Is Ed Balls talking balls?

Ed Balls would seem to be well qualified when it comes to economics. He used to be lead economics writer for the Financial Times and studied economics at Oxford and Harvard.

Unfortunately, like many people at the top of the economics profession, he doesn’t understand the basic book-keeping entries done by treasuries and central banks.

Reason I say that is that he claimed recently that Positive Money’s proposals are out of the same mold as monetarism – a claim also made by Ann Pettifor. That claim can only come from people who don’t understand the latter basic book-keeping entries, for reasons I’ll set out below.

I’ve been thru this before on this blog, but unfortunately getting simple points across normally requires repeating those points ad nausiam, so here goes.

Positive Money (PM) and others claim that the best way of implementing stimulus is simply to have the state print money and spend it, and/or cut taxes. And the effect of that (as is hopefully obvious) is to increase the money supply, or more accurately to increase the private sector’s stock of central bank created money (base money).

The Balls and Pettifors of this world then jump to the conclusion that PM & Co are advocating monetarism Milton Friedman style.

Well the first flaw there is that a money supply increase also occurs under conventional forms stimulus. That is, one conventional form of stimulus is fiscal stimulus, which consists of government borrowing more and spending what it has borrowed (or cut taxes). But that extra borrowing is likely to raise interest rates, and assuming the extra borrowing takes place because stimulus really is needed rather than because politicians are being plain irresponsible, then the central bank won’t allow an increase in interest rates. It will therefor print money and buy back some of that government debt.

Indeed, assuming stimulus really is needed, the central bank is likely to go further and actually cut interest rates. So it will print even more money and buy back even more government debt!

Now as you may have noticed, this all involves a money supply increase in much the same way as PM policy involves a money supply increase.

And not only that, but given low interest rates of the sort we have had over the last five years or so, the central bank may go even further and buy back almost every single dollar of extra debt that arises from fiscal stimulus! I.e. the central bank may go for QE. The money supply increase is even bigger!

But for some strange reason, the Balls and Pettifors of this world do not accuse governments which implement interest rate cuts or QE of adopting Friedman style monetarism, which rather makes it look like Balls and Pettifors are scratching around for any old jibe to throw at PM.


Friedman’s monetarism.

So what did Friedman’s monetarism actually consist of? Well I’m not the world’s authority on that but certainly Friedman in his 1948 American Economic Review paper “A Monetary and Fiscal Framework for Economic Stability” argued that stimulus should take the form of the same annual increase in the stock of base money, and that should be effected by the state spending more than it received in taxes. I.e. he argued against discretionary stimulus.

So to summarise, the form of stimulus advocated by PM & Co comes to much the same as conventional stimulus, but with the difference that under PM’s system, monetary and fiscal policy are joined at the hip: they are merged. But in both cases, a money supply increase derives from stimulus. Thus the “PM equals monetarism” jibe is nonsense.

As to Friedman’s monetarism, that also involves an increase in the money supply, but it’s the same increase each year.

Thus while PM policy has similarities to monetarism, the similarities are no more than the similarities between monetarism and conventional economic policy, all of which makes a bit of nonsense of the claim that PM policy is flawed because it has similarities to monetarism.

I.e. all three of the above options (PM, conventional stimulus and Friedman’s monetarism) involve a money supply increase. What actually differentiates Friedman’s monetarism from PM and conventional stimulus is that the latter two involve discretion while Friedman advocated no discretion.

And finally, I am not saying the Balls and Pettifor should be totally ignored. I particularly like Ed Balls: he has a sense of humour. And Pettifor’s work “The Economic Consequences of Mr Osborne” is quality stuff.

Random charts - 42.

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

Has Bernanke been boozing?

Bernanke is pushing a bizarre idea that has being doing the rounds for some time, namely that given zero or near zero interest rates, central banks should “target” a higher rate of inflation, which apparently means inflation will increase, which in turn means interest rates can be increased.

Well now in the universe I live in, things don’t happen unless something causes them to happen. E.g. excess demand causes inflation to rise. And driving with excess alcohol in one’s blood stream tends to cause road accidents. And being stung by a wasp causes people to say “ouch”.  You get my drift.

