Banks outwit politicians.

FT article on the way banks have outwitted politicians.

Investment: the moron’s answer to the recession.

Escaping a recession involves giving a boost to spending in some shape or form: extra private sector spending will do as well as extra public sector spending. There is also a choice between extra current spending and extra capital spending.

Extra capital spending is daft because it takes anything between roughly a year and three years to get capital investment projects going, by which time we may be in the middle of the next boom!

Moreover, in a recession (certainly in the early stages thereof) there is a SURPLUS of capital equipment lying idle. Just to expand on that for the benefit of morons, when a car plant closes for lack of orders, the relevant building and machinery don’t disappear into thin air!

In addition, when current spending goes up, the businesses affected are not run by morons: that is, they can work out for themselves if demand for various products has risen by enough to warrant additional capital expenditure.

Unfortunately though, every time we have a recession, a range of cranks come out of the woodwork each advocating their own bizarre selection of preferred investments. Many of these investments may well be worthwhile, but they have nothing to do with escaping recessions.

It is thus a pity to see the pro-deficit Robert Skidelsky advocating investment in the Financial Times this morning.

Fiscal adjustments can’t be made quickly? Rubbish.

The conventional wisdom that fiscal adjustments cannot be made quickly, whereas monetary ones can, and hence that this is an advantage of monetary policy over fiscal policy. For example this article in The Economist makes the claim (2nd para).

Plus the claim appears on this economics tutorial site (under the heading “Differences in the lags…”)

This claim is very questionable.

It may well be that there are several types of tax which cannot be change quickly. But that is irrelevant. The important question is whether there are ENOUGH types and of sufficient size that CAN be changed quickly. Enough, that is to make the requisite changes to aggregate demand.

Well the U.K. reduced the Value Added Tax percentage around eighteen months ago and then increased it about six months ago. Moreover, the percentage change was only 2.5%, that is one eighth the total VAT percentage of 17.5%. I.e. the U.K. could have made EIGHT TIMES as big a change had it wanted to.

And for another quick fiscal change, Warren Mosler one of the most pro-deficit economists has long advocated a payroll tax reduction or abolition.

Plus it would be possible to temporarily suspend the payroll tax AND abolish a sales taxes, like VAT.

Retail chains can make changes to their prices at the press of a button. They can charge a different price for a given product at different stores if they want. It’s time governments learned to do the same sort of thing.

It would be perfectly feasible to change a payroll tax or sales tax from month to month (not that they would need to change that frequently). And if any “it’s never been done before” bureaucrats don’t like the idea, they should be replaced with people who CAN do things that have never been done before.

And finally we should never forget a nonsensical aspect of monetary changes. Cutting interest rates, for example, boosts the economy ONLY via firms and organisations that are, substantially in debt, AND rely to a significant extent on variable rate loans rather than longer term loans. This is no different from boosting an economy only via firms whose names begin with letters between A and F.

In contrast, a fiscal boost can be given to much wider sections of the economy, e.g. a payroll tax change effects ALL employers.

Peter G.Peterson.

Peter G.Peterson advocates "short-term deficits" and "social justice"! Now I really am confused. Do we have a damascene conversion? Do MMTers now have a billionaire on their side?

The phrases “fiscal policy” and “monetary policy” should be abolished.

The opening sentence of this economics tutorial site reads: “Fiscal policy should not be seen in isolation from monetary policy.” Too right. I’d go further: the two are so intertwined that making a distinction between them is near meaningless. Or as Robert Skidelsky puts it, “In Keynesian theory, monetary and fiscal policy are parts of a single process”.

Certainly those who refer to FS or MS alone normally fall flat on their faces.

For example this Wikipedia site suggests in its opening few paragraphs that FS can influence aggregate demand (AD). Well that is debatable.

Fiscal policy is normally seen as consisting of government raising or reducing taxes or spending and altering borrowing by an equivalent amount. But there’s a problem: the deflationary effect of the borrowing (assuming the objective is stimulus) to some extent negates the stimulatory effect of the spending (a problem called “crowding out”). So what do governments do about this? Exactly what they’ve done over the last two years: reduce interest rates to make sure that there is a stimulatory effect. But to force down interest rates they have to print money and buy some of the government debt they have issued. I.e. the money supply goes up (monetary policy again).

The two are well and truly intertwined! Moreover, since money printing has a definite effect, while the effect of borrowing is debatable, why bother with borrowing? Abba Lerner was right: borrowing is a farce. I give more reasons as to why borrowing is a farce here.

Instead of the phrases MS and FS it would be better if those advocating any economic policy just said what the policy consisted of: e.g. “have government borrow $Xbn and channel it to Wall Street” or “abolish the Federal Reserve” or “shoot the governor of the Bank of England.”

