Increase public investments when interest rates are low?

A popular belief among the great and the good is that since governments can borrow at around a zero real rate of interest, governments should borrow more to fund public investments like infrastructure. E.g. this Oxford economics prof says “The obvious response is for the government to borrow to increase public investment, particularly when it is so cheap to do so.”

Unfortunately there’s a problem with that argument which is that the only reason governments can borrow at ultra-low rates of interest is that governments have coercive powers: they can confiscate money from taxpayers with which to repay their creditors even when their investment projects are a flop.

Thus the rate of interest that should be charged to public investments is the sort of rate that a private infrastructure provider would have to pay, and that is significantly more than the approximately zero real rate of interest that many governments pay.

The original funders of the English-French channel tunnel lost nearly all their money. So what rate of interest would you want for funding a similar project in the future?

24 economists support Old Mac Donald.

24 economists have produced a statement in support of John McDonnell, the shadow finance minister (aka “Chancellor”). I’ve reproduced their letter below, followed by my less than entirely flattering response. Their statement reads:

Andrew Neil of the BBC Politics programme recently challenged the Shadow Chancellor, John McDonnell, on the likely cost in interest payments of additional public borrowing. He suggested that current debt interest payments are estimated at £49 billion, and rising. His use of £49 billion was misleading, as it included £9bn owed by the Treasury to the Bank of England (BoE). Because the Bank is part of the public sector, £9bn is in effect owed by government to itself, as the Office of Budget Responsibility (OBR) explains.[1] The government’s debt interest payments are therefore £40bn.

But the £40 billion is not meaningful in isolation. It is best understood as a share of the UK’s national income or GDP. This amounts to just 2% of GDP – a historically low share of the national ‘cake’. This is remarkably low, given the costs (debt) incurred by the government to bail out the private financial system after the 2007-9 global financial crisis, and given Britain’s falling wages which reduce government tax revenues. Above all, given the slowest economic recovery on record.

In 1987/88 when Conservative Chancellor Nigel Lawson was stoking an unsustainable boom, debt interest (see the OBR’s databank on public finances here) was at virtually the same level as the OBR estimates it is today - circa £40 billion (in 2016/17 constant prices). When the Tories left office in 1996/7 debt interest payments were again at the same level as estimated today –  £40 billion (also in 2016/17 constant prices).

But there is a stark difference between the period of Lawson’s boom, the Conservative government of 1996/ 1997 and Britain in 2017. Today the nation is struggling to recover from the devastating effects of a global financial crisis, and for ten years has suffered falling wages and incomes, the dismantling and defunding of vital public services and with it, the loss of the’ social wage’. And thanks to austerity, this has been the slowest economic recovery from a slump in history.

Chancellor Nigel Lawson and Prime Minister Margaret Thatcher were relaxed about spending close to £40bn on debt interest payments at a time of prosperity. Today we face ongoing economic weakness, the rise of populism and the possibility of a major economic shock posed by Brexit in 2019. In these circumstances, neither Labour (nor indeed the current government) should be deterred from borrowing for productive investment, especially at a time when interest rates are historically very low.[2]

Increased public investment in productive activity will expand our nation’s income and with it, government tax revenues.  By so doing public investment will enlarge the economic ‘cake’ and help bring down future debt interest payments as a share of GDP.


My response.

First, the fact that the cost of Mac Donald’s proposals are small compared to the cost of an almighty blunder, i.e. the 2007/8 bank crisis, is not a brilliant argument for those proposals.

Second, the fact that we’ve had the “slowest economic recovery on record” (just like other countries) is not an argument for a large dose of stimulus NOW. The crucial determinant of whether stimulus is justified NOW is what inflation is doing NOW. And in the opinion of the committee charged with looking at that question, the BoE MPC, inflation is sufficiently uppity NOW, that stimulus needs reining in.

Of course the BoE might be wrong, but determining whether IT IS WRONG requires a detailed look at how much inflation is cost push and how much is demand pull, rather than vague statements about the “slowest economic recovery on record”.

Third, this passage is defective:

“In these circumstances, neither Labour (nor indeed the current government) should be deterred from borrowing for productive investment…”. Total confusion of unrelated issues.

Assuming public investment is best funded via borrowing (and that is very debatable for reasons spelled out by Milton Friedman and Warren Mosler), the optimum amount of such borrowing will not be much affected by whether the economy is at capacity or in recession. I.e. sensible investment decisions are taken on the basis that the economy is at an average sort of level, capacity wise. I.e. the argument that “stimulus is needed, so let’s have a big increase in investment spending” makes little sense.

