Wednesday, 5 March 2014

New Keynsians’ faux pas.

Following on from my previous post which highlighted the fact that the geniuses at the British Treasury have recently re-discovered a point made by Keynes 80 years ago, it seems that New Keynsians are equally dumb (and MMTers correspondingly smart).
For MMTers (and indeed anyone with some common sense) it is obvious that a household’s spending will tend to be positively related to it’s stock of cash. In plain English, when a household wins a lottery, its spending rises.
According to Nick Rowe, “New Keynesians have . . . .  forgotten that some sort of real balance effect is the only thing that might (or might not) bring the economy to full employment automatically.”
That is, if government runs a deficit funded by new money, then the private sector’s stock of cash rises, all else equal. The fact of spending that money (or cutting taxes) will of course raise demand. But in addition, the mere fact of the private sector having an increased stock of what MMTers call “private sector net financial assets” will also tend to increase demand.
“Private sector net financial assets” is a collective term for base money and government debt, and MMTers are right to use that phrase because base money and government debt have something in common: they are both assets as viewed by the private sector to which there is no corresponding debt.
But perhaps that’s beyond the comprehension of New Keynsians.
And finally, I have of course extrapolated from the micro to the macro above, which is always dodgy, but I think it works in this case.


  1. The weakness of the MMT solution is that a one-time injection of money will bring increased spending accompanied by increased empoloyment ONE_TIME. Then, after the money increase has worked it's way into the hands of strong holders, the injection effect will fade.

    The answer for one-time injection fade should be REPEATED one-time injections. Just inject on an annual basis. This is what has happened for the last 50 years or more.

    Repeated injections of "one-time" stimulus evolves into annual expectation of a steady-state condition. In other words, the "new-normal" is repeated injections so everyone plans for that condition. Again, that is where we are after 50 years or more of stimulus.

    Bernanke did the next logical step. Increase the rate of stimulus. Move the rate to a new level. That is where we are today. We have had stimulus for 50 years or more, and now we are the beneficiaries of a new HIGHER rate of stimulus.

    Only problem, the plan is not working well.

    My own analysis of "why not" is that the benefits of stimulus are unevenly distributed in a very discriminatory way. I will not go into that politically charged arena.

    1. Repeated stimulus is actually inevitable given the 2% inflation target. E.g. and to keep things simple, assume no real economic growth, and assume inflation of exactly 2%pa. That means the monetary base declines at 2%pa in real terms. Assume also that the private sector wants the same stock of real monetary base to keep it spending at a rate that brings full employment. That all makes it inevitable than an annual dollop of stimulus is required.

      Re Bernanke, I don’t agree that the less than brilliant success of fiscal stimulus was down to such stimulus having lost it’s potency. What happened was a recession of unprecedented proportions, which in turn required stimulus of unprecedented proportions, and unfortunately the authorities just didn’t have the guts to implement adequate stimulus.

      Re the uneven distribution of stimulus, I quite agree that it should be evenly distributed. In particular, like most people, I think it’s a disgrace that much of the stimulus went into the pockets of the rich and the pockets of bankers.

    2. Dear Roger:

      Of course the money supply must increase every year (I live in the USA, so thats where I'm talking about) because productivity and the population increase every year.

      Here is a very simple example that describes the situation:

      Start with an economy of 2 people and $20. They are able to produce 20 apples in year 1.
      Assume all apples clear for the sake of simplicity, so we get a price level of 1. $20 / 20 apples and a GDP per capita of $10.

      Now say in year 2 we have 3 people and some productivity increases that allow 40 apples to be produced and sold.

      If the money supply stays the same we have deflation. $20/40 apples for a price level of .5 and GDP per capita of $6.67.

      If the money supply grows in perfect relation with Q, then there is no inflation $40 / 40 apples and GDP per capita still goes up because of productivity growth $40 / 3 = $13.33

      If the money supply grows faster than Q, here we get inflation and an even larger increase in GDP per capita. $60 / 40 apples and $60 / 3.

      Obviously, this is an extremely unrealistic ad simple example, but the main point still stands. Productivity and population growth require a growing money supply in order to maintain price stability, this is why all larger economies have more money than smaller economies.

  2. Ralph:

    The average yearly increase in the US money supply between 2000 and 2008 was ~$2 Trillion per year (deficits + nominal private debt growth).

    And even that wasn't enough to maintain full employment. When the GFC hit, between 2008 and 2010, private debt actually fell in nominal terms. So in order for the Govt to have maintained a relatively stable level of new money creation, US deficits would have to be about $2.5 trillion per year ($2.5T Govt - $.5 private).

    For my money, this is about the simplest way to figure the approximate level of appropriate deficits.

    How much new money have we been averaging?
    How much of that total is coming from private activity (RE: loan growth)?
    Which gives us our rough level of needed Govt contribution.

  3. Auburn,

    Re figuring the “appropriate level of deficits”, it strikes me any such “figuring” is near impossible. The first problem is that privately create money is very different stuff to central bank created money, so the two cannot be compared on a dollar for dollar basis.

    Second, the private sector behaves in an erratic manner: one minute it’s in irrational exuberance mode, and the next minute it’s saving more than usual. So all government can do is to look at what the private sector is doing, and try to counteract the gyrations in private sector behaviour by increasing or reducing the deficit (or running a surplus). The latter surpluses / deficits will of course influence the government debt and money supply, but that’s almost immaterial.

    And what I just said there comes to much the same as Keynes’s dictum: “Look after unemployment, and the budget looks after itself”.

    Hope that makes sense??!?

  4. Ralph

    If you can say this:
    "Re figuring the “appropriate level of deficits”, it strikes me any such “figuring” is near impossible."

    Then we get some cognitive dissonance when you say this:
    "which in turn required stimulus of unprecedented proportions, and unfortunately the authorities just didn’t have the guts to implement adequate stimulus."

    What do you "figure" would have been adequate stimulus?
    See my point?
    Anyways these are just some semantic things. As ffar as figuring an appropriate level of deficits, the only metric I can see worth using is as Mosler always says: "count the bodies in the unemployment line."

    Govt created money aka deficits simply remove non-active bank deposits to the Fed's balance sheet and give new bank deposits to Govt spending recipients. There is no difference between Govt created money and private sector created money, cash registers don't discriminate.

    Absolutely, Keynes makes sense. Govt spending or deficits more appropriately are the thermostat for the economy. With the goal being to maintain enough aggregate demand for full utilization of resources.

    1. Hi Auburn,

      Working out the appropriate level of deficits is certainly difficult. I agree there is much to be said for Warren Mosler’s “count the bodies in the unemployment line” strategy to which you referred a couple of days ago. That chimes with Keynes’s dictum, “Look after unemployment and the budget looks after itself”.

      The effect of a deficit in the form of extra government spending is is relatively easy to predict: e.g. if police decide to employ X people within two months, then employment will rise by “X+multiplier” people within two months or so.

      The effect of a deficit in the form of reduced taxes is more difficult because predicting exactly what households will do with the extra income is uncertain.

      Re privately created money, or debts incurred to private banks, to which you referred a couple of days ago, that might as well be ignored because that debt / money strikes me as being the RESULT OF the private sector’s desire to do business. Unlike base money, privately created money is not the cause of anything. That’s why base money (quite rightly in my view) is sometimes referred to as “high powered money”.


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