Wednesday, 31 May 2017

The optimum national debt / GDP ratio.


Asking what the optimum debt / GDP ratio is, is not a brilliant question in that base money and debt are almost the same thing. So a better question is: what should the sum of the debt and base be?

The debt and base are both assets as viewed by the private sector (which holds those assets) and the more of those assets the private sector has, the more it will spend, all else equal. Thus the optimum amount of debt plus base is whatever induces the private sector to spend at a rate that brings full employment.

The debt plus base will always tend to move towards that optimum if standard Keynsian measures are adopted to deal with recessions.

As for the best rate of interest to go for, there are no desperately good arguments for paying significantly above zero.


Government debt is not the only government liability: there is also central bank issued money (base money) which is a state liability of a sort. Certainly that money appears on the liability side of central banks’ balance sheets.  But the distinction between base money and national debt is largely spurious. That is, national debt is simply a chunk of base money which pays interest because holders of said chunk have handed it over to government for a while. I.e. national debt is effectively a term account at a bank called “government”.

Or as Martin Wolf, chief economics correspondent at the Financial Times put it, “Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year Japanese Government Bonds yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny…”

And in practice, very large amounts of debt have been transformed into base money via QE in recent years, with no very dramatic consequences: certainly not the hyperinflation that some thought would result from QE style money printing.

Also, note that advocates of Modern Monetary Theory (MMT) have spotted the relevance of the sum of debt plus base and sometimes call it “Private Sector Net Financial Assets” (PSNFA).

Thus the relevant question is not “What’s the optimum amount of debt?”. A better question is “What’s the optimum “debt plus base?”

The answer to that question is simple, and the answer stems from the fact that the more cash (and assets which are similar to cash) that the private sector has, the more it will spend, all else equal. Thus the optimum amount of “debt plus base” or “PSNFA” is whatever induces the private sector to spend at a rate that brings full employment, i.e. keeps the economy at capacity.

Moreover, government does not even have much choice as to how many dollars worth of “debt plus base” there is. Reason is that if the private sector has less debt plus base than it wants, it will save with a view to acquiring the amount it wants. And that saving causes Keynsian “paradox of thrift” unemployment. Ergo government has to run a deficit to deal with that unemployment, and the deficit increases “debt plus base”.

So if the state (i.e. government and central bank) increase the deficit whenever there’s too much unemployment, and conversely, run a surplus when there’s too much inflation, then “debt plus base” will always tend to move towards its optimum size, though doubtless it will never actually be at its optimum to the nearest dollar (or million dollars, come to that).

Indeed, the latter point is 100% compatible with Keynes’s dictum: “Look after unemployment and the budget will look after itself”.  That is, if there is excess unemployment, then run a deficit. That deficit will eventually and in principle raise the debt to the level at which it induces the private sector to spend at a rate that brings full employment. Though given the constant changes hitting every economy (bank crises, etc), the optimum amount of debt plus base constantly changes.

So…as Keynes so rightly said, stop worrying about the debt: just run a deficit till full employment is achieved. Or conversely, given excess inflation, run a surplus.

Pay interest on government liabilities?

Next, is there any point in paying interest on the debt or base?  Milton Friedman (1) and Warren Mosler (2), who founded MMT,  said “no”. There are however some plausible arguments for paying interest, none of which are desperately convincing. One popular one is that investments like infrastructure should be funded by interest yielding bonds / debt. (Incidentally, as MMTers often point out, a government which issues its own currency has complete control of the rate of interest it pays on its debt.)

However there at least three problems with that “infrastructure” argument, as follows.

1. What about education?

One problem with the infrastructure argument is that the education budget is one huge investment. To illustrate, the benefits of teaching kids to read and write continue to be reaped fifty years later. But advocates of the above “fund infrastructure with bonds” argument never argue for funding education with bonds: a clear inconsistency.

2. Cash shortages.

Much the best argument for borrowing is the simple fact of being short of cash. If a taxi driver wants a new taxi and happens to have enough cash with which to buy it, he’d almost certainly have the nouce to pay cash rather than borrow. Be nice if the country’s leading economists had as much nouce as taxi drivers, wouldn’t it…:-)

Much the same goes for government. That is, governments have a near in exhaustible source of cash: the taxpayer. In addition, governments can simply print money (suitable where stimulus is needed). So why borrow and pay interest?

3. David Hume.

David Hume writing nearly three hundred years ago pointed out that politicians main motive for borrowing is to ingratiate themselves with voters. That is, voters tend to squeal less when government funds spending via borrowing rather than tax.

Interest helps monetary policy work.

One argument for an artificially high level of debt with a correspondingly high rate of interest on the debt is that that helps monetary policy (specifically interest rate adjustments) work. That is, if interest rates are well above zero, then clearly the central bank can cut interest rates come a recession.

Frankly the arguments for that policy are not brilliant. Reasons are as follows.

First, the Bank of England claims interest rate cuts take a year to have their full effect.

Second, there is nothing to prevent an element of variability being built in to matters fiscal, i.e. tax and public spending. For example the UK cut and then raised VAT during the crisis, and all without politicians squabbling over the matter for weeks or months beforehand.

Third, an artificially high debt and rate of interest involves taxpayers having to pay taxes to fund interest paid to rich people simply to hoard cash: what you might call “barmy”.


A possible problem with a permanent zero rate (as advocated by Friedman and Mosler) is that there is then no point in holding government bonds: you might as well just hold cash (base money). But arguably, if the private sector holds excessive amounts of cash, it’s possible the private sector goes mad at some stage, and tries to spend it all at once, the result being hyperinflation. Thus arguably a better option is to pay a miserable rate of interest on government debt, like 0.5%. That induces the private sector to lock up much of its stock of “debt plus base”, thus making it more difficult to spend all at once.

Also, assuming the 2% inflation target is hit, that means an effective or real rate of interest of minus 1.5% on government debt. I.e. the debtor (government) profits at the expense of its creditors. Nothing wrong with that!


Implementing standard Keynsian / MMT policies to deal with recessions will result in the “debt plus base” always moving towards its optimum level.  As for the best rate of interest to pay on the debt, there are good arguments for paying a near zero rate, like 0.5%.



1. Milton Friedman. “A Monetary and Fiscal Framework for Economic Stability”, American Economic Review. (1948)  Para starting “Under the proposal..”.

2. Warren Mosler (founder of MMT). ‘Proposals for the Banking System’. (2010) Huffington Post Business. 2nd last para.

Tuesday, 30 May 2017

Simon Wren-Lewis says more spending will lead to more GDP.

Wren-Lewis is an Oxford economics prof, and he is normally very clued up. That’s why I follow his blog. But the following passage from his latest blog article (in green italics) is very questionable. (Title of article: “Growth will be lower if the Conservatives win”)

“Both the Labour and LibDem manifestos amount to an increase in public investment, and an increase in public spending financed by higher taxes, compared to current government plans. Standard macroeconomics implies that both higher investment and spending will lead to an increase in GDP, unless the Bank of England raises interest rates to exactly offset this effect. With interest rates currently stuck at their lower bound, and with public investment helping aggregate supply, that last possibility is extremely unlikely. The conclusion therefore has to be that GDP over the next few years would be higher under a Labour or LibDem government than under the Conservatives.

This is why, according to Larry Elliott, Oxford Economics estimate that “the economy would be 1.9% bigger under the Lib Dem plans and 1% bigger under Labour’s plans than under Conservative plans.”

