Government borrowing is pointless.

I actually addressed this issue on this blog in November last year, but on re-reading that article, it struck me as leaving room for improvement. So I’ve scrubbed it and re-written it in the paragraphs below. Here goes.

Both Milton Friedman and Warren Mosler (founder of Modern Monetary Theory) claimed that government borrowing is pointless, though they did not give any very detailed reasons. To be more accurate, Friedman claimed government borrowing served no useful purpose except in an emergency like war time, while Mosler simply said he opposed government borrowing.

For Friedman see under his heading “Operation of the proposal” in this paper of his entitled “A Monetary and Fiscal Framework for Economic Stability” published by the American Economic Review.

For Mosler, see the second last para of his Huffington article, “Proposals for the Banking System”.

In view of Friedman and Mosler’s lack of detailed reasons, I’m having a go at setting out some detailed reasons.

First, it’s important to distinguish between government borrowing as traditionally understood and another possible form of borrowing, which is to have government (or central bank) borrow with a view to damping down demand given an outbreak of irrational exuberance: i.e. excess demand. That form of borrowing would involve borrowing money and then doing nothing with that money.  I’m not advocating the latter form of borrowing as a particularly good way of dealing with excess demand, but clearly it’s a useful tool to have in reserve.

Second it’s important to distinguish between borrowing to fund current spending, and in contrast, borrowing to fund spending of a capital nature, i.e. investment spending. It is widely accepted by borrowing to fund current spending (both in the case of a household and in the case of government) does not make much sense. So that leaves capital spending.

For the naïve, that’s people who think government budgets can be treated the same way as household budgets, the purpose of government borrowing seems obvious: government borrows $Xbn instead of grabbing $Xbn off taxpayers. That borrowing appears to provide government with money to spend without any immediate costs for taxpayers or citizens generally.

There is however a problem, which is that the laws of macro-economics are very different to micro-economics: in particular, for every billion a year of extra spending by government (macro), private sector spending must be cut by a billion a year, assuming to keep things simple, that aggregate demand is to remain constant.  In contrast, when a household (micro) goes on a spending spree (e.g. buys a new house) as a result of having borrowed a large sum, there is no immediate need for it to cut down all that much on spending in other areas, e.g. on clothes, holidays, though of course over the very long term (decades rather than years) it will have to cut spending so as to repay the loan, or at the very least pay interest in the case of an interest only mortgage.

But does having government borrow a billion actually cut private spending by a billion? Certainly not! In fact it might not cut it at all. After all, those who lend to government, i.e. the well off, don’t invest in government bonds (or anything else) unless they think it makes them better off in the long run. So the net effect could easily be to increase spending by the private sector!

Of course raising taxes so as to fund interest on the sum borrowed will cut household spending, but that cut won’t be nearly enough: the cut required is the full amount of the capital sum borrowed, not just the amount of the interest thereon for a year or two.

Bill Mitchell draws attention to this nonsense, or at least implicitly draws attention to it in this video clip, where he says government bonds do not cut inflation.

And to add insult to injury, the above farce is even worse in the case of government bonds bought by foreigners. To illustrate, if someone in Switzerland buys UK government bonds, that might depress private sector spending in Switzerland (though for reasons given above, even that is doubtful). But it certainly won’t depress private sector spending in the UK!

Next, there is the problem of funding interest on the sums government borrows. If government simply raises taxes on the rich and poor in the same ratio as already obtains (which of course will involve, at least hopefully, taxing the rich more than the poor) then that still means the after tax income of the typical rich person has risen relative to the after tax income of the typical poor person. And that’s presumably not what government or the electorate would want, thus government will need to load some extra tax on the rich while reducing taxes on the poor so as to get back to, or near to the after tax income distribution that government and the electorate wants. In fact to get back to the “after tax income of the rich relative to the after tax income of the poor ratio” that existed prior to the above bout of capital spending, government will need to rob the rich of ALL OF the interest the rich get from lending to government, far as I can see.

Even if that latter point of mine is not quite right, it still looks like it would be much simpler to fund the capital spending by raising taxes on the rich and poor in a way that leaves after tax income distribution as between rich and poor at about the level that government and the electorate desires, and forget all about borrowing. That would be a lot simpler wouldn’t it?