But spelling out a proposal in detail involves THINKING (shock, horror). It involves commitment – it involves the risk of someone pointing to errors in your proposal.

It’s far easier to make vague and near meaningless generalisations about MS and FS. So just jumble up the words “fiscal”, “monetary” and “policy” with a thousand other words from the English dictionary at random, and you have an article you might get paid for.

The Financial Times debate continues.

Financial Times stimulus / austerity debate (26 – 30th July).

Thursday’s anti stimulus article is by Jeffrey Sachs of the Columbia University “Earth Institute”. My heart leapt for joy on seeing this, because as I have previously noted, Jeffrey Sachs and the Earth Institute are a fount of false logic and economic illiteracy. If deficit terrorists have to employ Jeffrey Sachs as a spokesman, then deficit terrorists are intellectually bankrupt.

Sachs’s article is mainly devoted to advocating his own quaint set of priorities for the U.S.: more infrastructure investment, clean energy, more education, defence spending cuts and so on.

Some of those items are perfectly laudable, of course. But they have precious little to do with the stimulus debate.

That is, the distribution of a country’s spending as between defence, wind farms, massage parlours, food, etc, etc has very little to do with the question as to how to maximise employment levels.

For the benefit of any mentally retarded readers from the Earth Institute I’ll put that another way. For a given deficit, national debt, labour market efficiency, etc. employment levels will be much the same regardless of the distribution of spending as between electric cars, internal combustion engine cars, gambling dens, you name it.

What is UTTERLY TRAGIC is that there are people teaching at universities who don’t understand the above very simple point.

Kenneth Rogoff.

The Financial Times debate this week on the deficit versus austerity argument continues. Wednesday’s anti-deficit contributor is Kenneth Rogoff.

The title of his article is “No need for a panicked fiscal surge”. Attributing “panic” to one’s opponents is fair enough if this is substantiated is the article that follows. No such substantiation appears.

Advocates of more deficit only advocate enough deficit to counteract the effect of the credit crunch and bring us back to full employment hopefully in two or three years or thereabouts. That does not constitute panic. It is a perfectly reasonable and measured response.

Rogoff’s first substantial claim is that “anaemic growth with sustained high unemployment is par for the course in post financial crisis recoveries”. OK, then: death was par for the course two hundred years ago on contracting various diseases. Thankfully the medical profession has not spent the last two hundred years just chanting the phrase “par for the course”. They’ve done something to solve the relevant problems.

Next, Rogoff refers to current “record peace-time” national debts. Well current national debts are nowhere near record levels. U.S. and U.K. debts were well over double their present level in the five or so “peaceful” years after WWII.

But Rogoff claims paying off these post war debts was made easy by the fact of large numbers of military personnel returning to civilian jobs. Now why on earth having large numbers shift from one section of the economy to another should make paying off debt any easier is a mystery. Rogoff offers no explanation and I can’t think of one.

The next, Rogoff deals, as indeed he must, with the fact that Japan has a national debt of around 200% of GDP without any big problems. He attributes this to its “ability to sell debt domestically”. So it’s not debt per se that is the problem apparently, but the source of funds to finance the debt.

This is a great new theory for which Rogoff offers zero words by way of explanation.

And it’s a weak theory. The first problem with it is that there are hundreds of international “cross holdings” of national debt. For example the amount of U.K. national debt held by U.S. entities is roughly the same as the amount of U.S. debt held by U.K. entities. So in that a country’s foreign held national debt is cancelled out by cross holding, there is presumably nothing stop it doing a “Japan”. And doubtless this applies to dozens of countries.

Moreover, if say China suddenly stops buying U.S. national debt, what of it? If it stops buying because it regards the U.S. government as not credit worthy, then U.S. citizens will probably react similarly, i.e. not lend to their government. So in this case the “foreign / domestic” point is irrelevant: the fundamental problem is the government’s lack of creditworthiness.

Alternatively, if China stops buying for reasons that have nothing to do with credit worthiness, then U.S. entities will probably step into the breach.

That in turn would mean a small standard of living cut for U.S. citizens, but that shouldn’t be a problem. The standard of living cut would be nowhere near the cut they’ve taken as a result of the credit crunch. In short, Rogoff’s “theory” looks a non starter.

Next Rogoff claims that the “evidence on Keynsian growth effects of fiscal deficits is thoroughly inconclusive”. Well I sort of agree with that, though we have to be VERY CAREFUL about what is mean by fiscal deficits, a crucial point which Rogoff (like almost everyone else who uses the phrase fiscal deficit) glosses over.

If one means government borrows and lets interest rates take care of themselves, the interest rates are likely to rise in reaction to the borrowing and negate some of the stimulatory effect of extra spending.

If one means government borrows and at the same time drops interest rates (which is what has happened over the last two years) then the result will be stimulation. But to do this, the government – central bank machine has to print money and at least to some extent monetise the debt. So in this case, it is the money printing doing most of the work.

