Abba Lerner and Milton Friedman were smarter than Lawrence Summers and Tim Congdon.

We are in a recession largely caused by excessive and irresponsible borrowing. Lawrence Summers in a recent article in the Financial Times says we ought to deleverage.

Then Tim Congdon in a letter in the FT criticises Summers for failing to notice that deleveraging is deflationary, which indeed it is: hardly what we need in a recession. So we seem to be stuck between a rock and a hard place.

Shock horror – what should we do, boys and girls?

Well this problem is easily solved by having the government / central bank machine create and spend additional money into the economy. Exactly what Abba Lerner and Milton Friedman advocated (see item No.1 under the heading “The Proposal” here.)

That way we’d get the deleveraging that Summers wants combined with the expanding or stable money supply that Congdon wants.

Of course in the real world it’s not quite that simple in that central banks are supposedly separate from governments. But that is not a huge problem. Implementing “create money and spend it into the economy” is achieved in the real world by a combination of fiscal expansion and QE.

Incidentally Robert Skidelsky has a fairly low opinion of Tim Congdon, as do I. Congdon has noticed a relationship between GDP and private bank created money, or “horizontal money” as advocates of Modern Monetary Theory call it. He then concludes that expanding this stock of money will expand GDP.

The cause / effect relationship is actually the other way round. Horizontal money RESULTS FROM the desire to do business, plus an expansion in the volume of horizontal money does not expand private sector net financial assets (PSNFA).

In contrast, an expansion of central bank money or “monetary base” does expand PSNFA, and is thus an inducement to spend, or “expand GDP”. At least the latter is the case where the government / central bank machine creates money and spends it into the economy. In contrast, if the base expansion comes about as a result of QE, the effect is more muted: there is very little expansion in PSNFA.

Moreover, people holding government debt regard that chunk of their wealth as SAVINGS. And if that chunk is converted to cash, they will likewise regard said chunk as savings: they won’t run out and spend it to any great extent (though they will attempt to find borrowers for their cash pile).

And finally, such is Tim Congdon’s faith in the effect of expanding the stock of horizontal money, that he recently advocated that government should borrow large sums from commercial banks! Given that the government / central bank machine can create and spend any amount of money at the press of a computer mouse, it is bizarre (to put it politely) to suggest that government needs to resort to commercial banks to come by money.


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Mosler Bonds.

Congratulations to Messers Mosler and Pilkington for at least trying to do something about Euro periphery austerity. (h/t to Naked Capitalism)

Don’t take my summary of their proposal as gospel. But their proposal, far as I can see, is that periphery governments issue bonds which can be used in payment of tax in relevant periphery countries. These bonds would only be used for payment of tax in the event of the country defaulting on its Euro denominated debt.

Warren Mosler is a successful bond trader, so I hesitate to question this scheme. But it strikes me that the austerity being imposed on the periphery is the EZ’s highly unsatisfactory method of dealing with lack of periphery competitiveness. If Mosler bonds have a stimulatory effect (i.e. bring less austerity) these bonds just undermine the above attempt to improve periphery competitiveness.

That in turn means that those holding Euro denominated periphery bonds will want even more interest.

Or perhaps I’ve missed something.

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The establishment’s schizophrenia on the subject of bank lending.

Summary: Keynes said “look after unemployment and the budget will look after itself”. The theme of this post is “look after demand, and finance for businesses will look after itself”. Which itself is a variation on Mosler’s law: “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.”

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The British establishment continues to hyperventilate about the alleged shortage of bank lending to businesses. E.g. see here, here, here, or here.

But at the same time, other members of the establishment claim banks are subsidised, bloated and need to be cut down to size. For example, Lord Turner, head of UK’s Financial Services Authority said that much of what banks do is “socially useless”.

Second, Andrew Haldane of the Bank of England claimed that total bank profits are dwarfed by too big to fail subsidy that banks get. See 3rd paragraph under the heading “Implicit subsidies” here.

