Saturday, 3 March 2012

A little mistake by Brad DeLong which Abba Lerner would not have made.

Brad DeLong argues that excess unemployment leads to a semi-permanent loss of productive potential because employers fail to invest the amount that would be suitable at full employment. Thus, so he argues, having government borrow and spend now is highly beneficial because in addition to the normal and not too spectacular increased GDP that comes from “borrow and spend”, the above loss of productive potential is avoided. And the latter is where the real benefit of borrowing and spending in 2012 comes in.

That is his basic arument and there is nothing wrong with it. But at the end of his article, he makes a slight mistake. He argues that current low interest rates make “borrow and spend” even more worthwhile than normal, because borrowing costs are currently low.

The flaw in that argument is that interest payments are just TRANSFERS, which are not a REAL cost. That cannot be set against or compared to any increased REAL output that comes from borrow and spend.

That is, when government borrows, interest is paid to those who have lent to government. While the people who PAY for this interest are taxpayers. But that is simply a TRANSFER between two groups of people: the net cost to the nation is nothing, or thereabouts.

To illustrate, suppose one had the option of increasing GDP in such a way that the interest so called “cost” actually EXCEEDED the rise in GDP. According to DeLong (as I understand him) that option would not be worthwhile.

I say it WOULD BE worthwhile, because the increase in GDP is a REAL benefit, whereas the interest rate so called “cost” has no effect whatever on total incomes for the population as a whole: to repeat, it simply boosts the income of one lot of people at the expense of another lot.

But . . . going ahead with “borrow and spend” in those circumstances would lead to a rise in governemnt debt, and possibly an exponential rise. Shock horror.

So there must be something wrong with the DeLong model. And what is wrong is that the basic idea of borrowing so as to fund government spending is one big nonsense. As Abba Lerner, said, in a recession, government should simply create new money and spend it into the economy.

Or as I put it two years ago on this blog, “Borrowing is particularly nonsensical given that when a government borrows, it borrows “stuff” (i.e. money) which it can produce an infinite supply of at no cost. Government borrowing money is a bit like a dairy farmer buying milk at the supermarket when there is a thousand gallon tank of milk a few yards from his house.”

If government “prints” instead of borrowing, that disposes of interest payments. Thus the only question for government is: “Will printing and spending (and/or cutting taxes) boost GDP without exacerbating inflation too much?”

As to which DEPARTMENT of government ought to take this stimulus decision, it is technical decision, a mile above the heads of politicians. Thus the decision is best taken by the central bank or some fiscal committee made up of economists (fallible as they are).

In contrast, there is the decision as to whether the stimulus takes the form of extra public spending or tax cuts. That is a POLITICAL decision which ought to be left to politicians and the democratic process.



  1. "As to which DEPARTMENT of government ought to take this stimulus decision, it is technical decision, a mile above the heads of politicians."

    Possibly, but it should be for a committee of parliament to make the decision (rather than the government) based on recommendations from advisors. Then at the very least we can throw them out for picking bad advisors.

    I say parliament rather than government because parliament should decide on the amount of money required in the system (above and beyond the auto-stabilisers). Government then distributes the discretionary spending based on the submitted budget as it has the mandate.

    I think that's a decent control system that at least has democracy at the forefront, rather than the requirements of private banks.

  2. Neil, On the other hand bad decisions made by technicians reflect AUTOMATICALLY on the relevant government. Put another way, “the buck stops at the top” – i.e. with the president, prime minister, political party in power, etc.

    E.g. the technicians who were supposed to be regulating banks while Gordon Brown was in power made a mess, and Gordon Brown plus the Labour Party got some of the blame.

    I agree that “the requirements of private banks” should have nothing to do with it. And in fact they don’t currently have much to do with it in Britain: I think there is just one representative of the private bank industry on the Bank of England’s monetary policy committee.

    But I’m not happy with politicains taking technical decisions. If that makes sense, how far do we take it? Do we have politicians deciding on technical design decisions re nuclear power stations, or government computer systems?

    Tom Hickey agrees with you. But I’m an awkward bugger, and I’m sticking to my idea. This that politicians and the democratic process should decide the proportion of GDP taken by the public sector. Plus they should decide on the SPLIT of that spending as between education, law enforcement, etc. etc.