Moreover, sudden changes in investment spending, or any other form of spending, tend to make for inefficiency. Put another way, when stimulus is needed, there is merit in spreading the extra spending as widely as possible over public and/or private sectors.

Minsky’s absurd objections to full reserve banking.

Jan Kregel wrote an article on Minsky’s views on full reserve banking entitled “Minsky and the narrow banking proposal..” (Public Policy Brief, No.125, published by the Levy Economics Institute of Bard College). “Narrow banking” as defined by Minsky is the same as what is normally called “full reserve banking”.

I actually tackled this article of Kregel’s five years ago in 2012, and set out some flaws in it. However, on re-reading Kregel’s article, it struck me there are even more flaws to be exposed. This present article runs thru some of the flaws I set out in 2012 and in addition deals with two or three new ones.

The first objection to full reserve cited by Kregel is one not actually raised by Minsky, but rather by Neil Wallace, whose objection is that full reserve “eliminates the banking system”  (p.5, 2nd column).

Well the answer to that is that advocates of full reserve are well aware that full reserve is such a fundamental change to the bank system that it is perfectly fair to describe that change is “eliminating the banking system” as we know it.

Indeed Matthew Klein penned an article, published by Bloomberg, in support of full reserve entitled “The Best Way to Save Banking is to Kill It”.

You could say the internal combustion engine is inherent to the definition of the word “car”, and thus that banning internal combustion engines and replacing them with electric motors and batteries equals the end of the motor car. That, however, is just semantics. The important question is whether fundamental changes to banking or cars make sense.


Stability.

The next objection to full reserve cited by Kregel and made by Minsky is: “such a system could neither ensure the stability of the real economy nor assure stability of the capital financing institutions…”. The answer to that is as follows.

The advocates of full reserve never claimed that full reserve would actually bring the above “stability”. For example a work by Positive Money and co-authors which advocates full reserve and is entitled “Towards a Twenty-first Century Banking and Monetary System” specifically says that demand management under full reserve is needed just as under the existing system.

Moreover, the implication in the above “stability” quote from Kregel’s article that the EXISTING bank system brings stability is hilarious. As readers may have noticed, we had a major bank crisis in 2007/8 which gave rise to a ten year long recession.


Return on investments.

The above “stability” quote from Kregel’s article continues as follows.

“First, the real investments chosen could still fail to produce the anticipated rate of return; and second, sectoral over-investment and financial bubbles could still exist if there were herding behavior by the investment advisers of the trusts that produced pro-cyclical financing behavior. There would always be a risk of investors calling on the government to save them from financial ruin.”

First, as regards “investments” which “fail to produce the anticipated rate of return”, that’s hardly unusual under the EXISTING system!!!! Ford’s disastrous Edsel car did not cause the sky to fall in.

As regards the idea that investors might “call on government to save them from financial ruin”, investors under the existing system do not normally go running to government for help when faced with ruin,  and they normally get short shrift when they do. There is no general expectation that government comes to the rescue when there’s a stock market crash.  Exactly the same would apply under full reserve.

Of course there are well known cases of where governments HAVE STEPPED IN under the existing system: e.g. General Motors and Chrysler were given government assistance in 2008. And then there were the trillions loaned to banks at sweetheart rates of interest during the recent crisis. Thus the charge by defenders of the existing bank system that under full reserve there’d be instances of taxpayer funded assistance is a joke: the words pot, kettle and black spring to mind.


Demand management.

The next objection to full reserve has to do with demand management, and is in effect just a repetition of the above mentioned demand management objection.  Kregel says “In such a system it is evident that total private saving would exceed investment by the private sector’s holdings of narrow bank deposits and government currency, creating a tendency toward deflation or recession.”

Well the quick answer to that is that, as already pointed out, advocates of full reserve are well aware that demand management is still needed under full reserve.


Large government sector needed?

Next, Kregel says “In the absence of a large government sector to support incomes, liabilities used to finance investment could not be validated in a narrow bank holding company structure.”

I’ve no idea what that’s supposed to mean. But the claim that a “large government sector” is needed is nonsense. What IS NEEDED as already pointed out, is demand management, i.e. deficits (and maybe the occasional surplus). But deficits are easily arranged even given a government sector half the present size.

To illustrate, public spending as a percentage of GDP in the US is near 40%. If that were halved, that would mean a deficit equal to about 20% of GDP would be no problem at all: that could be done by government ceasing to collect any tax and continuing to spend at a rate that equalled 20% of GDP. And of course a deficit equal to 20% of GDP is truly massive: it’s unheard of, thus the “large government sector” alleged problem mentioned above is nonsense.


