Wednesday, 29 August 2018

The IMF has a grasp of macro-economics???

Simon Wren-Lewis (former Oxford economics prof) claims in this recent article (1) that the IMF is on balance quite enlightened when it comes to economics. That’s not entirely consistent with this passage of his: “The IMF itself wavered on austerity. At first (before 2010) it encouraged coordinated fiscal stimulus. As the Eurozone crisis began to unfold it changed its mind, and advocated austerity. But this did not last that long.”

My translation of that is “when the comes to austerity, the IMF doesn’t know whether it’s coming or going”. Or maybe that’s over-cynical.

Certainly anyone or any organisation which thinks there is anything at all to be said for austerity (in the sense of pitching aggregate demand lower than is consistent with keeping inflation under control) is basically clueless.

That certainly ties up with Bill Mitchell’s view of the IMF (2), namely that the IMF is so hopeless, it should be closed down. (Mitchell is an Australian economics prof.)

Fiscal space.

Another piece of evidence that the IMF (along with the OECD) do not have much of a grip on macro-economics is that both organisations have long supported the nonsensical “fiscal space” idea. Bill Mitchell pours cold water on the "fiscal space" idea here (3) for example, and I demolished it here (4), here (5), and here (6).
Given that both Bill Mitchell and I are MMTers, the obvious conclusion is that if the IMF and OECD were replaced with a committee of MMTers, millions of people worldwide who have remained unemployed for years on end over the last ten years would had jobs. Millions would not have been kicked out of their homes because of inability to make mortgage interest payments and many a suicide would have been avoided.

Having said that, I’m well aware of the weaknesses of MMT. For example it is often said there’s nothing new in MMT. That’s true in that MMT is just Keynes writ large. However Keynes (or at least his main work, the “General Theory of Employment Interest and Money” is ridiculously complicated). I.e. what MMT has done is to take Keynes and simplify it.

Plus it’s clear that the IMFs and OECDs of this world do not understand Keynes. That is, they don’t get the point that the solution to recessions is easy: just have the state create more money and spend it (and/or cut taxes). So MMT has done a good job in simplifying Keynes: maybe the little dears at the IMF and OECD will then understand it.

In contrast to the above “non-original” idea that the solution to recessions is easy, there’s another idea advocated by several MMTers which is definitely more original: that’s the “permanent zero interest rate” idea.


Titles of articles referred to:

1. The IMF as a transmission mechanism for academic knowledge.
2. IMF still away with the pixies.
3. The ‘fiscal space’ charade – IMF becomes Moody’s advertising agency.
4. More fiscal space nonsense.
5. "Fiscal space" is hogwash.
6. Ghosh – IMF authors define “fiscal space”.

Stop press. (30th Aug 2018). The fiscal space brigade have unfortunately and coincidentally piped up again in the last 48 hours.

Bill Mitchell, quite rightly, tries to get them to shut up for the umpteenth time….:-)

Monday, 27 August 2018

The big flaw in artificial interest rate adjustments.

There is a widely accepted principle in economics, namely that government should intervene in the free market where there is what is called “market failure”. A classic example of market failure is monopolies which exploit their monopoly powers to make unacceptably large profits.

The artificial interest rate adjustments implemented by central banks are an obvious case of intervention in the free market, and the popular justification for that is that central banks do that when there is a clear case of market failure in the form of a recession which market forces are failing to deal with fast enough.

Unfortunately there’s a monster flaw in that argument, namely that the failure of interest rates to fall all that much in recessions is not the market failure that causes recessions to last longer than we would like. Indeed, it’s puzzling that anyone should think THAT IS the relevant market failure because the market for loans is at least on the face of it to be very much a genuine free market. That is, there are millions of would be borrowers and lenders out there and thousands of intermediaries trying to bring lenders and borrowers together. That is just the sort of scenario where markets work well.

In fact the market failure which prolongs recessions is the failure of wages and prices to fall. That is, given a perfectly functioning free market, wages would fall (in terms of money) and prices would fall. That would increase the real value of the money supply (base money in particular), which in turn would encourage spending, which would put an end to the recession. That “falling prices ends recessions” phenomenon is known as the “Pigou effect”.

But of course the Pigou effect does not work in the real world because of Keynes’s well known “wages are sticky downwards” phenomenon. That is, in heavily unionised sectors, it is often plain impossible to cut wages, and even in non-unionised sectors, trying to cut wages can be more trouble for an employer than it is worth.

To summarise, there is no obvious market failure when it comes to interest rates, but there is a glaring market failure in the form of wages and prices not falling in recessions.

Thus the logical cure for recessions is not artificial interest rate adjustments: the logical cure is something like the Pigou effect, that is increasing the real value of the private sector’s stock of money. And that is easily done via a helicopter drop.

However, it seems a bit silly to set up an entirely new system for distributing money to all and sundry, given that we already have such systems in place. That is, plain old public spending (funded with new base money) feeds money into the private sector, and where public spending takes the form of simple transfer payments (e.g. state pensions or unemployment benefits), increased spending there would amount to a helicopter drop.