Third, according to Mervyn King, the bank industry has expanded by a whapping factor of ten relative to GDP over the last fifty years. That is, total bank balance sheets have expanded from 50% of GDP fifty years ago to five times GDP nowadays. But mysteriously, economic growth fifty years ago was perfectly respectable.

So contrary to claims of the above hyperventilaters, any difficulty that businesses may be having in finding loans, does not need to be a constraint on economic activity or employment. That is, inflation permitting, we just need to boost demand, the GDP and employment will rise.

The EXTENT TO WHICH such activity is based on bank loans may well decline. But that activity will be replaced (at least to some extent) by alternatives: e.g. activity that is equity funded, or funded by loans other than from banks. Plus there will be a move towards less capital intensive forms of activity. The free market is far more flexible and imaginative than the brains of politicians.

In case the above hyperventilaters hadn’t noticed, we’ve just had a credit crunch caused by excessive and irresponsible bank lending. That means it is probably DESIRABLE for total bank lending to decline!!!!

Unfortunately, politicians are complete suckers when it comes to lobbying and pleading by well financed special interest groups: like businesses claiming they cannot get bank loans.

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Cuts – what cuts?

There is currently much foaming at the mouth in Britain by public sector workers on account of government having allegedly cut public sector budgets. However John Redwood claims that Office for Budget Responsibility figures show that there haven’t been any cuts.

I probably won’t have time to get to the bottom of this, but it looks interesting.

Modern Monetary Theory outsmarts DeLong and Summers.

Thanks to Winterspeak (23rd March 2012) for drawing attention to this paper by Summers and DeLong.

The argument in this paper is thus. Normally central banks negate the stimulatory effect of a fiscal boost. Or as the authors put it in their abstract, “In normal times central banks offset the effects of fiscal policy.”

But at the zero bound they don’t do this. Thus at the zero bound, fiscal policy can allegedly be used to provide stimulus.

Now there is flaw in that argument as follows.

If a central bank is keeping its base rate at zero (or any other figure, come to that), then it must be printing money and buying back government debt in sufficient quantities to negate any interest rate raising effect of fiscal policy. Put another way, the central bank will be doing some QE.

In fact in the latter scenario, my guess is that for every dollar government borrows, the central bank will print a dollar and buy back a dollar of debt, though admittedly there might not be an exact “dollar for dollar” relationship here.

Anyway, in this scenario, what is taking place is not pure “fiscal policy”. What is taking place is a combination of fiscal and monetary policy. Put another way, what is taking place is exactly what Abba Lerner advocated, namely that in a recession, the government / central bank machine should simply print or create new money and spend it into the economy (and/or cut taxes).


Governments / central banks don’t need to be “self-financing”.

The second flaw in this paper is the extreme concern the authors have with whether a fiscal boost will ultimately be what they call “self-financing”. Here are some typical passages.

1. Section II presents a highly stylized example making our basic point regarding self-financing fiscal policy…

2. They say their argument “analyzes necessary conditions for expansionary fiscal policy to be self-financing…”

3. “A very simple calculation conveys the major message of this paper: A combination of low real U.S. Treasury borrowing rates, positive fiscal multiplier effects, and modest hysteresis effects is sufficient to render fiscal expansion self-financing.”

Now where is the merit in a fiscal boost being “self-financing” in the long run? Darned if I know.

The government / central bank machine can print and spend any amount of money it wants so as to effect stimulus. Conversely it can confiscate any amount of money it wants anytime from the private sector simply by raising taxes.

MICROECONOMIC entities have to be self-financing in the long run. If they fail to “self-finance”, they go bust.

But the government / central bank machine is a totally different kettle of fish: it is not under the same constraints as a microeconomic entity.
If a fiscal boost fails in to the long run to be self-financing, that means the government / central bank machine must have supplied the private sector with a permanent increased stock of net paper assets (monetary base and/or government debt).