Well now it’s certainly true that “higher investment and spending will lead to an increase in GDP” all else equal and assuming there is room for that extra spending: i.e. assuming the effect is not just extra inflation rather than extra real GDP.

And it’s also true that that extra GDP is dependent on the BoE not raising interest rates. But it’s clear that the BoE ACTUALLY IS CONCERNED about rising inflation!!! Indeed, UK inflation has been above the 2% target for the last three months or so. Plus the governor of the BoE has warned that rising rates are coming soon.

Thus Wren-Lewis’s assumption that rates WILL NOT RISE is questionable to put it mildly. Hence his claim that increased spending, including investment spending, will lead to a quick rise in GDP is equally questionable.

Living standards.

Shortly after the above quote, W-L then says, “This is not the only reason why living standards would be significantly higher under a Labour/Lib Dem government.”

Now hang on. Increased GDP resulting from more investment spending DOES NOT lead to a quick rise in living standards. Investment spending (certainly investment spending on infrastructure or education) does not pay off for five, ten or even thirty years later. That’s not to criticise such spending. But the pay-back in terms of increased standards of living certainly does not come quickly.

BTW, I normally answer W-L’s articles in the comments after his articles, but he doesn’t seem to have had time to moderate many comments recently (for which I do not blame him). So I’ve answered on this, my own blog, today.

Sunday, 28 May 2017

Deficit phobes.

On February 14, 2010, the Sunday Times published a letter signed by nineteen of the UK’s leading economists plus Kenneth Rogoff of Harvard, America’s leading debt-phobe. That was at the height of the crisis and the letter advocated consolidation (i.e. austerity) of all things. I’ll refer to those economists  as “numpties”. The complete list of numpties is in an article entitled “Unrepentant Economists” and authored by Robert Skidelsky.

You might think the word numpty is offensive. As you’ll discover by the end of this article, “numpty” is if anything too polite.

I’ll run through the letter paragraph by paragraph, with excerpts in green italics. The letter starts:

"It is now clear that the UK economy entered the recession with a large structural budget deficit. As a result the UK’s budget deficit is now the largest in our peacetime history and among the largest in the developed world.

In these circumstances a credible medium-term fiscal consolidation plan would make a sustainable recovery more likely.

In the absence of a credible plan, there is a risk that a loss of confidence in the UK’s economic policy framework will contribute to higher long-term interest rates and/or currency instability, which could undermine the recovery.”

As regards “higher long-term interest rates”, as Keynes pointed out in the early 1930s, a government which issues its own currency does not need to borrow at all: for stimulus purposes, it can simply print money and spend it (and/or cut taxes). Maybe the numpties haven’t heard of Keynes, or if they have, perhaps they aren’t acquainted with his ideas.

Thus potential creditors of the UK can raise the interest rate they demand if they like. But the UK (or any country which issues its own currency) can respond by employing Keynes’s “print” strategy: more or less what several countries actually did in the event, in the form of QE.

Of course QE took place AFTER the numptie letter, so perhaps at the time of the letter, the numpties didn’t realize QE was an option. Certainly Rogoff referred to QE as “very experimental” which rather indicates the whole QE idea was new to him.

It’s sad that I need to spell out this sort of basic economics for the benefit of so called “professional” economists, isn't it?

Next, why the concern about the DEFICIT rather than the DEBT? A very large deficit is no problem as long as it lasts a relatively short time, and solves the problem (the recession) which in the event it did. In contrast, if a large deficit lasts SEVERAL YEARS and started to look like it might cause a record sized NATIONAL DEBT, that might be cause for concern. But at the time of the numpties’ letter, the UK debt was around ONE THIRD its maximum just after WWII, i.e. around 240% of GDP. And paying down the latter debt proved no problem at all in the 1950s and 60s. So what were the numpties on about? Darned if I know.

Currency instability.

Next, the above excerpt refers to “currency instability”. Now why would that occur? Presumably the numpties have in mind the “a loss of confidence in the UK’s economic policy framework” to which they referred earlier in the same sentence.

Well now, if foreigners or UK individuals and organisations likely to shift their money abroad think excessive deficits will lead to excessive inflation, then they’d mark down Sterling by some amount or other. But there is no obvious reason why they should change their minds on that every week or month and thus cause “instability”.

Moreover, in the event, the largish deficit continued for some time after the numpties’ letter, and the pound did not crash in value, nor did it suffer an great “instability”.

The “balanced budget” myth.

The next couple of paragraphs run as follows.

"In order to minimise this risk and support a sustainable recovery, the next government should set out a detailed plan to reduce the structural budget deficit more quickly than set out in the 2009 pre-budget report.

The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery. However, in order to be credible, the government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.”

This is grotesque incompetence. There is a very simple reason why a more or less PERMANENT deficit will be required. Coincidentally I set out the reasons (for the umpteenth time) just recently here. (Title of article: “Top UK Treasury official does not understand deficits.”)

At least the reason ought to be “simple” for an economics professor. But of course it is naïve to suppose an economics professor necessarily knows all that much about economics. Thus the numpties would probably struggle with the reasons why permanent deficits are inevitable.

The fact that it is not necessary to dispose of deficits in order to reduce the debt/GDP ratio is nicely illustrated by the chart below, produced by Prof Roger Farmer. As the chart shows, the debt/GDP ratio for the UK fell from around 240% in 1945 (as just mentioned) to around 50% in 1990. But during that time there was a non-stop deficit!!

Mixing politics and economics.

Next, the numpties say:

"The bulk of this fiscal consolidation should be borne by reductions in government spending, but that process should be mindful of its impact on society’s more vulnerable groups. Tax increases should be broad-based and minimise damaging increases in marginal tax rates on employment and investment.”

Now wait a moment: what’s a PURELY POLITICAL matter, like what proportion of GDP goes to the public sector, got to do with economists (or should I say “self-styled economists”)? The answer is “absolutely nothing”.

Just to drive that point home, for the benefit of numpties, any democratically elected political party is fully entitled to increase or decrease public spending, particularly if such an increase or decrease is in line with its manifesto. In short, it is not the job of economists to tell governments what “government spending” should be relative to GDP: that amounts to telling democratically elected governments how socialist or non-socialist they should be.


The final para.

The final para reads:

"In order to restore trust in the fiscal framework, the government should also introduce more independence into the generation of fiscal forecasts and the scrutiny of the government’s performance against its stated fiscal goals."

Well nothing wrong with that suggestion. In fact the UK’s “Office for Budget Responsibility” was set up with precisely that in mind just three months after the “numptie letter”.

So the only worthwhile idea in the numpties' letter was an idea that the leading lights in the UK were already in the process of putting into effect!


Saturday, 27 May 2017

Friday, 26 May 2017

“Invest in infrastructure while interest rates are low” is a flawed argument.

The above is a popular idea, backed by any number of professional economists. In fact I don’t know of a professional economist who questions the idea.

Unfortunately there is a glaring flaw in the idea, namely that interest rate changes are to a significant extent artificial: certainly central banks THINK they have a big influence on interest rates, and that idea is widely accepted.

Interest rates have of course fallen all of their own accord over the last twenty five years or so, but that fall has been accentuated by central banks since the 2008 crisis.