As for those on the political right who aren’t too keen on more public spending, money can always be distributed to households via tax cuts.

Another advantage of increased public spending as compared to helicopter drops is that there is what might be called an “immediate fiscal effect”. To illustrate, if government and central bank create money and hire a thousand extra teachers, employment rises the minute those teachers start their jobs, i.e. before the money supply increase effect kicks in.

That “immediate fiscal effect” also applies to tax cuts: there is plenty of empirical evidence that while households obviously save a proportion of the extra income they get from a tax cut, they also spend a significant proportion.  However, there is probably little difference between tax cuts and helicopter drops when it comes to the immediate fiscal effect.

The above arguments against interest rate adjustments form a significant part of a paper of mine which will appear in a journal shortly. There is earlier draft of it at “Open Thesis” entitled “A permanent zero interest rate would maximise GDP”. Watch this space.

Saturday, 25 August 2018

Physics prof at my local university writes about MMT.

Having supported MMT for about ten years and living two miles from Durham City centre (UK), I’m pleased to see a Durham University academic writing about MMT (Charles Adams). The title of his article is "Fiscal policy is a matter of life and death", published by Progressive Pulse.

I agree with the basic argument in his article, i.e. that balanced budgets are a nonsense. I also have a couple of quibbles, as follows.

First, Prof Adams claims “All money is created in the form of debt…”. That’s actually debatable. Certainly money created by commercial banks is a form of debt. In contrast, is central bank money a form of debt? Certainly £10 notes say “I promise to pay the bearer the sum of £10”, and that is signed by the Bank of England chief cashier. But that promise is just there as a nice bit of history: you won’t actually get £10 of gold from the BoE for your £10 note.

It can be argued that BoE money is debt in the sense that it can be used to cancel out another debt: a debt owed by taxpayers to government. But what about those who pay no tax, e.g. people living just on the state pension? Far as I can see there is no definitive answer to the question, is central bank money a debt?

For what it’s worth, the founder of MMT, Warren Mosler suggested central bank money is not a debt when he said that such money is like points in a tennis match: they’re assets as viewed by the players, but are not a liability as viewed by the umpire (i.e. the central bank).

Next, Prof Adams says “The finance sector prefers private debtors to government debt because it can extract a higher rent (a higher interest rate).” A problem with that claim is that the extra interest yielded by private debt simply reflects the higher risk. At least that’s the case in a perfectly functioning market. Thus in theory lenders will be indifferent as between public debt and private debt. Certainly the finance sector (i.e. banks, insurance companies and pension providers) are willing to hold very large amounts of public debt.

Finally, I’m not sure about Prof Adams’s claim (penultimate para) that if extra money (or more broadly “stimulus”) comes from more public debt, government can spend that on health and education, whereas if stimulus comes from a build-up in private debt, that increased spending on education & health is necessarily foregone. Strikes me that if stimulus does come from the latter source, there’d be nothing to stop government spending more on health and education by raising taxes.

I suggest the standard MMT view, at least certainly my view and that of several MMTers and indeed Keynes, is that the deficit simply needs to be whatever brings full employment. That’s why Keynes said “look after the unemployed, and the budget will look after itself”. To illustrate, it could be that in any particular year, enough stimulus comes from private debt build-up that government does not need to run a deficit at all.  (Steve Keen has done a lot of work on the relationship between debt build-up, and aggregate demand).

Alternatively, in some years the private sector will be paying off debts, in which case the government deficit will need to be much larger than normal. 

And finally, Charles Adams is nowhere near the first physicist to get interested in economics: several physics academics have. Physics and economics seem to go together. Certainly physics was the subject I was best at at school, though the teachers there would probably have used the phrase “least bad at” rather than “best at"….:-)

Friday, 24 August 2018

The popularity of structured deposits in China bodes well for full reserve banking.

I’m not an expert on structured deposits, but they seem to be ordinary bank deposits with conditions attached, or with some clearly defined element of risk over and above the risks attached to ordinary bank deposits (which are negligible in the UK, of course). For example, the interest paid on a deposit, or the proportion of the capital sum repaid might be related to stock market performance, or the dollar / Euro exchange rate, or you name it.

If you Google “China” and “structured deposit” you’ll find plenty of articles on the subject.

That all bodes well for full reserve banking, or at least the Lawrence Kotlokoff version of full reserve. Under Kotlikoff’s system, depositors would have a choice as to what is done with their money. E.g. if they want their money to be loaned only to conservative mortgagors, e.g. mortgagors with some minimum equity stake in their homes, depositors would be free to do that under Kotlikoff’s system

The popularity of structured deposits in China seems to indicate that many if not most depositors are well able to make that sort of choice.

Plus giving depositors that sort of choice ought to result in a more stable bank system. Reason is that under the existing system, bankers are relatively free to so to speak use grandma’s savings to bet on derivatives. In contrast, if grandma and other depositors said they want their money to be loaned just to UK based conservative mortgagors (which at a guess is what the typical UK depositor does want), the bankers’ scope for smart-arse derivative based nonsense is reduced.