What of it? Why does that matter? If the effect if that increased stock is to induce the private sector to spend at a rate that causes excessive inflation, then the stock needs to be reduced via extra tax. But if the private sector wants to hold this increased stock for the next twenty years, where’s the problem? Moreover, if this stock IS REDUCED the result will be paradox of thrift unemployment. So the stock should very definitely NOT BE reduced.





P.S. (4th April). Sumner also attacks the above Summers and De Long paper (on 26th March)
http://www.themoneyillusion.com/?p=13715

P.S. (2nd May, 2012). The above nonsensical DeLong / Summers “self-financing” argument is also criticised by L.Randall Wray in an EconoMonitor article published on 1st May 2012.


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The European banking and political elite are in cahoots.

The above is not an original suggestion. But it’s nice to see an additional person making the point.

Second, some interesting stuff on inequalities in different countries here.


I was burgled day before yesterday.

Regular followers of this blog (two people and a snail) will be devastated to learn that my house was broken into day before yesterday, so I’ll be doing less blogging for a week or two while I upgrade security on the house.

Currently it’s the least secure house in Britain on account of the low crime rate hereabouts.

All the burglars took was my mobile phone. Mad or what?

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Chinese woman arrested for shadow banking activity.

This story may be of interest to those concerned about banks and how alternative banking systems might work (or fail to work).

See in particular 3rd paragraph and paragraph 2/3rds way thru, starting “Fundraising from private lenders is illegal in China…”

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Leftie journalists continue to tell lies about the Work Experience scheme.

For the umpteenth time, an article has appeared in The Guardian claiming that people on the Work Experience scheme are “unpaid”.

Far as I’m aware people on this scheme invariably ARE PAID. They are paid the same as they’d have got on benefits. The pay might be inadequate, but that’s a different point. The central point is that they ARE PAID.

The official government site explaining this scheme says, “Young people undertaking a Work Experience placement will continue to receive their benefit…”.

So either the government is telling fibs, or Guardian journalists are. My guess is it’s the latter.

Moreover, the pay of the less skilled when in work is often little different to what they get on benefits, especially when they have two or more children. Perhaps the Guardian will start wittering on about all these people being “unpaid” as well.

The only real surprise in this article is that it does not include references to “slave labour”.

Certainly the author of the above Guardian article, for all the ink, paper and forest consumed, is vague on the question as to exactly he means by the word “unpaid”. So I assume he is into propaganda and deception rather than informing readers. But that wouldn’t be a first for our supposedly intelligent broadsheet newpapers.


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The inflationary and non-inflationary effects of Job Guarantee in the public and private sectors.

Job Guarantee (JG) is the name given by advocates of Modern Monetary Theory to what might be called “make work” schemes – though obviously the phrase “make work” is a bit negative. I.e. JG is similar to the WPA implemented in the US in the 1930s.

One common claim by JG advocates is that any number of JG jobs can be created with no inflationary effects. And the reason seems to be (though this is normally not explicitly stated) that no extra demand is required to create JG jobs since the output of those jobs is given away rather than sold. I.e. public sector jobs do not require extra demand. Now there are problems with that argument, as follows.

First, there has been an ASTRONOMIC rise in public sector activity in advanced economies over the last century or so. Yet unemployment has not declined (in as far as measurements of unemployment a century ago are comparable to those currently used).

Second, and in contrast to the above EVIDENCE, there is the THEORY, which is as follows.

If the only input on JG schemes is labour that would otherwise be unemployed, then it’s true that there is zero inflationary impact (assuming the pay on such schemes is not too generous). However, any form of economic activity that involves anything like normal levels of output has to employ permanent skilled labour, capital equipment and materials – i.e. other factors of production (OFP). So JG schemes require OFP. But OFP does not appear from thin air: it can only come from the existing or regular economy. And that is inflationary for the following reasons.