Innovation.

Next, Kregel says, “But, even more important, it would be impossible in such a system for banks to act as the handmaiden to innovation and creative destruction by providing entrepreneurs the purchasing power necessary for them to appropriate the assets required for their innovative investments. In the absence of private sector “ liquidity” creation, the central bank would have to provide financing for private sector investment trust liabilities, or a government development bank could finance innovation through the issue of debt monetized by the central bank.”

Frankly this is getting more absurd with each succeeding paragraph. It is also not entirely clear whether the latter objection to full reserve is Minsky’s or Kregel’s.

At any rate, as Kregel himself explains earlier in his article, under full reserve, all funds supplied to non-bank corporations come effectively via equity and bonds rather than via bank loans which themselves are funded via deposits. Thus the idea that under full reserve, non-bank corporations and firms have no way of obtaining “purchasing power” is pure, unadulterated nonsense. They just get their purchasing power in a slightly different way.

Indeed, some corporations under the EXISTING SYSTEM choose to fund themselves mainly via equity rather than bank loans: for example Google is funded 90% by equity, and Google is hardly a failure when it comes to “innovative investments”.


Conclusion.

Minsky and Kregel’s criticisms of narrow / full reserve banking are hopeless.

The bizarre failure of productivity to improve in construction.

In the last 20 years, productivity in Germany and Japan has not risen at all. In France and Italy it’s fallen by one sixth. And in the US it’s halved since the late 1960s. That’s according to this Economist article. Absolutely hopeless.!!!!

According to the Economist, the industry has become LESS capital intensive because builders are put off investing by boom and bust. It has also failed to consolidate. Another significant problem is different building codes in different parts of the same country.

However, we had boom and bust 50 years ago, and presumably also different building codes in different parts of the same country. So neither of those strike me as good explanations.

The Economist rightly considers mass production pre-fab as a possible solution. Strikes me that will never really get off the ground in a big way absent very very large scale mass production of apartment units.

The head of one of the UK’s largest construction firms said a few decades ago at a House of Commons investigation into this that the scale of investment needed to really reap the benefits of mass produced apartment units would require more money than an individual firm could come up with. Unfortunately I forget his name or the firm he worked for.

Possibly this is an area where Mariana Mazzucato’s ideas on entrepreneurial governments might work. For all the tens of thousands of words she writes, she seems a bit short of actual examples of where the entrepreneurial state idea would pay dividends.

On the other hand, it may be that productivity improvements are just not possible at the moment. After all, the typical house is constructed much the same way as in Roman times: one brick or stone plonked on top of another with mortar in between, plus wooden floor joists and wooden floor boards, plus tiles on the roof.

Random charts - 46.

Large text in pink on the charts below was added by me.

Simon Wren-Lewis and the job guarantee.

Job Guarantee (JG) is a name for an idea which has been around for a very long time. It’s the idea that there are an infinite number of useful jobs to be done, thus instead of paying the unemployed to do nothing, government could pay them to do something useful. Far as I know, Pericles in Ancient Athens was the first to implement that idea (about 2,600 years ago). The WPA in the US in the 1930s was another example of JG.

Wren-Lewis published an article (1) on JG a few days ago and made the point that if pay for JG work is too generous, that will attract people way from regular jobs, i.e. the effect will be to cut job search efforts, which equals cutting aggregate labour supply to the regular jobs market, which is inflationary. Hence aggregate demand has to be cut, which destroys regular jobs: hardly the object of the exercise.

That point by Wren-Lewis is far from original: indeed it’s a fairly obvious common sense point (which I and others were making at least twenty five years ago (2)). Maybe Pericles was aware of the point as well.

However, two of the more enthusiastic and I think naïve advocates of JG are having none of it. Neil Wilson (3) and Brian Romanchuk (4) argue that a generous JG wage will not have the above adverse effect: rather, a generous JG wage will induce employers to offer higher pay for the low paid, i.e. JG in that capacity would work much like minimum wage laws. And as evidence to support that, Neil Wilson cites a study which show that raising minimum wage rates has no effect on employment. (There are of course other studies which claim that raising the min wages DOES increase unemployment, but that’s not central to the argument here.)

The flaws in the “Wilson / Romanchuck” argument is thus.

First, the broad claim that raising the minimum wage never stokes inflation or raises unemployment must become nonsensical at some point, as the minimum wage is raised. E.g. if the minimum wage was $200/hr the effect would be catastrophic. Thus there is what might be called a “maximum feasible minimum wage”.

