Sunday, January 17, 2010
The stupidity of Keynsian “borrow and spend”.
Keynes’s big idea was that in a recession, governments should borrow more and spend more.
The major, and widely recognised potential weakness in this idea is “crowding out”. That is the fact that if government raises interest rates with a view to attracting funds to borrow and spend (B & S), this may simply reduce borrowing and spending by the private sector. That is the net effect of B & S could be zero.
In short, employing B & S is verging on the lunatic.
Far better would be to concentrate on interest rate reductions and/or on the part of B&S which is guaranteed to work, that is the “spend” part. I.e. why not just print money and spend it? (Actually "print and spend" will inevitably bring down interest rates).
The standard response of economic conservatives (and Tory Party members in the UK and Republicans in the US) is that money printing is inflationary. The answer to this is that money printing is not inflationary UNTILL such additional money results in additional demand.
David Hume in his essay “Of Money” written in 1752 recognised this when he said in reference to a money supply increase “if the coin be locked up in chests, it is the same thing with regard to prices as if it were annihilated”. The economic conservatives evidently have not learned much in 250 years.
The other daft aspect of B & S (which is perhaps just another way of re-stating a point made above) is that the objective of B & S is to stimulate or reflate an economy. In contrast, the “borrow” part of B & S is clearly deflationary. Now what on earth is the point of doing something which is DEFLATIONARY when the object of the exercise is REFLATION?
The purpose of pouring soap and water over a car is to clean it. Is there any point in throwing dirt over the car beforehand?
Of course “print and spend” is risky: the risk is that the relevant government and/or central bank fails to rein in the additional money when inflation looms. And Milton Friedman had a very good point when he said that governments are so hopeless at dealing with booms and recessions that it would be better if they did not try.
On the other hand, the political reality is that governments cannot stand by and do nothing when a serious recession, like the present one, occurs.
So given that governments are going to do something, it would be nice if they did something effective.
Moreover, the risks involved in B & S are much the same as those involved in print and spend. That is, B & S may prove more effective than anticipated, in which case excess inflation might ensue. Alternatively, B & S many be totally ineffective, in which case the result is arguably even worse: excess unemployment, poverty, homelessness and so on.
Another fatuous wheeze is printing astronomic quantities of extra money and handing it to banks who in turn just sit on it. Excess reserves at U.S. banks have always hovered around zero – until late 2008 when they shot up to around $800bn.
And finally I’d like to quote Warren Mosler:
“It’s a disgrace to the economics profession that they haven’t figured out how to sustain demand when all it takes are a few spread sheet entries by govt. I could teach any third grader to do it in 15 minutes.”