Saturday, 31 December 2011

Unproductive employees.

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.

P.S. 15th Feb. More discussion of the above idea here.


Friday, 30 December 2011

Malcolm Sawyer and government as employer of last resort.

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”.


Monday, 19 December 2011

Vickers does not separate safe from unsafe bank activities.

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.


Saturday, 17 December 2011

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

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.


Friday, 16 December 2011

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

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.”

Afterthought, 6th March, 2012. Here is another example of a “Prof.” claiming that government must either borrow or tax in order to spend. It’s John Cochrane, professor at the University of Chicago Booth School of Business.

See paragraph starting “But where did the money come from?


Thursday, 15 December 2011

Draghi believes in the confidence fairy!

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.


Wednesday, 14 December 2011

The Fed made a profit out of TARP?

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.


Tuesday, 13 December 2011

Modern Monetary Theory in England 1,000 years ago?

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.


Monday, 12 December 2011

MMT and Positive Money ideas in the Financial Times.

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?


Sunday, 11 December 2011

Bank subsidies are partially YOUR fault !!!!

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… 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”.


Thursday, 8 December 2011

No nativity scene in DC.

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.


The Euro will fail.

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.


Wednesday, 7 December 2011

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

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.


Tuesday, 6 December 2011

Willem Buiter is not 100% clued up.

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:


Monday, 5 December 2011

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

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.


Sunday, 4 December 2011

QE: Mervyn King versus Andrea Leadsom.

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”.)


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.


Saturday, 3 December 2011

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

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.


Friday, 2 December 2011

Krugman doesn’t fully understand Europe.

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.


Wednesday, 30 November 2011

Academia at its worst.

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.”


Tuesday, 29 November 2011

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

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.


Monday, 28 November 2011

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

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:


Sunday, 27 November 2011

Government should not subsidise bank loans.

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.”


Thursday, 24 November 2011

Germany fails to sell debt.

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?


Wednesday, 23 November 2011

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

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.


Thursday, 17 November 2011

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

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.


Wednesday, 16 November 2011

A flaw in Nominal GDP targeting.

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.


Tuesday, 15 November 2011

Saturday, 5 November 2011

Krugman confuses fractional reserve and maturity transformation.

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.


Thursday, 3 November 2011

The scourge that is unemployment.

Fractional Reserve.

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.

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

Tuesday, 1 November 2011


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.



Monday, 31 October 2011

Why can’t everyone have a printing press?

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)


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


Sunday, 30 October 2011

“Where Does Money Come From”?

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:


Saturday, 29 October 2011

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

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.


Thursday, 27 October 2011

Greek style austerity is not necessary.

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.


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.


Tuesday, 25 October 2011

Let the peasants eat cake.

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.


Monday, 24 October 2011

Lawrence Summers wants to pour gasoline on the flames.

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.