So what Rogoff is doing here is saying that Keynsian borrow and spend is of doubtful effectiveness, while keeping quite about the measure (interest rate cuts) which make it effective. Clever sleight of hand that one.

And finally, for a more effective demolition of Rogoff’s ideas than I’ve managed above, see here.

P.P.S. For another flaw in the Rogoff argument, see here.

“Confidence”: a deficit terrorist favourite.

The deficit versus austerity debate continues in the Financial Times this week. Niall Ferguson trots out a favourite deficit terrorist argument, the “confidence” argument. It runs thus (see in particular Ferguson’s last three paras).

The confidence of the population is damaged by deficits and national debts. Thus if the latter are reduced, confidence will increase, which in turn will get us out of the recession.

There is of course some logic here: logic which has a limitless number of hilarious applications. For example if the confidence of a football team is increased by the team painting their toenails pink, then pink nail varnish will certainly increase the team’s chances.

Now for the benefit of the hopefully very few readers who don’t know the name for this effect it’s called the

PLACEBO EFFECT !

It is a measure of the sheer ignorance and stupidity of deficit terrorists that they have to rely on something so utterly balmy as the placebo effect.

The medical profession (unfortunately) has to take the placebo effect into account when testing drugs. Reason is that while this effect is just a nuisance, the effect is definitely there: it cannot be ignored. But the vastly more important question is of course the chemical, biological and bacteria destroying effect of drugs.

It would be nice if those writing articles in the Financial Times were concerned about real economic effects rather than placebo effects.

Moreover, Niall Ferguson seems to be unaware of the REASON why the population is concerned about deficits and national debts. The actual reason is that they’ve been bombarded with a hundred million dollars of anti deficit propaganda paid for by the billionaire Peter G. Peterson and others.

A number of other trite anti-deficit arguments are put by Ferguson. One is that a selection of South American countries have gone over the top with deficits and suffered excess inflation as a result. Yes, the average mentally retarded ten year old knows that if one doubles the money supply every week a la Mugabwe the rampant inflation will ensue. Yawn yawn.

Also, while it is true that confidence is crucial in boosting commercial bank created money, it is precisely this form of money which balloons in the lead up to credit crunches, and the busts that inevitably follow. Far from basing an economy on “confidence” (or any other emotion come to that) it would be far better to base them on something more substantial. A currency based on gold is a possibility. Though gold has its drawbacks. Another more substantial form of currency is central bank created money.

Only dummies think that deficits mean future tax increases.

The Financial Times has a series of articles this week on the deficit debate. So I’ll pick out some low hanging fruit offered by deficit terrorists and do some piss taking.

As Martin Wolf rightly points out, one of the main arguments put against deficits is that households think that deficits equal additions to the national debt, and that the latter will have to be paid back out of taxes. Thus households allegedly save more as soon as they see deficits on the horizon. And this allegedly nullifies the stimulatory effect of deficits.

This argument is nonsense from start to finish.

First, the idea that the average house calculates, or is even ABLE to calculate the deficit per household is farcical.

Second, a fairly large amount of deficit is required simply to keep the national debt and monetary base CONSTANT as a proportion of GDP in real terms, not to mention the effects of a rising population and rising real output per head. Here is a quick “back of the envelope” calculation as to the size of deficit required simply to keep things constant. Assume the following. 1. Real output per head is rising at 2% a year. 2. Population is rising at 1% a year. 3. Inflation is averages 2% a year. 4. National debt plus monetary base equal GDP.

On the above assumptions, the deficit would need to be 2 + 1 + 2 = 5% of GDP just to keep things constant. This 5% is NEVER EVER PAID BACK assuming GDP etc keep increasing as assumed above. Don’t believe it? Well look at the figures for national debt or monetary base for the last fifty years at the St Louis Fed site.

Third, governments will not, or at least ought not to raise taxes to pay back national debt until an inflationary boom looks likely. And taxes consist of government siphoning off household income before households can spend it. Thus anyone who saves up to pay back national debt is engaged in double counting. They are as deluded as someone who saves up to pay a tranche of tax where the relevant tranche is siphoned off by the tax authorities at source. An example is the PAYE income tax system in the UK under which wage earners have their income tax deducted before they even see their pay packets.

Readers who have not fully understood the above might be tempted to answer the latter point something along the lines, “Ah, but you’ve admitted taxes DO have to rise to pay back national debt. And any tax rise equals a standard of living cut. Thus households are being perfectly sensible to save in the face of those forthcoming cuts”.

The answer to that, briefly, is that those tax increases only reduce household income and spending from totally unrealistic or fantasy levels to realistic levels. Put another way, if (as is the case where an inflationary boom is imminent) money incomes are sufficiently high to cause serious inflation, what might be called the “excess portion” of those incomes just has to be wiped out.