Wednesday, 22 August 2018

Swedish leftie and Bloomberg reporter discovers that GDP varies with population size.

The Swedish leftie in question is Rafaela Lindberg, and in this Bloomberg article she claims immigrants have improved Swedish GDP.

Well it’s pretty stark staring obvious that immigrants raise GDP – unless every single one of the immigrants sits around doing nothing!!!! To illustrate, if one hundred immigrants arrive, ninety nine of whom do no work, with just one doing a job with an output of $X a week, then GDP will rise by …… wait for it…… $X a week! Bet that surprised you.

What Rafaela dummie Lindberg needs to explain is why having the population of Sweden rise from say 9 million to say 10 million as a result of immigration makes Swedes better off: I mean are citizens of the UK better off than citizens of Sweden simply because the population of the UK is about six times that of Sweden? If so, that’s news to me.

In short, Lindberg fails to consider the fall important factor here, namely OUTPUT PER HEAD: she simply considers total output, or GDP.

But never mind: she’s very photogenic, and appearances are all that really matters in this world. She is also female, which is good for Bloomberg’s “diversity credentials”: again, a factor which is much more important than the actual content of articles.

And finally, this is nowhere near the first time economic illiterates have failed to distinguish between GDP growth and GDP growth PER HEAD: the Labour Party made the same mistake in its submission to the House of Lords select committee on economic affiars inquiry into the economic and fiscal impact of immigration in 2007.

Tuesday, 21 August 2018

Monday, 20 August 2018

Harvard’s incompetent economics professors.

There’s a bunch of economics profs at Harvard who clearly do not understand economics and who were pushing for restrictions on stimulus during the recent crisis: i.e. in effect they were advocating austerity. That bunch includes Kenneth Rogoff and Carmen Reinhart.

Rogoff’s objection to stimulus is the same as the objection often heard from those who have not worked through a basic introductory economics text book: i.e. that stimulus involves an increase in government debt, plus that debt must be repaid at some time, which will allegedly be a burden on the population in future years. Indeed, Rogoff has his own emotionally charged term for debt: he calls it the “debt overhang”, e.g. see here.

Well the first blunder there is that stimulus does not require more debt: as Keynes pointed out in the early 1930s, stimulus can be funded via more debt or simply by having the state (i.e. government and central bank) print money and spend it (and/or cut taxes). Indeed the latter “print and spend” policy is actually what many states have done over the last five years. That is they’ve implemented what might be called traditional fiscal stimulus (i.e. government borrows $X and spends $X while giving $X of bonds to lenders), plus that has been followed by QE (i.e. the central bank prints money and buys back those bonds), and that all nets out to “the state prints money and spends it”.

As regards the emotionally charged phrase “debt overhang”,  normally when people employ emotion, that’s because they have problem making their case using logic or reason.

But the emotion is not limited to “debt overhang”: another emotionally charged phrase used by Rogoff is “financial repression” (see the above linked to article by Rogoff and others). That’s the idea (alluded to above) that repaying the debt incurred to effect stimulus is some sort of burden on households.

Well the first problem there is that government debt (you may be amazed to hear) is almost never repaid. For example the UK’s national debt decline from around 250% of GDP just after WWII to around 50% in the 1990s. But scarcely any of that debt was repaid in the normal sense of the phrase “repay a debt”.

That dramatic decline in the debt / GDP ratio took place almost entirely because of two factors: first, the fact that inflation continually erodes the real value of the debt. Second, there’s the fact that given real economic growth, GDP expands in real terms, which means that even if there’s no inflation, the size of the debt relative to GDP will decline.

But let’s try to help Rogoff with his strange idea: i.e. let’s assume no inflation and no growth. Surely in that case the national debt would need to be repaid, which would be a burden on households? Well the answer is “nope”, and for the following reasons.

The national debt (and the stock of base money) are assets as viewed by the private sector. Thus the more of those assets that the private sector holds, all else equal, the more the private sector will spend, i.e. the higher will demand be. (Incidentally national debt and base money are pretty much the same thing, as explained by Martin Wolf, chief economics correspondent at the Financial Times (see his para starting “The purchases of…”).

So….if after a dose of stimulus (i.e. an increase in the stock of base money and/or national debt) and the economy remains at full employment, what on Earth is the point if “repaying the debt”, i.e. raising taxes and grabbing base money / national debt off the private sector? There is no point in doing that: the effect will be to cut demand and cause a recession!

Alternatively, if demand is too high, and inflation looms, then clearly it’s necessary to damp down demand, and that can be done by raising taxes and grabbing some of that base money / national debt off the private sector. And clearly that will be a burden as viewed by some individual households.

But notice that there is no effect whatever on the real incomes of households as a whole: reason is that the sole purpose of the latter “grabbing” is to keep demand down to the level at which the economy is as near capacity as possible without causing excess inflation.

