Wednesday, 15 January 2014

Olivier Blanchard and Lawrence Summers don’t understand that when people win a lottery they spend the money.

Nor, apparently do they understand that when someone’s income rises, so too does their spending.
Blanchard (for some bizarre reason) is the IMF’s chief economist. And the “terrifyingly brilliant Lawrence Summers” as Brad DeLong calls him, is a Harvard economics prof.
Anyway, Summers in a speech at the IMF at the end of last year put the argument that if an economy does not escape a recession despite zero interest rates, it might be necessary to stoke inflation so as to make the real interest rate negative. And Blanchard more or less agrees. As Blanchard puts it, “We should not dismiss the possibility, raised by Larry Summers that we may need negative real rates for a long time.  Countries could in principle achieve negative real rates through low nominal rates and moderate inflation.”
Now excessive inflation and negative real interest rates are an absolute stroke of genius, as the following illustration will show.
Suppose inflation is 10%pa, and interest rates are zero. That means I make minus 10% by leaving money in the bank. But all is not lost: I can invest my money with someone who promises to do better than that: they offer me let’s say minus 5%. And they do that by buying up houses and knocking down 5% of them every year.
Whoever thought up this negative real interest rate idea clearly deserves a Nobel Prize in economics.
Of course no one is going to engage in such a blatant form of wealth destruction as deliberately knocking down houses. But that doesn’t detract from the idiocy of the negative real interest rate idea because in most businesses it’s not obvious simply from turning up at the factory or whatever, and seeing what raw materials go in and what finished products come out, whether the business creates or destroys wealth. That is, gauging the amount of wealth creation/destruction can only be done by adding up the value of the output and subtracting the value of inputs. And if at the end of that bit of maths, the business makes a negative 5% return on capital, then in the bizarre world of negative 10% real interest rates, the business is viable.
And to add insult to injury, it’s not even clear how much of a relationship there is between interest rates and investment, as this recent Fed study demonstrated.

A better solution.
However, there’s a better solution to this nonsense than Blanchard and Summers’s wealth destoying stroke of genius. It’s thus.
Fidding with interest rates is not the only way to influence demand. Another way is for the government / central bank machine to simply to print money and spend it (and/or cut taxes).
In that government goes for the tax cutting option, household incomes rise. And staggering as this may seem, when household incomes rise, their spending tends to rise.
And to the extent that households DON’T raise their weekly spending, they are ipso facto SAVING. But they won’t save for ever. That is, as their stock of money rises, the point is bound to come where they start spending some of it.

Amateur economists better than professionals?
Luckily for us, so called “professional” economists like Blanchard and Summers are not the only ones with influence on economic policy. That is, there are at least two groups of economists (composed of amateurs as much as professionals) who have tumbled to the blindingly obvious fact that if the government / central bank machine prints money and spends it and/or cuts taxes, the aggregate demand will rise. The two groups are first, advocates of Modern Monetary Theory. Second there are the authors of this publication, namely Positive Money, The New Economics Foundation and Prof. Richard Werner.

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