    In contrast, all technical decisions should be taken by technicians – with politicians, as I said above, getting some of the blame if technicians get it wrong.

  3. Nice Ralph. I love the emphasis on interest payments (also taxing-and-spending) as transfers. This is something there was big resistance to in the recent blogosphere debate about whether debt is a burden.

    But I'm not enamored of the idea of having some technocratic panel of experts making the spending decisions, if that's what you're saying. I believe we should reform our institutional arrangements to allow our national treasuries to run "pure" deficits - by which I mean simple overdrafts in their accounts at the central bank that do not correspond to an obligation to repay the central bank. Or what is functionally the same thing: the central bank simply marks up the treasury account by a certain targeted amount in each fiscal period, unrelated to whatever other revenue the treasury receive from taxes and borrowing.

    I look forward to the day when each year, the legislature, seeking good macroeconomic advice first and finally grasping the MMT perspective, makes a decision on the size of the pure deficit to be run that year, and targets that deficit. The budget passed should then be designed to generate more spending than tax revenue, in the amount of the deficit target. The shortfall should not be made up by borrowing from the private sector. It should be "printed."

    Then leave the rest of the details up to the messy, beautiful, rancorous democratic process. I don't really care that some of the spending consists of pork barrels, bridges to nowhere and earmarks. That just means legislators are delivering spending to their constituents. Yes, it's a mess. Democracies mix in a bunch of misguided spending with the good spending. But on the whole they do a better job than technocrats. Big deal that it's a mess. As long as they have an MMT-inspired pure deficit target and hit the target, then let politics reign in the decisions about spending.

  4. Dan,

    I fully agree with your last paragraph, i.e. that DETAILED decisions on how taxpayers’ money is spent should be left to the democratic process and to politicians. Plus the decision as to what proportion of GDP is allocated to public spending is a decision for the democratic process.

    Re your idea that the legislature decides on the size of the deficit / surplus after taking what you call “good macroeconomic advice”, I’m happy with that as long as the legislature do exactly what they are told by the “macroeconomic advisors”. But that effectively means the size of the deficit is decided by technocrats, which is what I think is best.

    I.e. I just don’t see the case for politicians having a say in the size of the deficit / surplus. Most politicians have not worked their way thru a basic introductory economics text book. They are totally unqualified to take that decision.

  5. I don't think we really disagree Ralph. Basically, we agree that a deficit target should be established in some way by people with macroeconomic expertise, and then legislatures should figure out what kinds of taxes and expenditures to use to hit that target.

  6. However, in the case of a sovereign fiat currency issuer, who can never run out of money, interest on national debt becomes investment earnings in the civilian sector.

    Also, in the above case, there is no need for crowding out, nor does govt "borrow" from anyone. Govt creates bonds out of thin air, and the central bank uses those bonds in currency operations to maintain it's target interest rate, and banks and other civilians use govt bonds as a safe investment and parking lot for reserves.

    Fiscal policy should target full employment, and should be based upon the metrics prevailing during decades of full employment accompanied by stable growth and moderate inflation. In the case of the USA, this means reverting to the metrics operative during the period 1955- 1970, which are as follows:

    Union participation 35% of the work force
    Labor receiving 60% of GDP
    Debt / GDP ratio less than 70% for the private sector

    It will be necessary to implement policies which greatly reduce consumption of hydrocarbons for fuel, which means double tracked electrified rail powered by wind/geothermal/hydro/solar, including light rail and trams, passive solar heated housing, appliances double current levels of efficiency, particularly computers.

    It will also be necessary to implement the job guarantee, as it existed back in the 50's in the form of Civil Service jobs paying a fraction of private sector jobs, with pay scales supporting the desired minimum private sector wage.

    Implementing the JG, adopting universal national service, supporting collective bargaining, and other policies would restore labor's rightful share of GDP, obviate the necessity of household debt to finance living expenses, and provide funds desperately needed to enable households restoring their tattered balance sheets.

    Improving the amount of Social Security benefits would address the pension crisis engendered by 30 years of mis-managed economic policies, and permit the baby boom generation retiring on time, and vacating their jobs to the younger generations.

    Of course, resources should be used to improve infrastructure, repair same, and reduce the cost of economic activity through improved transportation, reduced environmental insults, restoration of the natural resource base and other means.



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