Pedro Da Costa thinks Minsky thought up the “Government as employer of last resort” idea.

That’s in this Reuters article of his which starts “The concept that the government should serve as an employer of last resort in times of economic stress was first floated by the late economist Hyman Minsky."
 
Well now much the biggest set of employer of last resort (ELR) schemes in the last century in the US came (unsurprisingly) in the 1930s – at which time Minsky was a teenager! I rather doubt he had a decisive influence on the WPA and other ELR schemes in the thirties. And of course in Germany in the thirties there was something similar: autobahn building, etc.

Going back a bit further in history, there were the work houses in Europe and America in the 1700s and 1800s. Those were ELR of a sort.

And going back still further, two and a half thousand years ago: Pericles in Ancient Greece set up an ELR scheme. In reference to Pericles, Plutarch’s book “The Lives of the Nobel Grecians and Romans” (p.192) says “….it being his desire and design that the undisciplined mechanic multitude that stayed at home should not go without their share of public salaries, and yet should not have them given them for sitting still and doing nothing, to that end he thought fit to bring in among them, with the approbation of the people, these vast projects of buildings and designs of work, that would be of some continuance before they were finished, and would give employment to numerous arts, so that the part of the people that stayed at home might, no less than those that were at sea or in garrisons or on expeditions, have a fair and just occasion of receiving the benefit and having their share of the public moneys.”

Part of the explanation for low interest rates and high levels of debt.

Money lenders (aka banks) print or “create” money. See the opening sentences of this Bank of England article (1) for verification of that. In contrast, other types of firm and corporation don’t do that: or at least their freedom to create money is severely restricted, as Richard Werner explains (2).
 
Now that’s pretty obviously a big leg up for the money lending industry. I mean most firms when they want to come by money have two options: earn it or borrow it. In contrast, and to repeat, private banks are in the happy position of being able to just print the stuff, or at least some of it.

And that is an entirely artificial bias in favour of private banks. GDP is maximised where every firm, industry and product is treated equally,  unless there are good reasons which are specific to a particular industry for doing otherwise. E.g. special laws relating to fire-arms and alcoholic drinks are fair enough.

So what good reasons might there be for the latter special treatment of private / commercial banks?

Well one ostensible reason is that letting private banks print and lend out money is stimulatory: it boosts demand. Well sure it does, but so does having the CENTRAL bank do the same thing. I.e. central banks can print and spend new money into the economy (and, in cooperation with government, they can do it in an entirely impartial way, that is, not involving special favours for any particular industry).


Interest rates.

Another ostensible excuse for private money printing by banks is that it reduces interest rates which according to some is beneficial.

Indeed, Joseph Huber describes that interest rate reducing effect in more detail in his work “Creating New Money” – see para starting “Allowing banks to create new money…” (3).

Well actually low rates have disadvantages as well as advantages: for example low rates encourage asset price bubbles. In more general terms there must be an OPTIMUM rate of interest.

As I’ve pointed out before on his blog, the concept “optimum” seems to be beyond the comprehension of most of the population and a sizeable proportion of the economics profession. But hopefully most readers of this article understand the concept. So how do we achieve the OPTIMUM rate of interest?

Well how about just letting interest rates be determined by market forces (unless someone can clearly demonstrate that market forces go wrong in this area). And a free market is a scenario where government abstains from granting special favors to one particular industry, e.g. letting money lenders print money.


Free markets.

It was argued above that the nearest thing to a free market involves having the state “print and spend new money into the economy” (i.e. do some helicoptering). That might seem questionable in that having the state doing anything is not normally regarded as a characteristic of the free market. In fact as explained in the previous post on this blog, the latter “print and spend” policy is a very close imitation of the free market. Briefly that’s because the free market’s cure for a recession is the Pigou effect, which involves an increase in the money supply.
 
Also, when it comes to money, there is really no such thing as a totally free market: “money is a creature of the state” as the saying goes. Or to quote another popular phrase, “money is a social construct”. That is, for any sort of money to work, there has to be general agreement as to what the money unit is, and how to control its production.

 
Conclusion.
 
To put all that another way, the existing bank system (sometimes called fractional reserve) involves an artificially low rate of interest and hence an artificially large amount of lending, borrowing and debt. Under the alternative system, full reserve banking, commercial banks are barred from creating / printing money, and full reserve is a closer approximation to a free market than the existing bank system. Thus full reserve banking is the GDP maximising bank system.

_________________

 References.

1. “Money Creation in the Modern Economy” by Michael McLeay & co-authors. Published by Bank of England (Quarterly Bulletin 2014, first quarter.)

2. “How do banks create money, and why can other firms not do the same?”. Richard Werner. Published by Science Direct.

3. “Creating New Money”. Joseph Huber & James Robertson. Published by the New Economics Foundation.

Helicoptering equals the free market’s cure for recessions.

In a perfectly functioning free market, and given a recession, wages and prices would fall, which would increase the real value of money (base money to be exact). That would encourage spending which would cure the recession. That’s known as the Pigou effect.

Unfortunately in the real world, wages are sticky downwards (to use Keynes’s phrase) thus the free market’s cure doesn’t work too well. However, it can be imitated simply creating and spending extra base money into the economy (helicoptering). That comes to the same thing as the free market cure for a recession. (Incidentally “QE for the people” is another name for helicoptering).

In contrast, while interest rates would doubtless fall in a recession given a free market, there is nothing much to stop them falling in the real world. There is thus little reason to think that additional and ARTIFICIAL attempts to cut interest rates engineered by central banks resemble the free market’s cure for recessions.

Indeed, there are obvious anomalies with interest rate cuts. First, any increased demand resulting from such cuts is concentrated in the capital goods sector of the economy, and that means more dislocation than if the increase in demand is spread more widely thru the economy (as occurs under the free market’s cure for recessions). Second, recessions are not necessarily caused by a decline in demand for capital goods: they can be caused by a decline in consumer confidence, i.e. a decline in demand for consumer goods. Third, even if a recession IS CAUSED by a decline in demand for capital goods, the assumption that that decline should be made good is questionable.