Profligate politicians.

Another problem with borrowing is the temptation for politicians to borrow too much. Simon Wren-Lewis (former Oxford economics prof) refers to this problem as the “deficit bias”.

And David Hume writing three hundred years ago made exactly the same point when he said, “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt, will almost infallibly be abused in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills, in this manner, upon posterity.”

Conclusion. Given the tendency of politicians to borrow too much and given that government borrowing achieves nothing or almost nothing, it looks like the best course of action is to simply abolish government debt!


The future generations myth.

And finally, there is the popular myth that since sums borrowed by government this year must be paid back in several decades time, that will enable to cost of capital projects to be loaded onto the future generations which benefit from such capital projects (bridges etc).

The flaw in that idea is that future generations inherit not just a liability, that is, the obligation to repay the latter government debt, but also an asset, namely relevant government bonds!

In fact the latter point stems more from the laws of physics rather than the laws of economics. That is, it just isn't physically possible to build a bridge in 2020 using steel and concrete produced in 2030 or 2040 etc. I.e. the blood sweat and tears required to build a bridge in 2020 absolutely must be expended in 2020 (or a year or two earlier).

Incidentally I'm well aware of "overlapping generations" idea proposed by Nick Rowe which claims to make the latter "load costs onto future generations" idea work. I'm not impressed by that idea, but the reasons are too involved to deal with here.

Grace Blakeley.

What – so those who “came of age” ten, twenty or thirty years earlier are too dumb or now too senile to work out that “mainstream economics has massive flaws”?

Also I’d guess that people who “came of age” in the 1930s high unemployment era also worked out that the economic system has “massive flaws”.

Come to that, I’d guess those who experienced bank crises and booms and busts in the 1800s tumbled to the above point as well….:-)

Simon Wren-Lewis tries to argue for unskilled immigration to the UK.

SW-L is a former Oxford economics prof and his article is entitled “Low paid jobs for British born workers”.

He starts (first four paras) with a hypothetical scenario where half UK employees are skilled and half are unskilled, and then claims (quite rightly) that if we have only skilled immigration, that will mean the proportion of native Brits in unskilled jobs will rise to above 50%. As he puts it “That has to mean that among British born workers, less than 50% are now skilled and over 50% are unskilled.” And that apparently is to be deplored.

But what exactly is wrong with a higher proportion of unskilled natives having jobs? Darned if I know! Far from being a disaster, more jobs for the unskilled strikes me as a win win. 

Just to emphasise my point, in SW-L’s hypothetical scenario, there is NO SHIFT for native workers FROM skilled work to UNSKILLED work: all that happens is that unemployment among the unskilled section of the workforce falls.

Then later in the article, SW-L advocates a very old and far from original way of raising the pay of the unskilled: raise the minimum wage. Well no one can possibly object to that if there are few job losses for the unskilled as a result. Unfortunately the evidence on that is mixed: i.e. the exact level of minimum wage pay at which the effects on jobs for the unskilled become serious is not entirely clear. A German study found that the recent rise in the minimum wage had in fact resulted in a significant number of job losses for the low paid.

And finally SW-L appears to be totally unaware of the point that if the UK imports both skilled and unskilled people, the only net effect is an expanded population. Now given that the UK is one of the most densely populated countries in the World, and given huge rise in real house prices over the last twenty years, and the difficulty those on lowish incomes have buying a home, a rise in the population doesn’t strike me as a brilliant idea.

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Afterthought (same day, 27th Feb 2020).

It occurred to me a few hours after publishing the above that the above “win win” point needs explaining more thoroughly, so here goes.

The constraint on raising demand is basically a shortage of skilled labour or at least specific types of labour. So assuming the economy is at capacity prior to importing a set of skilled workers who have jobs lined up, i.e. who have spotted unfilled skilled vacancies in the UK, then demand can be raised when those immigrants arrive, and not just by enough to employ those immigrants, but by an additional amount: that is enough to employ however many unskilled people are needed to work alongside the latter skilled people.

