Positive Money’s latest publication.

I like it. Although I’ve only skimmed thru it. It’s jargon free and waffle free: i.e. it’s written in plain English.

The authors advocate the combination of fiscal and monetary policy: i.e. they claim that come a recession, the government / central bank machine should create new money and spend it into the economy (and/or cut taxes). Incidentally, that has been PM policy for some years now.

They are well aware that the latter idea is not new: i.e. that there are numerous historical examples of the idea being put into effect. And some of the historical examples were new to me.

They get the point that central banks have been forced into bizarre forms of monetary stimulus like QE because of a refusal by politicians to countenance enough fiscal stimulus (i.e. large enough deficits). And apart from QE, in the UK we’ve been the lucky(?) recipients of other bizarre forms of monetary policy: e.g. Funding for Lending, and Help to Buy.

On the downside, I didn’t agree with the idea that governments should allocate new money to SPECIFIC types of spending (they advocate house building amongst other things). The problem there is that, as the authors rightly point out, new money is a form of stimulus and the amount of stimulus needed varies hugely from one year to another. Thus if new money / stimulus is allocated to SPECIFIC sectors of the economy, the amount spent on those sectors will gyrate from one year to the next.

And there’s an additional problem with housing. What happens when a series of houses are half built and it’s decided that stimulus is no longer warranted? Hundreds of building sites close down, and houses are left half-built? That doesn’t sound like an efficient allocation of resources.

Anyway, at least eight out of ten to the authors. I’ll read this publication right thru rather than simply skimming thru it at some stage.

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P.S. (15^th Nov): Re central banks being forced into “bizarre forms of stimulus” the new head of the Fed made a very similar point recently.

 

The loanable funds doctrine is not totally invalid.

The loanable funds doctrine is the idea that banks simply connect borrowers and lenders. Nowadays, that is regarded as an over simple view of what banks do. However, a baby has been thrown out with the bathwater: the loanable funds idea is not totally invalid, and for the following reasons.

 The flaw in the loanable funds idea is that a bank (and more particularly the bank system as a whole) does not need deposits in order to make loans: that is, when a bank spots a credit worthy borrower, the bank can simply credit the account of the borrower, and regardless of how much money has been deposited at the bank.

However, an INDIVIDUAL bank can’t take that activity too far, else it runs out of reserves. Reason is that most of the money that a bank lends into existence will be deposited at other banks, and the latter will want “proper” central bank money, i.e. reserves, in exchange for the first bank’s “created out of thin air” funny money.

It is thus largely true to say of an INDIVIDUAL bank that the amount of lending it can do is dependent on how much is deposited at that bank. So to that extent the loanable fund idea is valid.

In contrast, there are no such constraints on the bank system AS A WHOLE. That is, if every bank expands the amount it lends out by the same percentage, no individual bank will run out of reserves. So to that extent, the loanable funds idea would seem to be INVALID. (And if the bank system as a whole runs short of reserves, the central bank has to supply more reserves if the central bank wants to keep control of interest rates.)

So it seems there are no constraints on the commercial bank system’s freedom to lend money into existence.

However it’s not quite that simple, and for the following reasons. When a loan is made, the relevant sum is deposited in the accounts of sundry depositors fairly soon after the loan is made: after all, there is no point in getting a loan and paying interest and/or other bank charges and then not making use of the loan.

Now suppose those “other depositors” want to use their newly acquired money AS MONEY rather than to make a longish term loan to anyone: that is suppose those depositors want to use their newly acquired wealth as day to day spending money. The relevant depositors would put their money in a CURRENT account rather than in a term or deposit account.

Now that’s a problem for the banks concerned and the problem has to do with maturity transformation. Maturity transformation (MT) is the process of borrowing short and lending long, which is one of the basic activities of banks. But MT is a risky activity if taken too far, and indeed hundreds of banks thru history have failed because they’ve taken the process too far.

So, suppose the bank system as a whole expands the amount it lends, and suppose that system has already taken MT as far as is prudent, and suppose the depositors whose stock of cash expands as a result of the new loans don’t want to see their money loaned on long term (i.e. assume they want to use that money as day to day spending money). In that scenario, banks have a problem: the problem is that there is a shortage of depositors who want their money loaned on long term.

Conclusion.

While the commercial bank system can certainly create money out of thin air and lend it out, it is nevertheless constrained by the extent to which recipients of that new money want their money loaned on. So to that extent, banks are in the business of connecting borrowers to lenders: the loanable funds doctrine has some validity.

Endnote.

The above ideas occurred to me as a result of an exchange of views with Clint Ballinger. That’s the beauty of blogging: it forces you to think thru, and defend statements you make.

Professional economists conspire against the unemployed using e.g. New Keynsianism.

“All professions are conspiracies against the laity” as George Bernard Shaw said. And if you don’t believe that many professional economists are more interested in lining their own pockets than in sorting out economic problems, then perhaps the words of an economist, Adam Smith, will persuade you.

As he 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, or in some contrivance to raise prices.”

The main objective of academic economists is to further their careers and achieve promotion. And they do that by churning out papers and books, regardless of whether that literature clarifies or muddies economic issues. So if an academic economist can get something published that muddies economic issues, that will probably raise unemployment. But never mind: it furthers the career of the economist, so the economist will fire ahead with the publication.

New Keynsian economics.

A nice example of the above is so called “New Keynsian” economics: an idea that has kept hundreds if not thousands of economists employed worldwide.