The latter is no more of a standard of living cut than is waking from a dream in which one is a billionaire, and finds one has to live life on an average income.

This final para is a bit of a quibble, so stop reading now if you like. The above paras were based on the simplifying assumption that governments aim to keep national debts more or less constant as a proportion of GDP in the long term. Various articles on this and related sites advocate abolishing the national debt. So there might seem to be a contradiction here. I actually favour abolishing national debts. But for the purposes of this article, I’m just sticking with conventional ideas like “keep national debt more or less constant as a proportion of GDP”.

Keynsian “borrow and spend” is crazy.

When government borrows, it borrows something, i.e. money, which government itself created in the first place. It borrows something which government can create in limitless quantities any time. This is as absurd as a dairy farmer buying milk in a shop when there is a thousand gallon tank of milk a few yards from his front door. It is absurd as carrying coals to Newcastle.

As to whether printing money IS inflationary, it is not inflationary (as pointed out by David Hume over two hundred years ago) until it is spent, and spent in sufficient quantities. The latter equals stimulus (or possibly too much stimulus). Moreover “spent in exactly the right quantities” equals “stimulus of exactly the right amount”. Ergo stimulus can be achieved without any Keynsian “borrow and spend”, that is, without any borrowing.

Or in the words of Claude Hillinger, “An aspect of the crisis discussions that has irritated me the most is the implicit, or explicit claim that there is no alternative to governmental borrowing to finance the deficits incurred for stabilization purposes. It baffles me how such nonsense can be so universally accepted. Of course, there is a much better alternative: to finance the deficits with fresh money.”

Conclusion: Keynsian borrow and spend is crazy.

Endnote: it is quite likely that Keynes realised that Keynsian borrow and spend is crazy, to judge by what he said about Abba Lerner. (Lerner favoured “print and spend” rather than “borrow and spend” money”.) Keynes said "Lerner's argument is impeccable but heaven help anyone who tries to put it across to the plain man at this stage of the evolution of our ideas.”

In other words possibly Keynes realised that “print and spend” was beyond the comprehension of those surrounding him, and that he’d be better off going for the second best and daft alternative, namely borrow and spend.

Keynsian “borrow and spend” is crazy.

Definitions. 1. The word “borrow” is used here to refer to where a government borrows in the market, as distinct from borrowing from its own central bank. The latter operation typically involves the creation of bonds, payments of interest, etc. But this is just a paper and money shuffling exercise within the “government – central bank machine”. It has no effect on the real economy (assuming government bonds are not sold in the market by the central bank).

2. Having referred above to two separate entities, government and central bank, the word government will henceforth be used to refer to the two entities combined.

3. The word “print” as in “print money” does not refer simply to printing banknotes: it refers to creating money in the broadest sense of the phrase, e.g. creating money by pressing computer keyboards, which in practice is how banks create most of the money they create nowadays.

4. The phrase “Keynsian borrow and spend” is unfair to Keynes in that towards the end of his life he turned against borrow and spend and in favour of having government simply print extra money and spend it, in a recession. However, since his death, plenty of economists who call themselves Keynsians have stuck to the “borrow and spend” option (for reasons that baffle me). So to that extent, the phrase “Keynesian borrow and spend” is fair.

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When government borrows, it borrows something, i.e. money, which government itself created in the first place. It borrows something which government can create in limitless quantities any time. Thus borrow and spend is as absurd as a dairy farmer buying milk in a shop when there is a thousand gallon tank of milk a few yards from his front door. It is absurd as carrying coals to Newcastle.

As to whether printing money is inflationary, it is not inflationary (as pointed out by David Hume over two hundred years ago) until it is spent, and spent in sufficient quantities.* The latter equals stimulus (or possibly too much stimulus). Moreover “print money in the right quantities” equals “stimulus of exactly the right amount”. Ergo stimulus can be achieved without any Keynsian “borrow and spend”, that is, without any borrowing.

Wright Patman (Chair of the House Committee on Banking and Currency for 40 years) took a similarly dim view of borrow and spend. He said that when government “pays interest for the use of its own money” government has got involved in an “idiotic system”.

(Congressional Record of the House of Representatives (pages 7582-7583), Sept 29, 1941. A fuller quote is here.)

A second farcical aspect of Keynsian borrow and spend is thus. The latter borrowing is bound to push up interest rates, which crowds out private sector borrowing and spending. The latter is of course exactly what is not needed. So what do governments do to make sure this crowding out does not occur? They make sure that interest rates DO NOT rise! Indeed, since cutting interest rates is allegedly stimulatory, governments are very likely to CUT interest rates.

And how do they cut interest rates? Well they wade into the government bond market and buy back debt (with money created out of thin air), which raises the price of government debt, which in turn cuts interest rates.