Ergo, the net effect is that unemployment among unskilled native Brits declines, and with no adverse inflationary consequences. At least that is the INITIAL effect. But there’s a problem (and this is actually an additional or entirely new point, not alluded to above.)

The nature or type of skills in surplus and short supply is constantly changing. Thus there is no reason to suppose that roughly six months or a year after importing that above set of skilled immigrants, the inflationary pressures deriving from labour market inefficiencies won’t return the maximum feasible level of employment consistent with acceptable inflation back to its original level. In which case the original importation of the above original set of skilled immigrants will achieve very little apart from increasing the size of the population.

Incidentally, readers versed in economics may be wondering why I use the cumbersome phrase “maximum feasible level of employment consistent with acceptable inflation” when there is a vastly shorter acronym I could use: NAIRU. Well the reason is that over the last five years a large number of idiots have appeared out of the woodwork claiming NAIRU is nonsense, but for some bizarre reason, they’re perfectly happy if you refer the IDEA behind the acronym using different words and letters (which supports my contention that they are idiots).

It's a bit like a bunch of hypothetical people who are triggered by the word "car", but are perfectly happy with "steel box on four wheels powered by an internal combusion engine".

At any rate, mollifying idiots is always important, which is why I’m a firm believer in mollifying idiots. Incidentally and ironically SW-L himself had a go at the people who are triggered by the acronym “NAIRU”. I’m not sure how successful he was....:-)

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Household name economist doesn’t know what the job of being an economist entails.

John B Taylor (inventor of the “Taylor rule”) claims the US deficit should be reduced by cutting public spending. That’s in his Project Syndicate article “Restoring Fiscal Order in the United States”.

Well the first bit of nonsense there is that it is not the job of economists to pass judgement on strictly political matters, like what proportion of GDP should be allocated to public spending, unless there are major economic consequences or implications deriving from a change to the latter proportion.  And it would seem that significant rise in the proportion of GDP allocated to public spending (as opposed to the cut in public spending advocated by Taylor) does not have major economic consequences. To illustrate, several European countries devote a much higher proportion of GDP to public spending than the US, and the “disastrous” consequences of that are what exactly? Scandinavian citizens are perfectly happy with their relatively generous social security system and enjoy standards of living much the same as Americans.

The above failure by economists to understand that it is not their job to pass judgement on political matters is actually quite common in the economics profession: John B. Taylor is far from the only one who does not seem to understand that point.

Second, what does Taylor think he is doing passing judgement on what the optimum size of the deficit and debt will be in ten or twenty years’ time? Barmy. It may be that the private sector will want to accumulate state supplied financial assets (base money and government debt) in ten years time, or it may not. If it does, and government does not supply those assets, then the private sector (and foreign government sector) will try to acquire those assets by saving rather than spending, and that will just give rise to what Keynes called “paradox of thrift unemployment”.

Again Taylor is far from the only economist who makes that mistake.
 
You really have to wonder whether some senior members of the economics profession have the faintest idea whether they are coming or going.

And finally I am always amused by the non stop attempts by Project Syndicate to get people to actually pay to read the nonsense they publish. What’s got into their head?

Hot air from University College London.

One way to see if a paragraph or two are meaningless is to jumble up the words and see if it makes any difference. So I did that with the first paragraph of this UCL paper. I swapped four sets of words. E.g. that last sentence with just one pair swapped would read “I swapped four words of sets”.  See if you can tell which is the real, i.e. original version below. (Anything for a lark.)
 
Version No. 1:

Collective value is value that is created for a public purpose. This requires understanding of how public institutions can engage citizens in defining value (organisational competences), nurture dynamic capabilities and capacity to shape new opportunities (participatory structures); dynamically assess the value created (participatory evaluation); and ensure that societal value is distributed equitably (inclusive growth).

Version No.2:

Public value is value that is created collectively for a public purpose. This requires understanding of how public institutions can engage citizens in defining purpose (participatory structures), nurture organisational capabilities and capacity to shape new opportunities (organisational competencies); dynamically assess the value created (dynamic evaluation); and ensure that societal value is distributed equitably (inclusive growth).


