’s fine by me as long as they don’t demand the supposedly high living standards that Northern European enjoy. I say “supposedly” because sitting in the sun is arguably more enjoyable than working in a factory in Northern Europe. Thus it’s a moot point as to who is better off: southern Europeans sitting in the sun or northern Europeans in factories.

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On the opposite page in the FT there is a silly leading article which says in bold print (in the hard copy version) that “The challenge is to encourage cash-rich businesses to invest and employ people”. Luckily for us, most people running businesses have their heads screwed on tighter than FT leading article writers. That is, most businesses “invest and employ” when there is demand for their products, not just because they’ve got cash sitting in the bank.

Let the peasants eat cake.

2011-10-25T03:50:00.000-07:00

The Bank of England recently announced an additional £75bn of QE. When Simon Jenkins asked some bankers whether it might be an idea to direct the £75bn straight into the high street, they looked at him as if he was mad.

Well you can see their point, can’t you? I mean the purpose of the economy is to keep the elite supplied with fine wines, large houses, and so on. The purpose is most definitely not to enable ordinary consumers and peasants to buy what they want, please note.

Lawrence Summers wants to pour gasoline on the flames.

2011-10-24T11:46:00.000-07:00

Summers in the first paragraph of this Financial Times article has tumbled to something that has been obvious to most of us for three years. This is the recession was caused by excessive borrowing, yet the elite (i.e. Summers & Co) are trying to get us out of the mess by encouraging borrowing. I pointed out the absurdity here in a letter in The Times in 2008, but the absurdity is doubtless obvious to the average ten year old.

To be more accurate, Summers claims that three things will get us out of the mess: more confidence, borrowing and spending. As to confidence, that is thoroughly elusive and impossible to control, so FORGET IT. As to spending, well obviously more spending is required, but the question is how. Silly Summers wants to do it via more borrowing. Stupid!!!!!!!

Modern Monetary Theory (MMT) advocates spending debt free money (i.e. monetary base) straight into the economy in a recession. That way you get extra spending with no more debt.

Personally, and speaking as an advocate of full reserve banking, I’d take it further, and abolish the system we currently have (fractional reserve banking). Fractional reserve means that every additional $ of money is matched by an additional $ of debt. What’s the logical connection here? That is, if the economy needs an extra $1bn of money, whence the assumption that there should also and automatically be an extra $1bn of debt?

Milton Friedman favoured full reserve banking. He was right.

Yipee - austerity brings modernisation.

2011-10-20T12:38:00.000-07:00

In case you had any doubts as to whether the lunatics have taken over the asylum, the New York Times cites some authoritative figures round Europe to the effect that austerity in Greece will bring modernisation.

Anyone with any ideas as to how mass unemployment and cutting social security benefits helps turn an inefficient transport system into an efficient one, please leave your suggestions below. I’m always happy to learn.

Hat tip to Econospeak.

Tighter bank regulation does NOT impede growth.

2011-10-20T01:15:00.000-07:00

I’m getting tired of being told that tighter bank regulation impedes growth. The fallacies in this idea are as follows.

First, in the long run, economic growth is determined by improved technology (other things like educational standards being constant). Thus even if bank regulation is tighter than optimum, in the long run, the effect on economic growth is negligible.

Second, it is blindingly obvious that tighter regulation will reduce loans by banks to businesses, ALL ELSE EQUAL. In particular, if the sources of funding OTHER THAN loans from large banks are not expanded when funding from banks contracts as a result of tighter regulation, then obviously total funding for businesses will decline.
But there is no reason why funding from the alternative sources cannot be expanded! And this is easily done by the simply by expanding the money supply, or monetary base, to be more exact.

Those touchy feely “small and medium size enterprises” which politicians love to show concern for, are often funded in informal ways, e.g. by loans from friends and relatives. And another alternative is equity finance. These alternative methods of funding automatically become easier if the monetary base is expanded.

Moreover, given the extra aggregate demand that comes from expanding the base, (or indeed the extra demand that can be effected in other ways), businesses will be in a better position to pay the extra fees or interest that banks have to charge as a result of tighter regulation!!!! Doh!

Driving at high speed means higher fuel consumption, which boosts fuel sales, which in turn “boosts economic growth”. Is that an argument against speed limits on roads? I think not. I think the intelligent policy here is to try to design speed limits in such a way as to optimise the trade-off between numerous factors: environmental factors, the costs of treating those injured in road accidents, etc. If that restricts economic activity, then no problem: just boost the economy via the usual methods – interest rate reductions, budget deficits, QE, and so on. That will result in people spending less on fuel or treatment for car related injuries and more on other consumer goods. Is that a problem?

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Afterhought, 1st Dec, 2011. Nice to see the Financial Times main front page story also pouring cold water on the idea that tighter bank regulation impedes growth a week or two after the above post.

Infrastructure investments are NOT a cure for recessions.

2011-10-13T21:31:00.000-07:00

Every time there is a recession, sure as night follows day, infrastructure investments are cited as a cure for the problem. Unfortunately this idea gets a fair amount of support from senior members of the economics profession, e.g. Brad DeLong, Ann Pettifor, Nouriel Roubini (p.4).

Just in case these individuals think they are advocating something original, Pericles in ancient Athens, 2,400 years ago, advocated public sector projects as a means of providing work for the unemployed.

There are a string of problems involved in the above alleged cure for recessions, as follows.

1. Infrastructure investments, like any other form of economic activity requires SPECIFIC TYPES OF LABOUR. In the case of typical infrastructure investments (e.g. road, rail, bridge, school, and sewer construction), it’s electricians, carpenters, civil engineers, architects, people with experience of working with concrete, bricklayers, plumbers etc that are needed.

No doubt during a typical recession there is a decent supply of the latter skills to be found amongst the unemployed. But no more so than the skills suitable to other forms of economic activity. And as regards the current recession, it might seem that there is likely to be a super-abundance of unemployed and experienced construction workers. Unfortunately, the evidence is that former construction workers have found no more difficulty finding alternative work than members of other professions, thus it is not entirely clear that the above “super-abundance” exists. See here and see near bottom here.

To put the above point another way, if we HAVE TO concentrate on creating jobs via the public sector during a recession, there is no reason to concentrate on infrastructure rather than other forms of public spending. In particular, in the US, thousands of teachers, police, etc have been sacked as a result of the crunch. To have these people work on infrastructure projects rather than employ the skills they already have is absurd.

2. One big attraction of concentrating on the public sector in a recession is that effects of this spending are more certain than the effects of channelling more money to the private sector: the private sector multiplier is always uncertain.

However, requiring people to change the type of job they do involves costs: re-training, and time taken to learn profession specific or firm specific skills. If the distortion involved in expanding the public sector during a recession is unwound come the recovery, then further costs are involved as another lot of people have to change jobs and/or profession.

3. What proportion of infrastructure projects are “shovel ready”? In the UK it takes a minimum of about a year to get planning permission for any significant infrastructure project, like a bridge.

Declining participation rates.

2011-10-10T19:32:00.000-07:00

I pointed out here a few weeks ago that the US labour market started deteriorating well before the current recession. Or to be more accurate, the participation rate seemed to be on the decline.

Here is a more striking chart showing the same thing. (HT to Mish). Perhaps returning to pre credit crunch participation rates is not on.

What proportion of the money supply is created by commercial banks?

2011-10-07T10:49:00.000-07:00

I like the ideas in this paper authored by Prof.R.A.Werner, Positive Money and the New Economics Foundation. But I’ve got a technical quibble about the proportion of the money supply that is created by commercial banks.

Pos Money and NEF argue that because about 3% of the money supply is physical cash (£20 notes, etc), therefor about 97% must be commercial bank created money.

That point would be valid if physical cash was the only form of monetary base. But it’s not: there is also book keeping entry type monetary base: i.e. bank reserves.

NEF claim that “central bank reserves do not actually circulate in the economy” which is their reason for not counting reserves as part of the money supply. I beg to differ, and for the following reasons.

Suppose I have government debt which reaches maturity tomorrow. I’ll get a cheque from the central bank tomorrow for the relevant amount, which I then deposit at my commercial bank. And the latter than presents the cheque to the central bank, which then credits the account of the commercial bank in the books of the central bank.

I can then transfer £Y of my recently boosted bank balance to person X. And the central bank, as part of it’s role in helping commercial banks settle up between themselves, will transfer £Y from my commercial bank’s account at the central bank to the account (in the central bank’s books) of the commercial bank where X keeps his money.

Now the above transfer is no different to the transfer of commercial bank created money between two individuals (and hence between their commercial banks). Put another way, when I get monetary base as a result of my government debt maturing, I then in effect have money stored at the central bank. As to transferring this money to someone else, it just happens (because of institutional arrangements) that commercial banks act as “go betweens” when it comes to transferring this money. But effectively, the chunk of monetary base concerned is part of the money supply “circulating in the economy”.

But that doesn’t detract from any of the basic points made by Pos Money or NEF. It’s just that I think their 97% figure is a bit out. Since bank reserves are roughly 3% of total money supply (far as I can see – which is not very far) I am saying the figure should be about 94%. Though at the moment, bank reserves are somewhat bloated, so the figure will currently be less than 94%

George Selgin’s flawed pro-fractional reserve arguments.

2011-10-04T23:27:00.000-07:00

Prof. George Selgin in a work entitled “Should we let banks create money?” argues for fractional reserve (FR).

He takes three anti-fractional reserve arguments (p. 94) and tries to demolish them. These three are as follows.

1. FR is fraudulent.

2. It lowers interest rates to below their natural level, which exacerbates the business cycle and results in uneconomic investments being made.

3. FR gives rise to a fragile banking system because banks cannot pay all depositors if too many depositors demand their money back at the same time.

Fraud.

The fraud argument that Selgin criticises (p.95) is this. (Incidentally, this is the “least feeble” of his arguments – to coin a phrase.)

Depositors allegedly don’t know that their money is being invested by the banks at which they deposit. Plus they are allegedly unaware that so much is invested in long term loans, that banks cannot possibly repay all depositors their money, should too many depositors decide to withdraw their money all at once.

Selgin’s answer is that most depositors, especially in countries where there is or was no taxpayer funded deposit insurance, know perfectly well their money is being loaned on. Moreover, so argues Selgin, if there were any significant demand for 100% reserve accounts, banks would offer these.

The first answer to the latter point is that banks do offer ultra safe deposit accounts.

For example in the US (despite FDIC insurance) there is clearly a demand for EVEN SAFER deposits as provided by money market funds or money market accounts offered by banks: these invest depositors’ money only in government securities and high quality commercial bonds. And in the UK there is a demand for National Savings accounts.