So we have a slight semantic difficulty here, namely that increased taxes are certainly viewed as a burden by some households. On the other hand there is no burden on the population as a whole in the sense that real incomes do not decline. So is that “grabbing” a burden or not?

Well I suggest that since the basic net effect is to keep households’ incomes at the maximum possible level, there is no burden or “financial repression” as Rogoff calls it. However, I should say that I’ve ignored the effect of foreigners buying national debt, so as to keep things simple.  But even if that complicating factor is taken into account it does not change the basic conclusion here all that much.

And finally, a possible objection to the above argument is the idea that a higher than normal debt can mean a higher than normal amount of interest to be paid on the debt, which is a burden on taxpayers. Well the simple answer to that interest on the debt should never be allowed to rise significantly above zero.

For example, if interest on the debt actually is well above zero, and stimulus is needed, the first thing to do is cut interest rates, and keep cutting them till they are at or near zero. If more stimulus is still needed, then run a deficit (funded, as Keynes suggested, either by more debt or fresh base money). But any debt increase there should not be taken so far that it starts to push up interest rates to any significant extent.

Indeed the latter policy of keeping interest on the debt at or near zero is pretty much what the UK Labour Party’s new “fiscal rule” consists of. For more on that, see this article by Simon Wren-Lewis, who is a former Oxford economics prof, and co-author of the fiscal rule.

And Milton Friedman and Warren Mosler (founder of Modern Monetary Theory) advocated an even more extreme version of the “fiscal rule”: they advocated a permanent zero interest rate. E.g. see Mosler’s second last paragraph here.

Wednesday, 15 August 2018

Simon Wren-Lewis on fiscal versus monetary policy.

SW-L (emeritus economics prof at Oxford) has just published an article on his blog on the above topic. While I often leave comments after his articles, I have so many comments to make on this article that they could occupy more space than the article itself. So I’ve reproduced his article below, with my comments at relevant points in green italics. He starts…..

One divide between mainstream and many heterodox economists is on whether monetary or fiscal policy should be used for macroeconomic stabilisation (controlling demand to influence inflation and output). What makes a good instrument in this context? As I have argued before, a key difference between the mainstream and MMT involves different answers to this question. I think the following issues are critical.

1. How quickly do changes in the instrument (e.g. increases in interest rates) influence demand?

2. How quickly can the instrument be changed? Are there limits to how far it can be changed?

3. How reliable is the impact of the instrument on demand? In other words how uncertain is the impact of a change in the instrument on demand?

4. How certain can we be that whoever has power over the instrument will use it in the necessary way?

5.  Does changing the instrument have ‘side effects’ which are undesirable?

If we apply these questions to whether to use interest rates or some element of fiscal policy, what answer do we get?

Before doing that, it is worth noting this is all about the quickest and most reliable way to influence demand. It is quite separate to how demand influences inflation (as long as we are talking about underlying inflation).

The first question is important because long lags between changing the instrument and it influencing demand mess up good policymaking. Imagine how good your central heating would be if there was a day’s delay between it getting cold and the heating coming on. It is also perhaps the most interesting question for a macroeconomist. A full discussion would take a textbook, so to avoid that I’m going to suggest that the answer is not critical to why the mainstream prefers monetary to fiscal stabilisation.  

The second question is as important for obvious reasons. If an instrument can only be changed every year, that is like having very long lags before the instrument has an effect. On this question monetary policy seems to have a clear advantage given current institutional arrangements. Some of this difference is difficult to change: it takes time for a bureaucracy to move. As I noted with the fiscal expansion implemented by China after the crisis, about half of the projects were underway within a year. Others delays are in principle easier to change: there is no reason why tax changes need only happen during Budgets in the UK, for example.

First, SW-L obviously has a good grasp of what heterodox economists are thinking, when he suggests they have a preference for fiscal over monetary policy.

Next, SW-L says “Some of this difference is difficult to change: it takes time for a bureaucracy to move.” That is rather contradicted by his next sentence which says that half the fiscal expansion measures implemented in China recent were up and running within a  year.

Re “If an instrument can be changed every year…”, presumably SW-L has in mind the annual UK budget “ceremony” in the House of Commons, and I assume the suggestion is that some fiscal changes can only take once a year (apologies to SW-L if I’m putting words into his mouth). In fact that “budget ceremony” is peculiar to the UK: there is no good reason fiscal changes cannot be made at any time. Indeed during the recent crisis, the UK’s VAT rate was changed twice outside the “budget ceremony window”.

Another point here is that if fiscal changes are difficult and slow to implement, that messes up the Job Guarantee. JG is a system where jobs are supposed to be created VERY QUICKLY given a rise in unemployment. Those jobs can be with existing employers (public and/or private) or on specially set up schemes as was the case with the WPA in the US in the 1930s. (For a discussion of the relative merits of “existing employer versus special scheme” see the several articles I’ve written on that topic. Briefly I argue that the “existing  employer” option is better because one gets a better mix of skilled labour, unskilled labour, capital equipment etc, plus more realistic work experience.)

