Monday, May 16, 2011

Three economics Profs go off the rails.

This post by David Beckworth (economics prof at Texas State University) is odd.

Beckworth’s basic argument is thus. We are allegedly in a balance sheet recession. But the latter idea is debatable because it begs the question as to why the creditors of those indebted households are not spending the money they get from such households. As he puts it “why aren't the creditors who are receiving the increased payments spending the money?” Thus, according to Beckworth, we have an “excess demand for money” problem, not a balance sheet problem.

Even stranger, is that Beckworth’s argument is supported in the comments after his post by two other economics profs: Scott Sumner, of Bentley University, and Bill Woolsey, economics prof at The Citadel, South Carolina.

Now for the flaws in the above argument.

A significant portion of the above mentioned creditors are banks. And the reason those banks don’t “spend the money” is that the fact of repayment extinguishes the money! That is, commercial bank money is borrowed into existence. And when the money is repaid, the money vanishes!

The only other major category of creditors are firms which supply households or other firms with goods on credit. The reason those creditors do not “spend the money” is, first, that the fact of coming into possession of such money does not expand such creditors’ net assets. That is, if someone repays me $X, then $X worth of “debtor” on my balance sheet is replaced with $X of cash. I am no better off. There is little inducement for me to go on a spending spree.

Second, firms are not in the business of spending money just because they have some in the bank. The ultimate source of all demand, households do that, but not firms.

Indeed, for a firm or employer, plenty of customers owing money to the firm indicates a decent level of sales in recent months, which represents profits, as long as the customers are credit worthy. That is, for firms, far from a large pile of cash being a reason to spend, it is arguably a sign of poor sales, and thus a reason NOT to spend on expansion.

Or have I missed something?

Afterthought (17th May): There is something I missed, namely reserves. As Neil in his comment below implies, banks are sitting on record reserves which they could lend. And this could be seen as “excess demand for money”. On the other hand it could equally well be claimed to be evidence of banks’ balance sheet problem, namely that their so called assets are toxic to a significant degree. Thus on the face of it, these excess reserves do not support either the “excess demand” theory or the “balance sheet” theory.


No comments:

Post a Comment