Thus when it comes to the question as to how much to spend on infrastructure and other investments, what might be called the GENUINE fall in interest rates is a valid reason for spending more. But that reason for more infrastructure investment was valid just before the crisis hit. So did we hear repeated calls for more infrastructure investment at that time? Nope. We had almost complete silence.

Then come the crisis, and so called “professional” economists all started demand more infrastructure spending. In fact there was no more reason for such spending just after the crisis hit than just before.

Put another way, the artificial fall in interest rates is NOT a valid to spend more.

Indeed the latter point gains support from a brief look at how central banks actually cut interest rates: they do it by printing money and buying up government debt. What was that – “printing money”?

Hang on: if the state can just print money (which it can in a country that issues its own currency) why have government borrow at all??? I.e. what’s the point of borrowing money if you can print the stuff (and spend it on infrastructure or whatever)? There’s no point.!!

Put yet another way, why not just print money and spend on any selection of the usual public spending items (education, health, defence, etc). Alternatively, those with right of centre views might want to print money and “spend” that on tax cuts: i.e. have the additional spending come in the form of additional HOUSEHOLD spending.

Indeed, the latter is essentially a form of “helicopter drop” and the latter is widely regarded as a reasonable or viable form of stimulus.

But if one goes for printing / helicoptering, there is no obvious reason to give infrastructure investments any sort of priority. That is, for the purposes of unemployment reduction and getting the economy up to capacity, spending on CURRENT rather than CAPITAL items will do perfectly well. Indeed, “current spending” is probably better than capital spending in that it takes time (sometimes several years) to get infrastructure projects going.


P.S. The above argument could be criticised on the grounds that the WHOLE POINT of artificial interest rate cuts is to encourage borrowing and investment. However that is a weak criticism. Reason is that infrastructure lasts 50 or 100 years and there is no reason to suppose that interest rates over that period will be much reduced just because there was a recession which started around 2008. In contrast, loans for consumer durables last a much shorter time. So for the latter products, artificially reducing interest rates with a view to expanding demand makes more sense.

Thursday, 25 May 2017

Academics should back free speech 100%.

I hope you are not so naïve as to think the comments after articles written by academics and similar types of people are always a realistic representation of reader’s reaction to such articles. Some academics can be very selective in which comments they publish.

Universities used to be havens of free speech and open debate. Those days are long gone.

One reason for the latter censorship may be that negative reaction to an article may not do wonders for the author’s career. So if an academic is keen to keep the cash rolling in, a bit of censorship probably pays off.

Censoring comments which are blatantly offensive or totally moronic is perhaps justified. Though frankly I get a maximum of about one such comment per year on my blog. Moreover, there is a good argument for publishing blatantly offensive comments: when A insults B, it is normally A who is made to look stupid. So why not let people make fools of themselves?

The following is a list of sites where I have left dozens if not hundreds of comments over the years, starting with the most liberal or “pro-free speech” blogs. That is followed by a list of blogs where censorship is too common for my liking. Strangely enough, the tendency to censor does not seem to have much to do with whether I agree with relevant authors. For example, advocates of Modern Monetary Theory (which I support) seem to be towards the “censorious” end of the scale. Though to be honest, the number of blogs listed below is not a statistically significant, thus I shouldn't really make the latter generalisation.

Liberal / free speech blogs.

Frances Coppola. The only person I’ve known her to censor is someone I didn’t blame her for censoring. He was a total time waster and idiot. Strangely though, Frances is fairly “censorious” on twitter: regularly blocks people.

Worthwhile Canadian Initiative. 100% free speech on this blog, far as I know.

Mike Norman - an MMT blog.  Pretty much 100% free speech. One commentator was asked not to comment again. As with the idiot commenting on Coppola’s article, this is a genuine idiot and time waster. BTW, Mike plans to stand for president in the US in 2020. What you might call a "long shot"...:-)

Simon Wren-Lewis.  Very liberal. He even publishes comments that insult the great SW-L. But not absolutely 100% liberal, though. SW-L often does not publish comments because he does not have time to moderate them. I don’t blame him for that: he has a full time job to do as well as looking after his blog.

Ann Pettifor.
Lars Syll.
Project Syndicate.
Mark Wadsworth.
Wall Street Journal.  

Stumbling and Mumbling.
Lars Syll.

Blogs where unwelcome comments are sometimes not published.

London School of Economics blog.

Financial Times.

John Redwood. (Tory MP). He certainly doesn’t like publishing comments which criticise the Tories. Maybe the same goes for all or most politicians.

Social Democracy.  Very choosy. Odd, given that the author, who goes by the name of “Lord Keynes” is clearly very bright and well read. He should be well able to defend himself against critical comments.

New Economic Perspectives.  Very choosy about which comments get published.

Bill Mitchell.  Very touchy when it comes to comments that disagree with him. He often edits out links to people/organisations he does not agree with.

Wednesday, 24 May 2017

Top UK Treasury official does not understand deficits.

Nick Macpherson was the top bureaucrat at the UK Treasury 2005-2016. Simon Wren-Lewis (Oxford economics prof) draws attention to the fact that Macpherson claimed in a Tweet that the “Tory pledge to balance budget by 2025 is a disappointment to anybody who wants to break the cycle of deficits, debt and devaluation.” Macpherson then claims in subsequent tweet that, “running a structural current deficit when economy is at full employment is poor economics and poor public finances stewardship.”

I don’t have any big disagreements with Wren-Lewis’s criticisms of Macpherson’s thinking. I’ll set out my own criticisms below which I think are slightly better than Wren-Lewis’s. This is a bit technical: only suitable for people with a serious interest in economics. Here goes.

I’ve actually pointed out the flaw in Macpherson type thinking several times on this blog over the years. But I’ll run thru it yet again.

Assume inflation averages 2% pa over the years. I.e. let’s assume that while inflation may be a bit above 2% in some years, it is below 2% in other years: more or less what has happened in the real world in recent years. Also assume that growth averages about 1% pa in real terms: again, an entirely reasonable assumption – 1% is approximately the actual rate of growth for the UK economy over the last 20 years or so.

The “Macpherson theory” is that in that scenario there should be no deficit over the medium / long term. In fact a deficit is inevitable on the above assumptions and for the following reasons.

The 2% inflation and 1% growth mean that the national debt and monetary base will shrink in REAL TERMS relative to GDP. So on the entirely reasonable assumption that those two will need to remain CONSTANT relative to GDP, then they’ll have to be topped up regularly. And that can only be done via a deficit!

The assumption that the debt and base will remain constant relative to GDP in the long term, or perhaps I should say “very long term” is what has actually happened in the UK over the last 200 years.  That is, while the debt has risen to dramatic levels on some occasions, e.g. after WWII, it has on average hovered around the 50% to 70% of GDP level.

Notice that the sum of the debt and base are what MMTers sometimes refer to as “private sector net financial assets”. PSNFA is an important quantity. It equals or amounts to private sector net financial savings. And it seems (to repeat) that desired PSNFA over the very long term has remained roughly constant.

So, given that a constant deficit is needed, how big will it need to be? Well that’s easy. On the above assumptions, it will need to be (2+1)x50%=1.5% of GDP.!! Macpherson eat your heart out.



The argument put by Wren-Lewis in the above mentioned article is that zero is too low a rate of interest because it means the rate cannot be cut come a recession. Ergo at the zero bound, fiscal stimulus and an increased debt is needed to get the rate of interest up.