Second, absent taxpayer funded guarantees, like FDIC, a full reserve account offered by a commercial bank is still not 100% safe. A large amount of fraud and criminality is perpetrated by banks. If that was not clear prior to the recent credit crunch, it has become abundantly clear now that the reasons for the crunch are being revealed.

If depositors are as sophisticated as Selgin claims, then depositors will be well aware that any claim by a commercial bank that depositors’ money is 100% safe should be taken with a pinch of salt.

In short, given the choice between depositing your money with a less than entirely honest organisation which pays a decent rate of interest, and a less then entirely honest organisation which pays no interest, but claims to offer 100% safety, there are good arguments for going with the former.

Indeed many investors adopted precisely this strategy in relation to Bernie Madoff. It was widely rumoured that he was a crook years before his Ponzi scheme actually collapsed. But many investors stuck with him and did very well. Others lost out, of course.

Third, banks make their money out of investing depositors’ money. They will never be overly keen on advertising the ultra safe nature of full reserve accounts: that implies that their normal bank accounts ARE NOT safe.

Fourth, even if demand for 100% safe accounts is small, I suggest the availability of 100% safe accounts it is a fundamental human right.

Instability and business cycles.

Selgin’s argument here is not all that clear. On the face of it, his argument is simple enough. Unfortunately for those of us with an understanding of money, his argument is open to different interpretations.

Selgin’s “on the face of it” argument is that increases in the money supply do not matter as long as there is an increased DEMAND to hold money. I’ll assume to start with that he means “hold” in the sense of “hoard” or “hold for the well known precautionary motive”.

The first flaw in that argument is that only a very small proportion of money borrowed is borrowed simply to hold or hoard the stuff. That is, the vast majority of money borrowed is borrowed with a view to engaging in economic activity: buying a house, expanding a business, etc.

Second, for every dollar of commercial bank money created, a dollar of “negative money” is also created: that is, a debt of one dollar is created. It is thus PLAIN IMPOSSIBLE for the commercial bank system to create a NET ADDITION to “money” in the sense of adding to the private sector’s net liquid financial assets.

But that is not to say there is absolutely nothing in the idea that the private sector has a desire to hold liquid financial assets. Put another way, there is definitely something in Keynes’s “paradox of thrift” idea: the idea that given an inadequate stock of net liquid financial assets (which is pretty well another way of saying “money”) the private sector will not spend enough to bring full employment. However, while as stated above these “savings desires” cannot be met by commercial bank created money, they CAN be met by central bank created money, i.e. monetary base.

Holding money so as to do business.

Having dealt with the “hoard” sense of the word “hold”, it is possible that Selgin is referring to “hold” in the sense of “hold for the purposes of engaging in economic activity”. In this sense of the word, the person who originally borrows from a bank does not “hold” the money for long: the money is transferred to someone else, who holds it for a while before transferring it to a third party, and so on. But of course the result is that the private non bank private sector as a whole “holds” an increased stock of money.

Here, Selgin’s argument is that because there is a desire to hold more money, that additional money cannot be inflationary. The flaw in that argument is that it totally ignores the main arguments put by opponents of FR (and indeed many economists who do not see themselves as being particularly anti-FR). This is that during a boom, the private sector wants to “hold” additional amounts of money so as to engage in ramping up asset prices (mainly shares in the late 1920s, and mainly houses prior to the recent recession). Or the private sector wants to “hold” more money because it is in a fit of irrational exuberance not connected specifically with house or share prices.

In short, Selgin’s argument that additional amounts of money supplied to the non-bank private sector cannot be inflationary just because that sector “wants” more money, does not stand inspection.

Another argument that Selgin puts under the “instability” heading is that there are sources of instability other than FR. True. But the more sophisticated opponents of FR have never claimed that abolishing FR will bring perfect stability and an end to the business cycle. They simply claim that abolishing FR will IMPROVE stability. (E.g. see the Werner / Positive Money submission to the Independent Banking Commission).

http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

Third: bank fragility and risks.

On page 99, Selgin argues that because a full reserve gold based money system would produce an inadequate stock of money, therefor we have to have fractional reserve. The flaw in that argument is that the latter two systems are not the only possibilities.

Another alternative is a fiat based full reserve system. Indeed, gold bugs might not like it, but the reality is that the world’s monetary system is now very largely a fiat system, and there is little chance of it being anything else in the near future. Thus to advocate full reserve is in practice to advocate a “fiat / full reserve” system. If Selgin is unaware of this, then that is a glaring omission.

Indeed, a “fiat / full reserve” system is in the above mentioned Werner / Positive Money paper. Under this system, the private sector can at least in principle be provided with whatever quantity of money it feels comfortable with: the quantity that brings full employment without excess inflation.

Under the latter system, commercial banks can lend to whoever they believe to be creditworthy. But what they CANNOT do is effectively print the money they lend. That is, they have to find a saver who is willing to abstain from using his or her money for some period.

Instabilities caused by central banks.

On page 98. Selgin does make one plausible point, namely that the instabilities brought about by governments and central banks are worse than those stemming from the private bank system.

Given the catastrophic damage done by the private bank irresponsibility that caused the recent credit crunch, the latter point is weak. Also, even if central banks really are responsible for more instabilities than commercial banks, that is not a reason to abstain from improving commercial banks, if the latter is possible.

Fractional reserve funded the industrial revolution?

On his page 99 Selgin argues that fractional reserve banking funded the industrial revolution. True: it did.

But the opponents of FR have never said that FR banking is a system that does not work at all. It certainly does work. But the basic claim made by opponents of FR is that we can do better.

On the same page Selgin puts the very trite argument that the fact that FR involves risk is not a reason to dispose of it. He points out that houses involve risk as they can be demolished by earthquakes. I trust the flaw in that argument is so obvious that I don’t need to spell it out.

Conclusion.

The “full versus fractional reserve” argument is complicated. Some of the pro-fractional reserve arguments are easily demolished. E.g. I think I successfully demolished Steve Horwitz’s arguments here. Plus I think I’ve dealt with Selgin’s arguments above. But what is the absolutely clinching argument for full reserve? I’m not there yet. But watch this space.

Interns raise aggregate employment levels and GDP?

2011-10-02T04:30:00.000-07:00

The UK currently has excess unemployment AND inflation well above the 2% target. My guess is that the Bank of England is right in thinking the excess inflation is temporary (because of the surge in world commodity prices, etc). But suppose the inflation spike is NOT temporary. Do we condemn an excessive proportion of the workforce unemployment? The answer is “no”. There is a way out.

Interns.

Interns work for little or nothing (apart from what they get from benefits, if anything). Now what’s the aggregate effect of interns? E.g. do they simply replace regular or “normally waged” employees on a one for one basis? If the latter is the case, then the aggregate effect of interns on employment levels and GDP is zero or thereabouts.

However, there is a way in which interns actually raise employment levels and GDP, which is thus.

Inflation takes off when employers find it so difficult to obtain suitable labour that employers start bidding up the price of labour (or the price of most types of labour). However, if labour is available for free (as is the case with interns), that makes up for their unsuitability. Ergo NAIRU falls. Ergo employment and GDP can be expanded.

Now any old fool can think of flaws in that argument as it stands. But I can think of remedies for the flaws . . . . . . . . . . . see here.

Paying off the debt would not hinder the recovery.

2011-10-01T03:09:00.000-07:00

Indebted governments think that reducing their debts means raised taxes or public spending cuts so as to obtain the money to repay creditors. And since tax increases / spending cuts considered in isolation are deflationary, debt repayment is allegedly a difficult or impossible option during a recession.

That argument is nonsense.

Incidentally there is no urgency for monetarily sovereign countries to repay debt, particularly where the REAL interest they pay (i.e. after adjusting for inflation) is around zero. But if a country DOES want to pay off some debt, it’s easily done.

The first weakness in the “consolidation hinders the recovery” argument is that the money coming from extra taxes does not disappear into thin air, fantastic as that might seem: it ends up in the pockets of creditors. Put another way, every dollar of consolidation is a dollar of QE (the effect of which is stimulatory – not “recovery hindering”).

If going from A to C is a good idea, then going from A to C via B is probably also beneficial.

Let’s consider a government that decides to pay for some extra government spending by borrowing (while leaving aggregate demand constant), and then decides a few years later to pay off the debt.

When government funds $X of spending via borrowing rather than tax, it will not – it CANNOT – simply borrow $X, period. Reason is that the deflationary effect of borrowing is much less, dollar for dollar, then the effect of tax.

That’s because imposing $X of tax reduces private sector net financial assets (psnfa) by $X, whereas BORROWING $X does not reduce psnfa one iota: government borrowing involves taking $X of cash from the private sector and giving the private sector $X of government bonds in exchange.

In short, when government funds $X of spending via borrowing it will inevitably have to implement some sort of deflationary measure at the same time: e.g. raise interest rates, or do some “anti-QE”. In short it will have to withdraw money from the private sector.

Paying off the debt.

If the relevant government then wants to PAY OFF some debt it simply needs to reverse the above process. That is, it needs to raise taxes and/or cut public spending, AND DO SOME Q.E.

And for the benefit of those who worry about the money supply increase involved in Q.E., the above “run up some debt and run it down again” scenario simply returns the relevant country AND ITS MONEY SUPPLY to where it would have been had it never borrowed anything and funded its spending just from tax.

In effect, the country has gone from A to C via B instead of going direct from A to C. Is there a problem there? I don’t think so.

Foreign debt

The only weakness in the above argument is that it ignores the effects of paying debt back to foreigners. If foreigners invest the proceeds of debt repayment elsewhere in the world, the value of the currency of the debt repaying country declines, which will reduce its living standards. However the “foreigner” effect needn’t be all that dramatic, and for various reasons.

1. The Chinese have been wetting their pants over the possibility that the U.S. will monetise its debt. But they haven’t sold much of the debt and invested it elsewhere in the world: they’re short of other places to go. Likewise foreigners whose debt holdings are repaid will not necessarily take their money out of the country.

2. As to how big an effect devaluation has on living standards, the British pound was devalued by 25% in 2008 and UK citizens scarcely noticed.

3. Debt repaying countries can reduce the foreign exchange effect by coordinating their debt repayment efforts.

________________

Afterthought, 1st Oct. The above foreign exchange effect does not of course significantly hinder the recovery in the sense of hindering full employment (though as already stated, it does reduce living standards somewhat). Put another way, there is no reason to suppose a devaluation has a dramatic effect on NAIRU. The only NAIRU raising effect is that firms which export will benefit, while firms which rely on imports will contract. The shift of labour to, and acquiring relevant skills in exporting industries will take time, during which NAIRU will be temporarily raised.