So what is really doing the work here? That is, what is that has the stimulatory effect: the “borrow and spend” or the money printing?

Indeed, does it really matter which of the two latter has the real effect? The answer is “not really”. That is, whether an economy is stimulated by money printing or by borrow and spend does not make a scrap of difference in that money has to be printed in both cases! So why bother with “borrow and spend”? Answer: there is NO point! Borrow and spend is a farce.

A third reason for thinking that borrow and spend is crazy is that it involves governments in expanding the national debt and paying interest on that debt when there is no need to pay interest. Reasons are thus.

One of the reasons for unemployment is “paradox of thrift”: the belief by private sector entities that they hold insufficient financial assets, and thus that they need to save money. This saving, or “failure to spend” results in less aggregate demand than would otherwise be the case, which in turn means unemployment.

The obvious solution is to feed additional assets to the private sector. In the case of borrow and spend, this “feeding of additional assets” comes about as follows. 1, government borrows $X, 2, government gives $X of bonds to lenders, and 3, government spends $X. The net result is that the private sector is up to the tune of $X.

But for a government to borrow and pay interest on sums borrowed in this scenario is absurd because the private sector actually WANTS or NEEDS additional assets, and there is no need to pay anyone to take something they WANT or NEED.

Conclusion: so far as stimulus goes, it is CASH that ought to fed into private sector pockets, not bonds.

A fourth daft aspect of borrow and spend is thus. Borrowing is deflationary because it withdraws money from the economy. But that is in direct conflict with the purpose of borrow and spend which is REFLATIONARY or STIMULATORY.

In other words the borrow part of borrow and spend is a bit like throwing dirt over your car before cleaning it! Totally pointless!

In this connection, there is a possible objection to print and spend, namely that it is almost certainly a more potent weapon, dollar for dollar, than borrow and spend (because as just pointed out, much of the “spend” part of “borrow and spend” is cancelled out by the “borrow” part). That might induce some readers to conclude that print and spend is more inflationary, dollar for dollar.

Now there is a simple solution to this problem as follows. If you use a more potent fuel in an engine, but want constant power output from the engine, what do you do? The average ten year old knows the answer: use less fuel!

A fifth daft aspect of borrow and spend is that it expands the national debt and the larger the national debt, the more of such debt is likely to end up in the hands for foreign entities. Now borrowing from abroad CAN sometimes make sense. But paying interest to foreign lenders when (as pointed out above) no interest should be paid at all, is plain daft.


Conclusion so far: for stimulus purposes, borrow and spend is unnecessarily complicated. That is, simply printing money and spending it would make more sense, as pointed out by Abba Lerner, arguably the founding father of Modern Monetary Theory. And for those impressed by Nobel Prize winning economists, at least two agreed with the above money printing idea: Milton Friedman and William Vickrey. (The Friedman paper is also available here.)


A counter argument.

It could be argued that the costs of borrow and spend are not all that great, in that while this policy IS a pointless paper chase, the costs of paper pushing as a proportion of GDP are small. (Not a strong argument in view of the astronomic costs of the average country’s bureaucracy, but never mind!)

However, against that, there is a real and more serious problem as follows. An ever expanding national debt, or a national debt that expands too fast, causes economic illiterates to go berserk, and campaign for cuts in government spending (or tax increases). The two latter DO HAVE serious economic consequences: the result is a decline in demand in real terms, and means unnecessary unemployment. And this is a very real problem in the U.S. at the time of writing.


Another possible criticism.

A popular idea, which is also a possible criticism of the anti-borrow and spend argument here is that borrow and spend “gets an economy going”, and that come the recovery, a government can pay back the sums borrowed.

The problem with this argument is that if borrow and spend provides stimulus, then the most plausible prima facie assumption regarding the opposite of borrow and spend (i.e. repaying debt) is that the effect is ANTI-stimulatory, i.e. deflationary. And that in turn leads to the conclusion that debt should NOT be repaid (or at least not repaid till it looks like deflationary measures are called for, e.g. because of looming inflation).

And indeed, this “debt is never repaid” scenario is very roughly the reality for most countries. That is, while national debt as a proportion of GDP varies widely between different countries and as between different decades for any country you like to mention, most countries debt as a proportion of GDP is in the 30% - 100% range, just as it was a century ago.


Borrowing as a substitute for tax.

Government borrowing for stimulus purposes is quite different from government borrowing as a substitute for tax. And the above anti-borrowing arguments are not in themselves an argument against borrowing as a substitute for tax. (Though as it happens the arguments for the latter borrowing are pretty feeble. See here.)

Nor are the above arguments about the lack of any necessity for governments to pay interest in the case of stimulus borrowing applicable to “substitute for tax” borrowing. Indeed, given adequate PNFA and given full employment, a government which wants to borrow as a substitute for tax will HAVE to induce the private sector hold MORE than its desired PNFA. And inducements cost. In this case the cost is called “interest”.