A classic example of that was the decline in demand for housing / property which sparked off the 2007/8 recession. That in turn was caused by the irresponsible lending (particularly in the US) which preceded the recession. Now the idea that the best cure for a recession sparked off by irresponsible lending is to encourage more lending is stark, staring, raving bonkers. It’s LUNATIC.

Yup. The emperors running the show really don’t have any clothes.

The only possible problem with helicoptering comes when it needs to be reversed. Certainly things are more complicated there than in the case of an interest rate hike. However, the fact that some measure is easy for the authorities to implement is not a brilliant argument for it if that measure does not actually have much effect: and the evidence seems to be that interest rate adjustments do not actually have much effect.

Second, if an extra thousand bureaucrats are needed in a country like the UK (with a population of about 60 million) to manage reversing QE for the people, that is a complete irrelevance in the total scheme of things.


Reverse helicoptering.

As mentioned above, reverse helicoptering has potential problems. Altering sales taxes like VAT doesn’t seem to be too difficult: the UK cut and then increased VAT during the recent recession.

Putting a stop to new orders for government purchased stuff would not be difficult either. On the other hand cutting the state pension or unemployment benefit obviously involves potential political problems.

So I suggest the optimum policy is to use helicoptering as far as possible, while only using interest rate adjustments to the extent that helicopter adjustments prove too difficult.

Why not merge monetary and fiscal policy?

John Williams of the San Francisco Fed published an article recently advocating a bigger role for fiscal policy.

One relevant passage reads:

"Turning to policies that can help stabilize the economy during a downturn, countercyclical fiscal policy should be our equivalent of a first responder to recessions, working hand-in-hand with monetary policy. Instead, it has too often been stuck in a stop-and-go cycle, at times complementing monetary policy, at times working against it. This is not unique to the United States; Japan, and Europe have also fallen victim to fiscal consolidation in the midst of an economic downturn or incomplete recovery.

One solution to this problem is to design stronger, more predictable, systematic adjustments of fiscal policy that support the economy during recessions and recoveries (Williams 2009, Elmendorf 2011, 2016). These already exist in the form of programs such as unemployment insurance but are limited in size and scope. Some possible ideas for the United States include Social Security and income tax rates that move up or down in relation to the national unemployment rate, or federal grants to states that operate in the same way. Such approaches could be designed to be revenue-neutral over the business cycle; they also could avoid past debates over fiscal stimulus by separating decisions on countercyclical policy from longer-run decisions about the appropriate role of the government and tax system. Indeed, economists across the political spectrum have championed these ideas."

Well quite. In fact why not take it a stage further and simply fund fiscal deficits via new money? I.e. for each dollar of fiscal stimulus, there’d be an extra dollar of base money in the hands of the private sector (which is monetary stimulus of a sort). And that’s what’s advocated by Positive Money, the New Economics Foundation and Richard Werner.

But instead of the latter monetary policy in the form of adjusting the private sector’s stock of base money, Williams seems wedded to adjusting interest rates. Well the problem with that is that is first that there’s a wealth of evidence that interest rate adjustments don’t actually have much effect. Second, the lag between interest rate changes and actual changes in investment spending are long. Third, the GDP maximising rate of interest is presumably the free market rate. That is, ARTIFICIAL adjustments to interest rates are not on the face of it a GDP maximising way of attaining full employment.

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Reference. 'Monetary policy in a low R-Star world'. John Williams.

Positive Money isn't half getting stroppy...:-)

Images taken from tweets by Steve Keen.

Steven Keen’s debt jubilee.

I’m sceptical about Keen’s debt jubilee idea.

His argument, far as I can see, is thus.

1. Private debts have risen sharply over the last two decades or so.

2. When debts in the aggregate are paid off, or even when their growth ceases, the effect is deflationary.

3. When that deflation comes, governments won’t provide enough stimulus, ergo we need a jubilee.

The weaknesses in that argument are thus.

First, the rise in debts is not surprising given the fall in interest rates over the last two decades. To that extent, paying interest is not a big problem.

Second, the latter theoretical “not a problem” point seems to be born out in practice. That is, the proportion of debts which are “non-performing” is currently not at any sort of danger level. At the height of the crisis, that danger level was arguably approached in the US where “non-performers” rose to near 10% of total debtors. But that US problem has since subsided. As for Keen’s native Australia, which he seems to be particularly concerned about, “non-performance” seems to be a “non-problem” according to this chart.

Third, I agree (as claimed by Keen) that when it comes to implementing the right amount of stimulus, governments and central banks are pretty incompetent. In the recent crisis, that was thanks to the “pro-consolidation, pro-austerity” ideas coming from the IMF, OECD, Kenneth Rogoff, George Osborne, etc.

However, a debt jubilee does not solve the latter problem. That is, it’s perfectly possible for a recession to be sparked off by factors other than excessive debt. I.e. the best solution is to get it into heads of the latter economic illiterates (Rogoff etc) that given a recession (caused by debts being paid off or anything else) there is no reason to hold back on stimulus.

Fourth, it’s impossible to forgive one person $X of debt without robbing someone else of $X of savings, and that’s politically risky. Those robbed are liable to riot, or resort to other violent or illegal counter measures.

Plus, once savers suspect their savings are likely to be confiscated, they’ll charge MUCH MORE for saving/lending for the next two or three decades. Thus it’s very debatable as to whether debtors / mortgagors would gain much in the long run.

However, Keen proposes getting round the latter problems by dishing out as much freshly created money to non-debtors as to debtors! In his words:

“A Modern Jubilee would create fiat money in the same way as with Quantitative Easing, but would direct that money to the bank accounts of the public with the requirement that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injection would have their debt reduced but not eliminated, while at the other extreme, recipients with no debt would receive a cash injection into their deposit accounts.”

Well the obvious problem there is the ENORMOUS amount of stimulus involved: that is, we’d get hyperinflation. Here are some figures.


