Monday, 30 January 2012

Ghosh – IMF authors define “fiscal space”.

Atish Ghosh (of the IMF Research Department) and co-authors tell us what they mean by “fiscal space”. (H/T to J. Portes).

Turns out that what they mean is pretty much as expected, which is thus.

There is a limit to what a country can borrow before creditors get worried and start raising the interest they require for further lending. According to Ghosh & Co this limit comes where the debt to GDP ratio is around 100%. They seem to be unaware that this ratio for the UK just after World War II was over 200% without any big problems. (See 3rd and 4th charts here). They also seem to be unaware that Japan’s public debt is also around the 200% level, yet the yield on ten year Japanese debt is around 1%. Lending to someone for ten years at 1% strikes me as a HUGE VOTE OF CONFIDENCE in the relevant debtor.

But that 1% for ten year figure does not of course stop the debtphobes, the economic conservatives and economic illiterates from getting their knickers in a twist on the subject of Japanese debt. This doom laden article in the Wall Street Journal article points out that the cost of insuring Japanese debt for five years has risen from $155,000 to $222,000 for $10million of debt. Now if get out your pocket calculator, you’ll see that that equates to reducing the interest on the debt by the catastrophically large figure of 0.0044%. In other words, if you want to insure your Japanese debt, the rate of interest you get effectively declines from 1% to 0.9956%. All I can say is that the sky must be about to fall in – in Japan anyway.

Ghosh & Co also claim that creditors’ views of a country will be influenced by that country’s past performance in paying off debt, which is reasonable enough: lending to someone with a past record of alcohol abuse and a poor employment record is riskier than lending to a more trustworthy debtor.

Anyway, the much vaunted “fiscal space” according to Ghosh & Co is the difference between a country’s EXISTING debt level, and the level at which interest rates charged to that country lead to the situation running out of control. Or as they put it:

“Once the primary surplus does not keep pace with the higher interest payments on rising debt, there comes a point – a debt limit – beyond which, in the absence of extraordinary fiscal adjustment, debt dynamics become explosive and default becomes inevitable. Our definition of fiscal space is then simply the difference between current debt ratios and this debt limit.”

Well there is just one problem with all this. The IMF authors are assuming that fiscal stimulus can come only via increased debt. That is, they’re assuming that the only form of fiscal stimulus is the classic Keynsian “borrow and spend” policy.

As I’ve pointed out a hundred times on this blog, and as both Keynes and Milton Friedman pointed out, for a monetarily sovereign country (that’s one that produces its own currency) an alternative to debt financed fiscal stimulus is to do the funding via plain straightforward old money printing – inflation permitting. (Of course the policy is then no longer purely fiscal in that a money supply increase is involved at the same time. I.e. the policy then becomes fiscal plus monetary – but never mind.)

In fact I’d go further. As I’ve also pointed out several times on this blog, monetarily sovereign governments do not need to borrow. In fact I’d go further still: it is COMPLETELY LUNATIC for a monetarily sovereign country to borrow. What’s the point of borrowing something you can produce in infinite quantities yourself and at no cost?????? Anyway that’s my own what you might call “extremist” view. So I’ll stick to something nearer the convention unwisdom from now on.

Having said that (inflation permitting) a monetarily sovereign country which is not trusted by potential creditors can always fund fiscal expansion via money printing, it is possible that the mere fact of printing could make the creditors even more worried.

Well that again is no problem. The relevant country can simply print yet more money and pay off creditors as their debt reaches maturity. It’s possible that that money printing might be inflationary, but in that case all the relevant country needs to do is to raise taxes by enough to give a deflationary effect that cancels out the above inflationary effect. (Well actually it is SLIGHTLY more complicated than that as I explain here, but basically the above “print and tax” policy is the way to get rid of national debt, if that’s what a monetarily sovereign country wants to or needs to do.)

Of course, as Ghosh & Co point out, some countries do not have a good record when it comes to imposing enough tax on the population when required. But such a country is on the road to ruin ANYWAY: i.e. regardless of any arguments to do with “fiscal space”.

So what does this “fiscal space” idea amount to? For a monetarily sovereign country, the idea amounts to nothing.


Sunday, 29 January 2012

A boring idea on non-demand deficient unemployment by Arnold Kling.

Arnold Kling goes to great lengths to make the obvious point that a faster than usual pace of change can contribute to a higher than usual level of unemployment. The change can be changing technology and/or a change in the pattern of demand for goods and services, which in turn implies a change in the pattern of demand for different skills. E.g. here.

Yes, well anyone with a brain tumbled to this possibility early on in the recession. Some of them looked at what was happening to construction workers made redundant, since the latter type of employees (together with those employed in organising mortgages, etc) were badly hit by the recession.

Well the evidence seems to be that construction workers are finding no more difficulty in finding alternative employment than other groups. E.g see charts on p.8 here, and see last bar chart here.

The latter evidence does not DISPROVE the idea that a faster than usual pace of change is contributing to current elevated unemployment levels. But it casts a bit of doubt on it.

If the likes of Kling spend time producing EVIDENCE that a faster than usual pace of change is contributing to current elevated unemployment levels, then that is time well spent.

As for the simple banal point that a faster than usual pace of change can raise unemployment, it is fair enough to make that point in an introductory economics text book. But it’s not exactly the revelation of the century.


Friday, 27 January 2012

Fractional reserve causes artificially low interest rates.

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. (See Steve Keen for more on this.)

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, with some quotes from some and reasons why I think some 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).


Wednesday, 25 January 2012

Former Archbishop of Canterbury backs cuts in welfare.

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.


Tuesday, 24 January 2012

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

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.


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?


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.


Sunday, 22 January 2012

Central banks should do some fiscal.

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.


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.


Saturday, 21 January 2012

Government borrowing is pointless.

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.


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.


Friday, 20 January 2012

Mind boggling stupidity from the IMF and The Times.

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.


Monday, 16 January 2012

Government as employer of last resort.

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.


Sunday, 15 January 2012

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

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

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.


Saturday, 14 January 2012

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

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?”.

Friday, 13 January 2012

An argument for private sector JG.

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.


Thursday, 12 January 2012

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

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.

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!


Tuesday, 10 January 2012

The effect of temporary subsidised employment on employability.

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”

2. “Does Subsidised Temporary Employment Get the Unemployed Back to Work?”

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.$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.

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.

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:



Sunday, 8 January 2012

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

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.


Friday, 6 January 2012

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

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.


Wednesday, 4 January 2012

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

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.


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:


Tuesday, 3 January 2012

Employer of Last Resort, buffer stocks and price anchors.

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.


Monday, 2 January 2012

Why do ELR proponents always advocate public sector type work?

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.