Now if we’re going to have any sort of minimum wage, clearly the best way to effect that is the conventional way: that is, min wage laws. I.e. it’s frankly a bit odd to set up a form of employment (JG) which may make work easily available to absolutely everyone, but probably won’t, and which pays the desired min wage, and then hope that anyone working for less gets themselves a JG job. Put another way, if we think that working for less than $X/hr is unacceptable, then the obvious and simplest way to enforce that is a law which says “no one shall be paid less than $X/hr”.

Moreover, that $X level of pay ought to be at the above mentioned “maximum feasible level”.

But that puts JG into check mate in the following sense. JG cannot pay more than $X/hr because that puts the pay above the “maximum feasible level”: i.e. the effect of pay in excess of $X/hr would be to induce employers to shed a significant number of low paid “regular” workers.

In short, there are no logical circumstances in which the “Wilson / Romanchuk high JG pay doesn’t destroy regular jobs” theory holds.

And finally my latest and needless to say “seminal” paper on this subject is here.


References.

1. Article title: Some Thoughts on the Job Guarantee.
2. Article title: Workfare: A Marginal Employment Subsidy…”;.
3. Article  title: Thoughts about the Job Guarantee: A Reply.
4. Article: On Using NAIRU to Analyse a Job Guarantee.

Francis Coppola’s “money from thin air” argument.

 Her "thin air" argument appears in the initial paragraphs of an article of hers entitled “Money Creation in a Post Crisis World”.

Her argument is that the money created by commercial banks is not “created from thin air” because the money is backed by a debt. That is a flawed argument for the following reasons.

When a bank grants a loan, it credits the account of the borrower and in doing so “creates money”. But not unreasonably, the bank will want that money back at some stage, and to represent that obligation to repay, the bank debits another account with the borrower’s name on it. That’s the debt owed by the borrower to the bank.

But both book-keeping entries are just that: book-keeping entries. That is, both obligations arise out of thin air. Why does the fact that they are equal and opposite obligations created out of thin air make them “non-thin-air” rather than “thin air”? Darned if I know.

Next, there is no question but that governments and central banks create money out of thin air (as Francis herself points out – para starting “But in fact…”).  Thus there is nothing inherently wrong with creating money out of thin air. What MAY BE wrong in the case of private banks creating money out of thin air is that they reap an unjustified profit from doing so. And in fact I argue (as have others) that there is indeed such an unjustified profit there in a paper entitled “Taxpayers subsidize private money creation.”

Thus the “thin-airness” of money is irrelevant: the important point is the possible unjustified profit.

 
Donations to charity.

Next, there is nothing to stop a commercial bank crediting someone’s account WITHOUT there being any corresponding debt owed to the bank. That would be a gift by the bank to the account holder. Indeed, some banks may actually do that, for all I know, when they make gifts to a charity which happens to have an account at the relevant bank.

In that case, the book keeping entries would be: “credit charity Y” and debit “gifts to charities” account, which in turn will be debited to the profit and loss account at the end of the year.

Of course gifts to charities by banks are a small proportion of banks’ turnover. “Gifts” to politicians and political parties with a view to getting bank favorable legislation passed are doubtless more common, though even those will be a small proportion of banks’ turnover. But the important point here is that contrary to Francis’s claim, a debt owed to a bank is not needed in order for the bank to create money “out of thin air”.


Unproductive loans.

Next Francis Coppola criticises the claim by Zoe Williams in the Guardian that too much is loaned to allegedly unproductive sectors of the economy like mortgages, with not enough going to SMEs. I fully agree with Francis there. The fact is that the proportion of SMEs which fail to repay loans is double the equivalent proportion for mortgagors. I.e. there just aren’t all that number of viable potential loans to SMEs out there.

It is also a mistake by Zoe Williams to claim that mortgages which fund the purchase of existing houses are less productive than mortgages which fund to construction of new houses. Basic reason is that the purchase existing houses pushes up the price of houses, which in turn induces builders to build more houses. I go into that in more detail in an article entitled “Borrowing to BUILD houses is no more productive…”.


Positive Money and debt.

Next, Francis says “Those who propose "sovereign money" to replace money creation through bank lending appear to be driven by an irrational, though perhaps understandable, fear of debt. And they also, to my mind, place far too much faith in central planners, as this comment from Zoe Williams shows.”

The comment by Zoe Williams is thus:

“The nature of centrally created money should itself be opened up for debate, whose starting point is: if we agree that commercially created money is skewing the economy, can we then agree that it should be created by a public authority, even if we don’t yet know what that authority would look like.”