As regards permanent skilled labour, withdrawing such labour from the regular economy is a reduction in aggregate supply. So aggregate demand has to be reduced if the inflationary effect is to be avoided. To that extent, JG jobs are AT THE EXPENSE OF normal or regular jobs: hardly the object of the exercise.

As to capital equipment and materials, ordering those up from the existing or regular economy is inflationary, assuming the economy is already at capacity. (If it’s not at capacity, then JG is not the best cure for unemployment: the best cure is a straight rise in demand. Indeed, I’ll continue with this “at capacity” or “at NAIRU” assumption in the paragraphs below.)

So the reason that the vast expansion in “give away” economic activity has had no effect on unemployment over the last century is that when well-paid jobs are created in the give-away sector, such labour virtually gives up looking for work in the private sector. That’s inflationary, so demand has to be reduced . . . You get the picture.


The OFP conundrum.

Output can always be improved on a JG scheme if the OFP to unskilled labour ratio is improved. But the more it is improved, the nearer the scheme becomes to amounting to the same as a normal public sector employer.

In fact, suppose there are two public sector outfits producing a similar product, a normal employer and a JG scheme, with the JG scheme employing significantly less OFT per unskilled person, where is the logic in that arrangement? The two outfits might as well be merged and be classified as a normal employer.


Is commercial JG inflationary?

As distinct from JG schemes where the output is GIVEN AWAY, there is no reason in principle why output cannot be SOLD. Indeed the output of the scheme set up in Hanstholm in Denmark thirty years ago was sold. See second article here.

If JG schemes are set up which SELL their output, obviously an increase in demand is required. And it might seem that that increase in demand is inflationary.

However, there will be no inflationary effect if the only input on the scheme is labour that would otherwise have been unemployed, AND IF the extra demand is actually channelled to such labour, rather than raising demand for relatively skilled labour. (That is because inflation stems from SKILLED labour shortages plus capital equipment and material shortages.)

Thus so far as inflation goes, there is no difference between a commercial and non-commercial JG scheme where both schemes employ only those who would otherwise have been unemployed.

But as soon as such schemes start employing OFP, the inflationary effect arises in both the case of commercial and non-commercial JG. So there again, there is little difference inflation-wise between commercial and non-commercial schemes.


Conclusion so far.

First, there is little point in making a distinction between JG schemes and normal or regular employers. That is, the relevant labour might as well be allocated to EXISTING employers.

Second, there is little point in making a distinction between public and private sector employers.


Why don’t JG employees displace existing employees?

If a JG scheme is a “specially set up” scheme as distinct from allocating labour to EXISTING employers, the extra demand needed to get the scheme going COULD spill over into other areas of the economy and exacerbate inflation. However, that problem is easily enough dealt with (at least in principle) by pricing the relevant product low enough.

However, where labour is allocated to EXISTING employers, an explanation is needed as to why demand is actually channelled towards those extra employees, rather than spilling over and raising demand for NON-JG labour. The explanation is here.

Wren-Lewis and fiscal councils with real powers.

Nice to see Simon Wren-Lewis (economics Prof. at Oxford) toying with the idea of fiscal councils or committees with the same powers that central banks have over monetary policy. I advocated pretty much this idea here. See Wren-Lewis’s final paragraph on p.R4 and next few paragraphs, here.

If monetary policy is taken right out of the hands of politicians and put into the hands of central banks, then why not do the same with fiscal policy? That does NOT MEAN, as Wren-Lewis correctly points out, and as I pointed out, that strictly political decisions should be taken away from politicians or the democratic process. And those political decisions are basically two. First, there is the decision as to what proportion of GDP is allocated to public sector spending, and second there is the decision as to how that money is split as between defence, education, roads, law and order, etc etc.

But the decision as to how much stimulus we get from monetary policy is in the hands of central banks. So why do we leave the decision as to how much stimulus comes from fiscal policy in the hands of non-experts, i.e. politicians? It makes no sense.