In fact, it shouldn’t be beyond the wit of man to set up a system where local and city governments, central government departments, state schools, state run hospitals etc can be instructed very quickly to spend more and take on a few extra staff, either in the form of JG people or as regular employees (who might then have to be sacked when the fiscal stimulus is withdrawn).

In contrast, other forms of fiscal spending, e.g. construction projects take much longer to get going.

SW-L continues….

The second part of the second question is a clear negative for interest rates, because they have a lower bound. This is not the case for fiscal instruments: you can always cut taxes further for example. Because this is a critical failure for interest rate policy, effectively the discussion in this post is just about what happens when interest rates are not at the lower bound. Even so, potentially having two different instruments for different situations is a count against monetary policy.

There’s another “count” against monetary policy, which I go into in detail here – “here” being a thesis which will hopefully be published (in updated form) in a journal quite soon. The latter count is thus.

As explained in the latter thesis, most of the arguments for government borrowing do not stand inspection. Thus we are in the strange position where interest rates have been artificially elevated for decades, but the state (i.e. government and central bank) cannot reduce interest rates unless they are first artificially elevated, which is an absurdity. Put another way, if we had a permanent zero interest rate policy (advocated by Milton Friedman and several MMTers and in the above thesis), then cutting interest rates would be impossible.

SW-L continues…

The third question is often not asked, but it is absolutely critical. Imagine raising the temperature on a room thermostat which not only had no calibration, but which acted in different ways each day or even each hour. OMT is a clear example of a poor instrument because central banks have far less idea of how effective it is than interest rate changes, partly because of less data but also because of likely non-linearities.

Are interest rate changes more or less reliable than fiscal changes? The big advantage of government spending changes is that their direct impact on demand is known, but as we have already noted such measures are slow to implement. Tax changes are quicker to makes, but many mainstream economists would argue that their impact is no more reliable than the impact of interest rate changes. In contrast some heterodox economists (especially MMTers) would argue interest rate changes are so unreliable even the sign of the impact is unclear.

The fourth question is only relevant if the power to change interest rates is delegated to central banks. Let me assume we have a UK type situation, where the central bank has control over interest rates but it has to follow a mandate set by the government. A strong argument is that, by delegating the task of achieving that mandate to an independent institution, policy is less likely to be influenced extraneous factors (e.g. there is no way interest rates rise until after the party conference/election) and therefore policy becomes more credible. (There is a whole literature involving similar ideas.)

This advantage for monetary policy simply follows from the fact that it can be easily delegated. However even if it is not delegated, fiscal policy has the disadvantage that changes are either popular (e,g, tax cuts) or unpopular (tax rises). In contrast interest rate changes involve gains for some and losses for others. That makes politicians reluctant to take deflationary fiscal action, and too keen to take inflationary fiscal action. So even without delegation, it seems likely that interest rate changes are more likely to be used appropriately to manage demand than fiscal changes.

That problem with fiscal policy was solved by Ben Dyson, founder of Positive Money. As he explained, decisions on the size of the deficit (or surplus) can in principle easily be delegated to some sort of independent committee of economists. (At least I think Dyson was the first person to solve that problem – I may be wrong.)

That committee could perfectly well be the Bank of England Monetary Policy Committee. Moreover, decisions on the size of the deficit are increasingly being handed over to such committees the World over: for example in the UK there’s the Office for Budget Responsibility.

Note that handing the latter decision to the latter sort of committee does not, repeat not mean the committee has powers over strictly political matters, like what percentage of GDP goes to public spending and how that is split between education, health, defence and so on (as Dyson explains).

The fifth and final issue could involve many things. In basic New Keynesian models the real interest rate is the price that ensures demand is at the constant inflation level. Therefore nominal interest rates are the obvious instrument to use. Changing fiscal policy, on the other hand, creates distortions to the optimal public/private goods mix or to tax smoothing.

I’m baffled. Strikes me it is easy to implement fiscal stimulus (i.e. increase the deficit) while not altering the “public/private mix”. To illustrate if the public/private mix is 50:50, then expand public spending by the same amount as taxes are cut. Though to be realistic it’s a bit more complicated: e.g. taxpayers do not spend 100% of the amount by which their weekly income rises as a result of tax cuts. But it’s not IMPOSSIBLY difficult to get quite near to retaining the 50:50 mix. Plus I don't see why interest rate changes are guaranteed to leave the public/private mix untouched.

SW-L continues…..

So the case against fiscal policy as the main stabilisation tool outwith the lower bound might go as follows: it is slower to change and it cannot be delegated. Even if monetary policy is not delegated politicians may allow popularity issues to get in the way of effective fiscal stabilisation. While government spending changes have a certain direct effect, they are also the most difficult to implement quickly.

A potentially strong argument against monetary policy is the lower bound problem. You could argue that having monetary policy as the designated stabilisation instrument gets government out of the habit of doing fiscal stabilisation, so that when you do hit the lower bound and fiscal stabilisation is essential it does not happen. Recent experience only confirms that concern. I personally do not think mainstream macroeconomists talk enough about this problem.