However that sort of NAIRU raising effect is far from unique to devaluations. For example the above hypothetical rise in public spending as a proportion of GDP would also require people to change jobs and occupations.

Brad de Long wants government to borrow $500bn to spend on infrastructure.

2011-09-30T04:13:00.000-07:00

The US government can currently borrow for 30 years at a REAL rate of interest of 1% (i.e. after taking inflation into account). Brad de Long wants government to borrow $500bn to spend on infrastructure.

Now what’s the point of borrowing money (even at 1%) when you can print the stuff at no cost? Of course the knee jerk reaction to the phrase “print money” is “inflation”. But as David Hume pointed out over two hundred years ago, money supply increases are not inflationary except to the extent that they are spent: i.e. except to the extent that they increase demand. And all demand is ultimately demand for labour.* Thus creating jobs for X people as a result of printing will be no more inflationary than creating jobs for X people as a result of borrowing.

Of course the demand stemming from that extra money may cause excess inflation in two years time: especially if there is a significant rise in demand for US exports or a rise in consumer confidence. But in that case the extra money will just have to be reined in via extra tax (and/or less public spending) and “unprinted”. Pretty much the same scenario obtains if the “borrow” option is adopted: that is, given excess inflation, governments can raise interest rates, which involves the central bank selling government bonds and withdrawing money from the private sector.

Second, infrastructure projects get trotted out every time there’s a recession – Pericles advocated the idea in ancient Greece two and a half thousand years ago. Now why does the optimum mix of infrastructure and other forms of public and private spending change just because GDP expands a bit slower than normal? It doesn’t! In short, an ALL ROUND increase in spending, public and private, is preferable to the bizarre collect of pet projects that politicians, economists, greens, etc etc come up with every time there’s a recession: infrastructure schemes, windfarms, bridges to nowhere – the list is endless.

_________________

*Reason why all demand is ultimately demand for labour is as follows. First, I’ll cheat a bit and classify profits as the “wage” of a particular type of labour: the entrepreneur.

The cost of anything is made of the cost of the capital equipment, materials and labour needed to make it or supply it. And in turn the cost of the latter capital equipment and materials is made up of the cost of the capital equipment, materials and labour needed to make it or supply it. And in turn the cost ………you get the picture.

Ultimately, 100% of the cost of anything is the cost of the labour. Or if you don’t like classifying “profit” as “labour”, then 100% of the cost anything is the cost of labour and entrepreneur’s “labour”, i.e. profit.

Velocity of circulation of money.

2011-09-28T04:27:00.000-07:00

I took the first chart above and superimposed the figures given by Mariner Eccles (p.710) for the velocity of circulation in the 1920s/30s. Hat tip to Zerohedge for the first chart.

This is all very unscientific. I’ve no idea whether the figures given by Eccles for the 1920s are comparable to the figures given in the Reuters chart. But the RELATIVE changes in velocity around the time of the 1929 crash seem to be more violent than in the recent credit crunch . . . so far. Perhaps there is a treat in store for us: perhaps we’ll go right off the bottom of the chart in a year or two. Sweet dreams.

What’s the optimum long term debt to GDP ratio?

2011-09-27T02:50:00.000-07:00

The answer is easy. Advocates of Modern Monetary Theory (MMT) answered that question long ago. Though the question still seems to puzzle some authorities. For example Brad de Long (who I normally greatly respect) says:

“As to what is the appropriate debt-to-GDP ratio to pursue in the long run, that is a difficult empirical question….”

As one of the leading MMTers, Warren Mosler has pointed out (2nd last paragraph), there is no point in government debt rising to the point where government has to pay any interest on such debt. I.e. government should not issue interest paying debt.

Put another way, most of the alleged and popular reasons for government borrowing are bunk, as I point out here.

The only reason for having government issue liabilities is to ensure that the private sector has sufficient net financial assets to ensure that the private sector spends at a rate which brings full employment. Indeed, the latter point is simply a re-statement of Keynes’s “paradox of thrift” point. That is, if the private sector is intent on saving money, rather than spending it, the result will be excess unemployment unless government prints enough money to satisfy the private sector’s savings desires.

Just Google the phrases “private sector net financial assets” and “savings desires”. You’ll find MMTers grossly over-represented in the first ten or twenty items that Google finds.

Mariner Eccles.

2011-09-26T10:13:00.000-07:00

This is an extract from page 708 of evidence given by Mariner Eccles to the US Committee on Finance in 1933. Hat tip to Bill Mitchell.

Why was it that during the war when there was no depression we did not insist upon balancing the Budget by sufficient taxation of our surplus income instead of using Government credit to the extent of $27,OOO,OOO,OOO? Why was it that we heard nothing of the necessity of balancing the Federal Budget in order to maintain the Government credit when we had a deficit of $9,000,000,000 in 1918 and $13,000,000,000 in 1919? Why was it there was no unemployment at that time and an insufficient, amount of money as a medium of exchange? How was it that with one billion less gold then than we now have we were not concerned about our gold standard?

How was it that during the period of prosperity after the war we were able in spite of what is termed our extravagance - which was not extravagance at all; we saved too much and consumed to little - how was it we were able to balance a $4,000,000,000 annual Budget, to pay off ten billion of the Gov¬ernment debt, to make four major reductions in our income tax rates (otherwise all of the Government debt would have been paid), to extend $10,000,000,000 in cedit to foreign countries represented by our surplus production which we shipped abroad, and add approximately $100,000,000,000 by capital accumulation to our national wealth, represented by plants, equipment, buildings, and construction of all kinds? In the light of this record, is it consistent for our political and financial leadership to demand at this time a balanced Budget by the inauguration of a general sales tax, further reducing the buying power of our people? Is it necessary to conserve Govern¬ment credit to the point of providing a starvation existence for millions of our people in a land of superabundance? Is the universal demand for Government economy consistent at this time? Is the present lack of confidence due to an unbalanced Budget?

What the public and the business men of this country are interested in is a revival of employment and purchasing power. This would automatically restore confidence and increase profits to a point where the Budget would automatically be balanced in just the same manner as the inddividual, corporation, State, and city budget would be balanced.

Why don’t PIGs devalue their currencies?

2011-09-25T00:45:00.000-07:00

There is a way that European periphery countries could solve their problems in 24 hours – at least in principle. And that is to organise a substantial and instantaneous cut in ALL wages. This would amount to a devaluation of their currencies. Indeed this is the ultimate objective of the long drawn out and extremely painful deflation currently being imposed on these countries.

A wage cut of X% in a given country would not of course cut living standards by anywhere near X% for the simple reason that the cost of goods and services in each country is made up mainly of the cost of local labour needed to make and get those goods and services to market. And this simple point would have to be drilled into the heads of the population before proceeding with this “wage cut / devaluation” policy.

There are of course HUGE political difficulties in organising an instant all round cut in wages. That is, as suggested just above, the local population would be up in arms. Thus a large and expensive advertising campaign would be needed to teach the local population some basic economics.

And there is the knotty problem as to how far employers could cut their own “wages” (i.e. profits) at the same time. But one answer to this is to include in the above campaign something to the effect that “If you don’t like the profit that employers are making, don’t just sit there complaining: become an employer. Set up your own business.”

The costs of the above campaign would be huge. But the costs of the existing “deflation lasting several years” policy is HUGE as well.

Moreover, once the rationale of the “instant wage cut / devaluation” policy became widely understood throughout Europe, future problems deriving from lack of competitiveness of individual countries would be much easier to deal with.

Of course lack of competitiveness is not the only PIG problem: debts are a problem as well. But any bank or creditor is happy to lend to someone in debt as long as the debtor is competitive and is earning money.

_______________

Afterthought (28^th Sept 2011). A way of persuading PIG citizens of the merits of the above type of “fast devaluation” would be something along the following lines.

Look at the UK. It devalued its currency by about 25% in 2008. Nine out of ten UK citizens had no idea at the time that this was happening. There was no dramatic effect on living standards. The whole episode was one huge non-event.

Paul Volker says low interest rates cause asset bubbles. No kidding?

2011-09-23T23:55:00.000-07:00

Congratulations to Paul Volker for his statement of the bleed’n obvious, namely that “if money is too easy for too long, we’ll have more asset bubbles”

First we have a credit crunch caused by excessive and irresponsible borrowing. And the solution the world adopts is . . . . wait for it . . . . . to cut interest rates so as to encourage more borrowing.

But seriously, we have a conundrum: the economy needs boosting, but if we boost it via low interest rates, that is liable to cause bubbles. So what’s the solution? Well I’ve spelled out the solution several times already on this blog. But there is no harm in repeating it.

Indeed, Australian economist Bill Mitchell on his blog repeats the same points over and over and over and over and over and over and over and over. That is not because he is stupid. It’s because the bulk of the human race is stupid. I.e. to get a point across to the bulk of the human race, it’s no use explaining a point in any sort of intelligent or logical or concise fashion. The only way of getting a point across is to repeat it over and over and over and over and over.

Harold MacMillan, former British premier once said that his speeches consisted of nothing more than repeating the same point over and over – with slight variations of course so as to avoid blatantly insulting the audience.

Anyway, there is a method of boosting economies which does not involve low interest rates, and that is, as advocated by MMT, to simply create new money and spend it into the economy: in particular, channel the money into the pockets of middle and low income groups because they are more likely to spend such money quickly than the wealthy. As to interest rates – to hell with them. Let them look after themselves. Let them find their own level.

It is a generally accepted principle in economics that the price of anything should be the market price, unless market failure can be demonstrated. So unless anyone can demonstrate market failure in the case of interest rates, rates of interest should be determined by market forces.

Moreover, why boost an economy just via a narrow range of activities or assets: the ones most influenced by interest rate changes. You might as well boost an economy via firms and households whose names begin with the letters A-M and ignore the “L-Zs”.

But the elite can’t bear to see money being wasted on the less well off. Given a recession and the availability of some extra money to deal with the recession, the elite would rather use the money to tinker with the various levers and knobs at their disposal: interest rates, investment incentives, job creation schemes, infrastructure projects, bridges to nowhere, green projects, special measures for “small and mediums size enterprises”. Very touchy feely, that last one. Moreover, if you are a politician, being seen to back SPECIFIC projects which allegedly “create jobs” is probably a better vote winner than boring old tax cuts, or an all round increase in public spending.

And finally, the basic purpose of an economy is to produce what PEOPLE – that is the consumer – want. If there is insufficient demand, then the PEOPLE should be given more spending power. Market forces can then sort out how much of that extra spending is diverted to investment, small and medium size enterprises, and so on.

