The plonkers running Western economies have for the most part not grasped the distinction between micro and macroeconomics: in particular they think government, plus government income, spending and borrowing can be treated the same way as a household’s income, spending and borrowing.
In fact the two are as similar as chalk and cheese. (Incidentally, I’ll use the word “government” in the sense “government and central bank combined”).
Micro and macro borrowing.
Borrowing can make good sense for a microeconomic entity, like a household or business. For example, where such an entity wants to make an investment that makes sense, and the entity does not have enough cash, it will borrow. Nothing wrong with that.
However a country that issues its own currency (a “monetarily sovereign” country / government), is totally different. This “entity” has a limitless supply of cash: it can print the stuff. Borrowing is totally pointless. (Same goes for the Eurozone as a whole – though INDIVIDUAL COUNTRIES within the EZ are a different kettle of fish.)
New Economic Perspectives and Friedman.
The New Economics Perspectives site has just published an article by Dan Kervick (who I regard as very clued up) arguing that government borrowing is pointless. This argument is not new, but it’s good to see someone joining the “borrowing is pointless” chorus.
Milton Friedman in 1948 argued for a zero government borrowing regime. See paragraph starting “Under the proposal…” (p.250) here.
Friedman’s arguments were, first, that borrowing might be justified in war time when government spending relative to GDP is very high, and collecting very large amounts of tax might be impractical. However, so argues Friedman, this point is invalid in peace time, ergo borrowing is not justified in peace time.
Second, Friedman debunks the argument that borrowing is justified because, in his words, it is “less deflationary” than getting a similar amount of money via tax. As he rightly points out, simply printing money is even less deflationary.
Warren Mosler
Warren Mosler also argues for a zero borrowing regime. See second last paragraph here.
He does not give any detailed reasons, far as I can see. He says that “No public purpose is served by the issuance of Treasury securities with a non-convertible currency and floating exchange rate.” That is true, but that simple statement needs bolstering with some more detailed arguments, which I attempted to set out in a paper entitled “Government borrowing is near pointless”.
My Reasons
It is not possible to accurately summarise all the arguments in the latter paper. But briefly the main arguments are thus.
1. A popular argument for borrowing is the Keynsian “borrow and spend with a view to stimulus” argument. However, Keynes himself pointed out that printing money was a perfectly good alternative to borrowing it. But even that is too charitable an attitude towards borrowing. Reason is thus.
Where a government issues its own currency and borrows units of its currency, it is borrowing something which it can create itself in limitless quantities: similar to, and as pointless as a dairy farmer buying milk in a shop.
2. There is borrowing with a view to the purchase of assets, like infrastructure investments. One flaw in that argument is that infrastructure investment spending is small compared to total government spending, thus such spending can perfectly well come out of income.
Another possible excuse for borrowing to fund infrastructure is that the borrowing spreads the cost over the generations that benefit from such spending. That argument is nonsense because it is just not physically possible to consume real resources like concrete or steel produced in 2030 to construct roads and bridges in 2012.
3. Government borrowing smooths out the erratic timing of government expenditure and income from taxation? Sorry: just another flawed argument.
To illustrate, if all corporation tax is paid in January, government will on the face of it be short of funds towards the end of each year, which for “borrow” enthusiasts means government will have to borrow.
Not true: suppose the government just prints money towards the end of the year, would that be inflationary? The answer is “no”, because corporations know perfectly well that a significant chunk of their cash is going to disappear in January. That money is not “spendable” money. In fact the deflationary effect of abstaining from spending that money will pretty much cancel out any inflationary effect of government printing and spending money late in the year.
4. Given the hopeless arguments for government borrowing, what are the REAL REASONS for such borrowing? Well, the real reason is moral hazard, skulduggery, corruption - call it what you will.
To be specific, voters attribute tax increases to governments and politicians to a far greater extent than they attribute interest rate rises to governments and politicians. Thus it always pays incumbent politicians to run up national debts, and leave the consequent mess to their successors to sort out.
And finally.
So if three MMTers (Warren Mosler, Dan Kervick and me) all say the same, namely that government borrowing is pointless – not to mention Milton Friedman - I challenge anyone to contradict us!!!!
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P.S. (28th April). Another MMTer with similar views is Bill Mitchell. He said, “A sovereign government within a fiat currency system does not have to issue any debt and could run continuous budget deficits (that is, forever) with a zero public debt.”
H/t to “Peter” on the New Economics Perspectives site.
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I like this post by Simon Wren-Lewis. The first two sentences say, “Internal consistency rather than external consistency is the admissibility criteria for microfounded models. Which means in ordinary English that academic papers presenting macroeconomic models will be rejected if some parts are theoretically inconsistent with other parts, but not if some model property is inconsistent with the data.”
Later he says “In Real Business Cycle models, all changes in unemployment are voluntary. If unemployment is rising, it is because more workers are choosing leisure rather than work.”