The fiscal rule that Jonathan Portes and I developed, a version of which is Labour's fiscal credibility rule, does attempt to address this very issue. Switching from monetary to fiscal at the lower bound is a key part of the rule. It is also worth stressing that this rule does not prevent temporary changes in fiscal policy to counteract a downturn outwith the lower bound. (Anyone who says otherwise does not understand the rule.) For example if interest rates are already low, a fiscal expansion that is planned to last less than five years is consistent with the rule, and might be a sensible precautionary measure. (Public investment, which is outside the rule, could also be used in this way.) So Labour’s fiscal rule allows monetary policy to do its job, but fiscal policy is always there as a back up if needed.

And my final comment is that I like the fiscal rule thought up by SW-L and Portes. It’s a good idea. But as a self-confessed heterodox economist (and general oddball) I’d prefer fiscal policy to dominate, with interest rate adjustments being only used in emergencies.

Saturday, 11 August 2018

Labour’s strange new fiscal rule.

Warning note added on 13th August. There's a serious mistake below (unlike me of course...:-)). I assumed that if a long lasting and deep recession lasts more than five years, then the fiscal rule would prevent adequate stimulus being implemented. That possibility is actually catered for by Simon Wren-Lewis's so called "knockout" clause, which is that if interest rates are at or near zero, and more deficit is need in such a long lasting recession, then the five year rule is ignored. Put another way, the rule is that if interest rates are well above zero, then a deficit plus interest rate cuts are used to combat the recession, but if interest rate cuts cannot be used because they are at zero, then there's no limit to the deficit. However, I'll leave the paragraphs below unaltered, i.e. I'll leave the mistake there.


The rule is that the budget should balance over the medium term (five years to be exact), while borrowing should only be permitted to fund investment.

Well the first bit of nonsense there is that education is one huge investment, but for some strange reason the advocates of “borrow to invest” never claim the entire education budget should be funded via borrowing. For some more flaws in the idea that public investments should be via borrowing, see sections 4 to 4.6 here.

Next, Labour’s fiscal rule contravenes Keynes’s dictum: “Look after unemployment, and the budget will look after itself”. I.e. given a recession, as Keynes said, the state needs to print or borrow money without limit and spend it (and/or cut taxes) until the recession is cured. If that involves running a deficit for MORE THAN five years, then Keynes’s response would doubtless be “then so be it”, and quite right.

Next, if the budget balances over the very long term, the real value of the monetary base will eventually shrink to nothing because of inflation! I.e. inflation gradually erodes the real value of base money, thus if the stock of base money (and the national debt) relative to real GDP is to be maintained, then a  more or less constant deficit is needed. Plus real economic growth increases GDP, which further increases the need for a deficit if the “base money to GDP” ratio is to be maintained.

Note that the actual size of the deficit needed to keep the stock of base money and debt constant relative to GDP is quite large, as I’ve explained a dozen times on this blog. To illustrate with some not unrealistic figures, if inflation is at the 2% target and the stock of base money and debt are 50% of GDP, and real growth is 2%, then the deficit needed to achieve the latter “constant” relationship is (2+2)x50%=2% of GDP.

Simon Wren-Lewis (emeritus Oxford economics prof and co-author of the rule) claims a fiscal rule is needed so as to deal with what he calls “deficit bias”, i.e. the temptation that politicians always fall for (first pointed out by David Hume over two hundred years ago), namely to borrow too much. (Incidentally I have plenty of respect for Wren-Lewis an read most of his articles, but I think he's gone off the rails here.)

Well clearly the temptation to borrow too much needs to be countered, but there’s a simple solution to the problem, namely to have some sort of committee of economists (e.g. the Bank of England Monetary Policy Committee) decide all matters relating to the deficit, stimulus, etc, while politicians stick to strictly POLITICAL matters, like what proportion of GDP is allocated to public spending and how the latter is split between education, health, defence, etc. And what do you know? That’s the system advocated by Positive Money!

Plus it is hard to see why any government should not be happy with that system because where the central bank (CB) is relatively independent, the government has ALREADY handed the final say over the amount of stimulus to the CB: that is, if government implements what the CB thinks is too large a deficit, the CB can, under existing arrangements, nullify that with an interest rate rise.

Moreover, Wren-Lewis himself claimed recently that CBs ought to have the right to tell governments what to do when it comes to strictly economic rather than political matters.

Friday, 10 August 2018

The IMF still exudes BS.

Bill Mitchell (Australian economics prof and leading MMTer) has claimed more than once that the IMF is a waste of space and should be disbanded. So it was good to see this recent admission by the IMF that they have blundered.

The main problem with the IMF is their non-grasp of macroeconomics, as is shown in this recent blog article of theirs written by Vitor Gaspar and Laura Jaramillo. They claim that high government debt is a potential problem: as they put it, “Countries with elevated government debt are vulnerable to changing financing conditions, which could hinder their ability to borrow, and put the economy in jeopardy.”