Well the slight flaw in that argument is that having got the debt and rate of interest up, the debt will shrink again because of the above mentioned 2% inflation and 1% growth. So Wren-Lewis would need to repeat his “fiscal stimulus so as to get the rate of interest up” process all over again after a few years.

In contrast, I’m advocating a PERMANENT deficit so that the latter “repetition” is not needed. I claim my “model” (for want of a better term) is a bit better.


Artificial interest rates.

Another weakness in the Wren-Lewis model is that under that model, interest rates seem to be simply a device for adjusting aggregate demand. In fact the rate of interest (e.g. for a zero risk loan) is the price of borrowed money, and it is reasonable to assume that GDP is maximised when interest rates are at free market prices, in the same way as it is normally assumed in economics that GDP is maximised when the price of anything else is at free market prices (except where it can be shown that there are good social arguments for the price being artificially low (as is the case with kid’s education) or artificially high (taxes on alcoholic drinks).

I.e. there is merit in the idea that interest rates should be left to find their own level, an idea promoted by Positive Money among others. The only possible flaw in the latter “Positive Money” strategy is that interest rate adjustments might work more quickly than fiscal adjustments. However, it’s far from clear that that is the case.

There is a Bank of England article which claims interest rate adjustments take a year to have their full effect. Plus there is no need to wait for politicians to have lengthy debates on the matter before adjusting fiscal stimulus: an element of variability can easily be built into tax and public spending which DOES NOT require lengthy debates. For example the UK adjusted VAT downwards and then up again during the recent crisis without the say so of politicians (apart from the UK’s finance minister, of course, who implemented those VAT changes.)

Monday, 22 May 2017

Most studies of the economics of immigration are useless.

There’s a very simple reason. Most of them do not consider a HUGE cost that net immigrants impose on host countries, which is the fact that each person requires several tens of thousands of pounds worth of infrastructure and other forms of capital, like housing. (The phrase “net immigrant” refers to the excess of immigration over emigration.)

Thus for each net immigrant, taxes have to be imposed on existing residents of the country to pay for the infrastructure that each net immigrant requires.

Of course the latter point assumes that the host country ACTUALLY DOES create suitable amounts of infrastructure when net immigrants arrive or shortly thereafter. An alternative assumption (one that actually occurs in the real world to some extent no doubt) is that the host country FAILS to create suitable amounts of infrastructure. But the result is still a burden placed on the host country: in the form of overcrowded or inadequate infrastructure.

The above infrastructure point is not to deny that OVER THE LIFE-TIME of each net immigrant, those immigrants will pay, roughly speaking, enough tax to cover their contribution to the country’s infrastructure. But certainly during net immigrants’ first decade or two in the host country, they are “free riders”, thus on balance over their lifetimes, net immigrants do not pay their fair share of infrastructure costs.

As for what the total value of infrastructure and other forms of capital per head is, this study puts the figure at £141,000. The title of the study is “Warning: Immigration Can Seriously Damage Your Wealth” and is published by the Social Affairs Unit. £141,000 is a HUGE AMOUNT.

That is not to suggest that all net immigrants on arrival owe the host country £141k. The issue is more complicated than that. For example the amount of capital that immigrants bring with the must be taken into account. But the size of that figure does mean that to TOTALLY IGNORE the above infrastructure point in any study which purports to measure the costs and benefits of immigration is a huge blunder. And most such studies do in fact ignore the above infrastructure point.

Thus, to quote the title of this article, most such studies are “useless”.

Saturday, 20 May 2017

Pavlina Tcherneva suggests that sales don’t create jobs!*?*!??

If you want to know why the Job Guarantee or “government as employer of last resort” idea is getting nowhere, reason is that the more vociferous advocates of the idea are incompetent  – which is not to say I oppose the JG idea. It’s an idea with definite possibilities, as long as the current leading advocates of the idea are sent to Siberia.

Tcherneva is one of those “leading advocates”. In this article (entitled “Full employment through social entrepreneurship: the non-profit model for implementing a job guarantee” published by the Levy Economics Institute) she starts by questioning whether “expansionary fiscal policy” as she calls it, creates jobs. (I actually referred briefly to this article a few weeks ago, but a closer look at it will do no harm.)

Her first para says (I’ve put her words in green italics), “When it comes to fiscal stimulus, the conventional approach always centers on tax cuts, investment subsidies, accelerated depreciation, contracts to firms with guaranteed profits, and extensions to unemployment insurance and food stamp programs. Though the specific preferences for certain policies may differ from one political party to the next, the objective remains the same: boost private investment and growth by all means possible and jobs will hopefully follow.”

Why “hopefully”? If households are given more money, whether via the above mentioned tax cuts or unemployment insurance, the empirical evidence is that they spend a significant proportion of their newly acquired wealth (gasps of amazement). And that spending creates jobs – how else are relevant goods and services produced other than by people working, at – er – “jobs”?  A large majority of the economics profession believe that fiscal stimulus increases demand and jobs. They are right.

As to the “guaranteed profits” point, that’s irrelevant. Certainly some corporations sign guaranteed profits contracts with government, while other contracts involve a fixed quote for a specific task. In the latter case, relevant firms may then make a profit or loss depending in how well they estimated the cost of the task. But the important point is that when government places orders with firms for goods and services, jobs are created. Or at least a large majority of economists think jobs are created. Tscherneva evidently thinks otherwise.

Modern Monetary Theory.

Another strange aspect of Tcherneva’s above point is that she claims to back Modern Monetary Theory (MMT). But stimulus as proposed by MMT is not much different to stimulus under conventional policies. That is, one of the main forms of stimulus under conventional arrangements is government deficits, while MMTers tend to go for the simpler “just create money and spend it (and/or cut taxes)”. But given that central banks have created money and bought up most of the extra government debt created over the last few years, stimulus over the last few years has in effect taken the above mentioned form that MMT advocates!!!

A total re-think.

Anyway, since sales don’t create, or may not create jobs, Tcherneva claims we need a total re-think here. Her second paragraph reads:

“This way of thinking about the problem, however, is precisely upside down. Growth declines when investment and consumption fall. Investment falls when sales fail. Sales and consumption fall when employment falls. To reverse this vicious cycle, policy must begin by fixing the unemployment situation, which will then lead to a recovery in sales and consumption, which in turn will improve business conditions and profit expectations - all of which will finally boost investment and growth. Growth, in other words, is a by-product of strong employment, not the other way around.”

So apparently if we create lots of JG type jobs – planting trees, picking up litter, charity work, etc – then by some unexplained magic, millions of hi-tech manufacturing jobs, etc will appear from nowhere. This bizarre!

To re-phrase Tcherneva’s argument, she is saying that given a grossly excessive amount of unemployment, instead of giving households money and having government spend money on normal public sector jobs (as per conventional stimulus) we should pay the unemployed to do relatively unproductive and low paid JG type work. There is of course a problem there, and as follows.

If pay for JG work is for the sake of argument half the average wage (and certainly most proponents of JG rightly advocate relatively low pay for such work – e.g. the minimum wage) then there won’t be a huge addition to aggregate demand. Thus relatively few PRODUCTIVE jobs will be created as a result.

In contrast, if demand is boosted in the normal manner, the average job created will be an average sort of public or private sector job paying around the national average wage. More output per job! So why go for the “Tcherneva / JG” option?