So there you have it. The rise in unemployment over the last five years has nothing to do with silly lending by banks. If I’ve got this right, it’s all down to those lazy workers choosing leisure as against going out to work.
Can’t these economists just be given the job of counting the number of angels dancing on pin heads?
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Skidelsky says the system is gummed up with bad debts (particularly in the case of banks), so debt forgiveness is needed.
Wrong. Forgiving debts just encourages irresponsible lending and borrowing in the future (as if we haven’t had enough of that already in recent years). Moreover, why should the average citizen make sacrifices to rescue incompetents – in many cases, RICH incompetents?
Of course there is the point that the larger banks have wheedled their way into a position where they are too big to fail (TBTF). So those particular creditors have been helped, and may need more help. But the TBTF problem should never be allowed to arise: we need to cut TBTF banks down to size, and/or structure them so they can be put through bankruptcy and administration in an orderly way.
Anyway, the quickest way out of a recession is just to give citizens money to spend (and/or raise public spending). As long as the stimulatory effect of that is enough to counteract the deflationary effect of letting incompetent lenders and borrowers go bust, then the problem is solved. There is no need for special taxpayer subsidised “debt forgiveness” programs.
General stimulus combined with letting incompetent creditors go the wall could easily result in an economy based less on lending and borrowing than is currently the case, but what of it? In the UK, the size of the banking industry relative to GDP has increased a WHAPPING TENFOLD relative to GDP over the last forty years (see p.3 here). Anyone know what we’ve gained from this? Is economic growth any better than forty years ago? Nope.
Skidelsky needs to study Modern Monetary Theory and Mosler’s law. The latter is in yellow at the top of Warren Mosler’s site.
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I love this description that appeared in a comment on Warren Mosler’s site about how tax helped destroy the Roman Empire. Any classical scholars like to pass judgement on whether the description is accurate?
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In the terminal collapse of the Roman Empire, there was perhaps no greater burden to the average citizen than the extreme taxes they were forced to pay.
The tax ‘reforms’ of Emperor Diocletian in the 3rd century were so rigid and unwavering that many people were driven to starvation and bankruptcy. The state went so far as to chase around widows and children to collect taxes owed.
By the 4th century, the Roman economy and tax structure were so dismal that many farmers abandoned their lands in order to receive public entitlements.
At this point, the imperial government was spending the majority of the funds it collected on either the military or public entitlements. For a time, according to historian Joseph Tainter, “those who lived off the treasury were more numerous than those paying into it.”
Sound familiar?
In the 5th century, tax riots and all-out rebellion were commonplace in the countryside among the few farmers who remained. The Roman government routinely had to dispatch its legions to stamp out peasant tax revolts.
But this did not stop their taxes from rising.
Valentinian III, who remarked in 444 AD that new taxes on landowners and merchants would be catastrophic, still imposed an additional 4% sales tax… and further decreed that all transactions be conducted in the presence of a tax collector.
Under such a debilitating regime, both rich and poor wished dearly that the barbarian hordes would deliver them from the burden of Roman taxation.
Zosimus, a late 5th century writer, quipped that “as a result of this exaction of taxes, city and countryside were full of laments and complaints, and all… sought the help of the barbarians.”
Many Roman peasants even fought alongside their invaders, as was the case when Balkan miners defected to the Visigoths en masse in 378. Others simply vacated the Empire altogether.
In his book Decadent Societies, historian Robert Adams wrote, “By the fifth century, men were ready to abandon civilization itself in order to escape the fearful load of taxes.”
Perhaps 1,000 years hence, future historians will be writing the same thing about us. It’s not so far-fetched.
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The conference in Edinburgh last week on banking was organised by Friends of the Earth and was entitled “Just Banking” with “scales of justice” logos plastered all over the literature handed out. The implication of the latter, plus the actual titles of several of the meetings was very much geared towards environmental, ecological and equity matters.
However, several of the more enthusiastic supporters of the above objectives had little grasp of how to achieve their desired objectives at minimum cost.
That is, the latter “enthusiasts” have no grasp of the Tinbergen Principle. Jan Tinbergen was an economics Nobel laureate, and his principle (or at least my preferred variation on it) states that for each policy objective, one policy instrument is required, and one only. I.e. the above “enthusiasts” were advocating policies that would have resulted in more than one policy instrument for each objective.
The environment.
For example, one way of inducing banks to invest in environmentally responsible ways is to make them consider the environmental effects of each investment decision. That involves a HUGE amount of person-hours, bureaucracy, form filling and so on.
Moreover, the latter imposition on banks fails to deal with investments that are NOT bank funded!!!
A vastly cheaper way of cutting CO2 emissions, for example, is simply to tax carbon based fuels, as is already done. In Britain, about 60% of the retail price of petrol and diesel is tax. (Personally I’d be happy to see the retail price of petrol and diesel doubled.)
