Wednesday, April 27, 2011
The recent recession, like most recessions, was sparked off by excessive and irresponsible borrowing. So how have the authorities responded? By cutting interest rates to record lows – with a view to bringing stimulus via . . . . wait for it . . . . more borrowing!
You couldn’t make it up.
The above absurdity is a bit like the emperor with no clothes. The folk looking at the emperor with no clothes got so used to the sight that they ceased seeing anything absurd. Likewise, most of us are so used to mantra about interest rate reductions being a good way of dealing with recessions that we fail to see the absurdity.
Modern Monetary Theory (MMT) doesn’t make the above interest rate mistake because it advocates bringing stimulus via more government net spending (i.e. more public spending and/or less tax). That is, in a recession, the government / central bank machine just creates new money and spends it: neither taxes nor borrowing are raised so as to fund the extra spending. And conversely, when inflation looms, the government / central bank machine does the opposite: that is, it reins in money via extra tax, and “unprints” or extinguishes money.
But the above “more borrowing so as to solve the problems brought by excessive borrowing” is not the only crackpot element to the conventional wisdom. There is another, and possibly even more hilarious bit of nonsense: Keynsian “borrow and spend”.
The idea here is that government borrows and then spends the money borrowed. This allegedly brings stimulus. The big problem here is that taking money away from the private sector (borrowing) and then channelling it back to the private sector in the form of more spending quite possibly has no net effect.
But even if it does have a net effect, there is still a nonsense involved, as follows. The government of a sovereign currency issuing country (e.g. the U.S., Japan, etc) can print any amount of money any time. Now what’s the point of borrowing something (i.e. money), when you can produce it yourself for free? Even worse, what’s the point of borrowing money from OTHER COUNTRIES and paying them interest for the privilege of having something you could have produced yourself for free? Darned if I know.
MMT doesn’t make the latter mistake either.
And the third absurdity is quantitative easing (QE). That involves giving the rich cash in exchange for their securities. Now what’s the reaction of the rich going to be? No prizes for guessing the answer.
What they WON’T do is what we want them to do: raise their weekly spending, which would raise demand and create jobs. The spending habits of the rich are not much influenced by changes in the value of their income or assets.
What they WILL do is purchase other assets with their newly acquired pile of cash. That is, they’ll try to buy other securities – hence the stock market appreciation. Or they’ll seek investment opportunities abroad, which messes up other countries: exactly what has happened.
Apart from dropping nukes on cities so as to provide re-construction work, I can’t think of a more hopeless collection of anti-recessionary policies than the above.
Afterthought - 28th April 2011: Apart from the theoretical flaws mentioned above is using interest rates to control demand, the evidence seems to be that adjusting short term interest rates does not actually have a dramatic effect anyway.
Afterthought (4th May 2011): I said above that the borrowing involved in fiscal policy might negate the stimulatory effect of the relevant spending (commonly called “crowding out”). The conventional view is that the “negation” is less than 100%, i.e. that fiscal policy still has some effect. However, Tim Congdon in the Financial Times argues that the crowding out effect is more than 100%. I.e. that the effect of fiscal policy is the opposite of the intended effect! So the farce is possibly even bigger than I thought.
Afterthought (5th May 2001): The first paragraph above highlighted the self-contradiction involved in encouraging more indebtedness so as to escape a recession sparked off by excessive indebtedness. This contradiction was alluded to very eloquently by Mervyn King, governor of the Bank of England, a couple of days ago, when he said “the sheer volume of debt in the economy, is still very large and this poses massive macro- economic challenges,”
Sunday, April 24, 2011
I’ve always had doubts about the idea that all forms of money throughout history have been state money. No doubt the large majority of money, volume wise, has been organised and imposed by states or governments. But there are examples of money arising spontaneously, and simply because of the useful function that money serves and hence the desire for it.
An example of the latter was the bronze axe heads that were used for international or inter tribal trade in the bronze age in and around Europe.
But bronze axe heads had a problem around 500 B.C., namely the introduction of iron. Seems this might have caused a “bronze age recession”.
For an hour long BBC program covering this period, see here.