Laugh of the year: Bernanke claims bank bail outs cost the taxpayer nothing.

2011-09-21T04:46:00.000-07:00

See here.

Runner up in the laugh of the year contest is Rupert Merdoch’s claim that he knew nothing about phone hacking.

And third prize goes to Jack Straw, Britain’s former foreign minister, for his claim that he knew nothing about the torture of those “rendered” to Libya from the UK before Gadaffi’s removal from power.

Rubbish from Nouriel Roubini.

2011-09-20T02:31:00.000-07:00

For low grade drivel, this article by Roubini takes some beating. The article is an eight point plan to avoid a depression.

First, Roubini trots out a nonsensical piece of conventional wisdom, namely, in his own words that “First, we must accept that austerity measures, necessary to avoid a fiscal train wreck, have recessionary effects on output.”

The phrase “fiscal trainwreck” is slap-dash and imprecise because it fails to distinguish between the part of the deficit which is structural, and the part which is supposed to bring stimulus. I’ll deal with the structural part first.

Dealing with the structural deficit is child’s play. At least there are absolutely no technical difficulties that cannot be explained to an adult of average I.Q. in three minutes.

A structural deficit occurs when government fails to collect enough tax and resorts to borrowing instead. Reversing this process is easy: cut borrowing and raise taxes (or cut spending). There may be political difficulties in doing this, but there absolutely no technical difficulties. Moreover and contrary to Roubini’s claims, NO AUSTERITY need be involved. That’s because as long as the AMOUNT OF tax increase and borrowing reduction are such that the deflationary effect of the former equals the stimulatory / inflationary effect of the latter, there is no net effect. I.e. there is no net effect on demand, GDP, numbers employed, etc etc, i.e. NO AUSTERITY. (The issue is actually A BIT more complicated than suggested in the latter sentence, but the latter sentence is more or less correct.)

As distinct from the structural deficit, there is the “stimulus deficit”, that is the extent to which government runs a deficit with a view to doing some Keynsian “borrow and spend”. Well the alternative to borrow and spend, as Keynes, Milton Friedman and others pointed out is to go for “print and spend” (and/or print and reduce taxes). Again, as long as stimulatory / inflationary effect of the printing equals the deflationary effect of the reduced “borrow and spend”, then again, there is no austerity, no net effect on inflation, or GDP or anything else.

Roubini’s second point starts “while monetary policy has limited impact when the problems are excessive debt and insolvency rather than illiquidity….”. No, monetary policy can have a substantial effect even given excess “debt and insolvency”. Here’s how: channel money into the pockets of middle and low income earners. They will tend to spend a relatively large portion of that money, compared to the elite.

The evidence is that when the average household’s income rises, its spending rises, fantastic as that might seem. The latter point will be blindingly obvious to the average mentally retarded snail, but it seems to way above the heads of economics professors (and not just Roubini).

Roubini’s third point is worth quoting in full (in italics):

Third, to restore credit growth, eurozone banks and banking systems that are under-capitalized should be strengthened with public financing in a European Union-wide program. To avoid an additional credit crunch as banks deleverage, banks should be given some short-term forbearance on capital and liquidity requirements. Also, since the US and EU financial systems remain unlikely to provide credit to small and medium-size enterprises, direct government provision of credit to solvent but illiquid SMEs is essential.

Well that’s great, isn’t it? Governments have already shafted taxpayers with a view to rescuing banksters. Now Roubini wants a few more trillion to be given the assortment of depraved fraudsters, spivs and conmen that make up Wall Street.

I’ve got a better idea: channel the trillions into household pockets and let a few banks go bust. Don’t close them down of course – just wipe out the shareholders, unsecured creditors, etc. Then have government wind down the relevant banks or sell them to the highest bidder. If the highest bidder for a bank bids $1, so be it.

Roubini is under the illusion that the only form of salvation for employers can come as a result of loans: that is having employers grovel in front of the above mentioned Wall Street fraudsters in the hope of getting a loan (or grovel in front of government bureaucrats in the hope of same). There is of course an alternative (mentioned above). That is simply to channel funds to households rather than banks. That way employers get the cash they want from customers rather than banks.

Fourth, Roubini wants big hand outs for European periphery countries. Well obviously that will solve the problem in the short term, but it does not solve the longer term problem of such countries’ lack of competitiveness relative to core countries. Moreover, German taxpayers are getting understandably sick of subsidising periphery irresponsibility. Rather than make fatuous statements about hand outs for the irresponsible, perhaps Roubini could solve a more difficult problem, namely how does Angela Merkel persuade Germans to carry on supporting Greek fraudsters, and do Germans really have much of a moral obligation to continue supporting Greeks bearing gifts.

As to Roubini’s fifth, sixth, seventh etc ideas, can you really be bothered with them? I can’t. Of course if one trots out ideas at random, sooner or later one will come up with a good idea. By the same token, let a chimpanzee press keys at random on a piano for long enough, and eventually you’ll hear a Mozart sonata (after waiting a billion years). I can think of quicker ways of getting to hear a Mozart sonata when I want to listen to one.

The Peterson Foundation thinks foreigners fund the budget deficit – tee hee.

2011-09-19T04:44:00.000-07:00

When a government collects insufficient tax, it borrows instead, and the result is a budget deficit. Borrowing takes the form of issuing government bonds, e.g. Treasuries in the US, and obviously foreigners buy some of those bonds. This leads numerous folk to conclude that foreigners to some extent fund the deficit. The flaw in this argument is thus.

If a government fails to collect enough tax, and simply prints money to fund the relevant spending, the effect is inflationary (assuming the economy is already at NAIRU). Thus some form of deflationary counter-measure is needed: that is, demand from DOMESTIC sources must be curtailed.

One such deflationary measure is to borrow from domestic sources, i.e. sell government bonds. But there is a problem here, namely that foreigners will buy a proportion of these bonds. But the latter does not achieve the desired objective, namely curtailing domestic demand. That is, those foreigners, had the bonds not been available would not have spent the relevant money on consumer goods (and hence created demand) in the country that issued the bonds. To that extent, selling bonds to foreigners is a COMPLETE WASTE OF TIME.

Alternatively, those foreigners might in the absence of those bond sales have lent to some other entity in the country concerned. But there again, their switching from lending to those other entities to lending to government does not have a deflationary effect.

To put it figuratively, if foreigners buy $X of bonds issued to fund a budget deficit, government will just have to issue ANOTHER $X of bonds, and hope that DOMESTIC entities buy those bonds.

I argued here that all government borrowing is a farce. That is, government “borrowing” in the sense of paying interest to anyone is a farce. (Non interest yielding monetary base could be construed as a debt owed by central banks to holders of said base, but this so called debt is irredeemable, so it is not really debt.)

The above uselessness of incurring debt to foreigners on which one pays interest is just one aspect of the farcical nature of government debt.

Examples the above “foreigners fund the budget deficit” mistake are thus.

The Peterson Foundation makes the mistake (pages 14-16 & 28). See also the sub-heading here, and the first sentence here.

______________

Afterthought – a few hours after putting the above online….. I’ve just noticed an article published by Warren Mosler today which also makes the above point about the uselessness of government paying interest to anyone. The article concerns a “mini-currency”, the so called “buckaroo”, set up at the University of Missouri-Kansas City. It was set up to facilitate trade between students and the university authorities. As the article puts it, “The UMKC, as well as the students, have failed to identify any public purposes that may be served by having the UMKC pay interest on buckaroo savings, so the 0 interest rate policy remains in place.”

The marginal product of labour.

2011-09-16T12:52:00.000-07:00

As unemployment falls, the marginal product of labour falls. That is, each succeeding person hired becomes progressively less suitable for the vacancy they fill. This occurs because the fewer unemployed there are to choose from, the less likely an employer is to be able to find the perfect employee to fill each vacancy.

When this “product” or output of those hired falls to the minimum wage, union wage, etc etc, unemployment cannot be reduced any further, else employers tend to resort to poaching each other’s employees (consciously or not) rather than take labour from the dole queue, thus inflation kicks in.

So what’s the solution? It’s easy – in principle. Just subsidise those marginal employees.

Identifying the marginal employees is easy at first: they are the unemployed. But there is a problem: as time passes, the unemployed who have been subsidised into work are no longer “marginal”, i.e. they are not the least productive people in each firm.

This is for several reasons. First they gain firm specific skills and begin to become economic propositions even without any subsidy. Second, the pattern of supply and demand for different types of labour on each local labour market, and within each firm, is constantly changing: types of labour which were in surplus, and which were thus “marginal” one month, may not be in surplus six months later.

So how do we ensure that employers claim the subsidy only in respect of those employees who are genuinely marginal? Easy: call the employer’s bluff. That is, limit the time each subsidised employee stays with a particular employer, or remove such employees from subsidised jobs at a random interval after they start their subsidised job. Employers DO MIND losing valuable employees, but they DON’T MIND losing peripheral or marginal employees.

Additional rules.

There are of course a number of refinements or additional rules that could be added to the game. For example an obvious way for employers to cheat would be claim the subsidy in respect of employees who were not marginal (i.e. who were economic propositions without the subsidy). And then when the subsidy expired for a given employee, the employer could simply continue employing the employee on a normal or unsubsidised basis. The solution to that problem is to bar employees from returning to a given employer for several months if the subsidy expires before the employer has voluntarily ceased to claim the subsidy.

Disadvantages.

A disadvantage of the above system is that it would involve bureaucractic expense. But then half the problems of the labour market stem from artificially imposed bureaucratic interferences: union wages, minimum wages, unemployment benefits, etc. These may be worthy “interferences” but they constitute a move towards having labour allocated by the bureaucracy rather than by the market.

So there is a choice: a genuinely free labour market, or a bureaucratically run / regulated labour market. If you want the latter, don’t complain about bureaucratic expense.

Another disadvantage is that turnover amongst the least skilled and talented would rise. But then many people quite happily work for temporary employment agencies, and that often involves several “jobs” a week. So the “high turnover” point is a weak objection.

The Edmund Phelps subsidy.

Phelps* advocated a subsidy of ALL low paid labour. The disadvantages of that idea relative to the above “marginal” idea as follows.

1. The total number of people subsidised under the Phelps subsidy would be far more than under the marginal version, thus taxpayer costs be higher. But those costs should NOT be seen as consisting entirely of REAL or RESOURCE costs.

2. The Phelps subsidy involves subsidising many people who would have been employed anyway: that reduces the incentive to get work out of such employees, and that certainly is a REAL cost.