And the latter sort of tax AUTOMATICALLY makes CO2 emitting investments less profitable: it will divert investment (bank funded and non-bank funded) away from petrol and diesel consuming activities and towards other forms of economic activity. Job done. No need for any extra bureaucracy.
Equality.
At least one speaker at the Edinburgh conference claimed that banks should promote equality. I’m baffled. I cannot for the life of me see how banks do much to this end, laudable as equality is.
We ALREADY SPEND BILLIONS promoting equality: progressive personal taxes, social security, state education, etc. That is, using Tinbergen phraseology, we already have “policy instruments” to deal with inequality. And presumably we have chosen the most efficient instruments. Further policy instruments are a waste of time – never mine further and probably LESS EFFICIENT instruments.
Bubble blowing versus productive investments.
Another popular criticism of banks is that they invest and lend relatively safe ways, e.g. in property rather than in productive activities.
Well given that those who deposit money in banks want their money back, banks are bound to do go for relatively safe investments, aren’t they? If you want to take a risk with your money and potentially make bumper profits, then invest direct in the stock exchange, set up your own business, pay a visit to Las Vegas, or put your money on a horse – the options are numerous. No one is stopping you.
But don’t ask to have to have your cake and eat it: that is, don’t expect an institution to invest your money in a risky and potentially profitable way, at the same time as expecting your money to be 100% safe.
Indeed, therein lies one of the basic flaws in the existing banking system: depositors are promised 100% safety thanks to the taxpayer, while banks can lend in relatively risky ways. The solution to that problem, as advocated on p.7-8 of this submission to the Vickers commission, is to force depositors to choose between 100% safe deposit accounts and “investment” or “risky” deposits where they get a decent rate of interest, but stand to lose their money if it all goes belly up.
Fatuous statement of the obvious: we need more money put into productive investments.
Obviously a country will be better off if more capital is put into productive investments. That just begs the $64k question: “which investments are productive?”. Anyone who has a sure fire answer to that question will quickly make a billion.
Simply diverting money from property to allegedly productive industries other forms of investment will not automatically raise GDP. Some of the latter or “other” investments will be winners and some will be losers.
It looks like the UK is not too good at making finance available to small businesses compared to other countries. So there is probably SOME MERIT in putting this right. But I doubt that in itself will transform economic growth.
Just been to an amazing banking conference in Edinburgh (organised by Friends of the Earth). The main speakers (in no particular order) included:
* Adam Posen (Bank of England Monetary Policy Committee).
* Steve Keen (Economics prof University of Western Sydney).
* Ben Dyson (Positive Money).
* Richard Werner (International Banking prof Southampton University).
* Ann Pettifor (Director of Policy Research in Macroeconomics).
* Mary Mellor (former sociology prof, University of Northumbria, UK)
* Huw Davis (Head of Personal Banking at Triodos bank).
* Chris Cook (Senior Research fellow, University College London).
* Tony Greenham (New Economics Foundation).
Highlights of their speeches (for me) are set out below – but this won’t be a fair summary of their speeches.
First a couple of general points. Several speakers were very critical of the fact that private banks are free to create money and of the use banks have made of this freedom. But none of them (far as I remember) actually said, “let’s ban private money creation” – though they got very near.
Second, two or three of the speakers seemed to have no idea of the likely bureaucratic costs of the changes they proposed to the existing banking system. These were the speakers particularly concerned with environmental and ecological matters. I’ll enlarge on that in a post in a day or two.
Anyway, the interesting bits for me were thus. Comments by me are in brackets.
Adam Posen said:
* He accepted his current job at the Bank of England partially because of the intensity of debate in Britain as to what to do with the banking system.
* No central banks have successfully pricked bubbles.
* All of the worst bubbles were caused by house / property price increases. (This was subsequently contradicted by others who pointed to 1929 which was mainly about shares.)
* A possible way of deflating property bubbles might be to use existing property taxes – i.e. hike those taxes when bubble enlarges.
* Britain is good at international banking and has been for a long time. But it is not good at local banking for small businesses. Britain needs the VARIETY of types of finance for small businesses that the U.S. has.
* Bank subsidies are more dangerous than subsidies for other industries
* We need to question the idea that a country benefits much from having an internationally competitive banking industry.
* Bank subsidiaries in other countries should be capitalised from sources in the latter countries.
Steve Keen said:
*Schumpter said in 1934 that private banks create money out of thin air.
* Neo classical economists are clueless on money, banking, etc.
* Krugman does not realise that private banks create money.
* Solow debunked neo-classical economics.
* There is an undesirable feed-back mechanism in the private bank money creation process. (I quite agree. I think this is one of the main flaws in private money creation: it is pro-cyclical.)
* Private debts are much bigger than government debts.