Using interest rates to regulate economies.


A possible objection to the above arguments is that they imply an abolition or near abolition of government borrowing. And since governments adjust interest rates by buying or selling government securities, the above print and spend policy would make it difficult for governments to regulate interest rates.

To be more accurate, the fact of not engaging in borrow and spend for stimulus purposes does not rule out borrowing as an alternative to tax. But when politicians borrow rather than raise taxes, the motive is usually political cowardice, or (much the same thing) the desire to buy votes. So there is a good argument for abolishing or reducing government borrowing here as well.

So let’s assume a near ideal world in which politicians abstain from borrowing in order to buy votes: that is, let us assume there is no government borrowing either for stimulus purposes for “substitute for tax” purposes. Does the resulting paucity of government securities matter?

There several reasons for thinking it would not matter.

First, using interest rates to adjust demand is distortionary, since it works only via private sector entities that are significantly reliant on variable rate loans. It is true that less or more activity by these entities ultimately affects other entities. Given for example an interest rate cut, it is true that additional activity by those entities will sooner or later trickle down to other entities. But that is far from ideal.

In particular, by the time the trickling down is complete, it is possible the economy is suffering excess demand and inflation, and stimulus from the latter “trickle down” is exactly what is not needed.

The ideal is to induce as many private sector entities into additional activity as soon as possible, and print and spend is a superior measure in this respect to altering interest rates: at least, a well designed print and spend policy would be less distortionary. For example, a payroll tax cut would benefit every employer and employee in the country. That of course leaves out pensioners and others on social security. But with a little ingenuity the latter could be catered for.

Second, the fact of not borrowing for stimulus or “substitute for tax” purposes does not rule out borrowing specifically so as to influence interest rates. Indeed, where a government wanted for example to damp down demand by raising interest rates, the effect would come not just from the increased rates. Such a government would announce a willingness to borrow at a higher rate than the prevailing rate. That in turn would withdraw funds from the economy, which (as pointed out under the second objection to borrow and spend above) has a deflationary effect. At least that would be the effect, assuming the money borrowed is not spent.

The conclusion is that print and spend is a superior policy to borrow and spend, plus any shortage of government securities resulting from a print and spend policy would not make it significantly more difficult for governments to raise interest rates, and even if it did make it more difficult, that would not matter, because governments can always regulate by altering their net spending.



Conclusion: Keynsian borrow and spend is crazy.


Endnotes:1. it is quite likely that Keynes realised that Keynsian borrow and spend is crazy, to judge by what he said about Abba Lerner. (Lerner favoured “print and spend” rather than “borrow and spend” money”.) Keynes said "Lerner's argument is impeccable but heaven help anyone who tries to put it across to the plain man at this stage of the evolution of our ideas.”

In other words possibly Keynes realised that “print and spend” was beyond the comprehension of those surrounding him, and that he’d be better off going for the second best and daft alternative, namely borrow and spend.

Also Keynes in a letter to Roosevelt in 1933 said that government should “create additional current incomes through the expenditure of borrowed or printed money.” Thus it seems Keynes was well aware of “print” as an alternative to “borrow”.

Incidentally, Keynes in this letter also makes the point (mentioned above) that the quantity of money is irrelevant: rather it’s the rate at which it is spent that is crucial.

2.Note, dated 17th Aug. 2010. This post has been regularly added to and revised since it was first published on 19th July. Also I have expanded the above points into something more like a formal academic paper. See here.

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* See David Hume’s essay “Of Money”, in particular the two paras starting “It seems a maxim….”

Yipee: Krugman almost accepts functional finance.

Interesting exchange of views between James Galbraith and Paul Krugman. Crucial bits (as I see it) are thus.

Galbraith says “So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system.”

Krugman answers: “OK, I don’t think that’s right. To spend, the government must persuade the private sector to release real resources.”

Galbraith responds: “In the actual world we live in, government does not have to “persuade the private sector to release real resources.” In the actual world, the private sector has already released those resources by the tens of millions of people.

All the government has to do, in the actual world, is mobilize those resources, which it does by issuing checks, preferably to pay people to do useful things.

Krugman’s only answer is to worry about the possible inflationary effects of the increased monetary base when the economy returns to normal (see final three paras).

The answers are thus. First, at the time of writing, the base increase is no more than the collapse in commercial bank created money, thus there has arguably been no money supply increase.

Second, an increased monetary base does not increase banks capital. Banks are capital constrained, not reserve constrained, thus the base increase does not increase banks’ ability to lend. Thus there won’t be an EXPLOSIVE increase in demand or inflation.

