Steve Keen criticises Mosler’s Law.

Mosler’s law states that “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it”. See sentence in yellow at top of Warren Mosler’s site.


Steve Keen questions the above law.

Keen’s article starts by attacking crowding out. He says:

“This is the argument that a government deficit 'crowds out' private expenditure, so that overall there's no increase in output and employment. We are told that private projects that would have gone ahead without the deficit are made unprofitable because the government deficit increases interest rates, so that in fact we're worse off because unproductive government expenditure occurs rather than potentially productive private expenditure.

The argument against government deficits begins with: "Let's assume there's a fixed supply of money out there", but that's where it goes wrong.”


The crowding out idea or hypothesis is based (like many ideas, theories, etc) on the “other things being equal” assumption. Obviously IF there is a sufficiently large monetary base increase, that will negate the undesirable effects of crowding out!

If I say that when a car crashes into a wall at 60mph, then more damage will be done than if the speed is 30mph, do I really need to insert the phrase “other things being equal”? I mean, do I need to say “assuming a big foam rubber cushion hasn’t been placed in front of the wall for the 60mph impact”?

Keen then claims “Australia's recent economic performance – when a huge government stimulus meant that the GFC seemed to be reduced from a serious case of pneumonia to a mild cold – should make most people sceptical about this 'crowding out' argument....”

Most of those who support the crowding out idea (which includes me) do not claim that crowding out is complete, i.e. that interest rate rises consequent to increased government borrowing TOTALLY stymies the increase in demand that the above “borrow and spend” strategy is supposed to bring. We just claim that the effect is there. As to the extent of the effect there is widespread disagreement. Thus the fact that Australia’s borrow and spend effort worked does not disprove crowding out.

It gets worse. Keen then says:

As the previous RBA governor Ian MacFarlane put it: "Any government deficits not financed by an exactly coincident issue of debt to the public, for example, would mean a rise in cash and a fall in interest rates."

If some of the government deficit isn't offset by selling bonds to the public, the debt created between the government and the central bank must also be serviced; but that is also a book entry for a government that has a 'captive' central bank. It's only when the government sells bonds to the public (especially the offshore public) at a market-determined rate that it can have problems in servicing its debt.

So a government deficit per se isn't going to cause 'crowding out' – as Ian MacFarlane notes, it actually might cause interest rates to fall, which would make private borrowing cheaper and actually encourage private investment rather than stifling it. Private spending itself could expand because of the increase in the money supply caused by the government deficit, or because the private banking system also expanded the money supply by creating more loans.

The phrase “a government deficit per se.....might cause interest rates to fall” is nonsense. Keen is saying that where a money base increase is so large that it smothers the effect of crowding out, the net effect is reflationary or “stimulatory”. Agreed. But it’s the base increase that has the stimulatory effect, not the deficit!

As to money supply increases other than base increases (i.e. money supply increases brought by the commercial banking system), if this occurs IMMEDIATELY AFTER a base increase, it is probably a secondary effect. (Which, just to emphasise, is not to suggest that all commercial bank created money increases are secondary to base increases: indeed Steve Keen has done some quality research, as I understand it, into commercial bank money supply increases that are independent of central bank money supply increases (base increases).

Keen’s second last para has got me beat. I don’t understand it. Ideas anyone?

Keen’s concluding para says,

“Addressing the crisis by running large government deficits alone – without confronting the reality that the private financial system lent irresponsibly for the last two decades – would also enable that irresponsible Ponzi-behaviour to continue, when that's what really caused this crisis in the first place.”

Agreed. In fact this is an obvious enough point. Does Keen seriously think that Warren Mosler or anyone else is unaware of the dangers of reviving irresponsible lending? Obviously the criminal, fraudulent and irresponsible behaviour of banks needs dealing with.