* Keen showed several charts / graphs showing a close relationship between the ACCELERATION of private debt and economic buoyancy: things like employment levels, stock exchange levels, etc.
* Keen favours what he calls “jubilee shares”.
* Re the business of banks lending first and finding reserves later, they now have a month in which to find reserves, which is longer than it used to be. (Not sure if this applied to the US, UK or both or all over the world.)
* Quoted Marx on the subject of financial capital messing up industrial capital.
Richard Werner said:
* He was part responsible for originating the term “quantitative easing”. It originated by his thinking up a phrase to describe the process that would be acceptable to the Japanese (who he was advising at the time). The Japanese phrase then got translated into English as QE. (However, subsequent speakers pointed out that QE was first implemented centuries ago. Thus Werner was responsible for the phrase, but not the idea)
* Text book description of how banks work is nonsense.
* The Asia crisis was caused by excessive reliance on banks as opposed to other forms of finance.
* 97% of money in circulation is privately created, and central banks try to hide the fact.
* Quoted Donald Kohn’s attack on neo-classical economics.
* Banks are not financial intermediaries: they are creators of money. (They’re both aren’t they?)
* If newly created money / credit is used productively rather than to fund asset purchases, inflation is lower. (Not sure about that.)
* The activities of credit unions in Britain are restricted, so the activities of large private banks should also be restricted: in particular, directed towards to something better than bumping up asset prices.
* Small local banks in Germany play a much bigger role than in Britain. (There were two or three Germans at the conference who offered suggestions and support.)
* Local currencies are a good idea.
* A recent survey showed that about 80% of the population think money is created by governments / central banks. The interviewees were biased towards the more educated section of the population, so a realistic figure would be over 80%. 90% were against letting private banks create money.
Ann Pettifor said:
* Money created by banks (forget whether she was referring to central or private banks) should be allocated to specific purposes, e.g. environmentally responsible investments. (Sounds bureaucratic to me.)
* Private banks have displaced central banks when it comes to credit / money creation.
* The rise in private sector debt has been more significant than public sector debt.
* The crises was sparked off by the big rise in interest rates in the five or so years prior to the crunch plus de-regulation.
* Debt is being cut, but slowly and chaotically.
* Roosevelt as of 1933 had made a good job of dealing with the recession.
* Rogoff and Reinhart’s ideas are flawed.
* The EU has no idea what it is doing.
* Another crisis is coming. After that, everyone will be so sick of the private banking industry that draconian controls will be imposed.
* She is keen on the so called “golden age” of banking: 1945-71. This was a period during which there were much tighter controls on banking than today.
* Those of us who want a better banking system need to organise politically, but at the moment we are in a muddle as to exactly what we want.
Tony Greenham said:
* The New Economics Foundation has had plenty of help from the Bank of England with research to back the NEF’s unconventional ideas on banking. (This could be on instructions from Mervyn King, because King is very open to such unconventional ideas.)
* The conventional view of how banks work is out of date: private banks lend first, then look for reserves. And if there are not enough reserves available, the central bank is forced to supply them.
* Most bank lending goes to the asset rich, not to productive industries.
Ben Dyson said:
* The fact that privately created money or credit is backed by government means arguably that such money is in effect publically created.
* The time taken for the average household to pay off their mortgage has approximately doubled over the last 20 years. (I think it was 20 years - might be wrong there.)
* Private banks have in effect taken over seigniorage from governments / central banks, and the profit from this activity is around £2bn a year in Britain.
Mary Mellor said:
(Mary Mellor is a sociologist and fairly left of centre, which means that violently right wing male chauvinist pigs like me tend to disagree with her!! She has written a book about the crisis). She said:
* Re-jigging the private bank system needs to be done so that banks take environmental matters into account. (I don’t agree: for example CO2 emissions are best cut by increasing the price of carbon based fuels, I think.)
* Repeated the point made by Ben Dyson, namely that since government stands behind private money creation, that money is effectively publically created. (Interesting point.)
* Barter economies have never existed in any very formal sense, though there has been what she calls “recopricity”.
* The cards handed out in baby-sitting economies (she was presumably referring to Krugman’s baby sitting economy) are effectively monetary base or publically created money. (She was hinting that this is a better form of money than privately created money, though (to repeat, I don’t think she actually said “let’s ban private money creation”).
Huw Davies (Triodos Bank – www.triodos.co.uk)
(This bank lends only for environmentally and ecologically responsible investments. It was set up in 1980.) He said:
* 30% of depositors think their money is just kept in bank vaults, and not loaned on.
* He’d like to see every depositor ask their bank what the bank uses their money for.
* Triodos has no bonus culture.
Chris Cook.
(This fellow is clever, articulate, and knows his stuff. His ideas are very unconventional. I haven’t yet worked out whether he is a genius or is right off the rails.)
* He wants to seek solutions to banking problems from centuries ago even a thousand years ago. In particular, he wants a return to the tally stick system, but done in a high tech way.