Third, it is obvious that the more monetary base is effectively in the hands of consumers, the higher demand will be (possibly leading to excess inflation). But governments and central banks are constantly having to deal with excess or deficient demand ANYWAY. For example if inflation looms, the extra money can be reined in as quickly as it was created, and by the usual anti-inflationary devices available to governments: increased interest rates, increased tax and so on.

Game, set and match to Galbraith.

The only remaining weakness in Galbraith’s argument is the point made by Milton Freidman, namely that governments are so hopeless at regulating demand that it would be better if they didn’t try. That is a good point, on the other hand the fact that the first twenty attempts to cure a disease don’t work is not a reason to give up, is it?

Crowding out nonsense.

More nonsense is written about crowding out than almost any other subject in economics. Crowding out is allegedly a problem. The reality is that it is not, and for the following reasons.

Governments (in the sense of “government and central bank combined”) borrow and spend for two reasons. The first is with a view to stimulus. Obviously such stimulus would be thwarted if the result of the borrowing is increased interest rates. Where stimulus is the objective, a government is hardly going to let interest rates rise as a result of the borrowing is it? And this is exactly what has happened in the last two years or so: more borrowing plus interest rate cuts.

As to the idea that public spending crowds out private spending because the former makes it difficult for the latter to obtain resources to meet demand, this idea is nonsense. Of course the latter scenario is a possibility, but where this possibility becomes a reality, the relevant economy is very near capacity, and that is not the scenario we are dealing with. We are dealing with the scenario where stimulus is required, that is where the economy is a long way from capacity.

A second reason for borrowing is so as to fund spending (with stimulus not entering into the picture). Funding say additional roads and schools where an economy is already at full employment, is an example.

In this case, crowding out is exactly what is wanted. That is, half the purpose of borrowing is to suppress or “crowd out” private sector spending so as to make room for more public sector spending. (Advocates of Functional Finance would, quite rightly, replace the word “half” in the latter sentence with the phrase “the whole”, but that is incidental.)

Conclusion: there shouldn’t be any crowding in a falling interest rate scenario. As to the second above mentioned scenario, that is where crowding out is positively desirable, the only problem is not knowing the exact extent of and effect of crowding out.

In other words the folk who have been worrying about crowding out over the last two years or so (a falling interest rate scenario) are worrying about nothing.

Banks fool governments yet again.

According to the Wall Street Journal, banks have persuaded governments to water down restrictions on bank activities (big surprise). Governments have been persuaded that “tougher requirements would diminish the credit needed to revive a sluggish global economy”.

The flaw in the latter argument is that there is no limit to the stimulus that a government can give its economy for a given set of bank regulations. Stimulus CAN come from more commercial bank lending, but equally, it can come from government spending more (and/or cutting taxes).

So what is the optimum combination of the two variables, first, bank lending and second government spending and/or tax cuts? A precise answer is difficult, but for a statement of the obvious, commercial bank lending does not want to be on a scale that means that at the margin loans are irresponsible. Unfortunately the latter seems to be exactly what is happening. That is irresponsible lending is rearing its ugly head even though the economy is still a hundred miles from getting back to pre-crunch levels.

But banks don’t give a hoot. Ninja mortgages, mortgage fraud etc with banks taking their cut at every turn and leading to another trillion dollar taxpayer funded bank bailout is how banks make their money nowadays.

Ellen Brown.

Nice description by Ellen Brown of the way in which the private banking sector captures the money creation process from government. It’s done by capturing the press and buying politicians.

Note added 6th Aug 2010: Ellen Brown’s point is much the same as a point made by John Hylan, Mayor of New York, 1918-25. In reference to bankers he said “Woe to the public officials who dare resent their dictatorship. If there be such public officials who will not submit to their imperious dictation, then the floodgates of lying press propaganda are released…."

Scroll down about half way here for the above quote.

Let's all export more.

Obama’s latest brainwave for employing millions of unemployed Americans is to double American exports.

Germany keeps telling other European countries to be more like Germany export more.

And George Osborne, the UK’s finance minister thinks that unemployed Brits will somehow automatically shift to export related employment.

So where are all these additional exports going to go: Mars? Or is it Jupiter?

And one final question: how do we get rid of the above mentioned clowns?

US and Euro private sector surplus: $3,000bn this year?

According to Martin Wolf the combined private sector surplus in the US and Eurozone will be $3,000bn this year.

He says “My conclusion, then, is that the advanced countries remain highly short of demand”. Agreed.

His final para says that the G20 countries “may hope that retrenchment now will spur on private spending. But what is their plan if it turns out that it does not?”

Yes, there are a fair number of people who would like an answer to that one (me included). Or to be more blunt, there isn’t a plan (except in the Baldrick “I’ve got a cunning plan” sense of the word plan).

