Saturday, February 25, 2012

Kenneth Rogoff is 250 years behind the times.

Kenneth Rogoff has not caught up with a point made by David Hume 250 years ago, namely that additions to the money supply will not be inflationary unless the extra money is actually SPENT. I’ll explain.

Rogoff thinks that imparting enough stimulus to effect a quick recovery from the recession is not possible. His reason is the currently elevated levels of debt (national and household).

Household debt.

As to HOUSEHOLD debt, he does not give any actual REASONS as to why household debt prevents stimulus. At least he does not give any reasons in this Bloomberg article of his, or this Project Syndicate article.

And if he doesn’t give a REASON, then I conclude that he doesn’t have one. Indeed, I conclude, as does Krugman, that Rogoff’s concerns about debt stem from emotional problems with the word “debt” and the negative overtones of the word (“foreclosure”, “bailiff”, etc). As Krugman puts it, “So where does Ken’s call for short-run austerity come from? As best I can tell, it comes from a generalized sense that debt is dangerous…”

The above tendency to be swayed by the emotional overtones of the word debt explains the general public’s concern about national debts. But so called professional economists ought to be able to analyse the ACTUAL NATURE of national debts and see that they are very different from micro economic debts: debts of households or firms.

National debt.

As to national debt, Rogoff is under the popular misapprehension that increasing the deficit requires more debt. As I’ve point out a hundred times on this blog, both Keynes and Milton Friedman made it clear that deficits can be funded EITHER by borrowed money or by printed money. (Be nice if professors of economics at Harvard, like Rogoff, had actually studied Keynes and Friedman, wouldn’t it?)

Anyway, Rogoff’s solution to all this (proposed in 2008) is to deliberately stoke inflation, which would have the effect of writing down debts (see 2nd last paragraph here). And he proposes doing it by QE. As he puts it, “Fortunately, creating inflation is not rocket science. All central banks need to do is to keep printing money to buy up government debt.”

Well the first and glaring problem there is that the U.S. has actually implemented QE on an unprecedented scale over the last three years or so (just in case you hadn’t noticed) . . . . but where’s the elevated rate of inflation??? Nowhere to be seen!!!

In fact many of us predicted this “non-inflationary” result before QE even got started. But that’s not the important point. The really important point is as follows.

As David Hume pointed out around 250 years ago, money supply increases will not be inflationary unless those increases are actually SPENT. See para starting “It is also evident…” here.

Now investors can only do one of two things with the cash they get as a result of QE: spend it or not spend it.

To the extent that they DO SPEND the money on consumer goods and so on, the effect will be inflationary IF THE ECONOMY HAS LITTLE SPARE CAPACITY. But in a recession, the economy DOES HAVE spare capacity!!! Thus the effect of the extra spending will probably be to boost demand, create jobs and get us out of the recession.

Which according to Rogoff is impossible. Let’s be clear: he is saying in effect that a rise in demand, given ample spare capacity will not expand GDP because of all those debts. God first makes mad.

To the extent that the extra money is NOT SPENT, well there won’t be any effect on inflation, so the great “Rogoff let’s boost inflation wheeze” does not work. Or as David Hume put it, “if the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated”.

Having said that if investors spend their money, it will be spent on CONSUMER goods, an alternative is of course that they spend the money on purchasing other assets or investments. But the effect there is not nearly as inflationary.

At a guess, a rise in stock markets has next to no effect on inflation. As to a rise in house prices, that’s inflationary, on the other hand a rise in house prices induces builders to create jobs and build more houses: an outcome which Rogoff, remember, claims to be impossible.

As to speculation in commodities, this looks like it has been exacerbated by QE: commodity prices may have been boosted by QE. However, neither house or commodity price increases have been enough to give a SUBSTANTIAL boost to inflation.


So the conclusion is that David Hume was essentially right and Rogoff is wrong. A money supply increase can do three things. First in that the extra money is NOT SPENT, there is no effect on inflation or output.

Second, in that the money IS SPENT, and there is ample spare capacity, the result is a rise in demand and GDP. Third, in that the money IS SPENT, and there is LITTLE SPARE CAPACITY, the result is inflation.

But a “no spare capacity” scenario does not sound to me like a recession! Or if extra demand does cause inflation at relatively high unemployment levels, the explanation must be inadequate amount of or types of capital equipment or it could signal a change in the pattern of demand for different skills.

In short, Rogoff advocates a cure for our problems which is nonsense in theory, and which has been shown not to work in practice. How much lower can you get?


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