* Pointed to the municipal banks that exist in some areas in Scotland.
P.S. (24th April). Having said that none of the participants actually said “ban private money creation”, three of the participants do actually favour such a ban (i.e. favour full reserve banking). They are Positive Money, Prof. Richard Werner and the New Economics Foundation. See here.
Summary.
Full reserve banking has two main advantages over fractional reserve. First, money creation by private banks as under fractional reserve is pro-cyclical. Second, fractional reserve leads to a sub-optimum interest rate.
Pro-cyclicality.
Creditworthiness depends largely on the value of collateral offered. But the value of collateral depends on the stage of economic cycle: e.g. asset prices rise in a boom. Thus during a boom, private banks create money faster than usual: exactly what is not needed.
Conversely, during a recession, the private sector deleverages. That is, the amount of privately created money shrinks. Again, exactly what is not needed. In short, private bank money is pro-cyclical: it exacerbates instability.
Artificially low interest rates and how private banks rob everyone.
A second problem with the private money creation is thus.
Assume an economy where only the central bank creates money, and where the central bank keeps the money supply at a level that ensures everyone spends at a rate that brings full employment.
As in real world economies, borrowing and lending would take place in such an economy: e.g. those supplying goods and services would doubtless allow customers time to pay.
As in real world economies, interest would be charged by creditors for two basic reasons. First, creditors forgo consumption in order to lend, and in consequence they require compensation for that sacrifice. Second, lenders incur administration costs and the costs of bad debts. So interest is made up of the above two items or costs: the “consumption forgone” cost and the “administration plus bad debts” cost.
Now suppose that money creation by private banks is allowed. The beauty of being allowed to create thin air money for private banks is that they can lend without forgoing consumption. That is, administration and bad debt costs apart, private bankers are happy to create money and lend it out at almost zero percent. But of course if you can produce something at no cost, and the existing market price is $Y/unit, you don’t sell at $0/unit do you? You sell at nearer $Y/unit and pocket the difference.
Or as Huber and Robertson (p.31) put it, “Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0% debit-interest = 9% profit = 5% normal profit plus 4% additional special profit”.
Robbery.
Moreover, if the economy is at capacity or full employment, the effect of this new money and spending is inflationary. In effect, those in possession of monetary base are robbed. And who benefits? It’s the private banker!
The private banker pretty much takes over seigniorage from the central bank. Printing your own $100 bills or £20 notes is profitable as various naughty printers who have taken to this activity will testify.
Of course there are differences between central bank money creation and commercial bank money creation. Commercial banks create money and HIRE IT OUT. In contrast, the government / central bank machine sometimes GIVES AWAY new money, as in the case of tax cuts. Or alternatively, the new money is spent into the economy in the case of public spending increases.
Inflation can be forestalled.
Having said that private money creation is inflationary (on the above assumptions), an alternative is that government and/or central bank spot the looming inflation and forestall it with tax increase or public spending cuts. But the result is the same: the population at large has to forgo consumption in order to enable the private banker (and shareholders) to INCREASE their consumption.
Interest rate adjustments are inferior to monetary base adjustments.
A possible weakness in the idea that private banks should not create money is that this reduces the effectiveness of interest rate adjustments. That is, as others have pointed out, private banks “lend money into existence”. And interest rate changes affect the amount of lending. Thus if private banks cannot create money, that reduces the influence of interest rate adjustments.
However, there is a VERY LONG LIST of weakness in interest rate adjustments as a method of controlling demand.
First, a very simple and obvious point is that the basic purpose of an economy is to produce what the customer wants (i.e. the private sector consumer and public sector “consumers” – state funded educational institutions, the police, etc). Thus if the economy can be expanded, the way to do it is to give customers more of that which enables them to consume more.
Doubtless interest rate cuts bring stimulus, but why effect stimulus in a way that distorts the price of something: borrowed money? Interfering with the market price of anything leads to a misallocation of resources, unless market failure can be demonstrated.
Second, interest rate cuts are a near farce just at the moment: private sector entities lent and borrowed irresponsibly before the credit crunch and got their fingers burned. They are wary of repeating the mistake. Yet we have the pathetic spectacle of the authorities and reputable economists scratching their heads as to why interest rate cuts are not bringing as much stimulus as is required.
Paradox of thrift unemployment.
A third problem with interest rate adjustments is that debt encumbered money does not deal with paradox of thrift unemployment.
As Keynes rightly pointed out, unemployment will rise if the private sector saves more money: that is, and putting it in slightly more general terms, if the private sector decides it wants more net financial assets, excess unemployment will ensue unless the government / central bank machine provides those extra net financial assets (NFA).