According to the first two charts in Keen’s article, the private debt to GDP ratio in the US peaked at 300% in 2010, while in Australia, it peaked at 150%. So the “Keen” solution would involve printing and distributing an amount of money equal to 600% of GDP in the case of the US (that’s 300% for debtors and another 300% for creditors to make sure creditors are not unfairly discriminated against in this massive distribution of freshly printed money). And in the case of Australia, the figures would all be half that much.
Those figures are completely lunatic. It couldn’t be done even if the process was implemented over several years. Milton Friedman never had anything like that in mind when he suggested helicoptering.
 
Obviously the above figures are all halved if we take the Australian 150% figure rather than the US 300% figure. But the stimulus is still of unheard of proportions.


Bureaucracy.

But that’s not the end of the problems. People who are happy going into debt would then find their debts much reduced, thus they’d go running along to their bank demanding far bigger mortgages with a view to buying much larger or more expensive houses.

Unless something was done to curtail that activity, the alleged debt problem would just reappear in a few years. Thus we’d have to implement much stricter rules about who can borrow how much: all thoroughly bureaucratic.

I suggest it’s easier to work WITH the grain of what people and lenders want to do that work against the grain. That is, I prefer a system under which people can borrow what they want, as long as their bank thinks they’re creditworthy: i.e. as long as the bank thinks they’re able to eventually pay off the debt and in the meantime, pay the interest.

The only slight reservation that needs making to the above “hyperinflation” points is that arguably Western economies are not at capacity, thus there is room for some more stimulus (done via the Keen jubilee method or in some other way). Well clearly there is SOME TRUTH in that point. But Western economies have largely recovered from the recession which started in 2007/8, thus there wouldn’t be room for the MEGA STIMULUS package which is inherent to Keen’s jubilee.

___________________

P.S. (22nd August 2016).  In the original version of the above article (published 19th Aug) I got in a muddle with the above 300% and 150% figures. I estimated the amount that needed to be printed and distributed at HALF the right figues. Correction made 22nd Aug.

.
  

Brainless nonsense in The Guardian on immigration.

I don’t have time to do a complete demolition job on this Guardian article, but I’ll deal with one key point which is the claim (an ever popular one) that “Britain, like Switzerland, relies on migrants not just to fuel its economy but to prop up key public services such as healthcare.”

The answer to that point is that Britain is only reliant on immigrants to run the health service because successive governments, Labour and Tory, have failed abysmally to train enough medics. To put that another way (for the benefit of low IQ cretinous Guardian readers) had Britain trained the right number of medics over recent decades, there’d be little need for immigrant medics.

That of course is not to criticise ALL IMMIGRATION. That is, even if each country aims to train the right number of bricklayers, plumbers, lawyers, medics, etc there will always be temporary shortages and surpluses of specific skills. But there is no excuse for a total failure to train anywhere near the right number of people for each profession.

But if failure to train a sufficient number of medics is a brilliant idea, perhaps we can look forward to some dim-wit effete Guardian journalist advocating the same total failure in respect of chefs, bricklayers, electricians, you name it.

__________

Reference: "Theresa May's Swiss holiday will show her just how bad Brexit could be". Ian Birrell. The Guardian.

_____________

P.S. (Same day, 16th August, 2016).  I could of course have tried to answer that Guardian article in the comments section after the article. But unfortunately The Guardian is terrified of free speech: normally it won't publish strident criticisms of it's articles, or so I've found.

Prof John Kay tries to debunk helicopter money.

That’s in a recent article of his entitled “Essays on modern monetary policy….”.

Kay starts by claiming (para starting “Bookkeeping by double entry..") that double entry bookkeeping is a good system and under that system it is impossible to create a financial asset without at the same time creating a liability, ergo helicopter money, which seems to be an asset of the private sector, but not a liability of the public sector must be a nonsense.

Well there’s an obvious flaw in that argument, namely that double entry is not the only possible form of financial record keeping. Double entry did not exist in Europe till the 13th century, and wasn’t introduced to Britain till about 300 years ago. Plus even today, it is often not used by very small firms.

So do we take it that helicopter money is possible in a country which employs some system other than double entry, but not possible in a country which does? That argument is clearly absurd.


Taxes.

Next (para starting “But notes and coins..”), Kay cites the argument put by Randall Wray, namely that since helicopter money, or base money to give it its more normal name, can be used to pay taxes to government, such money must be a liability of government. Well there are several problems with that argument, as follows.

1. What about someone who has a stock of base money, but will never have to pay taxes, for example because they’re a pensioner on a low income? In what sense is that stock of base money a liability of the state? None that I can see.

2. There is no obligation to pay your taxes using base money. Certainly in the UK, the tax authorities (out of the kindness of their hearts) are very cooperative and flexible when it comes to paying taxes: they’ll accept jewellery, antique furniture, valuable paintings, land, you name it in settlement of tax debts.

Of course when they do that, they try to make sure that the relevant jewellery etc is worth more than the amount of tax owed. But that’s their business. The important point is that the tax debt is extinguished when the jewellery is handed over.

So…to the extent that people settle tax debts in the latter way, base money just isn't a liability of the state. Indeed, numerous countries thru history have collected taxes in the form of agricultural produce (e.g. in Roman Britain). It would be perfectly possible to have a system under which ALL TAXES were paid that way, with the state still issuing a form of money. In that case, it is very hard to see in what sense that state issued money would be a liability of the state.

Of course the latter arrangement wouldn’t make much sense: half the point of introducing state issued money thru history has been to make the collection of taxes more efficient. But the important point is that having the state issue a form of money, while taxes were paid with agricultural produce would be perfectly possible.

3. Even to the extent that base money really is a liability of the state, what of it? The IMPORTANT point here is: does helicoptering work? If so (and assuming it’s a good way of imparting stimulus) then we should go ahead with it.

Indeed, and still assuming that base money really is a liability of the state, the reason helicoptering works is that when the private sector’s paper assets rise in value, the private sector spends more. And that helps cure recessions. End of story.

The fact that some of those paper assets could be construed as a liability of the state is irrelevant because that liability does not REDUCE spending by the state.


An example of helicoptering.

Kay then runs thru a hypothetical example of helicoptering (para starting “Let us suppose now…).