3. The marginal idea gives the option of taking the marginal product of labour down to zero or near zero, which might seem a silly objective. But it could be justified, first, in “work experience” or training grounds. Second, it could be justified on what might be called “workfare” grounds. That is, one way of calling the bluff of unemployment benefit spongers is to tell them to turn up at some place of work (even if they don’t do very much) else their benefit gets cut.

Third, the fact that no one is prepared to pay anything for a product does not prove the product is worthless. That is, given excess unemployment, the reason people are not prepared to pay for extra units of all the products they already consume is not that they regard those extra units as worthless: if aggregate demand were to rise, those extra units WOULD be purchased. So why not so to speak just produce a few extra units of everything and distribute the extra units to everyone – which is more or less what zero revenue product labour achieves under the above marginal idea.

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* Phelps, E. S. (1997), Rewarding Work How to Restore Participation and Self-Support to Free Enterprise, Harvard University Press.

US labour market began deteriorating well before the recent recession.

2011-09-15T23:35:00.000-07:00

Employment to population ratio.

Hat tip to Economist’s View

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The Wall Street Journal’s daft anti-stimulus arguments.

2011-09-15T00:25:00.000-07:00

One argument put by this WSJ article against stimulus is that stimulus money is often wasted. That is true, but the reason for this waste is easily dealt with, at least in principle.

This reason for the waste that often accompanies stimulus is that as soon as politicians and others get wind that extra money is available, a large assortment of cranks come out of the woodwork to push their own pet forms of spending, whether it’s Japanese style bridges to nowhere, or plain old fashioned pork.

But this failing does not prove that stimulus as such is wrong. The waste derives from letting people – politicians in particular – take economic decisions they are not used to taking. Put another way, where stimulus is in order, we should just expand the money available to EVERY entity and organisation which spends money.

For example as regards private sector spending, the main source of such spending is the CONSUMER. So part of any stimulus package needs to consist of feeding extra spending power into the pockets of ordinary households. That’s why advocates of Modern Monetary Theory have long advocated a payroll tax reduction.

That’s all very boring and does not attract attention to ego-centric politicians in the world’s capital cities. Plus the millionaires and billionaires who make up the elite can’t bear to see ordinary people have more spending power. However, the basic purpose of economic activity is to produce what PEOPLE or CONSUMERS want – not what makes politicians or the elite look good.

The public sector.

As distinct from expanding private sector spending, stimulus packages normally expand the public sector as well. And part of that will normally include, for example, having local / municipal / US state governments spend more. Fine. Give those local governments more cash and let them get on with it.

But to a significant extent, this is NOT what has happened in the current recession. What HAS happened is that thousands of bog standard productive jobs have been destroyed: fire-fighters, police, librarians and so on. And in their place we have a variety of farcical bridges to nowhere jobs to which the WSJ rightly objects.

And even LOCAL politicians should not have too much of a say in how the money is spent. They should allocate the extra cash to local police forces, local education authorities, etc and let the latter get on with it. Who knows how best to spend extra money in a particular school: the head teacher or a politician in some distant city?

Stimulus money has to be “repaid”?

The WSJ article then claims that “A dollar that eventually will be taken out of the private economy through borrowing or higher taxes to fund pointlessly expensive projects . . . .is not the way to nurture a recovery.”

The WSJ obviously doesn’t get the difference between macro and micro economics, because the above sentence applies profit and loss account principles (micro economics) to government and the economy as a whole (macro).

The first flaw in the above “eventually taken out” idea is that today’s deficit money JUST ISN’T necessarily “taken out” in years to come. Deficits accumulate as extra monetary base and/or extra national debt. Just look at the monetary base figures over the last few decades. Taking some figures from the latter source, the US base was $50bn in Jan 1960 and $600bn in Jan 2000. Children with a basic grasp of maths know that 600 is a bigger number than 50, though whether the WSJ has worked this out, I’m not sure.

And even where stimulus money IS EVENTUALLY “taken out” of the private sector, this has nothing to do with any waste or lack of waste.

The waste arises from the initial mis-allocation of resources, e.g. building bridges to nowhere. And that is the end of the waste, at least as far as the mis-allocation of capital expenditure goes.

Taking dollars out of the private sector simply involves changing numbers in computers: e.g. subtracting from household accounts and adding to government accounts. And the latter is a good idea if demand and inflation look like getting excessive. But if demand and inflation are well under control there is no point in removing these “numbers” from private sector accounts.

Put another way, the WSJ obviously thinks that “taking a dollar out of the private economy” involves removing REAL RESOURCES from the private economy. It doesn’t. Reason is that, as pointed out above, it only makes sense to “take dollars out” if inflation looks like getting excessive. That is, the purpose of “taking dollars out” is NOT to reduce the private sector’s consumption or turnover in REAL TERMS: the purpose is, or should be, to ensure that demand in money terms is not so excessive as to cause excess inflation.

The UK’s Independent Commission on Banking puts chickens and foxes inside the same the same “ring fence”.

2011-09-14T09:53:00.000-07:00

The purpose of the ring-fence is to separate retail banking from the riskier investment banking activities: i.e. to separate the essential money transfer functions which cannot be allowed to fail from the risky, clever clever stuff. (Of course there are still systemic risks from the clever clever instiutions, (e.g. Long Term Capital Management), but the basic money transfer system is more important.)

The basic problem with the ICB proposal is that they’ve put BOTH risky AND stuff which is supposed to be safe (i.e. not to be contaminated by risky stuff) inside the ring fence! It’s a bit like putting foxes inside the chicken coop.

Paragraph 2.27 says that deposits from and loans to individuals and firms or corporations should be inside the fence. But this involves significant risk. How in God’s name does one stop banks lending to firms, particularly large ones, which turn out to be thoroughly dodgy and high risk?

Still on para 2.27, the ICB says that loans to “non financial companies” should be inside the fence. That’s just asking for squabbles over exactly what constitutes a “financial company”. I can see lawyers earning big fees there. Or as Martin Jacomb put it in the Financial Times, “The fingfencing proposal involves much detailed regulation.”

Some small retail depositors actually WANT risk.

The next problem is that some small depositors actually WANT to expose themselves to risk, and why not? There is nothing wrong with the basic idea behind capitalism, namely that people can take a risk and possibly make money or lose money.

As pointed out above, the ICB ring fencing does not guard small retail depositors against risk, but just supposing it DID guard those depositors against risk, that is a nonsense in that some small retail depositors actually WANT to have a flutter or take a risk. They are not catered for under the ICB regime.

So what is the solution to all this? Well the solution was given very eloquently by Mervyn King, governor of the Bank of England. As he said, “If there is a need for genuinely safe deposits, the only way they can be provided, while ensuring costs and benefits are fully aligned is to insist such deposits do no coexist with risky assets”.

In other words why not give depositors a choice. Choice No 1 is to have an account which is 100% safe and taxpayer backed. But in keeping with Mervyn King’s principle outlined above, the money in such accounts cannot be invested in commerce or exposed to any kind of risk. The money can only be deposited at the central bank or perhaps invested in government securities.

On the other side of the fence so to speak is choice No 2. This is for customers to let banks invest their money any way the bank sees fit. Alternatively banks could offer a range of accounts with different levels of risk, or other characteristics, like “money will only be invested in the UK”. But that is a minor detail. The important point is that the money is used for commercial purposes, and it is NOT the job of taxpayers to subsidise commerce. Thus there would be no taxpayer funded rescue if it all goes wrong.

The latter “two choice” system involves minimal regulation. For example there is no need to distinguish between financial and non financial firms. Investing in ANY firm is commerce. The investment will thus earn more interest than the safe No 1 choice above. But there is no taxpayer funded guarantee.

Likewise there is no need for regulators to look in detail at what loans banks are making and try to decide whether individual loans are too risky to be acceptable. Indeed the very idea that regulators are able to make this judgement is laughable. Banks themselves are scarcely able to quantify the riskiness of those they lend to: look at the disastrous loans they made prior to the crunch.

As to what to do with the commercial or risky activities or divisions of banks, those can only be made less of a systemic risk by reducing leverege, enlarging capital requirements, insisting on bail-ins and so on.

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Afterthought (26th Oct 2011): I just noticed that the Guardian’s City editor, Jill Treanor, is also critical of the commission’s hazy ideas as to what does and does not go inside the fence. She says, “The commission is vague about whether banking to large companies should be in or outside the ringfence.”

If only Dani Rodrik understood MMT.

2011-09-13T03:02:00.000-07:00

Dani Rodrik trotts out, and goes along with the alleged dilemma that 99% of the elite in the US and Europe think they face. This is that stimulus is needed, but governments are already heavily in debt and can thus allegedly cannot afford much more stimulus.

The latter so called dilemma is a complete non-problem for those of us who understand Modern Monetary Theory (MMT). Rodrik’s solution to the problem is to have what he calls an “independent board” solve the problem. Well that was easy, wasn’t it? Let’s solve the world hunger problem and global warming by appointing committees to solve those two problems. Put another way, the $64k question which Rodrik doesn’t answer is exactly what ideas and principles does his “board” use to solve the problem. The principles / ideas should be as follows.

The structural debt and deficit.

Re the structural part of the debt, reducing it is child’s play: just print money and buy back the debt (i.e. Q.E. it). To the extent that that is too stimulatory or inflationary, just raise taxes and use the money collected to buy back more debt. The money printing element is stimulatory/inflationary, while the tax element is deflationary. Mix the two in the right proportion, and the net effect is neutral. I.e. GDP remains unaltered, as does the total number employed, etc etc. Meanwhile big chunks of debt disappear.

Of course the latter wheeze COULD to some extent result in debt being replaced with monetary base, which might seem a bit of a cheat. Explaining the reasons why this is not a cheat leads us nicely into the question as to how to deal with the “non-structural” part of the debt and deficit, i.e. the stimulus element. After that it will hopefully be apparent why no “cheat” is involved.

The stimulus element.

Rodrik makes a big mistake when he says that “Everyone agrees that the country’s public debt is too high and needs to be reduced over the longer term.” Well MMTers don’t agree it is too high. In the view of MMTers, private net financial assets (of which the debt is an important part) need to be whatever induces or “stimulates” the private sector into spending at a rate that brings full employment.

If that level of assets happens to be larger than ever before, so be it. If it happens to be smaller than ever before, so be it.

A predictable response to the latter point is that debt involves paying interest, and there must be some limit to the interest rate burden that governments can carry.

Well at the moment, the REAL rate of interest on US debt is NEGATIVE!!!!! So there is not much of a problem there. However, if rates turn significantly positive in the future, then obviously there is a problem: a problem which calls for a solution.