Incidentally, I shouldn’t strictly speaking assume that views expressed by two authors of an IMF blog article have the blessing of the IMF as a whole. However, the views expressed in this article are actually very much in line with IMF thinking as I understand it and judging by other IMF articles I’ve read. Plus the IMF like any organisation is certainly not likely to publish articles which flatly contradict their basic thinking. 

Now what exactly are “changing financial conditions”? I’m almost certain what they mean is a rise in interest rates: certainly if you are a debtor and interest rates rise, they you’re liable to have problems.

So why don’t they call a spade a spade? I.e. if they mean a rise in interest rates, why don’t they say so? Well if you’re not too sure what you’re talking about, then it’s best to keep what you’re saying on the vague side. Then if anyone accuses you of saying one thing, you can claim you were saying something else!

At any rate, are rising interest rates a problem for a monetarily sovereign country with a relatively high debt? I’ve been through this several times before on this blog, but when trying to teach the educationally challenged (or whatever the correct PC phrase is), what else can you do apart from repeat yourself till you’re blue in the face?

A rise in interest rates is not a problem for an indebted government  in that the interest it has to pay on its existing debt does not rise immediately: the rate of interest was fixed when the debt was first issued. And that’s an important point in the case of the UK where the average date to maturity of government debt is on the long side: only about 10% of UK government debt matures and needs replacing each year.

As to the debt that DOES NEED replacing or “rolling over”, a monetarily sovereign government is free to tell potential creditors who want more interest than previously to shove off. That is, such a government can simply print money, pay off the creditors and tell them to go away.

Of course that is liable to be inflationary (not that printing billions and buying back government debt as part of the QE operation has actually proved all that inflationary). But to the extent that inflation is a problem, that is easily countered by anti-inflationary measures, like raising taxes and “unprinting” the money collected.

But apparently the IMF doesn’t understand that.

No doubt I’ll be spelling out the same message in six months time. You have been warned.

Thursday, 9 August 2018

Why replace state issued money with privately issued money which has to be backed by the state?

There is a farce at the centre of our money system. It’s the one alluded to in the above title: one that Prof Mary Mellor deals with in her two books, “The Future of Money” and “Debt or Democracy”.

Money, as the saying goes “is a creature of the state”. That is, there has to be general agreement in any country as to what the country’s basic form of money shall be: it would be highly inconvenient if some people used gold coins as money, while others used silver and others used cowrie shells (which have long been a popular form of money on desert islands and similar). And in practice throughout history, money has normally been organized by some central authority: often a king or ruler who wants to make tax collection more efficient.

So the basic form of money in the US is the Fed issued US dollar. In Russia it’s the Russian central bank issued Ruble, etc.

As to the optimum amount of such money to create and spend into the economy, clearly that needs to be whatever brings full employment without causing excess inflation. The more money people have, the more they will spend (not that the relationship there is particularly close or predictable). So ideally an amount of money needs to be issued that (to repeat) brings full employment without too much inflation.

Commercial banks.

Having done that however, commercial banks normally play a little trick which is profitable for them: it’s to issue their own dollars (in the case of the US) or pounds in the case of the UK. To be more exact, they create and lend out “promises to pay” central bank dollars, pounds, etc. In fact commercial banks make good on that promise when you get physical cash from an ATM.

But when you get a loan for $X from a commercial / private bank, and $X is credited to your account, the bank invariably keeps quiet about the fact that you have not actually got $X there: to repeat, what you have is a promise by the bank to pay $X to whoever you want to pay $X to (possibly to yourself at an ATM).

Another important feature of privately created money is that it tends to displace state created money. That is, if the state creates and distributes an amount of money that brings full employment without too much inflation, and commercial banks then start creating and lending out their own home made money, then households and businesses will find themselves with an excess supply of money. Demand and inflation will rise, so the state will have to raise taxes and withdraw some of the state issued money.

An alternative scenario, set out by George Selgin in the first few paragraphs of his Capitalism Magazine article “Is Fractional Reserve Banking Inflationary” is that government lets inflation rip, which means the real value of the stock of state issued money is whittled away to near nothing. But either way, privately issued money displaces state issued money. (Incidentally I am not suggesting Selgin would agree with everything in this article or even most of it.)

But the big problem with commercial bank created money is that it is not 100% reliable: the fact is that commercial banks, regular as clockwork, go bust and have to be rescued by the state. Now what on Earth is the point of replacing state issued money with privately issued money which cannot function unless it is backed by the state?

Moreover, to add insult to injury, it is precisely the fact of trying to create a form of money / liquidity that makes banks vulnerable and prone to bank runs, as Douglas Diamond explains in the abstract of this paper.

Well one apparent advantage of privately created money is that interest rates are presumably lower than under a “state money only” system. Reason is that if a commercial bank can simply print or “create from thin air” the money it lends out, that is clearly cheaper for it than obtaining the relevant money the same way households and non-bank corporations obtain money, namely earn it or borrow it. But in that case lending is being subsidised by money printing, or by seignorage of a sort, and there is no particular reason why money lenders (aka commercial banks) should reap the benefits of seignorage rather than garages or restaurants.