He points out (correctly) that given a helicopter drop, the notes concerned will end up back in the vaults of the central bank, which in turn increases commercial banks’ reserves, which Kay claims to be a liability of the central bank or the state.

Well we’ve already dealt with that point above. Just exactly what does a central bank owe a commercial bank where the latter has $X of reserves? The only obligation is to supply the commercial bank with reserves (i.e. base money) in a slightly different form, that is, in PAPER form (dollar bills, pound notes etc) if that’s what the commercial bank and its customers want. And dollar bills are inherently worthless bits of paper. It costs central banks next to nothing to produce them. It’s a bit difficult to see in what sense there is any sort of REAL LIABILITY there.

At any rate, once the latter paper notes have been deposited at the central bank, Kay claims “And within a few days the banks would have used these deposits with the Central Bank to buy other assets – either from government or with payments which the Central Bank would have to honour.”

Well commercial banks might well TRY TO DO THAT. But they face a problem, namely that on the “all else equal” assumption, the stock of government debt is fixed, as is the stock of other financial assets.

Thus to some extent commercial banks would FAIL in the latter attempt. Indeed, in the most recent attempt by the Bank of England to do more QE, it FAILED because (much to everyone’s surprise), the normal sellers of government debt refused to sell!  But to the extent that commercial banks SUCCEEDED in buying other assets, the above mentioned base money would be paid to sellers of those other assets, who in turn would deposit that money back at the central bank (in some cases using a commercial bank as an intermediary).

Thus all the central bank would do is shift money, in its own books from the accounts of commercial banks A,B and C to the accounts of banks X,Y and Z. Bit difficult to see where the “liability” for the central bank is there!


Three points of clarification.

Next comes a section in Kay’s article entitled “Three points of clarification”, which is split into three sub-sections.

In the first two of those, Kay argues that helicopter money has little effect on the private sector’s stock of physical money ($100 bills etc) because physical money is becoming increasingly unpopular due to the fact that it’s largely criminals who use physical cash. Strangely, Kay does not mention the decline in demand for physical cash caused by the increased use of plastic cards, but never mind.

And the conclusion he draws from those two points, to quote, is that, “The implication of points one and two is that there is no reason to think that ‘helicopter money’, in any quantity, would have any material effect on either the volume of currency held outside the banking system or the level of transaction reserves held by commercial banks.”

So what’s the relevance of that? Kay doesn’t explain.

In particular, given the decline in the use of physical cash to which Kay refers, what does it matter if there is no increased usage of physical cash? The important point is that households and firms DO HAVE an increased stock of money held in bookkeeping or electronic form at their bank. And that will induce them to spend more.


Bank assets and liabilities.

The third of Kay’s above mentioned three sub-sections is far from clear, but it reads thus.

“Third, measures of money other than fiat currency – including sight deposits and other entries on bank balance sheets – are manifestly assets which are fully matched by liabilities. Each penny of customer deposit corresponds to a penny of bank obligation. The claim that banks ‘create money’, while true in a certain sense, does not repeal the law that there is a financial liability corresponding to every financial asset. Everything that has been said above about fiat money is true a fortiori of broader money.”

By “fiat currency” I assume Kay refers to central bank issued money, i.e. base money. That being the case, he is right to say that as regards the other main form of money, i.e. commercial bank created money, assets are “fully matched by liabilities”. That’s because that form of money comes into existence when a commercial bank makes a loan (as pointed out in the opening sentences of this Bank of England article – article title, “Money Creation in the Modern Economy” by M.McLeay & Co).

But it is precisely that form of money which is NOT under discussion here. That is, Kay’s article is concerned with CENTRAL bank created money, not COMMERCIAL bank created money.

Then in the second half of the above quoted paragraph, Kay tries to argue that because in the case of COMMERCIAL bank created money there’s a liability to match each pound or dollar of asset, that therefore the same applies to what he calls “broader money” (which I take to mean CENTRAL bank money as well).

Well I’m not falling for that sleight of hand. As explained at length in the above paragraphs, there are big differences between central bank and commercial bank created money.


There is no free lunch.

The final section of Kay’s article is entitled “There is no free lunch”. It starts with this claim: “Helicopter money is simply another mechanism of fiscal stimulus funded by government borrowing.”

Complete nonsense! Let’s run thru this very slowly.

Suppose the state does a helicopter drop, i.e. prints and spends $X of new money. Where’s the borrowing? The borrowing to which Kay refers is a figment of his imagination.
There is of course the argument already dealt with above that base money can at a stretch be regarded as a liability of the state in that such money can be used to pay taxes. But on the “all else equal” assumption, i.e. assuming taxes remain constant, there is no $X increase in that “tax liability” to match the $X increase in base money.

Ergo - roll of drums – that $X is an asset as viewed by the private sector without there being any $X liability that corresponds to it.

___________

P.S. (15th August 2016).  Another paper just out which takes a more positive view of helicopter money is by William Buiter: “The Simple Analytics of Helicopter Money: Why It Works – Always.”

Kenneth Rogoff is still clueless on government debt.

Rogoff for some bizarre reason is a professor of economics at Harvard, and he has the dubious distinction of having given a huge amount of academic credibility to austerity – arguably more than anyone else in the world. At least he has campaigned against fiscal stimulus and the increased government debt that accompanies it. He’s not the only pro-austerity numptie at Harvard. For example there’s Alberto Alesina with his “expansionary austerity” theory. But I’ll concentrate on Rogoff.

Rogoff’s basic reasons for limiting fiscal stimulus seem to be much the same as the reason given by your average economically illiterate politician and the average member of the public. It’s the simple minded idea that government debt is much the same as the debt of a household, and hence that the debt (or at least much of it) has to be paid back and pain is involved in the paying back process.

That is nicely illustrated in a recent article by Rogoff entitled “America’s Looming Debt Decision”. One of the key passages reads:

“Suppose, for example, that US voters elect as their president an unpredictable and incompetent businessman, who views bankruptcy as just business as usual. Alternatively, it is not difficult to imagine a sequence of highly populist leaders who embrace the quack idea that the level of government debt is basically irrelevant and should never be an obstacle to maximizing public spending. Unfortunately, if the US ever did face an abrupt normalization of interest rates, it could require significant tax and spending adjustments. And the overall burden, including unemployment, would almost surely fall disproportionately on the poor, a fact that populists who believe that debt is a free lunch conveniently ignore.”