Alternatively I could have constructed the fake version from this brilliant “meaningless phrase generator”....:-)

It's actually the SECOND of the above two versions of the UCL passage which is the genuine one. The eight words which have been moved from somewhere else in the passage (in the messed up version) are shown in red here:

Collective value is value that is created for a public purpose. This requires understanding of how public institutions can engage citizens in defining value (organisational competences), nurture dynamic capabilities and capacity to shape new opportunities (participatory structures); dynamically assess the value created (participatory evaluation); and ensure that societal value is distributed equitably (inclusive growth).
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Positive Money says Sovereign Money and full reserve banking are not the same.

That’s in an article of theirs entitled “Setting the record straight: Sovereign Money is not Full-Reserve Banking.”
 
Unfortunately the article fails in its basic objective, i.e. to show how or why there is actually any difference between FRB and SM.

The article says “Sovereign Money proposals are often mentioned alongside FRB proposals. And they do indeed have a same goal; that is to stop banks creating money in the process of making loans (or buying assets).” (FRB is short for “full reserve banking”).

But the next paragraph says “In the case of FRB it is done by forcing banks to hold reserves against their deposits. As the Bundesbank correctly notes, this doesn’t necessarily stop banks creating money – that is, it is quite possible for there to be money creation by the banking sector with 100% reserves.”

Well in that case, according to Positive Money,  FRB fails in its basic objective, i.e. stopping money creation by commercial banks!

Well the first problem there is that numerous leading economists, including a clutch of Nobel laureates, have advocated FRB and precisely because (as the Postive Money article rightly suggests) they want to stop money creation by commercial banks. Those “leading economists” include Milton Friedman, James Tobin, Laurence Kotlikoff, Irving Fisher, to name just four. For a more complete list, see here.

So do we take it that those leading economists have all made a bit of a blunder and advocated a system which is supposed to achieve an objective, but which in fact fails to achieve that objective? I think not.

The second problem concerns the Bundesbank’s claim that FRB “doesn’t necessarily stop banks creating money”. Well it’s true that under FRB there are no auditors or bureaucrats breathing down the necks of every bank employee in the country every hour of the day, thus it certainly would be possible for a bank to create some money for a while under FRB. However, under FRB, as under the existing system, banks do get audited. And one of the jobs of auditors under FRB (a very simple job in principle) would be to add up the total of all deposits at a bank and see whether that tied up with reserves held by the bank at the central bank. If it turned out that deposits significantly exceeded reserves, then it would clear that the bank had been creating money, and to make FRB work, a penalty would be payable by the bank large enough to ensure the bank did not disobey the rules again any time soon.

The Positive Money article then says “Our Sovereign Money proposal, on the other hand, does not suffer from this problem. Instead of backing deposits with reserves, we give people access to the state-created means of payment itself.” Well PM’s SM proposal quite clearly does not necessarily do that: that is, SM does not necessarily involve everyone being allowed to have an account at the central bank. Indeed, PM article itself says as much!

That is, the article says “….we would contract with the banks and/or other financial technology companies to administer our accounts for us”. In other words under full reserve / Sovereign Money (as is explained in other PM literature) instead of everyone having an account at the central bank, they could continue with accounts at their existing commercial banks, with the total amount of money deposited at each commercial bank being deposited at the central bank at the end of each working day.


Conclusion.

I’m not much impressed by this article. So I will continue to regard full reserve banking and Sovereign Money as essentially the same thing.

Joseph Huber & James Roberton’s “Creating New Money”.

Summary.

The above work (published around 2000) is a very worthwhile and widely cited contribution to the debate on how we ought to organise banks. One central claim is that commercial banks can lend at below the free market rate of interest because they can simply create or “print” the money they lend out. In the paragraphs below, I argue that actually there is no LONG TERM effect on interest rates, or the total stock of money, or the total amount of debt, however, the ability of private banks to have their money displace state issued money still results in the absurdity that having displaced most state money, the state is left with the job of having to stand behind privately issued “funny money”. And that of course raises the question as to whether that funny money should be permitted at all. In other words, the article below arrives at the same conclusion as H&R but in a slightly different way.