And the solution is simply to have the above mentioned government issue net financial assets consisting of NON INTEREST PAYING debt: i.e. cash, or monetary base. Put another way, if a government wants to spend more, what on earth is the point of it borrowing something (i.e. money) which it can produce in infinite quantities itself? Paying someone else to borrow something which you produce yourself for free is RAVING BONKERS!!!

Milton Friedman in 1948 advocated a monetary / economic system which incorporated the latter idea: i.e. a system under which governments issue no interest paying debt. (See page 250).

It would be nice of today’s so called economists had actually studied economics and knew about ideas which are now over sixty years old.

Readers will hopefully have tumbled to why the above “cheat” in connection with the structural debt and deficit is no cheat at all. Assuming the interest paying debt is reduced (or, a la Friedman, abolished), then the monetary base needs to be whatever “stimulates” the private sector into spending at a rate that brings full employment without too much inflation. If that level of monetary base is $1 per person, so be it. If it happens to be $10,000 per person, who cares? The IMPORTANT point is to bring about full employment.

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Krugman, invasions by aliens, Keynes and hole digging.

2011-09-12T01:07:00.000-07:00

Anti-Keynsians have been putting their foot in it big time recently by taking Keynes’s parable about pointless hole digging seriously.

Keynes made the point that the multiplier works even if the form of spending that sparks of a “mulitiplier episode” is pointless, like having people dig holes and fill them up again all day. At the same time he made it perfectly clear (for the benefit of the humourless) that he did not actully favour pointless hole digging.

Krugman, making the same point, gave as an example, spending money on defending the world from an invasion by aliens from outer space: an invasion which in the even turns out to be a false alarm.

Unfortunately a number of less than sophisticated folk have taken Keynes’s hole digging and Krugman’s hypothetical alien invasion seriously.

Two examples of these humourless economists are thus.

1. Wall Street Journal Op Ed article (para starting “The authors are careful….”).

2. The Cobden Centre

The moral is: keep humour, irony and words with more than two syllables out of debates on economics, else those simpletons will get the wrong end of the stick.

Actually economics is so complicated that it’s VERY GOOD IDEA to keep humour and all unnecessary words and syllables out of it.

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The economically illiterate Tim Geithner now wants stimulus!

2011-09-09T13:00:00.000-07:00

The main headline in today’s Financial Times is that Geithner is calling for stimulus. Would this by any chance the same Tim Geithner who earlier on in the recession was a staunch OPPONENT of stimulus? The same Tim Geithner who is part responsible for the unemployment and poverty being experienced by millions of Americans?

If I was Tim Geithner I’d have died of shame by now. But then in the West’s elite don’t know the meaning of the word shame.

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Obama’s employment subsidy: not much use.

2011-09-09T05:40:00.000-07:00

The idea that employers should be rewarded in proportion to the number of new or additional employees they take on is as old as the stars. The idea is a waste of time given very high levels of unemployment because a straight rise in demand is simpler and just as effective.

As to lower or “NAIRU” unemployment levels, the idea works for a short time. That is, it reduces NAIRU for a short while, perhaps up to a year or so, but loses its effect thereafter.

Conclusion: the idea is not much use. For a detailed analysis of the idea, see here.

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This is the best economics article for months.

2011-09-07T04:03:00.000-07:00

This article by Simon Jenkins in The Guardian is brilliant.

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Congratulations to the Swiss for printing lots of money.

2011-09-06T23:56:00.000-07:00

Faced with a sharply appreciating Swiss Franc, the Swiss are at last reacting in a logical way: printing Swiss Francs in whatever volume is required for those who want to hold them. This will NOT be inflationary because the demand for these additional Francs is a demand to HOLD Francs, not spend them. As David Hume pointed out in his essay “On Money” two hundred years ago, additions to the money supply are not inflationary until and to the extent that the additional money is actually spent.

Hopefully the rest of the world will tumble to the latter point before we get too far into a Japanese lost decade. That is, weak demand in the US stems from a desire by the private sector to hoard or hold more money than is usual (in addition to the effect of deleveraging).

The solution to the latter problem is to print money and spend it (and/or cut taxes). And if inflation looks like getting excessive, do the opposite: raise taxes and rein in money and “unprint” this money.

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Bruce Bartlett opposes a payroll tax reduction.

2011-09-02T01:53:00.000-07:00

As Dean Baker put it “In elite Washington circles ignorance is a credential.” This seems to be particularly true of “elite members of the elite”: former presidential advisors, e.g. Martin Feldstein and Bruce Bartlett.

Bartlett in a New York Times article tries to argue against a payroll tax reduction, and gives some hopeless arguments to back his case. Plus a payroll tax reduction is one of the main measures advocated by adherents to Modern Monetary Theory, Warren Mosler in particular. So this is an additional reason for looking at the alleged weaknesses in payroll tax reductions put by Bartlett. Bartlett’s first argument is thus (in italics).

First, the tax cut only helps those with jobs. While many have low wages and undoubtedly are spending all their additional cash flow, those with the greatest need and most likely to spend any additional income are the unemployed.

Well obviously a payroll tax reduction doesn’t help EVERYONE: for example pensioners are not assisted by this tax reduction. A mentally retarded six year old can think of groups not assisted by a payroll tax reduction. But the important point about a payroll tax reduction is that it channels money into the pockets of a VERY LARGE group of the sort of people who are likely to spend a fair proportion of any increased income, that is, middle and lower income groups.

Having done that, if a government wants to assist the groups NOT ASSISTED by a payroll tax reduction (e.g. pensioners), then so much the better.

Perhaps Bruce Bartlett prefers the main stimulatory measures taken to date: QE and giving billions to banksters. The latter two measures shovel VAST amounts of money into the pockets of a MINUTE portion of the population. And not only that, but the recipients of the money include the wealthiest people in the country – exactly what Bartlett argues against! God first makes mad those he wishes to destroy.

Bartlett’s second and third reasons are that the payroll tax reduction will simply be saved by employees rather than spent. He does not cite any evidence to back this point. Well I can cite evidence. The evidence is that (surprise, surprise) peoples’ weekly expenditure varies with their income!

Of course, and equally obviously, A PROPORTION of any increased income will be saved. That is entirely predictable. For actual studies of household reactions to changes in income (temporary and permanent) see:

http://onlinelibrary.wiley.com/doi/10.1111/j.1745-6606.1984.tb00322.x/abstract
http://www.nber.org/digest/mar09/w14753.html

http://www.kellogg.northwestern.edu/faculty/parker/htm/research/johnsonparkersouleles2005.pdf

http://finance.wharton.upenn.edu/~rlwctr/papers/0801.pdf

http://ideas.repec.org/p/kud/kuiedp/9611.html

Bartlett’s reason No. 4 is that cutting the cost of employees will not work in that labour costs are nowhere near as big a problem for employers as lack of demand or lack of sales. At last: a half intelligent point. A significant proportion of the elite in the US and Europe have not tumbled to the blindingly obvious point that sales create jobs. But at least Bartlett has. So congratulations are in order there.

Bartlett’s fifth and final reason is that the payroll tax finances benefits of one sort or another, thus a reduced payroll tax will induce employees to save in order to compensate for the loss of those benefits.

The first flaw in that argument is that it fails to distinguish between saving in the form of accumulating cash, and in contrast, saving in the form of storing up other assets, like a house, qualification, etc.

When people save for pensions, a significant portion of the saving is not just plonked in deposit accounts and left there, which WOULD be deflationary. The latter effect is what Keynes called the “paradox of thrift”. What actually happens is that a significant portion is invested in real assets: office blocks, factories, etc.. And the effect of the latter saving is stimulatory.

Moreover, even if for some strange reason it was impossible to invest peoples’ savings in office blocks, factories, etc it is highly unlikely that employees would allocate ALL their increased cash holdings to boosting their bank deposit accounts. That is, it is EXTREMELY unusual where a cause has two possible effects for just one of the effects to be in evidence.

Take the above mentioned evidence as to what households do with increased income. It is POSSIBLE they’d spend it ALL, and save none of it. But the evidence is that they do a bit of both.

Or again, suppose the price of apples rises. One extreme possibility is that consumers react by buying exactly the same volume of apples and ignore the price increase. The second extreme possibility is that they spend EXACTLY THE SAME amount as before on apples, and do all the adjustment via cutting the volume of apples purchased. But the latter is a highly unusual effect. What nearly always happens when consumers face a price increase for a particular commodity is a compromise between the above two extremes.

Conclusion: nine out of ten to MMT and one out of ten to Bruce Bartlett.

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Andrew Sentance and the confidence fairy.

2011-09-01T03:32:00.000-07:00

The so called “confidence fairy” is a term used for the most part by advocates of Modern Monetary Theory (MMTers) to describe a popular but largely mythical obstruction to economic growth. This is the extent to which business confidence in government finances impinges on economic growth.

So far as I can see from actual surveys of business opinion, this confidence or lack of it is near irrelevant compared to other problems which entrepreurs face or think they face, e.g. lack of orders, shortage of skilled labour, taxes, etc etc. E.g. see page 18 here.

This survey gives entrepreneurs main problems as being, first, poor sales, and second, taxes.

See also page 26 here.

This gives excess regulation, tax and lack of demand as the main problems.

The URL of a third survey giving similar results is thus:

http://www.blumshapiro.com/pub/articles/BlumShapiroCBIASurvey.pdf

But the latter was unavailable when I put this post online. Might be a temporary problem.

But empirical evidence, the truth, reality and so forth, are of no great concern to a large portion of the human race, in particular those who believe in fairies, unicorns, astrology etc. Andrew Sentence in an article in today’s Wall Street Journal appears to be a firm believer in unicorns – sorry I meant the confidence fairy. He cites no evidence to back his claim: presumably this is because the evidence does not exist. For some strange reason, Andrew Sentence was a member of the Bank of England’s Monetary Policy Committee.

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Afterthought, 4th Sept: Just noticed Brad de Long making a similar point.

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Economic fluctuations since 1870.

2011-08-26T04:36:00.000-07:00

This chart is from a Financial Times article by Samuel Brittan. Fluctuations seem to have moderated a bit since the 1800s. The chart appeared on the hard copy version of the article but not on the internet version.

The economics of degrees.

2011-08-25T01:27:00.000-07:00

A report in today’s Guardian cites an Office for National Statistics (ONS) study which shows that those with degrees earn more than those without. As is entirely predictable, someone then jumps to the conclusion that this shows that getting a degree is worthwhile.