OK, let’s run thru this V-E-R-Y  V-E-R-Y  S-L-O-W-L-Y. So slowly that hopefully even Harvard economics professors can understand it, though I’m not optimistic on that score.

First, Rogoff’s claim that there are people who think “the level of government debt is basically irrelevant” is of course complete nonsense. The average mentally retarded ten year old has worked out that increasing the debt has results. The big question is: when is that a problem?

Next there is Rogoff’s claim that there would be problems (unemployment in particular) if interest rates rose after a government had incurred a larger than normal amount of debt.

Well let’s suppose the Worldwide and gradual decline in interest rates over the last twenty years or so goes into reverse. That would be no problem because it’s easy to adjust to any sort of GRADUAL change.


A sudden rise in interest rates.

Alternatively suppose there is a relatively sudden and large increase in interest rates. Well initially there’d be none of the “tax and spending adjustments” to which Rogoff refers. That’s for the simple reason that 99% of the time, interest on debt issued by governments is fixed at the time such debt is issued. That is, if the interest demanded by potential holders of US government debt doubled tomorrow, there’d be essentially no effect on interest payments made by  government next week.

However, over a longer period, an increasing proportion of the total debt would become due for rollover, and the question would then arise as to whether to pay the new higher rate of interest, or simply print money, pay off relevant creditors and tell them to go away.

Now whenever the words “print” and “money” appear the in same sentence, a host of economic illiterates appear from the woodwork chanting the word “inflation”. But apparently unbeknown to the latter numpties, we’ve actually BEEN printing money and buying back government debt like there’s no tomorrow for several years, and under the guise of what’s known as Q-U-A-N-T-I-T-A-T-I-V-E   E-A-S-I-N-G. You’ll have heard of QE, but whether Rogoff has, I’m not so sure.

And where’s the inflation? Nowhere to be seen – just as many of us predicted before QE was implemented.


QE raises demand.

But to be fair, it’s quite possible that more QE could raise demand too much and hence raise inflation too much. So what then? Well that excess demand is easily curtailed by cutting the deficit, i.e. by raising taxes and/or cutting public spending.

Now you might think that tax increases and public spending cuts would raise unemployment, as indeed Rogoff suggests.

But hang on: the only purpose of those tax increases / public spending cuts, as intimated just above, is to keep inflation within bounds, i.e. to keep inflation at the target 2% level.

I.e. it’s only the above mentioned “excess demand” that needs to be curtailed. Thus given competent management of the economy, all that happens is that government keeps demand at the full employment / 2% inflation level, and nothing much else happens. In other words the “unemployment” to which Rogoff refers is a complete myth.


Interest rates rise in just one country.

It was assumed above that an interest rate rise is more or less Worldwide. Another possibility is that potential buyers of a particular government’s debt take a dislike to that government IN PARTICULAR and to the relevant country in particular, and increase the rate of interest demanded for holding that government’s debt, or indeed to keeping money in the country at all.

Well in that case, again, there is still no excuse for a rise in unemployment. Former debt holders on receiving cash when their debt was due for rollover would in some cases place the money elsewhere in the world which would depress the value of the relevant country’s currency on foreign exchange markets. And that would depress living standards in that country.

But then if a household or individual person repays debts, that is a painful experience: it involves a temporary decline in consumption, i.e. a decline in living standards.

The unemployment to which Rogoff refers is still a myth.

Why I moderate comments.

There’s only one reason I review comments before publishing them: it’s to weed out those nuisance comments which pose as normal comments but contain links to firms selling everything from double glazing to porn.

I get about one a week of those, which wouldn’t be too bad if that was the only problem. But some clever clogs a couple of years ago managed to place one of those bogus comments on about thirty of my posts at once, so I had to go thru those deleting them all. But that bogus comment problem has subsided in the last year or so (maybe thanks to improved anti spam software on this blog system) so I might revert to a “no moderation” policy.

Apart from the above bogus comments, I don’t remember receiving anything sufficiently abusive or plain stupid that I’d want to censor it.

Admati and Hellwig criticise full reserve / narrow banking.

I criticised part of an article by Admati & Hellwig a day or two ago. This present article criticises another part of the same article of theirs.

A&H’s article is entitled “The Parade of the Bankers’ New Clothes Continues:  31 Flawed Claims Debunked”. Their criticism of the full reserve banking (FR) comes in TWO sections, Nos 26 & 27.

No.26 refers specifically to “narrow banking”, while 27 refers to FR or something very close to what is normally understood by the phrase FR. In fact the two amount to the same thing. The only difference is that narrow banking BY IMPLICATION leaves lending to entities that are funded by equity, whereas FR EXPLICITLY does that. Thus I’ll treat the two as the same thing.

What A&H describe as “Flawed claim No.26” is thus.

“The  best  way  to  make  banking  safer  is  to  require  banks  to  put  funds  from  deposits into reserves of central bank money or Treasury Bills (so-called narrow banking or the Chicago Plan for 100% reserve banking). Narrow banking will give us a stable financial system, and there would be less need to impose equity requirements.”

As to what’s wrong with the latter claim, A&H start their explanation by saying:

“What’s wrong with this claim? Requiring banks to put all funds into cash or Treasury Bills will make these banks safer but the financial system as a whole may become less efficient and/or less safe.”

Well it’s quite untrue to say that under FR, “all funds” go into cash or Treasury Bills. The reality is (as mentioned above) that bank customers / depositors have the CHOICE of putting their money in to ultra safe stuff like Treasury Bills, or if they want something more risky, that’s up to them.

As for the “less efficient and/or less safe” claim, the authors make no attempt to substantiate that claim, so that’s not much use.