And personally, I wouldn’t bother with two committees: one for fiscal and one for monetary. I’d just merge them. That is because with a view to determining the TOTAL stimulus (or “anti-stimulus”), close cooperation would be required between the two committees ANYWAY.

But I know some advocates of Modern Monetary Theory don’t like that arrangement. However I’ll wear them down eventually :-)

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P.S. (11.10 am UK time). Another good point made by Wren-Lewis relates to what he calls “deficit bias”. That is the temptation that politicians fall for, namely failing to collect enough tax, and with a view to ingratiating themselves with the electorate. The tax shortfall is made up for by borrowing of course. Today’s politicians are more than happy to leave the resulting mess, i.e. an excessively large national debt for their successors to sort out.

In contrast, a fiscal committee would hopefully borrow just to bring fiscal stimulus where appropriate – not to make anyone popular with the electorate.

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Help stop tax dodging.

War on Want along with other organisations are campaigning for an abolition of tax havens. The picture above is from a post card they’ve produced. Below is what appears on the back of the card. Send an email to your member of parliament with the picture and the stuff below!!!

Dear MP

Tax dodging costs the UK £100 billion a year. That's enough to double funding for the NHS. Developing countries lose an estimated £250 billion every year as a direct result of corporate tax dodging - money which could be used to reach the UN's Millennium Development Goals several times over.

The UK plays a major role in tax dodging, with many of the world's tax havens British dependencies such as Jersey or overseas territories such as the Cayman Islands. The City of London acts as the financial nerve centre for these tax havens and supports an army of pinstriped lawyers and accountants devoted to helping companies dodge tax.

Companies should pay their fair share of tax not only here but in the developing world. Taxes collected should be used to help fund vital public services such as healthcare, education and housing in developing countries as well as in the UK.

I ask you to write to the Prime Minister urging him to take firm action to end tax dodging by:

• putting a moratorium on staff cutbacks and tax office closures in HM Revenue & Customs
• abolishing UK tax havens
• working with other countries to eradicate trade mispricing and promote transparency through 'country by country' reporting by companies
• prosecuting corporate executives, lawyers and accountants for profit from laundering and tax dodging.

Yours sincerely,


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Mr Revolving Door claims to disapprove of revolving doors.

I do like this article in the Wall Street Journal by Timothy Geithner in which he claims to disapprove of Wall Street’s influence on the U.S. government.

By way of trying to persuade us of his sincerity, he drags his wife into it. The sub heading of the article reads, “My wife looks up from the newspaper with bewilderment at another story about people in the financial world or their lobbyists complaining about Wall Street reform.” I’m moved to tears.

Of course it is just conceivable that Geithner is genuinely concerned about U.S. banks rather than democratically elected political parties running the U.S. But I doubt it. I suspect this article is a publicity stunt: it’s Geithner trying to portray himself as a saint before his arrest for this part in the Goldman Sachs / AIG affair.

When he quits his job as Treasury Secretary he’ll almost certainly return to Wall Street, where he will continue to push the interests of Wall Street at the expense of the peasants, while pretending to do the opposite.

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Osborne is clueless on the structural deficit.

Not that the Labour Party are any better.

According to shadow chief secretary to the Treasury Rachel Reeves, George Osborne wants to "achieve a cyclically-adjusted current balance by the end of the rolling, five-year forecast period".

And as Rachel Reeves points out, this amounts to “eliminating the structural deficit five years forward from any given point…”

Now a structural deficit by definition provides no stimulus. Or put another way, the structural part of the current deficit is that part which provides no stimulus. Or put it yet a third way, a structural deficit is a deficit which arises purely out of politicians’ failure to collect enough tax, not out of a desire to impart stimulus.

So what’s the big problem in disposing of a structural deficit? That is, if you want to dispose of a structural deficit, there is no earthly point in waiting five years to do so. All you need do is to rectify the fact that insufficient tax is being collected. That is, taxes need to be raised and borrowing needs to be cut.