This is not to say that the value of axe heads had a close relationship to the metal content. The value of metal tokens used as money has always had a tenuous relationship to the value of the actual metal content. In other words what people are looking for, absent any form of money, is a formal and widely accepted system of CREDIT. The actual tokens used to represent units of that credit don’t matter too much, though obviously it helps a bit in primitive societies if the tokens have some inherent value.
There is a good article on this in the Banking Law Journal published in 1913. The article is also available on Warren Mosler’s site, where I first saw it.
Friday, April 22, 2011
Krugman’s criticism of an article by Steve Landsburg makes it clear that Krugman still doesn’t understand MMT. Although Steve Landsburg’s clever clever exposition of an MMTish point is not a big help to anyone trying to understand MMT.
Here are the details.
Steven Landsburg’s article is a rather extreme and stylised illustration of the difference between MMT thinking and conventional economics. The article makes the point that if government tries to raise revenue by taxing a rich person who subsequently does not reduce their consumption, this gets government nowhere: it does NOT, repeat NOT, enable government to spend more (assuming full employment).
Reason is that for government to be able to spend more, spending somewhere else has to be reduced, else aggregate demand becomes excessive.
Landsburg describes a rich man who fits the above description as “The Man Who Can’t be Taxed” – that’s the title of his article. And that is a silly title, because in a sense a rich man who fits the above description obviously CAN be taxed in the sense that money can be taken from him by government.
So Mr Landsburg – and one or two others – please stop trying to be clever. Just keep it simple. Getting the MMT message across is difficult enough without people trying to be too clever and introducing ambiguities.
And Krugman is completely wrong when he says that taxes “don’t primarily exist as a way to induce lower private consumption, although they may sometimes have that effect; they are there to ensure government solvency.”
That statement is totally wrong first for the reason given above, namely that for government to spend more, spending or consumption somewhere else must be reduced. Second, taxes have nothing to do with “solvency” for a sovereign currency issuing government, because such a government can print its way out of “insolvency” anytime. Of course an irresponsible use of the printing press will lead to excess inflation, but “insolvency” is plain impossible.
Wednesday, April 13, 2011
The political right wants the deficit cut. The political left says the public spending cuts and/or tax increases needed to do this will hinder the recovery.
So the big question is how to cut the deficit while not reducing demand. Or put another way, how do we increase the demand increasing characteristics of each dollar of deficit?
The first part of the answer is to let the deficit accumulate as cash rather than bonds (as I pointed out here, sort of, a year ago). Cash is more liquid than government bonds. The stimulatory effect dollar for dollar of cash is more than that of bonds (that’s why QE, while it is not the best thing since sliced bread, does have a finite stimulatory effect).
Second, given an increase in household income and/or assets, the poor spend more than the rich. Put another way, the multiplier is larger in the case of the former than the latter. So deficit money needs to be channelled to Main Street not Wall Street.
But the rich / political right don’t like either of these solutions.
As to the first solution, the political right tends to think that printing extra money brings inflation. They don’t get the point that the quantity of money is irrelevant: it’s the rate at which it is spent that influences demand, and hence inflation.
As to the second solution, it’s a bit hard to see why the rich would object to channelling deficit money to ordinary households if this raises GDP and employment. Presumably the rich prefer being surrounded by paupers, to being equally rich (or even richer) and surrounded by people with enough money to buy food. Or in the words of Marie Antoinette, “Let them eat cake”.
Certainly the thrill gained from wealth is no so much the absolute level of wealth: if everyone has a ten bedroom house, there is not much of a kick to be had from owning a ten bedroom house. The real thrill comes from having stuff that others don't have. Charming creatures we human beings!
Monday, April 11, 2011
House Minority Leader Lawrence F. Cafero Jr., R-Norwalk, pictured standing, far right, speaks while colleagues Rep. Barbara Lambert, D-Milford and Rep. Jack F. Hennessy, D-Bridgeport, play solitaire Monday night as the House convened to vote on a new budget. (AP)
The guy sitting in the row in front of these two...he's on Facebook, and the guy behind Hennessy is checking out the baseball scores.
These are the folks that couldn't get the budget out by Oct. 1, and are about to control your health care, cap and trade, and the list goes on and on….
Should we buy them larger screen computers - or - a ticket home, permanently?