In this case, it is Nicola Dandridge, chief executive of Universities UK – at least she very much seems to imply that the ONS study demonstrates that getting a degree pays off.

The problem with the above line of argument is thus. Those with degrees tend to come from stable and/or middle class backgrounds, and these sort of people tend to earn more even when they DON’T have degrees. Thus to prove to what extent having a degree pays off financially, it is necessary to control for family background: something the ONS study does not do.

The only study I know of that DOES control for family background shows (as might be expected) that getting a degree DOES pay off, but the pay-off can be undramatic. In particular arts degrees for men are a waste of time from the purely commercial point of view.

As if to prove the point, the above Guardian article features a picture of a male graduate wandering the streets with a placard saying “Job wanted. History graduate. University of Kent. Interview me.”

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Stiglitz doesn’t get Modern Monetary Theory.

2011-08-23T08:15:00.000-07:00

Joseph Stiglitz wrote an uninspiring guide to reducing the deficit at the end of last year. Here is guide to the main ideas in the paper.

He gives seven main ideas, starting on page 1.

Brainwave No 1.

The first idea is to go for “Public investments that increase tax revenues by more than enough to pay back the principle plus interest reduce long-run deficits.”

One flaw in that idea is that worthwhile public investments (and private investments) should be being made ANYWAY – regardless of whether we are in a recession or not.

The second problem is that if the investment “increases tax revenues by more than enough to pay back the principle plus interest…” then the investment will withdraw cash from the private sector. In a balance sheet recession that’s plain daft. Or in MMT parlance, the last thing that needs to be done in a recession is to reduce private sector net financial assets.

Thirdly, public sector investments often require specialised labour, e.g. highway or bridge construction. A dramatic increase in public sector investment in a recession could be plain impossible or difficult for lack of the relevant skilled labour. But even if it is possible, to dramatically expand one sector of the economy, only to contract it again come the recovery simply distorts the labour market: hardly desirable. The distortion has to be unwound come the recovery.

Stiglitz then enlarges on this public sector investment idea under item A in his page 2. Here he claims that public sector investments during a recession a good idea because interest rates are currently low.

Well hang on. WHY are interest rates low? It’s because the government / central bank machine has DELIBERATELY lowered them! And those low interest rates have been lowered by printing money and buying government debt.

So Stiglitz is saying government should borrow the stuff (i.e. money) which government itself has produced. Well now, why go to all the trouble of dishing out money to the private sector only to borrow it back again????

It would be much simpler just to print money and spend it (in a recession), which is what MMT advocates!!!

His next reason under item A for public investment is that given high unemployment, the multiplier from such investment will be high. True. But the same goes for any sort of spending, so this is not specifically a point in favour of investment!

MMT beats Stiglitz yet again: MMTers tend to favour payroll tax reductions in a recession. Having expanded the economy via such payroll tax reductions, a portion of the expanded economy will doubtless end up in the form of extra public sector investment. But that’s by the by.

Brainwave No 2.

Stiglitz’s second brainwave is that “It is better to tax bad things (like pollution) than good things (like work).” Revelation of the century! There was me wondering why we tax alcohol. Now I know.

Brainwave No 3.

His 3rd idea is that “Economic sustainability requires environmental sustainability. The polluter pay principle—making polluters pay for the costs they impose on others—is good both for efficiency and for equity.”

Quite right, but what’s that got to do with deficits or recessions? Absolutely nothing. Again, the above principle applies recession or no recession.

Brainwave No 4.

This is that “Eliminating corporate welfare is good both for efficiency and for equity.” True, but for the umpteenth time, this has nothing specifically to do with recessions or deficits.

Brainwave No 5

This is “Given the increases in inequality and poverty and given the inequitable nature of the 2001 and 2003 tax cuts, the incidence of any tax increases should be progressive, and there should be no increases in the tax burden on the poorest Americans.”

At last: an idea with a small amount of logic! The inequality point is irrelevant in that optimising the level of inequality is a valid aim recession or no recession. But the idea does have a small amount of logic in that the poor have a higher propensity to spend income increases than the rich. Thus transfers of money from rich to poor would be stimulatory. But as far as I can see Stiglitz has not grasped the latter “stimulatory” point: at least I can’t find it in his paper.

Getting technical.

But even the above stimulatory effect of transferring money from rich to poor is a feeble saving grace for this paper. Reason is that it is a classic example of the “bang per buck” argument – the idea that there is some merit in getting as much employment as possible from each dollar spent.

The latter apparent merit is not actually a merit at all because the process of government creating dollars and spending them is virtually costless in real terms. The only important question is: what are the REAL effects of the different options available? The number of dollars that need to be created and spent to effect each option is irrelevant.

As Abba Lerner put it (p.39) "government fiscal policy, its spending and taxing, its borrowing and repayments of loans, its issue of new money and its withdrawal of money, shall all undertaken with an eye only to the results of these actions….” (the italicisation of the word “results” is in the original).

Stiglitz’s paper thus consists of a series of random ideas, most of which are no good. But when it comes to the one idea that is half valid, the author does not seem to realise why it is half valid.

I’ve had enough. I’m can’t be bothered reading beyond Brainwave No 5.

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Anti fractional reserve banners on streets of Newcastle.

2011-08-22T09:48:00.000-07:00

We set up in the shadow (literally and metaphorically) of Grey’s monument.

Grey was a leading light of the Great Reform Act of 1832 which cleaned up some of the corrupt practices in parliament. He’ll be turning in his grave . The inscription on the monument reads:

This column was erected in 1838 to commemorate the services rendered to his country by Charles Earl Grey,K.G. who during an active political career of nearly half a century was the constant advocate of peace and the fearless and consistent champion of civil and religious liberty. He first directed his efforts to the amendment of the representation of the people in 1792, and was the minister by whose advice, and under whose guidance the great measure of parliamentary reform was, after an arduous and protracted struggle safely and triumphantly achieved in the year 1832.

Plenty of interest in the banners. The daughter of a professor who has done a podcast for Positive Money spotted us and gave us some moral support. And a fellow who helped start a credit union in London stopped for a chat.

Full versus fractional reserve arguments on the streets of Durham, UK.

2011-08-18T10:13:00.000-07:00

I set up a couple of anti fractional reserve banners on a street in Durham yesterday. We handed out some leaflets from Positive Money and the Money Reform Party. Both the latter are opposed to fractional reserve. There was plenty of interest.

Even though the university term does not start for a few weeks yet, three or four students who were doing economics came up to us and asked questions.

Expect full versus fractional reserve riots on the streets of North East England in the coming weeks. There were no riots here over the last two weeks. We Geordies don’t go in for your common or garden type of riot: looting and all that. But we get very worked up about more intellectual stuff.

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Krugman on MMT.

2011-08-16T03:40:00.000-07:00

I have far more respect for Krugman that for some of the time wasters who claim to be professors of economics – Rogoff and Martin Friedman for example. However, there is just one little nit I’d like to pick with Mr K.

In reference to MMTers he says “I’m not clear on whether they realize that a deficit financed by money issue is more inflationary than a deficit financed by bond issue.” Well thanks Mr K., I’m well aware - e.g. see my last paragraph here.

And from November last year, see here (see paragraph under the para in red). Coincidentally, the latter post deals with some of Martin Feldstein’s nonsense.

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Two points which advocates of “make work” / job guarantee type schemes often don’t get.

2011-08-15T23:44:00.000-07:00

The “make work” or “job guarantee” idea has been around for centuries, if not thousands of years. (Pericles advocated or implemented the idea in ancient Athens.) MMTers tend to call the idea “job gurantee” (JG). But the idea has flaws, as follows.

First there is the idea that because the schemes involve public sector type output, no increase in demand is required, hence there is allegedly no inflationary effect.

The latter idea would be valid if the wage paid is the same as unemployment benefit and the only factor of production involved was otherwise unemployed labour (i.e. relatively unskilled labour). But any form of employment that involves only unskilled labour and no permanent skilled labour or materials or capital equipment will be hopelessly unproductive. Ergo finite quantities of the latter other factors of production (OFP) must be employed.

But JG is caught between a rock and a hard place here, as follows. If little OFP is employed, JG will be very unproductive. But the more OFP is employed, the more JG becomes the same as a normal public sector employer. And if JG becomes near indistinguishable from a normal public sector employer, then arguments will arise (trade unions or no trade unions) as to why the pay and perks of JG employees are any different to those of normal public sector employees.

Also, ordering up OFP from the rest of the economy (assuming the economy is at capacity) will be inflationary, so that destroys the “no inflationary effect” idea. Alternatively, if the inflationary effect is dealt with by reducing demand for the rest of the economy, then JG jobs will be AT THE EXPENSE OF regular jobs: not the object of the exercise.

A possible escape from the above dilemma might seem to come where the economy is well BELOW capacity. But in this scenario, JG is not the best solution for the problem: the best solution is to raise demand. That’s what I call a “rock and hard place scenario”.

Are JG schemes are productive?

Make work schemes can be reasonably productive, given very high unemployment, and JG enthusiasts sometimes cite this as evidence that JG schemes can ALWAYS be productive. Examples of relatively productive JG type schemes include the Jefes program in Argentina and the WPA scheme in the US in the 1930s.

Re the WPA, Jonathan Kesselman in a Brookings Institution book called “Creating Jobs” (editor: J.L.Palmer) claims there is evidence that WPA schemes in New York state were 75 – 90% as efficient as their regular private sector equivalents.

Certainly given very high unemployment, JG has relatively few problems. For example there will be a good availability of skilled labour. Plus any OFP ordered up from the regular economy will not be inflationary because the economy is not near capacity.

Unfortunately the above points are not a merit in JG, because (as mentioned above) given very high unemployment, it ought to be possible to go for a much better way of reducing unemployment, namely raising demand!

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In a fiscally united Europe, would core countries subsidise the periphery?

2011-08-13T01:10:00.000-07:00

Philip Pilkington (PP), a journalist and writer based in Dublin, has an article on the Naked Capitalism site attacking Otmar Issing (former member of the ECB’s executive board.). As far as I’m concerned it’s game, set and match to Otmar Issing.

PP tries to argue that the core does not subsidise the periphery.

To back his point PP implores us to take a “proper macroeconomic perspective”. OK by me. Unfortunately his article contains far more blarney than macroeconomics.

PP’s main point (towards the end of the article) is that Germans are privileged to be able to sell stuff to Ireland, Greece, etc because it keeps Germans employed. And without such a market, Germans would have to go for greater internal consumption in Germany, i.e. run a larger deficit. And Germans abhor deficits because of the Weimar episode.