Re “Those who propose “sovereign money””, that’s a reference to Positive Money which (far as I know) is the only organisation to use the phrase “Sovereign Money”, though it’s not the only organisation to advocate full reserve banking (a system under which private money creation is banned).

Re Francis’s reference to “irrational fear of debt”, I agree that about 95% of those who write on the subject of debt are motivated by the negative emotional overtones of the word debt rather than by reason or logic. Indeed that phenomenon is even worse in Germany, where the word debt (schuld) also means “guilt”. Yup: I’m afraid about 95% of the human race are motivated by emotion rather than reason.


Central planners.

Also in the above passage quoted from Francis’s article, she refers to “placing far too much faith” in mysterious “central planners” who would decide on the amount of money to periodically create in a “central bank money only” system (i.e. full reserve banking).

Well I have news: money created by the state and spent into the economy is simply a way of imparting STIMULUS, something a committee of “central planners” already does.!!! Those “central planners” are more popularly referred to in the case of the UK as the “Bank of England Monetary Policy Committee” and the "Treasury". Plus the latter to bodies actually effect stimulus in much the same way as Positive Money proposes.

Now what happens if the Treasury and BoE agree that stimulus is needed? Well the Treasury borrows and spends more, and the BoE (with a view to making sure that extra borrowing does not raise interest rates) will very likely print money and buy back some of that debt. And what d’yer know? The net effect of that is: “the state prints money and spends it into the economy”. Indeed, over the last few years, the BoE has bought back virtually ALL the debt incurred by the Treausury via QE.

Hey presto: the existing system is little more than a roundabout way of doing what Positive Money (and others) propose.

But there is absolutely no “central planning” there: at least there is no central planning in the old Communist / Eastern Europe sense of the phrase: that is, some central organisation deciding whether to expand a steel plant or supermarket in Vladivostok or Manchester.

Put another way, under both the existing system and Positive Money’s proposed system the only job the people “at the center” do is to implement stimulus as required.

Conclusion: both Francis and Zoe William’s references to “central planners” are flawed.

Former governor of Spain’s central bank is impressed by Positive Money and full reserve banking.

 At least that’s the basic thrust of this video clip which lasts about three minutes.




 
I have just three minor quibbles. First the former governor seems to suggest that modern technology has made it possible for full reserve to work and for everyone to have an account at the central bank – (apologies to him if I’ve got him wrong there).

In fact, full reserve (as indeed the former governor himself points out) is an idea that has been going for decades. E.g. , as he says, the idea was advocated by Milton Friedman.

Thus unless Milton Friedman and other like minded economists were clueless on the practicalities of full reserve, modern technology is clearly not needed in order for full reserve to work: computers and the internet were essentially non-existent when full reserve was first suggested by the Chicago school in the 1930s, or indeed when Friedman advocated the idea in the 1940s, 50s and 60s.

A second quibble is that Positive Money published an article some time ago claiming their preferred bank system was not the same as full reserve. I’ve never been able to work out what the important difference is between PM’s preferred system and full reserve. I.e. I think PM is splitting hairs there.

A final quibble is that the former governor refers to PM as a “left of centre” organisation.  That’s not true in the sense that the arguments for full reserve are entirely technical: they should appeal (or not) to those on the right as well as the left. Indeed, Friedman was not exactly noted for being a leftie.!!

Do let’s force mortgagors to pay more interest so as to enable monetary policy to work better.

Many economists at the moment seem to want to raise interest rates back to their “normal” level, and in some cases, they want to do that simply to enable central banks to cut interest rates come a recession. I.e. they want mortgagors to be forced to pay more interest just to enable monetary policy to impart stimulus, when in fact fiscal policy can perfectly well impart stimulus.

There’s an example of this sort of thinking in a tweet by Simon Wren-Lewis where he says “I would add a fiscal policy that sees its primary goal as avoiding interest rates hitting their lower bound….”

So what’s the problem with the “lower bound”? Milton Friedman and Warren Mosler advocated a permanent zero rate. I.e. they argued that government should pay no interest to anyone: it should simply issue whatever amount of non-interest yielding base money is needed to keep the economy at capacity.

A case could be made for artificially high interest rates and hence interest rate cuts working better when needed if it can be shown that interest rate cuts work much more predictably and/or quickly that fiscal stimulus. But there’s little evidence for that, far as I know.

