Sunday, 21 January 2018
The fact that stricter bank regulations raise interest rates does not mean GDP is reduced as a result.
It’s obviously tempting to think that if stricter bank regulations raise interest rates, that’s an additional cost for mortgagors and businesses which need to borrow. Thus it would seem we’re all worse off. The UK’s “Vickers Commission” fell hook, line and sinker for that argument. So too does Congressman Keith Rothfus: see the second para of this recent “Money and Banking” article (entitled “Money Funds – The Empire Strikes Back”).
Of course I’m aware that Rothfus’s motives for wanting to get back to the old “heads the banks win and tails the taxpayer loses” arrangement is possibly not entirely altruistic: he may have had wads of $100 stuffed into his back pocket by banks. But corruption is not the central issue I’m addressing here.
I’ve been thru the flaws in the above “higher interest rates makes us worse off” argument at least once before in this blog, but I’ll run thru them again.
The first obvious flaw in that argument is that every additional pound or dollar of interest paid is an additional pound or dollar for creditors, thus to that extent interest rate changes have no effect on GDP.
However it is widely accepted that a rise in interest rates does have a deflationary effect: indeed interest rate adjustments are one of the main weapons used to regulate aggregate demand. Thus a rise in rates stemming from stricter bank regulations would indeed cut demand and thus GDP. But that effect is very easily countered by standard stimulatory measures, monetary and/or fiscal and the latter measures cost nothing in real terms. As Milton Friedman and others have pointed out ad nausiam (figuratively), having the state print money and spend it and/or cut taxes costs nothing.
To summarise so far, the fact that stricter bank regulation cuts GDP via the above “higher interest rates cuts GDP” channel is completely irrelevant.
The really important question is whether the higher rates that stem from stricter regulations give us something nearer the genuine free market rate of interest. If they do, then GDP will rise: reason being that, as is widely accepted in economics, GDP is maximised when prices are at free market prices, unless there are good social reasons for thinking free market prices should not prevail: i.e. where there is “market failure” to use the jargon.
Now it might seem that conventional or “fractional reserve” banking under which loans are largely funded via deposits and under which those deposits are insured by government (with banks being charged an insurance premium by government) is very much a free market system: at least it seems to be free market in that all costs, in particular the cost of insuring banks seem to charged to banks.
But there’s just one problem: the only reason government can afford to insure dozens of banks with assets and liabilities running to hundreds of billions is that government has access to two near infinitely large sources of cash: first the taxpayer and second the right to print money. Normal, or “free market / commercial” insurers do not enjoy the latter two luxuries.
Indeed, in the US, large banks are not insured via FDIC: what happened during the crisis was that the Fed rescued large banks with loans totaling billions at derisory rates of interest: an obvious subsidy or “non free market” ploy.
In contrast, a system under which bank loans are funded via equity or “floating net asset value” stakes in banks is entirely subsidy free: if a bank makes silly loans, all that happens is the value of its shares or “net asset value stakes” falls. There is no danger of the bank collapsing and no need for taxpayer funded rescues.
And a further point is that funding private banks via deposits actually enables private banks to create or “print” money. That is, private banks can use the profits of seigniorage to subsidise the lending process, as I explained here recently.*
And finally, if the widespread belief that there is too much debt is valid, then a rise in interest rates would cut the total amount of lending and debt, which according to the latter “too much debt” theory would be beneficial.
* Article title: "Why private banks are counterfeiters in 300 words."
Saturday, 20 January 2018
Thursday, 18 January 2018
This article in the Wall Street Journal is a laugh. It’s by Neel Kashkari (president and CEO of the Federal Reserve Bank of Minneapolis and participant in the Federal Open Market Committee.) Article title: “Immigration Is Practically a Free Lunch for America.”
He argues, first, that immigration raises GDP (as distinct from GDP per head). Well that’s pretty obvious: the more people there are in a country, the larger will its GDP be all else equal. In fact even if all else is not equal (e.g. if immigrants are all unproductive, lay-abouts) GDP will STILL RISE. As long as a bunch of immigrants produce at least SOMETHING, however little, then the effect of their arrival will be to raise GDP.
Kashkari then says “Legislators of both parties, policy makers and families all want faster economic growth because it produces more resources to fund national priorities and raise living standards.” He doesn’t tell us what “national priorities” are, but I assume he’s referring to infrastructure, schools, hospitals, etc.