Unfortunately, interest rate adjustments and private bank created money does not supply the private sector with NFA because for every extra money unit (dollar, pound, etc) that private banks create, they also create a money unit of debt. Thus private sector non-bank financial assets do not rise as a result of private bank money creation. They only rise when the CENTRAL BANK creates money, AND SPENDS IT INTO THE ECONOMY. (Note: having a central bank create money and implement QE does NOT change NFA).
Plus, there is disagreement as to HOW LONG interest rate reductions work for: they MAY work as a pump primer, after which rates can be raised. But they may not.
And finally, I listed several other problems with interest rate adjustments here. (Some items on this list repeat some of the above points, but some are in addition to points made above.)
And finally: some quotes.
Abraham Lincoln: “The government should create, issue and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers.”
“The essence of the contemporary monetary system is creation of money, out of nothing, by private banks' often foolish lending.” - Martin Wolf (chief economics commentator at the Financial Times), 9th Nov 2010.
“Of all the many ways of organising banking, the worst is the one we have today” - Mervyn King, governor of the Bank of England.
Milton Friedman on the subject of why we have not adopted full reserve banking: “The vested political interests opposing it are too strong, and the citizens who would benefit both as taxpayers and as participants in economic activity are too unaware of its benefits and too disorganised to have any influence.” (Ch 3 of Friedman’s book, “A Program for Monetary Stability”.)
"The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented."
- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.
Milton Friedman: “There is no technical problem in achieving a transition from our present system to 100% reserves easily, fairly speedily and without any serious repercussions on financial or economic markets.”
The phrase “fiscal space” is popular with respectable members of the economics profession and particularly in IMF and OECD circles. E.g. see here, here, here or here. But you can easily find a hundred other examples of IMF and OECD staff and others wittering on about “fiscal space” by Googling. Unfortunately the whole concept “fiscal space” is nonsense: it is irrelevant.
A country with a low debt to GDP ratio allegedly has “fiscal space”: that is, come a recession, such a country allegedly has the option of running a deficit and in consequence running up its debt.
In contrast, a country which already has a high debt to GDP ratio, allegedly cannot implement the above policy, thus, so the argument goes, it cannot escape a recession or has more difficulty doing so. The reason given is that potential creditors are not impressed by entities that are already heavily in debt.
Unfortunately the above argument just doesn’t apply to a country which issues its own currency. Incidentally I’ll deal below just with such countries: Eurozone countries are another matter.
Where a government is already heavily indebted, it is perfectly true that potential creditors may well not lend other than at relatively high rates of interest. But there is a simple solution to that problem: don’t borrow money - just print the stuff and spend it (and/or cut taxes).
As long as the relevant country is in recession, i.e. has ample spare capacity, the additional demand will not be inflationary. Thus the lack of fiscal space is a complete irrelevance.
And there is a second reason for thinking that the whole concept “fiscal space” is irrelevant, as follows.
Where a country DOES HAVE fiscal space, why is that any help? Allegedly the reason is that the country can adopt the classic Keynsian “borrow and spend” method of escaping a recession. But what on Earth is the point of the “borrowing” part of “borrow and spend”?
The purpose of borrow and spend is to impart stimulus. But borrowing (i.e. withdrawing cash from the private sector) has THE OPPOSITE EFFECT!!!!!! That is, the effect of borrowing “anti-stimulatory” or “deflationary”.
The exact extent to which public sector borrowing crowds out and thus negates the intended effect of borrow and spend is of course disputed. But it beggars belief that borrowing has no deflationary effect at all.
As Keynes himself pointed out, “print and spend” is a perfectly viable alternative to “borrow and spend”.
The OECD wants less the debt. Meanwhile the IMF says there is a SHORTAGE of quality government debt.
Bill Mitchell regularly tears strips off the IMF and I nearly always agree with him. His latest bout of “strip tearing” is here.
I also drew attention some time ago to the IMF and OECD’s failure to understand the basic nature and characteristics of national debts. See first few pages here.
The above mentioned study by the IMF claiming there is a shortage of quality debt also claims that if governments WERE to increase their national debts, creditors would then have increased doubts as to whether the debts would be repaid. Well that’s just brilliant: we apparently have a shortage of quality debt, but if we expand the amount of debt, the quality declines. Thank you IMF for that illuminating suggestion as to the way forward.
Anyone with half a brain will by now be asking what the OPTMUM amount of debt is for a monetarily sovereign country to issue. I’ll repeat that in bold red letters for the benefit of any IMF or OECD staff reading this.
The important question is:
WHAT IS THE OPTIMUM AMOUNT OF DEBT FOR A COUNTRY TO ISSUE?
Well those acquainted with Modern Monetary Theory will know the answer to this one, so they needn’t read further. For the rest…..
The first point to grasp is that it is STARK RAVING BONKERS for a monetarily sovereign country to borrow any money. Such a country can produce any amount of money itself at no cost anytime. The only apparent advantage of such borrowing is that to the extent that money is borrowed from foreigners, it enables the country to enjoy a temporary standard of living boost, which it will then have to pay for later when the debt is repaid (never mind the interest). But what is the point of that? Absolutely none. So this “advantage” is no advantage at all.