As to the AMOUNT of tax cut and borrowing reduction required, this needs to be such that the overall effect on aggregate demand is zero. And that almost certainly means that the annual hike in taxes will NOT EQUAL the annual reduction in borrowing.

Of course the numpties who think in accountancy or microeconomic terms tend to think that the above two numbers need to be equal. But as Abba Lerner pointed out, when it comes to macroeconomics, the important consideration is the EFFECT of any change, policy, etc, not the numbers.

And too argue, as some do, that the structural deficit cannot be cut too quickly because that might stifle the recovery is a PLAIN SIMPLE CONTRADICTION IN TERMS.

Doh!

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Frederick Soddy.

MMT bloggers will be familiar with joebhed, but most of them won’t be aware that the picture that appears alongside joebhed’s comments is a picture of Soddy.

Soddy was a chemistry Nobel laureate who wrote a book on money in 1934: “The Role of Money”. It’s available for free on the net. Having skimmed thru it, here are my impressions, for what they’re worth.

If you want just to skim thru, miss out Ch 1: it’s of doubtful quality.

Soddy favours full reserve banking. He has an interesting definition of money. On p.40, under the heading “Money a Claim to What Does not Exist.” he says, “The essential feature of money is . . . that it is a legal claim to wealth over and above the wealth in existence, all of which in an individualistic society is already in the ownership of others independently of this claim.”

That definition has not caused me to change my own ideas about money, but watch this space.

On p.53 he claims that the more enthusiastic advocates of full reserve grossly overestimate the benefits of full reserve. So there’s nothing new under the sun: these over-enthusiastic advocates are still with us in 2012 – no names mentioned.

P.63 & 112. Soddy is concerned about the distinction between current or “checking” accounts and deposit accounts. He says the former is money and the latter is not.

I don’t think he gets the really important point here, which is that using money in checking accounts to fund long term loans (i.e. “borrow short and lend long” or “maturity transformation”) leads to bank fragility. And the same goes for accounts which are supposedly deposit accounts, but where the money deposited is actually available to the depositor very quickly and with little by way of penalty - like lost interest.

P. 79. In case you thought the revolving doors that connect the banking elite to the political elite are something new, they’re not. These revolving doors existed in Britain in the 1920/30s. (No doubt they existed in Ancient Rome!)

P.106. Soddy gets the point that economising on the stock of money is pointless. I.e. maturity transformation, while it seems to make sense at the micro-economic level, is a pointless activity for the country as a whole, i.e. at the macroeconomic level. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.”

I.e. he gets very near to the idea that maturity transformation might as well be banned, because it achieves nothing, except contributing to bank fragility. But he doesn’t quite get there – or perhaps I’m doing him an injustice.

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Sixteen reasons why MMT is right on the fiscal versus monetary policy question.

Note: this post is an updated version of a post I did in February this year called “Twelve reasons why MMT is right on the fiscal versus monetary policy question.” That post is now deleted. The text explaining the first twelve reasons below are is almost identical to that post. The four additional reasons 13-16 are new.

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Abba Lerner is often said to be the founding father of Modern Monetary Theory (MMT). He argued that in a recession, government should simply create new money and spend it into the economy (and/or cut taxes) – effectively combining fiscal and monetary policy.

I’ll ASSUME that this “combined” policy is part of MMT (though perhaps some MMTers will disagree). Anyway, the arguments AGAINST implementing fiscal or monetary policy SEPARATELY are thus.

1. Adjusting interest rates is a form of monetary policy, BUT interest rate adjustments are DISTORTIONARY. An interest rate change works only via households or firms which are significantly reliant on variable rate loans: i.e. those reliant on FIXED rate loans or not reliant on loans at all are not affected by an interest rate change. Thus this policy makes no more sense than boosting an economy only via people with black hair, with blondes, red-heads, etc waiting for a trickle-down effect.