So the conclusion is that the policy set out by Positive Money, the New Economics Foundation and Prof Richard Werner, namely that the state should simply print base money and spend it into the economy (and/or cut taxes) when stimulus is needed, while interest rates are left to their own devices, is the best one.

That policy is certainly supported by a significant proportion of MMTers, though I’m not sure that’s “official MMT policy”, if there is such a thing.

Note that the above “print and spend and/or cut taxes” is not what might be called “pure fiscal policy”: in that new money is created, there’s a bit of monetary policy there. So a better description of the latter Positive Money / MMT policy might be “monetary and fiscal policy joined at the hip”.

Also, the latter print and spend policy is not to rule out interest rate rises in an emergency. I.e. if there was a serious outbreak of irrational exuberance, having the central bank wade into the market and offer to borrow at above the going rate might be a useful tool. However, I suggest that “print and spend” should always be the objective.

Subversive ideas on money and banking for children.

With a view to leading the country's youth astray, I've done a short Powerpoint presentation on money and banking for children - (3 minute read). It can be downloaded from here . There's just six slides: reproduced below.

How to download.

I’m not the slightest bit computer literate, and the only way I can see of downloading is as follows. There has to be a quicker way, and I’d be grateful for guidance on that. Anyway my “slow” way is thus.

Having got to the site linked to above, click on "help" (top centre). In "search the menus", enter "download". Then choose the format you require (e.g. pdf, pptx, etc). Then retrieve the file from the download  file on your computer.

Goldman Sachs claims to be concerned about the poor. I can't stop laughing.

This is better than "doing God's work".
 
That’s in an article they published entitled “Who Pays for Bank Regulation?”.

Their basic argument seems to  be that the cost of bank regulation has to be born by SOMEONE, but the wealthy and large bank customers can go elsewhere for loans, whereas less well off households can’t. As they put it, “…we find in general that low-income consumers and small businesses – which generally have fewer or less effective alternatives to bank credit – have paid the largest price for increased bank regulation.”

The flaw in that argument is that while higher bank capital ratios do clearly have a deflationary effect, that is easily countered by standard stimulatory measures – which in effect put more base money into the hands of every household and business. Thus while higher bank capital ratios no doubt make life more difficult for less well off households who want to borrow heavily, less well off households who currently borrow relatively little will be better off: they’ll find themselves in possession of more money, which will mean they don’t need to borrow so much, and in some cases, don’t need to borrow at all.

Of course it’s difficult to prove that those two effects exactly cancel out, but if the widespread belief that there’s too much debt is valid, then higher bank capital ratios will on  balance bring benefits: there’ll be less borrowing and less debt.

Random charts - 45.

The first two charts are from this "Billyblog" article.

Text in pink on the charts below was added by me.

Francis Coppola tries to defend private money printing.

That’s in two recent articles of hers. One is on her blog (1) and the second at Forbes (2).  Those two articles are very similar.

The first problem with her articles is that she confines herself to criticizing an “anti private money” article by Zoe Williams in the Guardian (3). But Zoe Williams is just a bog standard broadsheet newspaper journalist: someone without specialist knowledge of banking, though Williams obviously mugged up the subject quite well in preparing her article.

In contrast, Coppola does not mention the numerous leading economists including at least four Nobel laureates have argued for a ban on privately issued money. I.e. Coppola is attacking a soft target. Or maybe she didn’t actually know that several leading economists back a ban on private money.

Anyway, I’ll run through the Forbes article.

First, Coppola criticizes Zoe Williams for saying that money created by private banks is “spirited from thin air”. The flaw in that idea, according to Coppola, is that private banks create money when they lend, ergo such money is backed by a loan, which apparently means it is not “spirited”.

Well that’s a strange argument, isn't it? When a private bank grants a loan, it simply adds numbers to the account of the borrower. That constitutes “spiriting from thin air” in my books.  Also the bank debits its loan ledger. That loan to the borrower is an asset as viewed by the bank. But that loan is also “spirited from thin air”. The fact that a second bit of “spiriting” takes place at the same time as the first does not stop the first being “spiriting”, seems to me.  The whole exercise simply consists of entering numbers in accounts, i.e. “spiriting”.

In contrast, in the case of a commodity based money system, say gold coins, a bank would not lend gold coins unless it actually had gold coins in stock. That gold coin scenario most certainly does NOT constitute “spiriting from thin air”.

Likewise, under full reserve banking, the only form of money is central bank created money (base money). In that scenario it’s the central bank that does the spiriting, not private banks.


Excess inflation and excess debt.

Next, Coppola criticises Williams for saying that private banks can stoke inflation via their money creation activities, whereas according to Coppola it is just governments and central banks that can stoke hyper-inflation.