 A&H continue:

“If  final  investors  maintain  current  funding  patterns,  banks  will  provide  a  lot  of  funding  to  the  government;  which  may  well  come  at  the  expense  of  funding  of  nonfinancial  firms.  The  experience of southern European countries in the decades before 1990 shows such crowding out of  private  borrowing  by  government  borrowing  can  have  substantial  negative  effects  on  economic growth.”

So what makes A&H think that most bank depositors given the choice between the above safe but low interest option and the riskier but higher interest yielding option will mainly choose the first? A&H provide no evidence.

However, there is actually some very clear evidence. In the case of money market mutual funds in the US which are currently being forced to obey the rules of FR, depositors are mainly opting for the safer option, as it happens. So A&H are right there, but because of good luck rather than good management I suggest. However, that doesn’t get their argument very far.

First, by way of trying to back up their claim about “experience of southern Europe”, they cite a work I cannot find. The citation is “Camina l et al., and Borges in Dermine (1990)”.

Second, the broad claim that more government borrowing suppresses growth clearly does not hold water if government borrowing funds relatively productive infrastructure or other investments.

As I’ve pointed out before on this blog, government funded infrastructure investments should compete on equal terms with privately funded infrastructure investments: i.e. there should be a realistic chance of investors losing their money (as happened with the English / French channel tunnel). And if that’s the case, then there shouldn’t be any sort of artificial preference for non-viable public investments where funders are safe because they are backed by taxpayers.

Put another way, if government is offering totally safe bonds which fund non-viable investments, and which pay a decent rate of interest, and those bonds are safe only because of entirely artificial taxpayer support, that’s an obvious fiddle or distortion. I.e. government is making a “too good to be true” offer, and it’s hardly the fault of FR if everyone makes a dash for that too good to be true offer.

A&H continue:

“More  likely,  narrow  banking  would  lead  investors  to  put  substantially  more  of  their  money  in    other  institutions,  for  example  money  market    funds (MMMFs)  which  are  “bank-like”  without  being    subjected  to  the  same  regulation  as  banks.  As we  have  seen    in  the  weeks  after  the  Lehman    bankruptcy, such institutions can also be subject to   runs and can be a major source of systemic  risk. Financial instability would merely shift from   banks to those “bank-like” institutions.”

Well as already intimated, the authors don’t seem to have caught up with the fact that (at least in the US), MMMFs are being made to obey the rules of FR.

As for the idea that savers would try to get their savings into entities which are “bank like”, but which manage to evade bank regulations, the solution to that, as pointed out by the former head of the UK’s Financial Services Authority, Adair Turner, is to apply the same regulations to ANY ENTITY which is effectively a bank.

Garages have to obey regulations. If a small firm claims not to be a garage, when it is quite clearly repairing cars, selling used cars and so on, that does not cut any ice with garage regulators, and quite right.

Moreover, much the same problem applies to A&H’s preferred solution to bank problems: much higher capital requirements. That is, if the latter were imposed on banks, do doubt numerous small “bank-like” entities would try to evade the rules.

Of course the authorities will never keep tabs on every small shadow bank, but that doesn’t really matter. One reason is that one of the main aims of FR is to bar private money creation, and money is by definition anything which is widely accepted in payment for goods and services. And the liabilities of a SMALL shadow bank are not “widely accepted”.


Flawed claim No. 27

A&H’s flawed claim No.27 is:

“The  financial  system  would  be  safe  if banks  are  subject to  a  100%  reserve  requirement  so  they  can  take  no  risk  with  depositors'  money,  while  non-bank  financial  institutions are entirely prohibited from borrowing.”

In the first paragraph after setting out the latter claim (p.28) the authors claim that under FR, where someone wants a larger than normal dollop of cash, they’d have to sell mutual fund units, and the value of those units might not be entirely clear if there is not a ready market in them. Well there are several flaws in that argument, as follows.

1. In the US and other large / medium size countries ALREADY HAVE HUNDREDS of mutual funds, and the mutual fund industry seems to work very smoothly. Certainly mutual funds do not go insolvent, like banks do. Plus those investing in them do not seem too bothered by the fact that when cashing in their fund units, what they get in cash terms is not entirely predictable.

2. As for the fact that there is not a ready market when it comes to a relatively small fund, well that’s a problem with which the mutual fund industry already copes with perfectly OK. Indeed much the same goes for shares in a small firm where there is not a ready market in its shares. But somehow or other that doesn’t stop smallish firms issuing shares.

3. The idea that people should be GUARANTEED to get their money back when they have a bank lend on their money sounds wonderful. But someone, somewhere is accepting the risk that that money goes West. And we all know who that “generous risk acceptor” is: it’s the taxpayer!!!

4. A&H’s claim, “Trading in stock markets exposes individuals who need to trade for liquidity reasons to losses from better-informed investors.”
Well that’s a problem already with the entire stock market and mutual fund industry. It’s also a problem in the used car industry and with housing. If that is indeed a problem, it’s a problem of astronomical proportions. I.E., the world is awash with instances of the “better informed” outsmarting the less well informed, whether it’s in the used car market, or any other market. But for some reason no one seems too bothered by the fact that the “better informed” manage outsmart others in almost EVERY human activity.

5. Even under the existing system, anyone with a sudden and large need for cash faces a problem. One option for them is to sell assets, which as A&H rightly say may mean selling at a loss. Another option is to borrow. In the case of the less credit-worthy that often means recourse to payday lenders who charge extortionate rates of interest. As to those who ARE credit-worthy, and who can borrow from regular banks, bank managers take a dim view of people who suddenly turn up saying they have an unforeseen need for cash. Those sort of people are normally charged high rates of interest.

6. Under FR, people are free, as they are under the existing system, to hold a relatively large stock of cash so as to deal with “rainy days”. Indeed, that’s the so called “precautionary” motive for holding cash referred to in most introductory economics textbooks.


Summarising so far.

To summarise so far, A&H list various ADVANTAGES of funding banks via debt, but they do not consider some of the costs (particularly the costs to taxpayers) of those advantages. So how do we know which system is overall the best? Well there’s a widely accepted principle in economics that gives the answer there.

It’s the principle that subsidies do not make sense, i.e. subsidies distort the market and reduce GDP, unless there is a very good SOCIAL reason for a subsidy (or indeed for a tax). Think kid’s education and alcoholic drinks respectively.