In other words, as long as we are talking about a GROSS DEFICIENCY in demand, then normal demand increasing measures (increased deficits, interest rate cuts, etc) are best.

In contrast to GROSS deficiencies in demand, there is the question as to what to do about the 5% or so of the workforce who remain unemployed even at so called “full employment”. Well certainly there is a case there for JG type jobs. To take a crude example, it is theoretically possible to dispose entirely of that “5% unemployment”: just tell the unemployed their unemployment benefit is henceforth conditional on walking up and down their street keeping it free of litter, with pay being equal to unemployment benefit. Anyone refusing the work would no longer be counted as unemployed on the grounds that they had refused work. Hey Presto: unemployment vanishes!

Of course that is a very crude JG system and doubtless we can do better. But it illustrates that the basic role for low paid JG type work is (contrary to Tcherneva’s suggestions) dealing with the above 5%, not dealing with the grossly excessive amounts of unemployment, which we saw for example in the recent recession (which is not to say there isn't a case for expanding JG a bit during recessions).

Tcherneva’s third para.

This reads, “How do we launch a virtuous circIe? One of the most effective ways is through direct job creation in the public sector. John Maynard Keynes spoke of "on-the-spot" employment (Keynes [1982], 171; Tchemeva 20]2b), while Hyman P. Minsky proposed the employer of last resort (ELR) (Minsky 1986). In both cases, the objective is to bring the job contract to the worker in distressed areas and regions with high unemployment, and to attain true full employment over the long run. One modern proposal inspired by Keynes and Minsky is the job guarantee (]G), in which the public sector provides a voluntary job opportunity, in a community project that serves a public purpose, to anyone who is willing and able to work but unable to find private sector employment.”

As regards “distressed areas”, developed countries have had policies in place since the 1930s, if not earlier, to create work in distressed areas!!!! In fact there’s a very large industrial estate covering several square miles just North of where I live in the UK which was started in the 1930s with precisely the latter objective in mind. That’s the “Team Valley” estate, which is now a hive of economic activity. And those efforts to create jobs in high unemployment areas continued after WWII in the UK and elsewhere.

Moreover, if one of the objectives of JG is to deal with distressed areas and ignore the rest of the country, that’s news to me, plus it will be news to most advocates of JG.

If Tcherneva put her “JG / distressed area” idea to the unemployed in distressed areas their response would probably not be couched in entirely diplomatic language. What people in high unemployment areas want primarily is normal, regular private and public sector jobs. No doubt they wouldn’t object to a few “non-profit / charity / JG” type jobs. And no doubt there’s a case for more JG jobs in distressed areas than other areas. But people in distressed areas do not want EVERY JOB or even every other job to be of the “charity / non-profit” type.

Plus the idea that the charity / non-profit sector can absorb a significant proportion of the unemployed in high unemployment areas is plain delusional.


Well that’s the first three paragraphs of Tcherneva’s paper dealt with. Or rather I’ve dealt with SOME OF the flaws in those paragraphs. Any reader with half a brain will have spotted other flaws.

I won’t be wasting time reading any more of this article. Hopefully I’ve gone some way to establishing the point made at the outset above, namely that some of the leading advocates of JG are not too clued up.

However Tcherneva, like many economists, is good at churning out pages of technical sounding text complete  with references to suitably impressive economists like Keynes and Minsky (mentioned above). That sort of stuff fools 99% of the population and about two thirds of fellow academic economists. So doubtless her job and career are safe.

Wednesday, 17 May 2017

The FERI Cognitive Finance Institute have a sense of humour.

I’m reading this work of theirs. I may do a post on it, but meanwhile I’m impressed by their sense of humour. The following two passages illustrate that.


When Lehman Brothers collapsed and subsequently several other banks in several countries in the US and Europe veered on the brink of bankruptcy, it was apparent that events in the   banking system exert a major impact on the rest of the eco-  nomy, including the future path of economic growth. However,   it is less well known that when journalists interviewed leading   experts in ‘economics’ and ‘finance’, namely professors of  economics and finance at major universities, such as Harvard,   Oxford or MIT, their honest response to the questions from the   journalist should have been: ‘I am sorry, but I cannot comment   on the banking crisis.’ An astonished journalist would have   inquired why this was not possible. And an honest academic would have responded: ‘The economic models and theories I use in my work do not include any banks. None of the leading   macroeconomic models and theories include any banks. We   simply do not analyse banks at all.’  


The futility of such a narrow inflation targeting can be illustrated by the European  Central Bank’s official claim that its monetary policy during  its first decade of operation was not interested in and did not monitor bank credit, economic growth nor even inflation in individual Eurozone countries, but was solely focused on  the aggregate Eurozone inflation target of 2%. When asked at a public meeting whether the ECB would thus consider its  monetary policy successful if half of the Eurozone countries  experienced 52% inflation (a disaster), while the other half experienced 50% deflation (an even bigger disaster), resulting in an aggregate inflation rate of 2%, the ECB’s spokesperson responded with a clear ‘Yes’.

Tuesday, 16 May 2017

Monday, 15 May 2017

Where will the money come from, minister?


Simon Wren-Lewis (Oxford economics prof) asks whether politicians should have to explain where they’ll get £X from if they propose spending £X extra.

A popular answer to that question is that since a proportion of the money in most years for government spending comes from the deficit (i.e. the money comes from thin air, so to speak), a politician does not need to explain where ALL OF the money will come from for the above £X of public spending.

My answer to that is that the fact of increasing the proportion of GDP devoted to public spending DOES NOT mean that the deficit should increase. I.e. if a politician, speaking just on behalf of his own government department or speaking for government as a whole proposes an £X increase in public spending, then he or she needs to explain where they’ll get £X extra tax from.

Of course I’m glossing over the fact that the stimulatory effect of £X public spending exactly counteracts the deflationary effect of £X of extra tax. But for the purposes of this argument, that bit of “glossing” can perhaps be overlooked.

Hopefully I’ve answered SW-L’s question, but I’m not 100% confident I’ve done so..:-)

Sunday, 14 May 2017

We don’t need to save in order to fund investment?

Michael Kumhof and Zoltán Jakab wrote an article, published by the IMF, a year or so ago entitled “The Truth about Banks”.  The article included the following paragraph, which leaves room for improvement.

“Many policy prescriptions aim to encourage physical investment by promoting saving, which is believed to finance investment. The problem with this idea is that saving does not finance investment, financing and money creation do. Bank financing of investment projects does not require prior saving, but the creation of new purchasing power so that investors can buy new plants and equipment. Once purchases have been made and sellers (or those farther down the chain of transactions) deposit the money, they become savers in the national accounts statistics, but this saving is an accounting consequence—not an economic cause—of lending and investment. To argue otherwise is to confuse the respective macroeconomic roles of real resources (saving) and debt-based money (financing). Again, this point is not new; it goes back at least to Keynes (Keynes, 2012). But it seems to have been forgotten by many economists, and as a result is overlooked in many policy debates.”

The truth is actually as follows.

If extra spending is to take place, assuming the economy is already at capacity, then some reduction in spending must take place to balance that increase, else demand and inflation will become excessive. One possible form of “reduction in spending” is extra saving. Thus, contrary to the suggestion in the above IMF article, saving can fund investment.