There is however a merit in the government / central bank machine (GCBM) issuing liabilities (i.e. debt or money): those liabilities are private sector assets. And sometimes the private sector goes into “saving mode”: i.e. it does not spend enough to bring full employment. Indeed, that is exactly where we are right now as a result of private sector deleveraging. I.e. we have “paradox of thrift” unemployment.
In this situation it’s desirable for gcbm to run a deficit and let the private sector accumulate assets (debt or currency).
As to the INTEREST that ought to be paid on any such debt, there is no point in paying any significant interest. And debt which pays no interest is cash. In other words governments might as well forget about debt and just issue cash, as suggested by Milton Friedman.
That is not to say that central banks should not from time to time wade into the market and offer to borrow money (or lend money): the latter activity is one way of implementing stimulus or deflation. But long term, government debt is pointless.
Moreover, government debt is effectively debt owed by the less well-off to the better off. And the interest on that debt is for the most part a payment by the poor to the rich. It is totally immoral to force or induce the less well-off to go into debt and pay interest on that debt. In contrast, if someone (rich or poor) decides off their own bat to go into debt, that is their business.
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P.S. (same day). Forgot to put a conclusion to the above post. The conclusion is thus.
Interest paid on national debts should be around zero. Whether that should be zero in nominal terms or real termsis debatable. But there is certainly no great harm in making it zero in nominal terms, which (per Friedman) makes debt the same thing as cash. As to the OPTIMUM amount of debt (and or cash / monetary base) that a government should issue, the amount should be such as to induce the private sector to spend at a rate that brings full employment.
Also: hat tip to Warren Mosler re the article about the OECD’s concern about debts.
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Vox have just published an article by the above two authors. According to Vox, this article is a “Lead Commentary”. OK, then: I’ll give it more careful consideration than I otherwise would.
The authors’ basic point is that tax increases have a bigger recessionary effect than public spending cuts, the suggestion being that in trying to cut deficits, countries should go for spending cuts rather than tax increases.
The first flaw in that argument is that the decision as to what proportion of GDP is allocated to public spending is a POLITICAL decision, not one for economists. Thus economists should not express views on the tax increase versus public spending cut point – unless of course there are insuperable problems in going for tax increases. In that case, economists WOULD BE justified in pointing to the problems. But there is no such problem: the only problem is that Alesina and Giavazzi can’t solve the problem (if you’ll excuse my over-use of the word “problem”). The solution to the problem is thus.
If raising taxes and cutting borrowing are too recessionary, a monetarily sovereign country can compensate by counteracting the recessionary effect of raised taxes by implementing less tax increase and printing money instead.
And that money printing is not a REAL COST. As Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances”.
Of course the knee jerk reaction of economic illiterates the phrase “print money” will be the same as it has been since the dawn of time, namely “inflation”. Well, there’ll be no inflationary effect unless and until that extra money results in excess demand (as pointed out by David Hume 250 years ago). And raising demand by the right amount gets us out of the recession. Doh!
Notice that replacing tax increases with some money printing DOES NOT cut the deficit, at least it certainly does not cut it immediately. And for those under the illusion that deficit cutting is the be all and end all, that might seem to be a problem. Well it’s not a problem and for the following reasons.
If it is necessary for government / central bank to print money and channel it to the private sector, that can only be because the private sector regards itself as being short of net financial assets. That is, paradox of thrift unemployment is rearing its ugly head.
The solution to the paradox of thrift problem (indeed the only possible solution) is to supply the private sector with what it wants: more savings or “net financial assets”. And that involves running a deficit for a while.
In short, as Keynes said, “Look after unemployment, and the budget will look after itself”.
The confidence fairy rears its ugly head.
You just know you’re reading nonsense when you see the confidence fairly cited, don’t you? Anyway, the authors claim that spending cuts makes employers more confident relative to tax cuts. I.e. apparently we have to give way to the political views or prejudices of employers.
Well the answer is “no we don’t”. If the political views of employers have a deflationary effect, that can be countered with a bit more money printing: if there is one thing that makes employers jump for joy, it’s a queue of customers all of them flush with money.
Revelation: eating good food helps you recover from an illness.
Next, the authors say, “…spending-based consolidations accompanied by the right polices tend to be less recessionary or even have a positive impact on growth. These accompanying policies include . . . . liberalisation of goods and labour markets, and other structural reforms.” The flaw in that argument is thus.
“Liberalisation, structural reforms, etc” are desirable AT ANY TIME. They would have been desirable even if the credit crunch had never occurred. Thus “liberalisation, structural reforms etc” are irrelevant to the argument here.