Friday, April 8, 2011
Wednesday, April 6, 2011
The national debt could be paid off in no time at all simply by, 1. creating extra money, 2, buying back the debt, and 3, counterbalancing the inflationary effect of this by raising taxes.
To the extent that those in receipt of cash in exchange for debt do not take their money out of the country, this process would involve no standard of living cut for the average household because the whole process consists of nothing more than re-shuffling assets and liabilities between different types of household. However, a standard of living hit WOULD occur to the extent that those in receipt of cash in exchange for their government debt take their newly acquired cash out of the country. The latter would reduce the value of the country’s currency on foreign exchange markets, which in turn WOULD involve a standard of living hit: but nothing like the hit that resulted from the credit crunch.
On the other hand if a significant proportion of the world’s larger countries adopted the “buy back” policy at the same time, there would be almost nowhere for the above cash to go, thus the standard of living hit would be minimal.
Mike Norman recently advocated a debt removal idea here and here which is much the same as the debt removal idea I set out here. Essentially the idea is “create new money and buy back the debt”, or “pay it off with printed money”.
Mike argues for this idea on the grounds that cash and govt debt are very similar in nature. Thus there would be little inflation resulting from paying off the debt with printed money. That is, govt debt is essentially a form of money.
The latter point is true in that both monetary base and govt debt appear on the liability side of central banks’ balance sheets. The point is also true in that govt debt near maturity is essentially the same as cash or monetary base.
However, the two are different in that govt debt pays interest, whereas monetary base pays little or none. And this is significant: the easier it is to find an interest yielding home for cash, the more “cash + interest earning deposits + plus government debt, etc etc” the private sector will hold. Put another way, if govt debt is removed, that makes it more difficult to obtain interest on cash and near cash investments, which in turn will reduce the amount of cash and near cash assets the private sector wants to hold. (And for those who want to see the latter point put in Warren Mosler terminology, see “1.” below.)
The result is that a “print money and pay off the debt” policy would result in the private sector attempting to dissave cash, the effect of which would be stimulatory and (if the economy is at capacity) the result could easily be excess inflation. But this is not an insuperable problem: the problem can be solved by counterbalancing the stimulatory effect of the “buy back” with some sort of deflationary measure like increased taxation, of which, more below.
Two “by the ways”.
At this stage, two incidental points need making. First, I’ll assume a closed economy for the moment: that is, it is assumed that debt holders do not take the cash they acquire as a result of the buy back out of the country.
Second, this article is no more than “thinking aloud” on the subject of paying off the debt. Ideally, a large number of factors need to be quantified before embarking on a quick “pay off the debt” policy. And identifying, never mind quantifying all those factors is way above my pretty little head.
Why pay off the debt?
An obvious and very poor reason for paying off the debt is as follows. One portion of the government / central bank’s liabilities (the portion that pays interest) is called “debt”. In contrast, the portion that pays little or no interest (the monetary base) is not commonly called “debt”. Plus the word debt has negative overtones. For the bulk of the population, that is the only reason for wanting to reduce the debt. And of course it is a nonsensical reason.
There are however some better reasons. See second last paragraph here.
Also, none of the arguments FOR government debt stand inspection. See here.
As pointed out above, the stimulatory effect of a large scale debt buy back would have to be counterbalanced by some sort of deflationary measure, like increased taxes. But this tax increase, while it might be a political or psychological problem, is not any sort of economic problem. In particular, the tax increase would not reduce household living standards (assuming a closed economy).
Put another way, there is no good reason why the buy back should necessitate a reduction in aggregate demand. And no change to AD means no change to the average household income. (Indeed, the problem if anything is avoiding an excessive INCREASE in demand.)
As distinct from household INCOMES, let us now consider household ASSETS. But be warned: the following section is abstruse!
Private sector assets.
Assume the economy is at capacity – (an assumption which will be relaxed later). This assumption means that prior to repaying the debt, cash and other household financial assets must have been at a level which induced households to spend at a rate which brought full employment. If those assets are expanded or made more liquid, household spending will rise too much (as pointed out above). The effect would be inflationary.
Put another way, additional spending at full employment results in NO ADDITIONAL SPENDING in real terms. Or to put it yet another way, the additional cash in private sector hands that produces this additional spending is in a very real sense TOTALLY WORTHLESS!!!
