Sunday, 8 April 2012

Profs Alesina and Giavazzi don’t understand a common MMT phrase: “private sector net financial assets”.

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.

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.

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