However there is no absolute need for the saving to precede the investment spending – by one day, or month or any other relatively short period of time. For example if the entity doing the investment just goes ahead with it, after borrowing money from a bank, and subsequently, a reduction in aggregate spending is brought about somehow or other, e.g. via an increase in interest rates, or increased VAT, that would do equally well.

To summarise, extra spending in the form of extra investment requires reduced spending, i.e. extra saving in some other part of the economy. But whether the extra saving takes place just before or just after the investment spending does not matter.

Saturday, 13 May 2017

Random charts - No.22.

I'm getting tired of Roman numerals, and have changed to Arabic numerals for the titles of this series.
Text in pink in the charts below is added by me.

Friday, 12 May 2017

Bundesbank criticises 100% reserve banking.

That’s in an annex starting on p.30 of a Bundesbank article entitled “The role of banks, non-banks and the central bank in the money creation process.”

The article starts by explaining a point set out in a Bank of England article recently namely that money is created when a commercial bank grants a loan. I.e. “loans create deposits” as the saying goes.

Then in the above mentioned annex, the Bundesbank article criticises 100% reserve banking. One of the first points made is that the existing bank system involves economies of scale. It is not entirely clear whether that is supposed to be a criticism of 100% reserves: i.e. it is not clear whether the implication is supposed to be that 100% reserves DOES NOT involve economies of scale. As the article puts it:

“Lending business involves reviewing loan requests, granting the actual loans and, given the information asymmetries that exist between the lender and the borrower, requires monitoring of the projects being funded through the loans. In performing this monitoring task, banks have one particular advantage in that they harness economies of scale and so reduce the monitoring costs.”

But if the latter point is indeed supposed to be a criticism of 100% reserves, then the simple answer is that 100% reserves involves what might be called “large lending organisations” in much the same way as the existing bank system involves such large organisations. Thus there is no loss of economies of scale under 100% reserves. Alternatively if anyone thinks it is worthwhile setting up a small local “lending organisation” under 100% reserve, then the obstacles to doing so are no more under 100% reserves than under the existing system.

Maturity transformation.

The Bundesbank article then praises an apparent merit of the existing bank system, a merit that would not exist under 100% reserves, which is that under the existing system banks can borrow short and lend long or engage in “maturity transformation” as it is called. As the Bundesbank puts it:

“By making sight deposits available while “simultaneously” investing in illiquid projects, banks provide a maturity transformation service. They create liquidity and give depositors the ability to consume intertemporally, whenever they want to.”

Unfortunately the advantages of maturity transformation (MT) are illusory, as I have explained before, e.g. here and here.

But I’ll repeat and summarise the argument against MT.

As the Bundesbank rightly points out, MT “liquifies” (to coin a phrase) relatively illiquid assets. That is, it turns an illiquid investment or asset into money or near money, which all else equal is convenient for the asset holder.

So if MT is banned, the initial effect is deflationary, as the Bundesbank implies, because the private sector then has a smaller stock of money or “near money liquid assets”. But the latter problem is easily dealt with by having government and the central bank print money and spend it into the private sector until the private sector again has the stock of money that induces it to spend at a rate that keeps the economy at capacity. And doing that costs nothing in real terms. 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."

Bank runs and credit crunches.

Then, in reference to the alleged advantages of MT, the Bundesbank says:

“However, this advantage is offset by the risk of a liquidity problem arising in the event that a bank cannot meet demands to repay deposits. If more depositors than anticipated withdraw their sight deposits – not because they need liquidity unexpectedly but because they fear that other depositors may withdraw their money and cause the bank to collapse – this form of coordination among consumers can trigger a run on banks.”

That’s a good point. Indeed, Messers Diamond and Rajan make much the same point in their paper “Liquidity risk, liquidity creation and financial fragility: a theory of banking.”.

As D & R put it in their abstract and in reference to the liquidity creating characteristics of banks under the existing bank system, “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”

So to summarise, what does MT achieve on balance? The answer is “absolutely nothing”. Or to be more accurate, it creates liquidity / money but at the expense of bank runs, credit crunches etc, when liquidity / money can perfectly well be created in whatever amount is needed to keep the economy working at capacity at zero cost and without incurring the risk of bank runs!

Maturity transformation is a farce!

The net effect of 100% reserves on lending.

The next criticism the Bundesbank makes of 100% reserves is that it does not increase lending by banks. For example on p.32 the article says, “The stricter the regulatory requirements regarding the collateral framework are, the likelier it is that a reserve ratio hike to 100% will be accompanied by a corresponding tightening of the provision of credit and liquidity.”

Well the answer to that is that 100% reserves certainly makes lending a bit more difficult for banks, as indeed the UK’s Vickers commission pointed out (sections 3.20-3.21). I.e. speaking as an advocate of 100% reserve, I have never claimed that it increases bank lending, and far as I can see, same applies to other advocates of 100% reserve, though obviously I cannot claim to have read every single sentence ever written on the subject.

But to claim that increased bank lending is necessarily beneficial is to assume that the existing amount of lending is sub-optimal. Well the first point that casts doubt on that claim is the popular idea that the total amount of private debt is excessive. Indeed, all too often people in high places claim that bank lending needs to be increased, and then in the next sentence or shortly after that, the same self-appointed experts claim private debts are excessive. If those self-appointed experts cannot see the glaring self-contradiction there, they should stop expressing opinions on the subject.

As to exactly what the optimum amount of bank lending is, and what the optimum rate of interest is, I argued for a very conventional answer to that question in this article, namely that the optimum is attained in the same way as the optimum amount of apple or steel production is attained: market forces. More specifically the argument in the latter article is that 100% reserves actually amounts to a free market or something nearer a free market than the existing bank system. The title of that article is “Privately Issued Money Reduces GDP”.

Unfortunately, as I’ve pointed out several times before on this blog, the concept “optimum” seems to be too difficult for many self-appointed experts in high places.

Macroeconomic stabilisation.

The final page of the annex in the Bundesbank article claims that 100% reserve would not bring macroeconomic stabilisation. Well certainly the advocates of 100% reserves have never claimed it would bring perfect stabilisation. For example this work entitled “Towards a twenty-first century banking and monetary system” which advocates 100% reserves, makes it perfectly clear that varying degrees of stimulus and “anti-stimulus” would be needed under 100% reserve, just as they are at present.

However, there is one way in which 100% reserves brings a HUGE increase in stability not mentioned by the Bundesbank, and that is that bank failures are all but impossible under 100% reserve. The reason is thus.

Under 100% reserve, the bank industry is split in two. One half accepts deposits but does not lend on those deposits because they are lodged in a totally safe manner at the central bank. That is eminently logical and (unlike the existing system) totally honest. Reason is that a bank deposit is supposed to be totally safe. That is plain incompatible with lending on relevant monies, because borrowers are not totally reliable.

So that half of the bank industry cannot fail.

The other half of the bank industry lends, but is funded by equity or something similar, e.g. bonds that can be bailed in. That half of the industry cannot fail either. Reason is that if loans made turn out to be worth say only half of book value, then all that happens is that shares in the bank approximately halve in value: the bank does not go insolvent.

 Shadow banks.

One of the final criticisms of 100% reserves made by the Bundesbank is one that has been made many times before, and rebutted an approximately equal number of times. That is the claim that if money creation by commercial banks is banned (i.e if MT is banned) small organisations, shadow banks perhaps, will spring up to exploit the newly available gap in the market. As the Bundesbank article puts it, “Moreover, there is a risk of evasive action being taken in that new, non-regulated institutions could be set up to fill the gap.”