The latter scenario is a bit like owning a pile of $100 bills, 10% of which are obvious forgeries. The obvious forgeries are just not worth anything: the authorities might as well confiscate them (let’s say via a ploy called “tax”).
It might seem from the above argument that in buying back debt, a portion of private sector assets (in the form of government debt) has been converted from being in some sense “real” to being “illusory”. And the latter point, if valid, would mean that the buy back WOULD involve a reduction in private sector or household assets.
However, the reality is that government debt is, and always has been to some extent an illusory form of wealth and for reasons very similar to those set out just above.
Take an economy which is at full employment and is stable (i.e. not entering or recovering from a credit crunch or anything else traumatic). Assume there is a chunk of government debt that is about to reach maturity. When it DOES reach maturity, the debt is converted to cash, at which point private sector assets are too liquid. Demand would become excessive, unless some sort of deflationary measure is taken. One possibility is to roll over the debt. Another is to raise taxes, i.e. confiscate a portion of private sector assets.
In short, when debt is converted to cash, private sector assets become too liquid REGARDLESS of whether the reason is bonds reaching maturity or whether a buy back policy is in operation. And in both cases, the part illusory nature of the bonds has to dealt with by some sort of deflationary measure.
Incidentally, the above argument relating to the part illusory worth of government debt is over simple in that government bonds do not suddenly acquire all the characteristics of cash on the date of maturity. In reality, such bonds GRADUALLY acquire the characteristics of cash as the date of maturity approaches. But never mine: hopefully the above over simple argument gets the point across.
The conclusion reached at the end of this section is as follows. The additional tax needed to counterbalance the stimulatory effect of a buy back appears to each household to involve a confiscation of some of each households assets. However, the reality is that all that is being confiscated is a portion of household assets that cannot be spent anyway: a portion which is essentially worthless.
An economy not at capacity.
It was assumed at the start of the above section on private sector assets that the economy was at capacity. It was then argued that if private sector assets are made more liquid, there is a danger that excessive spending takes place.
An alternative assumption is that the economy is at less than capacity. On this assumption, the argument is much the same.
Of course, where an economy really is at less than capacity it is obviously desirable to RAISE spending. But the decision to raise aggregate spending is separate from the decision to buy back the debt. Thus to consider how to go about buying back the debt assuming a CONSTANT level of capacity utilisation is perfectly logical.
And on the basis of the latter assumption, the argument about private sector assets is much the same. That is, briefly, the volume and/or liquidity of private sector financial assets cannot be increased, because to do so would be stimulatory: it would change the level of capacity utilisation.
An open economy.
It was argued above that a buy back has no effect on living standards, if those in receipt of cash in exchange for their government debt are not able to take their money out of the country. In contrast, in an open economy, these cash rich entities might well take their newly acquired cash out of the country. As a result, the value of the relevant country’s currency on the foreign exchange markets would decline. And that would represent a real standard of living cut for residents of the country.
On the other hand, if a significant proportion of the world’s larger countries adopted the buy back policy at the same time, it would be difficult to find an alternative and better home for the cash. So the standard of living cut would be relatively small.
Moreover, it seems that most voters are happy to take a standard of living cut if that helps reduce the national debt. So let’s go for the above “buy back the debt” policy!
The national debt can perfectly well be bought back with new or printed money. It would probably be necessary to counteract the stimulatory and/or inflationary effects of that policy with tax increases. However, contrary to appearances, such taxation would not reduce household incomes. Nor would it reduce the real worth of household financial assets (though persuading households of the latter point would be a difficult!)
The buy back policy would involve a standard of living cut if a significant proportion of those in receipt of cash in exchange for their debt took the cash out of the country. On other hand, if a significant proportion of the world’s larger countries adopted the buy back policy at the same time, there would be almost nowhere for this cash to go, thus there would be no significant standard of living cut.
There are no big logical or strictly economic problems involved in buying back the national debt with new money or printed money. The problems are almost entirely psychological or political.
1. See the parent, child and business card analogy in “Soft Currency Economics”. As Mosler puts it, “The parent might decide to pay (support) a high rate of interest to encourage saving.”