One of the two main elements of NK economics according to Wiki is so called “rational expectations”. And according to Wiki, rational expectations is “. . .identical to the best guess of the future (the optimal forecast) that uses all available information.”

In other words households allegedly make calculated choices based on “all the available information”. You ever heard anything so patently unrealistic?

This leads to the completely absurd conclusion (quoting Wiki again) that “If the Federal Reserve attempts to lower unemployment through expansionary monetary policy economic agents will anticipate the effects of the change of policy and raise their expectations of future inflation accordingly. This in turn will counteract the expansionary effect of the increased money supply.”

So do households actually act in the above “rational” and calculated way? Of course not, and the evidence supports the point: that is, households in the US spent a fair proportion of the Bush tax cuts soon as they got their hands on the money: exactly what anyone with some common sense would except them to do. So the “expansionary effect of the increased money supply” was not negated, as rational expectations would have us believe.

Sticky wages and prices.

Another (and hilarious) element of NK is apparently that “sticky prices and wages, are a central aspect of all New Keynesian models.” Er . . yes . . one of the main points made by Keynes himself was that wages were, as he put it “sticky downwards”.

But if your aiming to keep yourself employed, then no harm in dressing up as new, an idea that is old as the stars. Hopefully no one will notice.

Microfoundations.

A third important element of NK is “microfoundations” apparently. Now if by microfoundations one means ACTUAL EVIDENCE as to what households do (e.g. in reaction to the above Bush tax cuts), that’s OK. But what “microfoundations” actually means is more like: “convenient assumptions made by economists as to what households do so as to help them set out fancy models which they can get published and with no regard to the empirical evidence”.

As Simon Wren-Lewis put it, “Internal consistency rather than external consistency is the admissibility criteria for microfounded models. Which means in ordinary English that academic papers presenting macroeconomic models will be rejected if some parts are theoretically inconsistent with other parts, but not if some model property is inconsistent with the data.”

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PS (13th July 2014). Lars Syll has just done an article on the nonsense behind "rational expectations".

Centrally planned economies and the Job Guarantee.

Centrally planned economies prior to the collapse of Communism in Russia and Eastern Europe did pretty well when it came to minimising unemployment. Unfortunately they did it in two ways that had results which were about as undesirable as unemployment itself.

The first was a combination of excess demand and fixed or controlled prices. That lead to a result which is wholly predictable and for reasons spelled out in introductory economics text books: shortages, queueing, etc.

Second, they made it difficult for employers to sack anyone. Unfortunately that meant some employees got stuck in (and indeed were quite happy with) relatively unproductive jobs. And that in turn made it difficult for employers with more productive jobs on offer to find the labour they needed.

A Russian economist called Popov suggested a solution, which was to let employers sack whoever they wanted, and then put the sacked workers onto relatively low paid public sector type work. The low pay, he claimed, would give the employees an incentive to seek the above mentioned more productive jobs.

Now what was Popov advocating? He was advocating JG!

I got the above information from an article in The Times, 20^th Jan, 1981, entitled “The Russian who advocates unemployment” – not available online, far as I can see.

Bill Mitchell and the Job Guarantee.

It’s good to see Bill considering the fact that the amount spent on capital equipment, materials and skilled labour (relative the costs of actual JG labour) is a variable. He appears to be considering three different scenarios where the ratio of the above JG labour costs to other costs is 75/25, 60/40 and 50/50. (Word search for e.g. “50/50” and you’ll find the relevant paragraph).

I’m not sure what the logic is behind the above seemingly random figures. A more relevant point which I made here is as follows.

If the amount spend on “other costs” relative to amount spending on JG labour is very small, that necessarily means a JG scheme which employs JG labour and practically nothing else. Such a scheme will be highly unproductive. On the other hand, if the ratio of other costs to JG labour costs are similar to the sort of ratios of other costs to “relatively unskilled labour costs” that one finds with a normal or regular employer, then the JG scheme in effect becomes a normal or regular employer.

Thus JG is caught between a rock and hard place. Or rather, the inevitable conclusion one is driven to is that SPECIALLY SET UP JG schemes do not make sense: that is, JG labour might as well be subsidised into work with regular employers.

And indeed that is exactly what the UK’s Work Programme and similar “temporary subsidised employment” schemes that have appeared and disappeared over the decades have consisted of.

Private and public sectors.

And note that while the Work Programme involved subsidised work with PRIVATE employers, the arguments for and against letting private employers “join in the fun” have little to do with the above “rock and hard place” point. I.e. if private employers are barred from taking on JG labour, then the above rock and hard place point still drives us to the conclusion that JG labour should be allocated to EXISTING public sector employers rather than to specially set up JG schemes.

To which astute readers will respond: “Oh but it’s plain impossible for e.g. the UK’s National Health Service, state schools, etc to absorb a million not too skilled temporary employees”.

To which my response is: “Dead right. And that’s one argument for letting private sector employers join in the fun.”

And as to those who think that supplying private sector employers boosts profits, they need to study an introductory economics text book. There they will find an explanation as to why subsidies expand the SIZE OF an industry or firm, but do not boost profits as a proportion of turnover in the LONG TERM. (Likewise, and incidentally, taxes are a mirror image of subsidies and have a mirror image effect: that is while taxing a firm or industry INITIALLY depresses profits, the LONG TERM effect is simply to reduce the size of the firm or industry.)