Well one answer to that point was given by Adair Turner, former head of the UK’s Financial Services Authority. As he put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”

Much the same applies for example when it comes to safety rules in the construction industry. It does not matter whether a construction firm employs three or three thousand people: all construction firms have to obey the same safety rules.

Second, the idea that banks, small or large will try to evade regulations is not exactly an original observation: it makes no difference what banking laws are put in place, one thing is 100% certain and that is that banks will try to evade those laws. But the big merit there of 100% reserves is the extreme simplicity of the laws or rules. Simple laws are relatively easy to enforce. The basic rules of 100% reserves can be written on the back of a small envelope, unlike Dodd-Frank which occupies a good ten thousand pages. The basic rules are:

1. Loans can only be funded via equity or similar. 2. Deposits must be lodged in a totally safe manner. That’s it!

Third, it is not easy for very small banks to create money or near money. If you were offered a cheque drawn on a bank you’d never heard of, would you accept it? Probably not. Thus if for example the hundred largest banks (regular banks and shadow banks) in a medium or large country are forced to obey the rules of 100% reserve, that probably solves the problem. A few small banks or quasi banks trying to evade the rules is unlikely to be a significant problem.

Monday, 8 May 2017

More support for the “Bernanke / Positive Money” system.

Positive Money has long advocated a system under which stimulus takes the form of simply printing more base money and spending it (and/or cutting taxes) while the total SIZE of the deficit is decided by professional economists (e.g. by the central bank). As for obviously POLITICAL decisions like what proportion of GDP is allocated to public spending and how that is split between health, education, law enforcement and so on, those decisions remain with politicians. E.g. see the submission to Vickers authored by Positive Money, the New Economics Foundation and Prof Richard Werner, entitled “Towards a twenty-first century banking and monetary system”.

Bernanke also recently suggested that arrangement would have merits. See para starting “A possible arrangement…” in this Fortune article entitled “Here’s How Ben Bernanke’s “Helicopter Money” Plan Might Work.”

Note that that system DOES NOT reduce democratic accountability. Reason is that under the EXISTING SYSTEM, the final word on the amount of stimulus is taken by the central bank in that the central bank (at least where the CB is relatively independent) can nullify what it sees as excessive fiscal stimulus implemented by politicians using CB implemented interest rate rises.

Support for a system of the latter sort has recently come from Nobel laureate economist Eric Laskin. See Bloomberg article entitled “A Nobel Winner’s Radical Proposal to Solve the Euro Area’s Woes.”

Note that while the above mentioned work by Positive Money and co-authors advocates full reserve banking, full reserve is not an essential ingredient in a system where central banks (or some other committee of economists) decide the total size of a stimulus package. In fact neither Bernanke nor Laskin mention full reserve.

Apart from the latter full reserve point, there are other small differences between Laskin’s proposal and Positive Money’s. But there are any number of variations on the basic theme here.

It’s nice to see another supporter of the “basic theme”, especially a Nobel laureate.

Sunday, 7 May 2017

What’s the optimum or GDP maximising rate of interest?

Absent any particularly good reason for thinking otherwise, it is reasonable to assume the optimum rate of interest, i.e. the optimum price for borrowed money is determined in the same way as the optimum price for apples or anything else: supply and demand. In fact that is a standard assumption made in economics, i.e. it is normally assumed in economics that absent what economists call “market failure” market forces should prevail.

In the case of apples, apple growers and apple consumers, i.e. households, effectively meet in a market. Consumers buy whatever amount of apples they want at the going price. Producers produce whatever amount they think is profitable, and so on.

So the optimum rate of interest is presumably determined the same way. That is, the optimum rate would obtain where borrowers and savers effectively meet in a market.

Now apples are purchased with money. Nothing wrong with that. But suppose apple wholesalers managed to boost the purchase of apples by printing apple tokens which could be used for the purchase of apples. Those tokens would effectively become a form of money.

Not only would it be possible to use the tokens for the purchase of apples, but the mere fact the tokens being in effect worth a specific number of apples would make the tokens good for the purchase of other goods and services. Exactly the same applies to tokens issued by firms in other industries, e.g. air mile tokens issued by the airline industry.

Air mile tokens and the like CAN BE restricted to the person who has earned the air miles. But equally, if airlines so choose, airline tokens can be good for the purchase of flights with any airline. (Personally I don’t fly much, so I’ve no idea which of those two options the airline industry goes for. And it doesn’t matter for the purposes of this article).

As with apple tokens, if airmile tokens are accepted by every airline or almost every airline, and if almost everyone flies regularly, then airmile tokens become as good as cash.


There is however a problem with specific industries issuing tokens used in the first instance for the purchase of that industry’s products. Suppose the economy is already at capacity (aka full employment). As pointed out above, apple tokens are as good as cash because almost everyone purchases apples. And if the private sector’s stock of cash is increased when the economy is already at capacity, the effect is inflation.

Alternatively, if the economy is NOT AT capacity, the extra tokens / cash may not matter if the volume of tokens issued is not excessive. Indeed, the extra tokens / cash might bring the economy up to capacity without causing excess inflation.

But in either case, one thing is for sure: if extra demand is created by the printing of “apple cash”, the result will be an entirely artificial boost for apple growers: that is, the number of apples sold and bought will be above the GDP maximising level.


Doubtless some readers will have tumbled to where this is leading. But for the benefit of those who haven’t….

Private banks do exactly what apple wholesalers do in the above hypothetical example. That is, private banks print or issue their own tokens which can be used in the first instance for the purchase of the product that banks have to offer, namely loans.

Plus, as with apple tokens, once private bank issued money or “bank tokens” have been spent by the initial users of those tokens (i.e. those who borrow from banks), those tokens go into general circulation and are used as cash.

Private bank issued tokens / cash is not actual cash (in the sense that it is legal tender – i.e. central bank issued cash). Anyone can turn down private bank issued tokens / money on the grounds that it is not legal tender. But that does not happen very often.


Apple tokens, if they were issued, would not be desirable because they would result in an excessive or “non GDP maximising” number of apples being sold and bought.

Exactly the same applies to private bank issued money. It results in an artificially low rate of interest, and hence in an artificially high level of lending of debt.

And finally, this article is dedicated to all Cumbria apple pastie producers and (without his permission) to Nick Rowe who has used apples on dozens of occasions to illustrate various aspects of economics.

Saturday, 6 May 2017

Jo Michell’s criticisms of Positive Money and full reserve banking.

Michell teaches economics at the University of the West of England. I follow him on social media because he is a constant source of ideas.

I agree with some of his criticisms of Positive Money (PM) in this article of his. Title of the article is “Full reserve banking: the wrong cure for the wrong desease”. But on balance he doesn’t seriously dent the case for full reserve banking (FR). Reasons are thus.

1. Michell starts by criticising the popular and fallacious “continuous growth” argument. That’s the idea that when private banks make loans, the economy has to expand otherwise it will not be possible to pay interest on the loan. Ergo, so the argument runs, the existing bank system requires continous growth, which in  turn degrades the environment.

The flaw in that argument is that anyone borrowing from a bank can perfectly well pay interest on a loan, despite their income being constant if they cut down on some other form of spending. Simple.!!! Put another way, if person X saves money and lends it to Y at interest instead of making product Z and selling it to Y, Y will then pay money to X in the form of interest instead of giving money to X as payment for product Z.