Now assuming you have more brain than Kashkari, you ought to have spotted the flaw there: it’s that the larger the population, the more infrastructure, schools etc are needed!! Thus immigrants have no effect whatever on a country’s ability to afford those items unless the effect of immigration is to raise GDP per head. But Kashkari doesn’t address the question as to whether immigrants increase GDP per head!
Kashkari also trotts out the old canard about stimulus not being possible without increasing the national debt (3rd para). In fact as Keynes pointed out almost 100 years ago, stimulus can be funded either by more debt or by new money created by the central bank. Indeed that’s exactly what numerous countries have done over the last five years or so. That is, their governments have borrowed and spent more, with their central banks then printing money and buying back almost all that new debt. The net effect of that is: “the state prints money and spends it and/or cuts taxes”. Seems Kashkari is not aware of what has been going on. Evidently studying economics is not a requirement when seeking a nice well paid job at the Fed.
Why do I have to waste my time combating this nonsense?
Tuesday, 16 January 2018
Take a country which switches from barter to using money for the first time. It has the choice between state issued money, which I’ll call base money, and money issued by commercial / private banks. Base money is cheaper – indeed it’s costless as Milton Friedman and others pointed out. In contrast, when a private bank supplies money to a customer, the bank has to check up on the customer’s creditworthiness, perhaps take security off the customer, allow for bad debts, etc etc. Those are very real costs.
Having supplied the economy with enough base money to ensure full employment, people and employers would lend to each other, either direct (person to person) or via commercial banks. However, there is then a trick which private banks can pull: supply money to customers WITHOUT first having obtained necessary funds from saver / depositors. I.e. private banks could (as in the real world) in effect just print money. And printing money is clearly a cheaper way of obtaining money than borrowing or earning it. Thus private banks in our hypothetical economy are able to undercut the free market rate of interest. And that would reduce GDP because the GDP maximizing price for anything, including the price of borrowed money, is the free market rate (absent what economists call “market failure”).
But that extra lending would raise demand to above the above mentioned full employment level: excess inflation would ensue. Thus government would have to impose some sort of deflationary measure, like raising taxes and confiscating base money from citizens.
Now that’s exactly what happens when traditional backstreet counterfeiters print and spend $Xmillion of forged dollar bills: government has to confiscate about $Xmillion from citizens. QED.
Saturday, 13 January 2018
The Oxford Review of Economic Policy has published a special issue entitled “Rebuilding Macroeconomic Theory.”
There’s just one fly in the ointment, which is that one of the contributors is Oliver Blanchard (chief economist at the IMF, 2008 – 2015). Now the problem with Blanchard is that he has been one of the main promoters of austerity during the recent crisis and subsequent recession. That’s austerity in the “inadequate aggregate demand” sense rather than the “% of GDP allocated to public spending is too small” sense: i.e. the word austerity actually has two quite distinct meanings – unbeknown to 90% of those who witter on about austerity.
Of course Blanchard, like others who have managed to damage the World economy with excessive amounts of austerity, has never SPECIFICALLY advocated inadequate demand. But what he and like-minded individuals (e.g. Ken Rogoff and Carmen Reinhart) have done is to argue, first that stimulus is funded via more national debt and second, that that debt cannot be allowed to rise above some arbitrary level (90% of GDP is a popular figure). And that artificial limitation on stimulus can clearly lead to austerity when large dollops of stimulus are needed.
As to the idea that stimulus must be funded via debt, that’s nonsense: as Keynes pointed out almost a century ago, it can be funded simply by printing money. And as to the idea that the debt cannot be allowed to rise above 90% of GDP, that’s a bit hard to square with the fact that the UK’s debt stood at about 250% of GDP just after WWII. For some strange reason the sky did not fall in. In fact economic growth during the 1950s and 60s during which time the debt declined dramatically was very respectable.
In short, the very last person who is likely to produce worthwhile ideas when it comes to “rebuilding” economics is Blanchard. But economics is a respectable middle class profession, and members of every profession cover for each other, rather than point to each other’s faults. Or as Adam Smith put it, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public...”
For details on the cluelessness of Blanchard and the IMF, see sundry articles by Bill Mitchell, e.g. here and here.