That is, the above point is like saying that eating decent food helps you recover from an illness. True. But eating decent food is a good idea ANYWAY. Thus the “decent food” point is not the medical breakthrough of the century, to put it far too politely.
Likewise the above point about liberalising goods and labour markets, is not the economics breakthrough of the century, to put it far too politely.
In fairness to the authors, they DO MENTION that “easy money” can be used to counter the recessionary effects of tax increases, but this “easy money” is simply one of “pellets” in their scatter gun selection of solutions. Mention enough solutions to a problem and one of them is bound to be right.
Conclusion.
As I’ve said before on this site, every time I come across an economist talking nonsense, turns out they’re from Harvard. One of the above authors is a Harvard Prof. So the Vox article seems to be par for the course in that respect.
The title of an article in the Frankfurter Allgemeine reads:
“How does money come into the world?”
And the sub-heading reads:
“Not only the European Central Bank is allowed to create money, but also any normal bank. They create their credits from nothing.”
This is a translation of part of the article (in green):
The Occupy movement maintains the provocative thesis that it is the banks who do create money in our economic system. “Profit-seeking private institutions that are in no way democratically controlled, are creators of money.” This is dangerous, says Occupy.
Occupy is right, not with the assessment, but with the explanation. It’s the banks that created most of our money. Namely large commercial banks such as the Deutsche Bank and Commerzbank as well as small credit unions and savings banks.
About the growth of money supply are actually deciding banks but also private individuals and companies - depending on how much money they borrow or lend.
But not only in Occupy, even in science there is a debate over whether after the banking crisis experience the money creation can be left to the banks. Ironically, the thesis supervisor of current CEO of Deutsche Bank Josef Ackermann, Hans Christoph Binswanger, is one of the protagonists.
Another German daily newspaper die Tageszeitung published the whole interview with Prof. Joseph Huber – the leading representative of monetary reform initiative in Germany and co-author of the book Creating new money.
There is a booklet by Huber (in English) here.
And then we have Swiss daily newspaper Schweizer Zeit that explains in detail how the current way of money creation by commercial banks developed throughout history and how it makes the economic system inherently unstable. And it also introduces the idea of full-reserve banking as a solution.
Hat tip to Gerard Barrie who is interested in monetary reform and lives in the North East of England near me.
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Mention NAIRU in Modern Monetary Theory circles, and all hell is liable to break out. You’ll be told that NAIRU is an idea that has never been proved or that no one knows what level of unemployment actually corresponds to NAIRU, so the concept is useless.
However, if you refer to the idea but give it a different name, that causes no problems for some strange reason.
Alternative names include the “natural level of unemployment” – an idea / phrase that preceded NAIRU. There is Bill Mitchell’s “inflation barrier”. And there is the idea that an economy can be working “at capacity” or “below capacity”.
Of course the above concepts are not IDENTICAL. But they are so similar that I just cannot be bothered with the differences.
The natural level.
For example the “natural level” is the idea, first, that there is some minimum possible level of unemployment before inflation becomes unacceptable. To that extent, the “natural level” is identical to NAIRU.
However the two part company in that the natural level idea says that given excess AD, inflation rises to an unacceptably high but STABLE level, whereas NAIRU says inflation ACCELERATES. Hence the “A” in NAIRU.
Now I realise thousands of economists have kept themselves employed at the taxpayer’s expense in recent decades dreaming up models that support the natural level as against NAIRU or vice versa, but frankly the difference between the two is trifling as far as I’m concerned.
If inflation is unacceptably high, then it is unacceptably high. As to whether inflation ACCELERATES or not I’m not greatly bothered: though if NAIRU is a superior model to the natural level that just means that excess inflation of some given amount is a more serious matter than it otherwise would be.
The inflation barrier.
As to Bill Mitchell’s “inflation barrier” he has never set out in great detail what this consists of. Possibly this is because having attacked NAIRU, he then discovered that the NAIRU / inflation barrier / “at capacity” idea was indispensable. So he cannot now set out what his “inflation barrier” idea too clearly because the similarities to NAIRU would be a trifle embarrassing.
At capacity.
As to the idea that the economy can be “at capacity” this shares with NAIRU the defect that no one knows at exactly what level of employment the economy is at capacity. But for some bizarre reason this is allegedly a defect in NAIRU, but not a defect in the “at capacity” concept.
Why unmeasurable concepts are useful.
The fact that a concept or relationship or variable has never been measured or cannot be measured does not stop the concept being useful. These sort of unmeasured concepts crop up over and over in science.
Particle physicists have time and again posited the existence of sub-atomic particles before such particles have actually been seen or had their mass or other characteristics measured.
I’m not a mathematician, but I understand that the square root of minus one kept cropping up in maths well before anyone had a clear idea of what the square root of minus one actually was. And mathematicians plonked the square root of minus one into their equations, despite not knowing what it was, because it seemed to be a valid concept. They couldn’t do without it.
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