Moreover, Huber (but not Robinson) also claims that the issue of “debt based money” by commercial banks, as is current practice, does not increase debts (p.33). So that’s a second way in which the arguments below are not vastly different to H&R’s. 

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On p.31 of their work, Huber & Robertson (H&R) say, “Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0% debit-interest = 9% profit = 5% normal profit plus 4% additional special profit. This additional special profit is hidden from bank customers and the public, partly because most people do not know how the system works, and partly because bank balance sheets do not show that some of their loan funding comes from money the banks have created for the purpose and some from already existing money which they have had to borrow at interest.”

H&R certainly have some sort of a point there. To show why, take a hypothetical economy where the only form of money is state issued money. Also assume the state issues enough money to induce everyone to spend at a rate that brings about full employment, while avoiding excess inflation.

In that scenario, people and firms would lend to each other, plus commercial banks would doubtless set up and accept deposits and lend on a portion of those deposits. In that scenario there is no obvious reason why the rate of interest would not be some sort of genuine free market rate.

But if commercial banks then start creating and lending out their own home made money, clearly they can do so at below the free market rate, as H&R suggest. But that’s not the end of the matter (as H&R seem to suggest). 

That additional lending (and the additional spending that derives from it) will raise demand. Ergo the state will have to rein in demand somehow or other, e.g. by raising taxes and confiscating a portion of the private sector’s stock of state issued money.

But note that that additional spending is only a temporary phenomenon: to illustrate, if I borrow to have a house built, that will raise demand as long as bricklayers, plumbers etc are involved in building the house. But once it is built, the demand increase that derives from building the house ceases. Likewise, the demand increasing effect of additional lending stemming from commercial banks issuance of their home made money will in the above hypothetical scenario also cease: i.e. some sort of fixed and higher level of lending will on the face of it then be established.

There is however another demand increasing effect, which is that the money I spent having the house built is still in circulation and will presumably raise the population’s stock of money to more than the above mentioned “maximum that is consistent with acceptable inflation” level. Same goes for the extra lending that stems from commercial banks starting to issue their own money.

In contrast to the latter extra dollop of financial asset in the hands of households, there is of course extra “negative financial asset” in that my debt is still in existence. But that won’t necessarily have much effect on borrowers weekly spending: reason is that if (and taking a simple case) the percentage rise in borrowing is the same as the percentage fall in interest rates, then the amount that borrowers pay by way of interest every month will remain unaltered. Ergo their total weekly spending will remain about the same.

Moreover, the fall in interest rates will probably induce creditors to want to hold an even smaller stock of money than they started with: why hold more money than you want unless you get paid a decent rate of interest for doing so? And that’s an ADDITIONAL inducement for them to spend away their excess stock of money, and thus exacerbate the rise in demand.

The net effect, unless I’m much mistaken, is that while the money supply increasing phenomenon to which H&R refer may operate temporarily, in the long run, the money supply and rate of interest will simply revert to their original levels, or at least something close to those original levels.

So the overall and final result is that totally secure state issued money is replace with insecure private bank issued money which the state then has to make secure via taxpayer backed deposit insurance and billion dollar bail outs for banks in trouble.

And that of course is a farce and it’s a farce which Prof Mary Mellor often alludes to in her two books “Debt or Democracy” and “The Future of Money”.

The solution to that farce is to return to something like that above starting point, where the only form of money is totally secure state issued money. As for LOANS AND INVESTMENTS, those who want their money loaned out or to invest their money (whether it's via banks, mutual funds, private pension schemes or to make stock exchange investments etc) are free to do that, but those investor / lenders carry the risks involved. And that results in a level playing field as between banks on the one hand, and other financial institution, in contrast to the present set up, where banks get privileged treatment in that those who lend or invest via banks enjoy protection gratis the taxpayer.

The latter arrangement is of course what is normally called “full reserve banking or “Sovereign Money”, exactly what H&R advocate, only the exact way in which I arrive at that conclusion is a little different to H&R’s.

Moreover, the latter set up (full reserve banking / Sovereign Money) is entirely consistent with a very widely accepted general principle, namely that it is not the job of government (aka taxpayers) to stand behind or in any way subsidise or assist strictly commercial activities, unless there is a clear social reason for doing so.