But all is not lost. The answer to the above question, i.e. what alternative plan is there, is in the second last paragraph of a Huffington Post article by Warren Mosler. As Mosler says “.....deficit spending would accumulate as excess reserve balances at the Fed....”. I.e. the answer is: (a) just carry on with deficits, (b) let them accumulate as monetary base, not national debt (why pay interest when you don’t have to?????)

So why aren’t governments doing this or “planning” for this? Probably because they think more monetary base expansions are inflationary. Well they are wrong, and for the following reasons.

1. As David Hume pointed out 250 years ago in his essay “Of Money”, money supply increases are not inflationary till they are spent. I.e. it is SPENDING not the size of the money supply that is inflationary.

2. It is a popular belief that extra monetary base enables banks to lend more. That idea has hardly been born out in the last two years: we’ve had astronomic monetary base increases and politicians are tearing their hair out at the FAILURE of banks to lend. Secondly, banks are capital constrained, not reserve constrained. MB increases do not increase bank capital, therefore they don’t facilitate extra lending.

3. As regards the U.K. with inflation already worryingly high, further deficits and MB increases hardly seem appropriate. Answer: that’s possibly true, but the above points are not supposed to be applicable to EVERY country. They are intended as a general sort of answer to the question, “What should normally be done given a combination of, 1, high unemployment, and 2, the private sector saving as never before.”

Destroy jobs so as to curtail bubbles? Bonkers.

Conventional economics continues to struggle manfully with a problem it cannot solve, and which functional finance can solve. It’s this. Low interest rates can encourage asset price bubbles. But higher rates might hinder the recovery. So what to do?

As Brad deLong (Prof. of Economics at Harvard) put it a year or so ago, “......in a situation like 2003 should we try to keep the economy near full employment even at some risk of a developing bubble?”

To put that in plain English, conventional economics can involve destroying jobs, increasing home repossessions, families being made homeless, etc so as to discourage gamblers and other undesirables with more money than sense from taking silly bets on asset prices. Now there has to be something wrong there.

What is wrong is so fundamental to conventional economics, that it’s advocates won’t believe it: it’s that interest rate adjustments just aren’t a good way of regulating economies.

A better way, is simply to alter government income and/or spending and let interest rates look after themselves. And the reason is desperately simple. Altering government income and spending can be done in a way which is almost free from distortionary or directional effects. In contrast, interest rate changes are very distortionary.

To illustrate, reducing interest rates benefits borrowers and hits savers. Well, that is distortionary for a start: it involves benefiting one half of the population of the population, and hitting another half.

As the INDIRECT effects, reduced interest rates will encourage a very small proportion of the population (and firms) to make very large capital investments. That is distortionary again.

Doubtless the benefits of an interest rate change eventually “trickle down” to the economy at large. But how long does that take? Two years? Four years? Macroeconomic adjustments which are slow to act can easily be worse than useless. For example, if an adjustment is aimed at escaping a recession, and the main effect is to exacerbate the next boom, that is worse than useless.

In contrast, changes in government income and/or spending can have an immediate and less distortionary effect. For example the payroll tax reduction long advocated by Warren Mosler is distortion free in that it immediately benefits every employee in the country. That of course leaves out pensioners, the unemployed and few other groups. But with a little ingenuity, these latter groups can be allowed to join in the fun, e.g. via a temporary unemployment benefit increase. As for pensioners, countries with a state pension schemes can make temporary changes to the state pension. For example the U.K. has temporary and variable state pension supplements in Winter to help pensioners with fuel bills. It isn’t rocket science.

To summarise, any asset price bubbles that derive from an interest rate reduction derive precisely from the distortionary effect of interest rate reductions: the fact that the initial benefits land first in the laps of borrowers, in particular those tempted to borrow large amounts on the strength of the rate reduction.

So the solution is: don’t use interest rate adjustments as adjust economies.

Note added 9th July: Martin Wolf in the Financial Times doesn’t appreciate the problems with interest rate adjustments. He said (7th July) “expanding the interest elastic parts of the economy is the best way to climb out of the hole”.

David Blanchflower doesn’t answer the $64k question.

I like and respect David Blanchflower. He has an impressive CV. Amongst other things he is a former external member of the Bank of England's interest rate-setting Monetary Policy Committee. When there is a choice between stimulus and deflation he normally votes for stimulus.

In this Guardian article today (1st July) he attacks the U.K.’s recent deflationary budget decisions. So far so good. Then he ends by advocating further stimulus (i.e. reflation).

This does not answer the obvious question: the conventional way of bringing stimulus is to have government borrow and spend. But the one thing the entire world is trying to do at the moment is REDUCE national debts. Problem.

For the solution see “Musgrave’s Law” in the column to your right.

Even worse is Adam Posen, current member of the above committee. He said that “the UK had no choice but to cut spending because the deficit was so large...”. Hopeless.