The answer to the latter point is that if Germans have the same blinkered attitude to deficits as currently exists in Congress, then Germans (like members of Congress) need to study economics. Having done that, they’d have no problem at all doing without Greeks, the Irish or other periphery states.

But arising from the latter argument, there is the question, given a true fiscal union in Europe, of whether relatively high unemployment in periphery, core taxpayers would in effect be subsidising the periphery. Well it’s pretty obvious they would. And the solution to this problem would be, as it is now, to make the periphery more competitive: i.e. cut real wages in the periphery. That way, unemployment levels would be more or less the same in every country, thus no country would subsidies another.

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More drivel from Kenneth Rogoff.

2011-08-11T01:18:00.000-07:00

I pointed to some nonsense emanating from Rogoff here a few days ago. It never rains, but it pours. There is more Rogoff nonsense in the Financial Times a few days ago.

Along with many of the economic illiterates in high places he thinks that more deficit means more debt. See para starting “Everyone agrees that….” The reality is, as both Keynes and Milton Friedman pointed out, that a deficit can perfectly well accumulate as more monetary base rather than more debt.

For Keynes, see 2nd half of 5th para. And for Friedman, see p.250 para starting “Under the proposal…”

Then in the same paragraph Rogoff trots out the old nonsense that higher debt requires higher future tax in order to pay back the debt, which induces households to spend less.

This is a bizarre idea. That is, the idea that the average household pays careful attention to deficit and taylors its weekly spending accordingly is on the face of it pure lunacy. But it might just conceivably be right – however decent empirical evidence is needed to back bizarre ideas, and no evidence has ever been produced to back this idea, as far as I know.

But academics are not too interested in reality: their main concern, all too often, is to keep themselves employed at your expense dreaming up and discussing totally unrealistic ideas. It’s counting angels on pinheads all over again.

Such empirical evidence as there is on the above point actually contradicts the “future tax” idea, as far as I can see. The latter idea is based on the assumption that households try to even out their weekly spending over several years: that is, that they do NOT spend a significant proportion of windfalls. The evidence actually contradicts this. That is, households DO SPEND a significant proportion of temporary increases in their income fairly quickly. See here, here, here, and here.

Whether the deficit accumulates as extra debt or extra monetary base, it is of course POSSIBLE that the debt or base will need reining in via extra taxes. It is equally possible that they WON’T need reining in. For example if the economy expands at a decent rate over the next few years then the debt, relative to GDP will decline.

A second factor which tends to reduce the need to raise taxes so as to rein in debt or base is thus. The debt and base HAVE TO BE INCREASED in nominal terms if they are going to remain (for the sake of argument) constant relative to GDP in REAL terms. That’s because of the effect of inflation. Thus EVEN IF THE ECONOMY DOES NOT GROW, then long term, there STILL might be no need to raise taxes to rein the debt or base.

But that will all be way above Rogoff’s head.

As to the idea that the debt needs reining in because of those allegedly enormous interest payments, interest on national debts has for a long time more or less equalled inflation. Thus in real terms, no interest is paid by most countries on their debt. Most countries never have paid any significant interest in real terms on their debt.

That’s another simple point way beyond the comprehension of Harvard economics professors, like Rogoff and Martin Feldstein.

But anyway, let’s suppose that inflation gets uppity in two years time and that taxes ARE raised so as to rein in the monetary base. This taxation simply removes money from private sector pockets that the private sector effectively cannot spend anyway, because if the money WAS spent, it would just stoke inflation. Thus this confiscation of money from the private sector does NOT make anyone worse off. It does not equal austerity.

It is thus completely pointless for private sector entities to save now so as to be able to pay this tax. If they save now, the effect would be deflationary, which would mean that said tax would not be necessary!!! Or put it more accurately, every dollar that the private sector saves now so as to be able to pay the future tax, reduces the amount of that tax by about one dollar.

But frankly that’s all three miles above the head of the average consumer and six miles above Rogoff’s head.

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Joseph Stiglitz has a bright idea.

2011-08-10T08:36:00.000-07:00

One of our main economic problems is economists who are household names, perhaps because they won a Nobel Prize twenty years ago, but who now well past retirement age, and totally devoid of any ideas as to how to get out of the current mess. Indeed it is these economists who are part responsible for the system that gave us the credit crunch and the tens of millions who are now unemployed in consequence.

Three of the main perpetrators are Joseph Stiglitz, Kenneth Rogoff and Martin Feldstein.

Stiglitz’s “bright” idea in a recent article in the Financial Times for curing our problems is to make “high-return investments”. Wow! Well if the private sector could see any potential “high-return investments” the private sector would be making such investments!

As to the public sector, if these bizarre “high-return investments” exist, they presumably existed before the crunch. Why weren’t those investments being made then?

Put another way, a public sector investment should be made if it makes sense. The fact of being in a recession or boom is almost immaterial. Moreover, the sort of labour and equipment needed to make public sector investments (education, road building, etc) is pretty specialised. You just cannot produce a thousand economics teachers, or experienced highway construction engineers at the press of a button.

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Oh my God - David Cameron, the UK’s premier, thinks the UK government doesn’t have money to “kick start” the UK economy.

2011-08-04T00:10:00.000-07:00

On 26th July, The Times had an article entitled “No money for a kickstart, says Cameron”. The first paragraph reads, “David Cameron warned yesterday that the Government lacks the economic firepower to boost growth as fears mounted over the global recovery. He went on to claim that “the public finances were too strained to allow the Government the possibility of injecting extra life into the troubled economy.”

Inflation might be a constraint on growth, but the idea that the government of a monetarily sovereign country can be short of money is pure nonsense.

In the unlikely event of anyone being interested in Cameron’s ideas on economics, this should be an inspiring read: it’s an article in the Independent newspaper entitled “Why are we silent as Cameron preaches voodoo economics?”

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Rogoff’s lunatic Zimbabwe style solution for the recession: boost inflation.

2011-08-02T23:59:00.000-07:00

Rogoff claims that the recession is caused to significant extent by indebted household’s reluctance to spend. So far so good. Well to be more accurate, it’s not household debts that are the problem: it’s household NET ASSETS that are the problem. I.e. households whose debts exceed the value of their assets have BIG problems. Keep that phrase NET ASSETS in mind.

Rogoff’s solution is to inflate away those debts.

The first problem is that it would require five or ten years of seriously excessive inflation to really cut into household debts.

Second, he overlooks the point that inflation also erodes the value of creditors’ assets! In particular, the monetary base and government debt are ipso facto private sector ASSETS. And if the value of those assets is eroded, that will reduce the NET ASSETS of the private sector in general. Oops! Wasn’t it a lack of household net assets that is the root of the whole problem?

Congratulations to Rogoff for jumping out of the frying pan into fire. Just brilliant. No wonder he’s got a job teaching economics at Harvard.

A better solution (wouldn’t you know it) is the standard MMT solution. That is, have the government / central bank machine create new money and spend it into the economy. That is spend it into the economy IN GENERAL, rather than channel the new money in any particular direction (like into the pockets of Wall Street banksters or owners of government debt (QE)).

The inventor Thomas Edison said that any new money should be the property of the people, not of bankers. He was right.

As for the knee jerk reaction that “new” or “printed” money will cause inflation, well if it does, then that’s no worse than Rogoff’s “deliberate inflation” policy. In any case, if the expanded money supply is just enough to give some stimulus, but no so much as to cause gross excess demand, then there won’t be any excessive inflation.

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Afterthought (12 hours after putting the above online): I should have mentioned that transfer of wealth from creditors to debtors WOULD work in that the weekly spending of the poor is more sensitive to their income and net asset changes than is the case with the rich – not that Rogoff seems to have tumbled to that point. However that’s not much of a saving grace for the Rogoff “Zimbabwe” solution.

Afterthought Sept 20th. Paul Volker in the NY Times rails against the pro-inflation lobby.

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Alan Greenspan doesn’t understand banking.

2011-07-29T00:05:00.000-07:00

In a recent Financial Times article, Alan Greenspan (widely regarded as laughing stock amongst economics bloggers) criticises bank regulation. He claims that making banks safer requires “building up a buffer of idle resources”, and compares this to the resources lying idle in Japan in the form of earthquake protection. The flaw in this argument is as follows.

In the case of earthquake protection it’s true that large amounts of steel, concrete and clever bits of engineering remain idle for decades – till an earthquake hits. But banks are different.

Bank insurance consists essentially of book keeping entries or contracts. If there ARE any physical resources left idle as a result of bank insurance, like piles of gold or something, will some please tell me where these piles of gold or other physical objects are to be found?

As is pointed out in this work by Prof R.A.Werner and others, one way of making banks safer is to go for full reserve banking and/or curtailing maturity transformation. And as Werner rightly points out, this involves a larger amount of money sitting idle in bank accounts, which to the economically untutored, like Greenspan, might seem like a waste of resources.

However, money in a bank account is simply a book keeping entry or a number in a computer. A nation’s stock of money can be increased any time by little more a click on a computer mouse. Or as Milton Friedman put it in Chapter 3 of his book “A Program for Monetary Stability”, “It need cost society essentially nothing in real resources to provide the individual with…. an additional dollar.”

As regards increased capital for banks, this again is just book keeping entries and bits of paper. Purchasing shares in a bank or any business gives the purchaser the right to dividends plus the right to repayment of very roughly what they paid for the shares (depending on the share price when they sell). But those two rights may be lost when the bank goes under.

No physical resources are tied up here. All that happens is that when the bank goes under, shareholders forgo consumption rather than taxpayers.

A second fundamental and very simple point that Greenspan has not grasped is that economic activity does not have to be bank funded, i.e. loan funded. The alternative is equity funding. And those two basic options apply to ALL economic activity from a household purchasing a washing machine up to a multinational funding a new oil refinery. Thus stricter bank regulation will not curtail economic activity as long as the relevant government / central bank creates and spends new money into the economy to compensate for the reduced availability of money from private banks.

If households and oil companies have more money in their pockets, they won’t need to borrow so much.

There has to be some optimum combination of loan and equity funding for the economy as a whole. Clearly Greenspan favours near unrestricted lehttp://www.blogger.com/img/blank.gifnding – that is thousands of idiots trying to get NINJA mortgages. God first makes mad….

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Stop press, 2nd Aug 2011: About 16 professors in the Financial Times tear a strip off Greenspan. I'm almost beginning to feel sorry for him.

Afterthought, 3rd August. More rotten eggs thrown at Greenspan: today’s Financial Times has a letter from Rober Yohanan (former Chicago Fed board member) criticising Greenspan. Now I really am feeling sorry for him.

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