Briefly, a bank which is funded to any extent by debt is a bank that is able to print or create money. And the freedom to create money is clearly a subsidy: the most obvious case being a backstreet counterfeiter who prints inherently worthless bits of paper and uses them to purchase goods and services of real value. The counterfeiter is being subsidised by the community as a whole.

Private banks which create/print money do not of course do exactly the same thing as backstreet counterfeiters: banks LEND their money rather than buy stuff with it. Nevertheless if you are a money lender and are able to print some of the money you lend out, that’s a nice little boost or subsidy for your business.

Certainly, to the extent that you don’t need to pay interest on the money you print (and people do not get interest on £10 notes and $100 bills), you are being subsidised by the community at large.

Admati and Helliwig’s odd claim that bank deposits are not money.

Anat Admati is an economics prof at Stanford and Martin Hellwig is a German economist currently at the Max Plank Institute.

I normally agree with A&H, and in particular I fully support their call for much higher bank capital ratios and their criticisms of the corrupt banker  / politician / regulator revolving door.

But their claim in section 5 of a recent article that private banks do not create or “print” money is flawed. The article title is “The Parade of the Bankers’ New Clothes Continues:  31 Flawed Claims Debunked”.

Their argument is very short – so short that I’ll reproduce section 5 in its entirety below. In reference to the claim that bank deposits are not a form of money, they start as follows.

“This claim rests on an abuse of the word “money.” The notion that  banks  “produce”  or  “create”  money  is  based  on  the  observation  that  people  can  easily  transform deposits into cash and that they regard the funds they have in a bank deposit as being similar to cash and are able to use those funds for payments, such as by checks and credit cards. Monetary  economists  therefore  refer  to  people’s  total  holdings  of  cash  and  of  deposits  in  the  economy as the amount of “money” in the economy.”

Well now, it’s easy to “transform” your CAR into cash. You can do that within about two hours anytime at your local used car dealer. But that does not make cars a form of money.

What makes bank deposits a form of money is that they comply with the definition of the word money found in economics dictionaries and economics text books, which is something like “anything that is widely accepted in payment for goods and services or in settlement of debts”.

Offer your car in payment for something and you are highly unlikely to succeed. In contrast, offer a cheque or plastic card issued by a commercial bank, and you’ll almost certainly succeed.

In short A&H’s above “easily transform” point certainly HELPS make bank deposits a form of money, but that “transform” point is not good enough on its own.

A&H’s next para then contradicts their claim that bank deposits are not money. It reads:

“Money creation” in the sense described above is related to banks’ holding so-called fractional reserves, i.e. keeping a fraction of the funds deposited with them as cash reserves and using the remainder  for  loans.  As  the  banks’  borrowers  use  the  funds  they  get  to  make  payments, the  recipients  will  keep  parts  of  these  payments  in  bank  deposits.  In this  way,  fractional  reserve  banking causes total deposits to be larger than the amount of central bank money deposited with the banks. The amount of “money” measured as the sum of deposits and cash in the economy is thus bigger than the amount of money that the central bank has issued.”

Eh? That last sentence says that private banks do indeed cause the total stock of money to be larger than what the “central bank has issued”. I quite agree!

The next para reads:

“Putting demand deposits and cash into the same macroeconomic  aggregate does not mean that they are literally the same.  A critical  difference is that deposits are a form of debt. Banks are obliged to pay the  depositor  when  he  or  she wants the money  back.  If a bank cannot repay depositors, there is clearly a problem.  By contrast, cash, issued by a central bank, is nobody’s debt. (For a detailed discussion, see Chapter 10.)”

The first answer to that para is that the fact that two types of money are not “literally the same” does not stop them both being money, or complying with the dictionary definition of the word money. For example in some economies in the past, gold and silver were both used at the same time as a form of money. Gold and silver are clearly not the same thing, but there is nothing to stop them both being acceptable as money, if that’s the law or custom in the relevant country.

As to the point that central bank money is debt free whereas private bank money is debt encumbered so to speak, well Positive Money would certainly agree with that, as do I. But there again, the fact that there is a difference between two types of money does not stop them both being money. (Incidentally the opening sentences of a Bank of England article entitled “Money Creation in the Modern Economy” also make the point that private banks create money.)

As for A&H’s claim that this matter is more fully discussed in Chapter 10 of their book, I looked and didn’t find much enlightenment there.

And finally, as most readers will doubtless have noticed, my disagreement with A&H is as much about semantics as about substance. But it's important to get everything right in this area because millions of jobs depend on getting this banking stuff exactly right.

Biagio Bossone believes in Ricardianism..:-)

Biagio Bossone (of the IMF and World Bank) claims that for helicopter money to work, the central bank has to “credibly commit never to withdraw the increase in reserves.” (Reserves are the same as heli money.)

This is a fuller quote.

“There is broad agreement that helicopter money is best regarded as an increase in economic agents’ nominal purchasing power in the form of a permanent addition to their money balances. Functionally, this is equivalent to an increase in the government deficit financed by a corresponding permanent increase in non-interest bearing central bank liabilities… The central bank credibly commits never to withdraw the increase in reserves.”

Now the basic idea there is what’s known as “Ricardianism”, namely the idea that households and firms calculate what government is likely to do in the future, and that households and firms adjust their spending to suit. E.g. they allegedly calculate that if they come by a windfall as a result of a helicopter drop, and that if they think government will withdraw that money at some time in the future, then households and firms WILL NOT spend the money, since they have to keep that money in stock so as to be able to pay the extra taxes that enable government to withdraw said money.

Now of course for anyone with a grain of common sense, the latter idea is straight out of la-la land. I mean are we seriously supposed to think that the average household even knows how many dollars are involved in a particular bout of helicoptering or what a particular household’s share of that money is?

The reality (and this is supported by empirical evidence) is that households’ spending is heavily influenced by what they’ve got in the bank. I.e. if they come by extra money from whatever source (tax rebates, winning a lottery, helicopter money, etc), they spend a significant proportion of that money (surprise, surprise).