But in the Alice in Wonderland  universe inhabited by so called “professional” economists, things happen just because someone “targets” those things. For example if it’s my aim or “target” to be $10,000 richer, a pallet load of dollar bills will appear as if by magic in the middle of my living room apparently.

And it’s not just me who thinks economists living in Cloud Cuckoo land. Lars Syll said the other day that “Mainstream neoclassical economics has since long given up on the real world and contents itself with proving things about thought up worlds.”

Or as the Cambridge economist Ha Joon Chang put it “Unfortunately a lot of my academic colleagues not only do not work on the real world, but are not even interested in the real world.”

Taxpayer backed support for banks and depositors is absurd.

A bank is an entity at which you deposit money. The entity then invests or lends on your money so as to earn interest for you. Plus the entity makes the absurd promise that your money is totally safe: you’re guaranteed to get $X back for every $X you put it.

That promise is absurd because money which is loaned on or invested is never totally safe.

Indeed, if you deposit money at an entity which does exactly the same job as the one set out above, but it does not have the word “bank” over its front door, then the entity is SPECIFICALLY FORBIDDEN from making the above promise. Examples of those other entities include stock–brokers, unit trusts (“mutual funds” in the US), etc.

So what’s the big significance in ordering the letters B,A,N and K from a sign manufacturer and putting them over your front door, as opposed to putting the letters U,N,I,T, T, R,U,S and T over your front door?  Darned if I know.

Does it make a difference exactly how the letters are attached to the wall or what colour they are? I look forward to enlightenment on that point....:-)

That’s not to say there should NEVER be any sort of taxpayer backed support for those with bank accounts: everyone is entitled to a totally safe bank account. But they are most definitely NOT ENTITLED to let their money be loaned on or invested and then go running to taxpayers for help if the loan or investment does not pay off.

Ergo it’s justifiable to have taxpayer funded support for bank accounts where money really is totally safe: i.e. where it is NOT loaned on or invested (e.g. where the relevant money is simply lodged at the central bank). But there is no excuse for such support for investors and money lenders.

Random charts - 41.

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

Are Simon Wren-Lewis and Krugman now MMTers?

Lars Syll says “So SW-L has joined Paul Krugman and become an MMTer at the ZLB?” My answer is: “Yes they have”. And here’s my attempt to show why they should be MMTers at ALL TIMES. (I’m sure they’re hanging on my every word, ho ho.)

We’ve established that MMT is a good idea at the ZLB. So is it a good idea when interest rates are higher? Well the answer to that is that interest rates (at least the rate of interest on government liabilities) should basically NEVER be higher.

Warren Mosler (founder of MMT) explained why interest rates should never be higher,  i.e. why a permanent zero rate is desirable in his paper, “The Natural Rate of Interest is Zero”. Milton Friedman agreed with that “permanent zero” idea, incidentally, except that Friedman thought that perhaps government borrowing was justified in war-time. (That’s in Friedman’s American Economic Review paper “A Monetary and Fiscal Framework…”).

As for Mosler’s REASONS for advocating a permanent zero policy, I think I can set out a reason for that policy much more briefly than he does. Here goes.

Assume the yield on government liabilities (i.e. “government debt”) is currently zero or near zero. Assume a rise in demand is required. One way of doing that is simply to issue more government liabilities in the form of zero interest yielding base money. I.e. the state simply prints more money and spends it (and/or cuts taxes). The fact of that spending (on say more education) is to increase the number of teachers employed. Plus the increase in the private sector’s stock of money also increases demand stemming from the private sector.

An alternative and “interest rate increasing” method of raising demand is to issue AN EXCESSIVE amount of government liability and to the extent that government has to rein in some of the resulting demand by raising interest rates.

But what on Earth is the point of issuing an excess amount of “government liability / base money” and then borrowing the excess back? All that does is to artificially raise the rate of interest.