Well seems to me that Williams gets that point about right. In reference to central bank / government money creation, Williams says:

“This does not mean that creation is risk-free: any government could create too much and spawn hyper-inflation. Any commercial bank could create too much and generate over-indebtedness in the private economy, which is what has happened.”


Controlling aggregate demand.

Next, Coppola says, “Williams calls for a “public authority” to create money. But, given how difficult it is to estimate the present and future productive capacity of the economy, I find it hard to see how a public authority can be a better creator of purchasing power than banks. Flawed though it is, money creation through bank lending at least responds to demand.”

Well if it’s “difficult to estimate the future productive capacity of the economy”, why do we have “public authorities”, i.e. the Treasury and central bank determine how much stimulus is appropriate (fiscal and monetary stimulus respectively)?

Moreover, under the existing system, the latter two public authorities actually expand the money supply (Coppola will be shocked to learn) when implementing stimulus. That is, the Treasury borrows and spends more, and/or the central bank prints money and buys back government debt so as to make sure interest rates don’t rise, or they may take that further and implement an interest rate cut. And the latter enables commercial banks to create and lend out more money. In short, money creation is very much under the control of “public authorities” under the existing system. So the differences between the existing system and OVERT money creation by public authorities is less than Coppola seems to think.

Next, let’s consider Coppola’s phrase “money creation through bank lending at least responds to demand.” Presumably she is not advocating that when anyone wants a loan, a private bank should automatically create money and dish it out without looking at the credit-worthiness of the borrower.

I.e. the basic question here is this. Given an increased desire to borrow, should private banks automatically accommodate that demand, as Coppola seems to suggest? Well there’s a big problem there namely that it is PRECISELY the erratic nature of the desire to borrow, and private banks’ freedom to accommodate that desire that is behind the boom bust cycle.

That is, private banks create and lend out money like there’s no tomorrow in a boom, exactly what’s not needed. Then come the bust, they clamp down on loans and call in loans: again, exactly what we do not need. In short, the behaviour of private banks is “pro-cyclical” to use the jargon.

To summarise, money creation under the existing system is very much under the control of “public authorities”, thus full control of money creation as under full reserve banking would not be a big change.

In fact the only remaining question here is whether money should come only in the form of state issued money, or whether that should in addition be levered up by private banks. Well turns out there is a good reason to prefer the former option, a reason which has to do with the basic purpose of economic activity.

The purpose of the economy is to produce what people want, both in the form of the items they purchase out of disposable income, and the items they vote at election time to have delivered to them via public spending. Thus given inadequate demand, the obvious remedy is to increase both household spending e.g. via tax cuts and increase public spending, with private banks competing for those new funds on equal terms with other businesses as occurs under full reserve, rather than private banks being given the special privilege of being able to boost the above money supply increase by printing more of their own DIY money.

The latter is a subsidy of private banks, and it is widely accepted in economics that subsidies are not justified, unless there is a clear social reason for them.

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References.

1. “Money Creation in a Post Crisis World.”
2. Article title: “How Bank Lending Really Creates Money, And Why The Magic Money Tree Is Not Cost Free”.
3. “How the actual money tree works”.
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No rate rise without a pay rise, says Positive Money.

Nice catchy phrase, but is there any substance behind it? The quick answer is “not much”.

The most relevant article on the above topic published by Positive Money seems to be this one entitled (unsurprisingly), “No rate rise without a pay rise”. And what will bring about a pay rise apparently is a “robust programme of government spending”.

Well the obvious problem there is that the Bank of England’s judgement is that the economy is at capacity, or put another way that any further increase in demand (e.g. in the form of more government spending) will be inflationary, which would raise “pay” in terms of pounds, but would probably not raise pay in real terms, and might even reduce real pay because of the costs of excess inflation.

A much better argument against an interest rate rise was produced a few days ago by Simon Wren-Lewis who claimed that inflation is currently to a significant extent cost push, and thus that a rise in demand, or at least leaving interest rates and demand at present levels, will not be inflationary.

Shock, horror: UK finance minister may abandon “fiscal targets” (yet again).

That’s according to this Financial Times article entitled “Philip Hammond ‘between a rock and a hard place’…”.

Given that UK finance ministers have abandoned fiscal targets about ten times in as many years recently, you’d think that by now some of those in high places (e.g. at the FT and the Treasury) would have tumbled to the fact that there’s something a bit wrong with “fiscal targets”. But seems they just don’t get it.