As Joseph Stiglitz rightly said, “Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense.”

But for professional economists the important thing about Ricardianism is that it’s an extra bit of complexity they can add to their papers and mathematical models. I.e. Ricardianism keeps them employed.

As Upton Sinclair put it, “It's hard for a man to understand something when his salary depends on his not understanding it.”

Positive Money (which advocates a form of helicoptering) ignores Ricardianism, far as I know. Quite right.

Labour’s flawed fiscal rule.

The UK Labour Party’s recently announced fiscal rule is just a variation on the old so called “golden rule” which says that the government budget should balance over the cycle, with borrowing only undertaken to fund investment. That rule was first proposed by the Labour finance minister, Gordon Brown, in the 1990s.

The above mentioned variation is that government can ignore the golden rule it if the Bank of England has no way to effecting stimulus, i.e. if interest rates are at or near zero. (That assumes negative interest rates are a bit of a nonsense, which is fair enough assumption far as I’m concerned)

Well the golden rule and Labour’s recent variation on it sound amazingly responsible, and possibly that’s the main object of the exercise: to persuade the electorate that the party adopting the golden rule is responsible. At any rate the first flaw in that rule is that it assumes the amount of stimulus needed is equal to or at least closely related to the amount of public investment needed. That is obvious nonsense.

But first, there is a subsidiary matter to be settled, which is the question as to whether “borrow and invest” (or more generally “borrow and spend”) is stimulatory. And there are two possible scenarios there: first, the state borrows with the result that interest rates rise, but the central bank (CB) lets that interest rate rise stay in place. Second, the central bank agrees with the fiscal authorities that stimulus is needed, and hence that an interest rate rise would be inappropriate, thus the CB prints money and buys back sufficient government issued bonds to keep interest rates stable.

Consensus, far as I can see, is that both scenarios are stimulatory, though obviously the “keep interest rates stable” scenario is MORE STIMULATORY. In short, “borrow and spend” is stimulatory. Thus I’ll make the not unreasonable assumption (with a view to keeping things simple) that “borrow and spend” is stimulatory regardless of what the CB subsequently does with interest rates.


The first flaw.

So the first flaw in the golden rule (to repeat) is that it assumes that the amount of stimulus needed is equal to or closely related to the amount of public investment that needs to be undertaken. There is of course absolutely no reason for that assumption.

To illustrate, suppose government reviews public investment, and concludes it needs to be increased. Indeed, many people have claimed both in the US, UK and elsewhere in recent years that infrastructure investment should be increased.

But if the economy is currently at capacity, the additional demand stemming from that extra investment spending is not allowable: if it goes ahead without raising taxes, it will cause excess inflation! So the extra investment has to be funded via tax rather than borrowing. It’s all nonsense.


The second flaw.

A second flaw in the golden rule is a simple point which I’ve made many times, but which the economics profession seems to be too dim to understand. It’s thus.

Given the 2% inflation target, the REAL VALUE of the monetary base and national debt will shrink. And assuming those two are to remain constant in real terms (a not unreasonable assumption) that means they’ll have to be topped up regularly. But there’s only one way of topping them up: a deficit!

Moreover, given growth (in real terms) and assuming the base and debt are to remain constant relative to real GDP, then even more “topping up” will be needed!

Thus a significant amount of deficit is needed every year which has ABSOLUTELY NOTHING TO DO with investment. If you ever wondered why politicians and economists spend much of their time scratching their heads about why never ending deficits seem to be needed, you now have part of the answer!

Conclusion: the golden rule is nonsense.


The “golden golden rule”.

So what’s the absolutely ideal golden rule? Well there’s not much wrong with Keynes’s dictum, “Look after unemployment and the budget will look after itself”. In other words, if unemployment is excessive, then simply have government print or borrow money and spend it (and/or cut taxes).

As Keynes put it in a letter to Roosevelt in 1933, the “public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money.”


What’s the point of government borrowing?

As to which of those two options to adopt (print or borrow), it’s frankly a bit difficult to see the point of borrowing (which has a deflationary effect) when the object of the exercise is the opposite, namely “reflation” (to use a term which has gone out of use). “Reflation” means or used to mean the same as “stimulus”. In short, “borrow and spend” is a bit like throwing dirt over your car before washing it.

Indeed, the latter idea, namely that stimulus should be effected simply by printing was advocated by Milton Friedman and is currently advocated by Positive Money.

A second reason for questioning the logic behind borrowing so as to invest, is that borrowing clearly makes sense if the entity doing the investing has absolutely no other source of cash, as is the case with many households buying a home. But government has a near inexhaustible source of cash: the long suffering taxpayer. Plus it’s appropriate for government to PRINT a certain amount of new money most years.

Third, the Swiss academic, Kersten Kellerman had a close look at the “borrow versus tax/print” argument, and concluded that public borrowing does not make sense. That’s in a paper entitled “Debt financing of public investment: on a popular misinterpretation of the Golden Rule.” published by Science Direct and the European Journal of Political Economy.

Thus the claim by the Guardian that “Almost all macro economists support governments borrowing to make productive investments..” is wide of the mark.

For some more arguments against government borrowing, see my paper “Government borrowing is near pointless”.

And finally, given that the whole idea of borrowing so as to fund public investment is doubtful, it’s legitimate to ask why Keynes implicitly endorsed the idea in the above quote. (I say “implicitly” because he actually endorsed “borrow and spend” with a view to escaping recessions in the above quote, rather than specifically “borrow to invest”.)

Well my guess is that given that Keynes was an extremely intelligent man, he probably understood the dubious nature of “borrow to invest”. However, he realized he was dealing with idiots, or at least with people who were idiots relative to himself. Thus he couldn’t come out too blatantly in favour of “print and spend” because every time the words print and money appear in the same sentence, hoards of economic illiterates come out of the woodwork chanting “inflation”.

Thus assuming Keynes ACTUALLY DID favour “print and spend”, he probably wouldn’t have said as much too openly. There are certainly exchanges he had with Abba Lerner in which Keynes cautioned against saying things that might upset the above economic illiterates.