Ergo the optimum arrangement is a permanent zero rate, though I wouldn’t rule out artificial adjustments to interest rates in emergencies. Indeed, that’s more or less what Friedman said, when he suggested that government borrowing was justified in war-time.

Conclusion.  The optimum or GDP maximising arrangement is a permanent zero rate. And from that I conclude that SW-L and Krugman will now declare themselves to be MMTers….:-)

Martin Sandbu’s none too clever idea on bank capital.

Sandbu, concludes a recent article in the Financial Times on bank capital ratios with: “We may be uncertain where the right number is, but until equity requirements are manifestly harming the broader economy (and not just banks’ bottom lines), it is safest to keep making them tougher.” (Article title: “Banking systems remain unsafe”).

Well the first problem there is this. How on Earth do we know when excessive bank capital ratios are “harming the economy”?

An excessive ratio will not show up as excess unemployment for the simple reason that whatever the deflationary effect of raising bank capital, government can always counteract that with stimulus (fiscal and/or monetary). Of course that’s on the optimistic assumption that those in power have heard of Keynes and know what stimulus is, which is a debatable assumption. But I’m an optimist, so let’s assume those in power are not completely economically illiterate.

Next, would a substantial contraction in the bank industry prove that capital ratios were excessive? Well the trouble with that idea is that the bank industry in the UK has expanded a whapping ten fold relative to GDP since the 1970s. So if the bank industry HALVED in size it would still not be back to its 1970s size, and there were no howls of anguish that I remember in the 1970s to the effect that the bank industry was too small.

Next, whence the assumption that raising capital ratios constrains the bank industry at all? High capital ratios do not seem to constrain other industries: for example Google is 90% funded by capital. Far as I know, Google is not a disastrous flop.

And apart from the latter evidence that high capital ratios do not constrain an industry, there is a big theoretical flaw in the “constrain” idea, as follows.

Equity holders only demand a higher return than depositors or bond holders because equity holders run a bigger risk: in the event of a bank going under, equity holders are wiped out before bond or deposit holders take any sort of hit.

However, it’s a huge mistake to think that therefor if capital ratios are raised, the cost of funding banks rises: reason is that the capital ratio rises X times, then the risk run by equity holders must be 1/X what it previously was. And if you want proof of that consider two banks which are identical in all respects except that one is funded entirely by equity and the other entirely by bonds or deposits.

The risk of the bank’s assets declining to Y% of their book value is exactly the same in each case because that risk is determined by the nature of the loans and investments made by the bank, not by the way it is funded (e.g. NINJA mortgages versus sensible mortgages). And the nature of the two banks’ assets is the same.

Incidentally, the idea that a bank can be funded entirely by deposits or bonds is a trifle dishonest since any claim by a bank that all of those funding a bank are guaranteed their money back is patently dishonest: reason is that if the bank’s assets do decline to Y% of their book value, then clearly the bank cannot repay depositors or bond holders.

But then as others have pointed out, even the equivalent claim by a conventional bank (funded by say 5% capital and 95% bonds and depositors) is dishonest, since if assets decline to less than 95% of book value then in principle the bank cannot repay depositors and bond holders, i.e. the bank is technically insolvent.

Anyway, returning to the above point that equity holders only demand a higher return than depositors or bond holders because of the extra risk run by equity holders, that difference in risk is a mirage for a second reason: while depositors do not charge for the risk they run, banks are still charged for that risk via state run deposit insurance (e.g. FDIC in the US). At least banks ought to be charged for that risk.

Of course given that politicians have a habit of doing whatever banksters tell them to do (in exchange for – er – “generous donations to electoral expenses”), banks often do not get charged for deposit insurance, or they do not get charged the full and appropriate amount.

But assuming they are charged the right amount, then the total charge to banks made by equity holders and depositors and bond holders ought to be the same. At least the above is a strong case for thinking that the total charge will be very similar.

Hence raising capital ratios ought to have little effect on the cost of funding banks.

And the final joke is that at the time of writing, the return on bonds is higher than the return on equity.

All of which makes a bit of a nonsense of Sandbu’s claim that at some point, as bank capital ratios are raised, we will be able to detect when they have risen too far.