Incidentally Ann Pettifor recently penned an article criticizing the above “target” nonsense entitled “The Deficit and the IFS….”.     .  You may prefer her article, though the paragraphs below cover a few points which she doesn’t, and vice-versa.

I’ve been thru this target nonsense before, but I’ll go thru it again. After all, constant repetition is a much better form of persuasion than logic or reason.

The deficit, as explained by Keynes, needs to be whatever keeps unemployment as low as is consistent with not too much inflation. As he put it, “Look after unemployment and the budget will look after itself.” And that’s very much how MMTers see things. So the “target” for the deficit should simply be whatever deals with excess unemployment.

But that raises an obvious question, at least in the minds of debt and deficit-phobes, namely what happens if the national debt and deficit are higher than normal? Should we worry?

Well a POSSIBLE problem with a higher than normal debt is the debt holders will demand a higher than normal rate of interest for holding that debt. But if they AREN’T demanding that elevated rate of interest (as is the case at the moment) or put another way, as long as the real or “inflation adjusted” rate of interest is near zero, then why worry? Darned if I know.

And if debt holders DO START to demand a higher rate of interest, the solution is easy: tell them to shove off. Or to be more exact, print money and pay off debt as it matures, and tell those who have been paid off that if they want to buy more UK government debt, then they can’t.

The latter strategy of course amounts to QE which is mildly stimulatory and hence possibly inflationary. But that’s easily countered by raising taxes and “unprinting” the money collected. In that debt is held by native UK people and institutions, there won’t be any effect on aggregate demand or average living standards, though there will be re-distributive effects.

In contrast, and in as far as UK debt is held by foreigners or other internationally mobile investors, those investors when they find they can’t buy UK debt, will tend to sell Sterling and seek investments elsewhere in the World, and that will result in Sterling falling a bit on foreign exchange markets, which in turn means a finite drop in UK living standards. On the other hand if the debtor country manages to get a loan at a zero or near zero real rate of interest for several years, why complain?


The correct “targets”.

If some sort of randomly chosen figure for the deficit and debt as a percentage of GDP is not the right “target”, what is? Well one was set out above: that’s Keynes’s point that the deficit needs to be whatever brings full employment.

As to the debt, it is important to realize that government debt and base money are virtually the same thing, as Martin Wolf once explained. Thus the basic question here is: what should the total of debt plus base be? Incidentally MMTers have tumbled to the importance of the latter quantity “debt plus base” and sometimes refer to it as “Private Sector Net Financial Assets”.

As to the debt, i.e. the interest yielding part of PSNFA, it is debatable as to whether there should be any at all. Milton Friedman and Warren Mosler argued for zero debt. I pretty much agree with them, one reason being this: if the state can print money or grab any amount of money from the citizenry via tax, why borrow the stuff and pay interest on it?

Put another way, as Keynes said, a deficit can be funded by printed or borrowed money, and no one, far as I know has explained the reasons for borrowing. The idea that because the state invests in infrastructure and similar is not a reason to borrow: if a taxi driver needs a new taxi and happens to have enough cash to buy one, why would he want to borrow money? He wouldn’t: because taxi drivers have more sense than economists. I’ve been through the possible arguments for borrowing before on this blog, and none of the arguments are impressive.

Thus borrowing makes sense only if there’s no other way of coming by cash.

Returning now to the subject of targets, what’s the ideal size of PSNFA, or put another way, what should the “target PSNFA” be? Well the more PSNFA there is, all else equal, the more the private sector will spend. After all, there is a limit to the amount of state liabilities (PSNFA) that households and businesses will want to hold. And how do we know what that ideal PSNFA size is?

Well we don’t need to know. If the state simply prints and spends base money when unemployment is too high, and does the opposite, i.e. raises taxes and “unprints” money when inflation is too high, then PSNFA always tend towards its ideal size. Whether that is 10%, 60% or 260% of GDP, well that’s wholly irrelevant.


To summarize.

We should forget about arbitrarily chosen and wholly illogical numbers for the debt and deficit and simply follow Keynes’s above prescription, namely print and spend money, and/or cut taxes when unemployment is excessive.

That’s beautifully simple isn't it? And anyone with a grasp of, or interest in science knows that science attaches importance to simple equations or rules which seem to explain a lot. Why is Einstein’s equation E equals MC squared held to be importance? Reason is first that it is simple, and second it seems to explain a lot: it explains things about the movement of plants round the sun and things about sub-atomic particles. That is unlikely to be a coincident: it’s more likely that Einstein’s equation is a fundamental property of the universe.