When money is created, the money creator normally makes a profit from doing so. E.g. when the state prints money and spends it on new roads, the state profits in that it obtains more road at zero cost to itself. But we all benefit from improved roads, thus the profit does not matter there. In contrast, there is no good reason for commercial banks to be the ones who benefit from money creation.


Another glaring weakness in any alleged advantages in the relatively low interest rates that stem from private money creation is that private banks have not had to pay a suitable amount of insurance for the risks that such money creation entails.

First, banks were rescued by the Fed in the recent crisis with billions of dollars worth of loans, not at the “penalty rate” suggested by Walter Bagehot, but at a near zero rate of interest. Don’t you wish you could borrow at a zero rate of interest?

Second, it would be perfectly reasonable to charge the bank industry for a significant proportion of the trillions of dollars worth of lost GDP that most countries have experienced over the last ten years as a result of bank irresponsibility: car drivers have to be insured in most countries against the possibility that they cause a serious and life-long injuries which cost millions of dollars to deal with. If banks paid an insurance premium that took account of the latter trillions of dollars of lost GDP, the cost of running commercial banks would go through the roof: put another way, that sort of insurance would make a complete mockery of the idea that privately issued money results in lower interest rates.

But even if the latter insurance point can be ignored, it might seem tempting to favour the lower interest rates that private money creation brings given that stimulus is often imparted by lowering interest rates.

The answer to that is that stimulus is easily imparted without adjusting interest rates: as Keynes pointed out in the early 1930s, stimulus can be imparted by having the state create new money and spend it (and/or cut taxes).

The line between money and non-money.

Another possible objection to the above argument is that even in the absence of commercial banks, individuals and non-bank firms would engage in a significant amount of money creation or at least “liquidity creation”. Thus, so it might be argued, banks should be allowed to do the same. I’ll expand on that.

Assume an economy with state issued money only. In such an economy people and firms would lend to each other and some people would grant relatively long term loans to others, e.g. ten years for a mortgage. But in that scenario, lenders would not be absolutely committed to losing access to their money for ten years. Reason is that if someone who had made a ten year loan wanted their money back after six months, there’d be a good chance they could sell the loan to someone else.

That process makes those loans more liquid. Indeed if the latter “loan selling” were efficient enough, then loans would be almost of liquid as money itself. Thus, so it might be argued, why shouldn’t commercial banks engage in that process and try to make it even more efficient?

Well there is no reason banks shouldn’t do that, but they’ll never be able to produce what is commonly understood to constitute money (i.e. something which is 100% guaranteed not to lose value (inflation apart)) without state backing. An exception to that doubtless comes where the state is very irresponsible (e.g. a Robert Mugabe style hyperinflation economy) and people regard commercial banks as more responsible than government. But that scenario is relatively uncommon.

Put another way, there’s nothing wrong with commercial banks funding loans via what are in effect bonds, even if those bonds take the form of small deposits at such banks. But there is no good reason for the state to give its backing to those “bonds” and turn them into genuine, 100% proof, pukka money. That just constitutes a subsidy by taxpayers of commercial banks.

In short, advocates of full reserve banking are right to claim that loans should be funded via equity or similar (e.g. bonds which can be bailed in).

Is deposit insurance OK?

Having said that depositors should be on the hook where a bank is sufficiently incompetent, another question arises, namely: is deposit insurance of those “bond / deposits” acceptable? Well it’s a bit hard to see why not if the insurance system is run on strictly commercial lines, as is the FDIC.

But doesn’t that then mean that those deposits then become 100% proof, pukka money? Well yes: it does. But there is a catch, as follows.

Milton Friedman and Warren Mosler (founder of MMT) argued for a permanent zero interest rate policy, and I argued the same here. But given that sort of low interest rate policy, how much interest will the above “bond / depositors” actually get after the costs of deposit insurance have been deducted? Well I suggest the answer is “none”, and for the following reason. This reason is not desperately well thought out at the moment – I’ll hopefully improve on the thinking in the future. But here goes.
Interest is paid for two reasons: first, as a reward for accepting risk. But depositors whose deposits are insured by an insurer with an infinitely deep pocket, i.e. the state, are accepting no risk!

A second reason for paying interest is as a reward for the lender for losing access to a sum of money (or some other asset) for a period of time. But if the above depositors have instant access to their money, then they aren’t losing access (to make a statement of the obvious). Conclusion: there is no reason for those depositors to get any interest.

In contrast, if as suggested by some proponents of full reserve banking, depositors do lose access to their money for a significant period, then there is good reason to pay them interest. (E.g. Ben Dyson and Andrew Jackson in their book “Modernising Money”) suggest a minimum of two months.) But in that case, those deposits cannot really be classified as money: certainly a deposit where the “term” is more than about two months is not counted as money in most countries, though obviously that two month dividing line is a bit arbitrary. I.e. there is no sharp dividing line between money and non-money there. But then there never has been a sharp dividing line between money and non-money.