However the fact that the continuous growth argument is nonsense is not a good criticism of FR because PM is nowhere near the only advocate of FR: at least four economics Nobel laureate economists have supported the idea, e.g. Milton Friedman and James Tobin. Those economists (and others) do not cite the environmental or continuous growth arguments far as I can see – and I’ve read large amounts of their material.

2. In the para starting “To the average person…” Michell’s accuses PM of using psychological tricks to make people feel uneasy about the existing monetary system. Well fair point: but then PM is a pressure group, not an economics text book. Other pressure groups, political parties etc use psychological tricks.

That’s normal. Plus most supposedly impartial “objective” economists use emotive language. They shouldn’t. But I don’t abstain from emotive language, so I can’t complain.

3. Michell’s then criticises an idea long pushed by PM along the lines that private banks create money when they make loans (on which interest is paid) ergo privately created money forces people to pay interest to private banks for the simple privilege of having money with which to do daily business. (See para starting “The ‘real’ (non-financial)…”)

I agree with  Michell:  i.e. where banks charge interest, they do so in respect of loans. And to the extent that they simply supply customers with money with which to do daily transactions, it would not make sense for them to charge interest, though it does make sense to charge for administration costs. I set out detailed reasons on that point in section 7 of an article of mine entitled "Privately issued money reduces GDP".

4. Michell then deals with PM’s claim that stimulus should come in the form of the state simply printing new money and spending it, and/or cutting taxes. See paragraph starting “Oddly, despite the environmental argument…”.

Michell says, “Further, the conflation of QE with the use of newly printed money for government spending is another example of sleight of hand by Positive Money. QE involves swapping one sort of financial asset for another – the central bank swaps reserves for government bonds. This is a different type of operation to government investment spending – but Positive Money present the case as if it were a straight choice between handing free money to banks and spending money on health and education.  It is not. It should also be emphasised that printing money to pay for government spending is an entirely distinct policy proposal to full reserve banking – which do would nothing in itself to raise infrastructure spending – but this is obfuscated because PM labels both proposals ‘Sovereign Money’.”

I agree with Michell there. About the only excuse I can offer for PM’s error there is that numerous other people have fallen for what might be called the “green / infrastructure QE” illusion. One is Richard Murphy.

5. Give £7,000 to everyone instead of traditional QE?

£7,000 is approximately the total amount of QE done per household, and Michell says “Further, the conflation of QE with the use of newly printed money for government spending is another example of sleight of hand by Positive Money.” I agree. Indeed PM have published material suggesting the average household would have enjoyed spectacular increases in income if the £7,000 (or a significant fraction of it) had been paid direct to households or spent on infrastructure or similar.  Reason why that’s a sleight of hand is that QE has little effect on demand, whereas spending £7,000 for every UK resident on infrastructure or helicopter drops or similar would have a HUGE EFFECT on demand: indeed it would be positively inflationary. I.e. PM should make it clear that the alternative to £7k of QE is not £6k or £5k going straight to households. At a wild guess, it’s probably more like £1k

6. Small banks, shadow banks, etc.

Next, in a para starting “The same is true..”, Michell makes a criticism of FR which has been made dozens times before, and demolished an equal number of times. It’s the idea that FR would deal only with large regular banks, while failing to deal with the smaller unregulated banks or quasi banks.

The answer to that was given by Adair Turner when he said “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards…”. I.e. no organisation which acts like a bank should be excused obeying bank regulations. Building firms, whether they employ three or three thousand people have to obey similar rules, e.g. as regards health and safety. There is no reason why banks cannot be regulated similarly.

Moreover, even if the smallest shadow banks are not regulated, that does not matter too much: if say the hundred largest banks, regular and shadow, ARE REGULATED, that cracks the problem basically.

7. Seigniorage.

Michell then criticises the claim by PM that money creation by private banks enables them to enjoy seigniorage profits. As he puts it, “There is simply no reason why the act of issuing money generates profits in itself.”

Well strikes me there is a very simple and obvious reason why money creation results in profits: to the extent that banks simply lend out “home made” money, the borrower and the bank obtain a valuable asset (e.g. a house) in exchange for mere bits of paper or book-keeping entries. Nice work if you can get it.

However, the latter is an over-simple view of what banks do. It is more realistic to say that banks’ freedom to create money enables them to lend at an artifically low rate of interest, and that’s where the profit lies. I.e. the latter seignorage profit is actually shared by all mortgagors and by those who fund banks (shareholders, bond-holders, etc).

Joseph Huber in his work “Creating New Money” alluded to the latter interest rate point. As he 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.”

In short, strikes me that what’s wrong with the existing bank system is the latter point of Huber’s rather than seignorage in the standard sense of the word and I enlarge on that in the above mentioned article of mine.

8. Milton Friedman.

Michell ends with a short discussion of Friedman’s ideas, which is of relevance since Friedman backed FR. But Michell makes the following strange claim about Friedman, “Like PM, he favoured a simple monetary solution: the Fed should print money to counteract the effect of bank failures.”

Well I’ve just looked at Friedman’s 1948 paper “A Monetary and Fiscal Framework for Economic Stability” in which Friedman advocates full reserve and money printing by the state. The phrase “bank failure” does not appear. Moreover, while the word “bank” appears about fifteen times, there is no suggestion that Friedman wants to have the state print money so as to rescue banks.

Indeed Friedman is quite clear that when entities in the half of the bank system which lend make poor lending decisions, shareholders take a hit or get wiped out.
That’s very much in line with Friedman’s pro-free market outlook.  In contrast the ACTUAL PURPOSE of money creation by the state as far as Friedman is concerned is exactly as envisaged by PM: it’s to provide general STIMULUS. Friedman is not bothered about the extent to which banks or “lending entities” benefit from that stimulus, and quite right too. Incidentally Friedman also advocated FR in his book “A Program for Monetary Stability” (mainly in the 2nd half of Ch3).

9. Financial instability.

Finally, there is an omission from Michell’s article as follows.

He says quite rightly that one of PM’s central claims is that FR reduces “financial instability”. But he does not say whether he thinks PM is right or wrong there.

In fact FR brings a HUGE INCREASE in financial stability in that it’s plain impossible for a bank to fail under full reserve. Reasons are simple and as follows.

As regards the half of the bank industry which simply accepts deposits, it cannot go bust because all those deposits are lodged at the central bank. And as to the half of the industry which makes loans, it cannot go bust because it is funded by shareholders (or something similar like bonds which can be bailed in). Thus if (to take an extreme scenario) a bank makes a series of seriously stupid loans, and the bank’s assets (i.e. those loans) become worthless, then the value of its shares and bonds become worthless as well. But the bank is not bust in the sense that its liabilities exceed its assets.

10. Conclusion.

Having set out the flaws in several of PM’s and Michell’s arguments, some readers may be left wondering what, if any, are the arguments for FR. The answer is, basically, the one alluded to in the above quote from Joseph Huber. I.e. the right that commercial banks have to print money is effectively a subsidy of those banks. I go into that point in more detail in the above mentioned article of mine.

Incidentally PM themselves also cite that “subsidy” argument in this short video. Thus PM’s basic error is what might be called their “scattergun” approach. I.e. they cite too many arguments against private money creation. Some of those arguments, as Michell rightly points out, are flawed.