Bizarrely, James Bullard, president of the St Louis Fed claimed (p.9) that TAXES ARE DISTORTIONARY! Well it depends which taxes. Sales taxes like VAT or payroll taxes are pretty distortion free. (Incidentally, Krugman demolishes another of James Bullard’s papers here.)

2. QE, another form of monetary policy, has the same defect: it works only via a limited proportion of the population, that is, the rich.

3. The idea that there is a close relationship between interest rates and the ACTUAL availability of credit has been shown to be TOTAL NONSENSE over the last two years. That is, rates are currently at record low levels, but banks are reluctant to lend.

4. Low interest rates can have a DEFLATIONARY effect (pointed out by Warren Mosler). If rates are cut, the central bank will then pay out less by way of interest. That is, less new money will be injected into the private sector.

Minor technical point: this effect depends to some extent on the rules governing the relevant central bank, Treasury, etc. To illustrate, in some countries a rate reduction may NOT automatically reduce the above injection. That is, the reduction may be treated as a reduced budgetary expense for the Treasury, which in turn is expected to collect less tax to compensate. In this case the above deflationary effect would not operate.

5. An interest rate reduction is an inducement to borrow and invest in assets, which tends to cause asset price bubbles. In contrast, a straightforward change in government net spending has less of a “bubble blowing” effect. That is, if the additional net spending is directed at a cross section of the population (not just the wealthy), there will not be a significant asset bubble effect.

6. The optimum price for borrowed money (i.e. the optimum rate of interest) is determined by the same sort of factors that determine the optimum price for concrete, steel or any other commodity: supply and demand. To put that in economics jargon, the rate of interest is optimised when the marginal disutility of forgone consumption by savers equals the marginal utility or marginal benefit from the investments that those savers fund.

If government interferes with this free market rate of interest, then the total amount invested will not be optimum. GDP will not be maximised.

7. Low interest rates allegedly encourage investment. Unfortunately those making investments look at LONG TERM rates, not the fact that the central bank has recently cut rates and will probably raise them again in two years’ time. And that applies both to firms investing in productive capacity and people who borrow with a view to buying houses.

While most people will not buy houses just because interest rates have dropped for a couple of years, there ARE those NINJA mortgage suckers who bought houses on the basis of near zero interests for the first year or two. I.e. there ARE idiots out there. So in that the “low interest rates encourages investment” argument DOES WORK, it works by encouraging idiots to behave irresponsibly!!! Now that’s a ringing endorsement for “low interest rates encourage investment” argument - I don’t think.

Incidentally, the difficulty central banks have in influencing interest rates for corporate bonds or mortgages, this seems to have been born out in the current recession. According to this Jan 2009 Bloomberg article, rates for mortgages and corporate bonds were NOT following the Fed’s low interest rates downwards. In contrast, by May 2011, the Fed’s low interest rates WERE starting to have an effect.

8. The idea that reduced interest rates encourage investment is rendered irrelevant by the fact that in a recession, more investment is exactly what is NOT needed. In recessions (certainly in SHORT recessions) there is more than the usual amount of capital equipment lying idle! Of course it takes TIME to manufacture or create real investments like machinery or factories, and assuming an economy will return to trend growth shortly after a recession, employers need to make sure they are not SHORT of capital equipment after a recession. But employers do not need governments to tell them this. Nor will irrelevant little inducements like 2% changes in interest rates do much to optimise any given employer’s investment strategy.

9. Radcliffe Report on monetary policy in the U.K. published in 1960 concluded that ‘there can be no reliance on interest rate policy as a major short-term stabiliser of demand’.

10. As to the possibility that credit card spending is influenced by changes in a central bank’s base rate, there seems to be no link between those rates and credit card rates. See here.

11. Now for the possibility of using fiscal policy alone: that is implementing the classic Keynsian “borrow and spend” policy. The problem with this policy is crowding out: that is, fact that when government borrows, that tends to raise interest rates, which has a deflationary effect, which negates the whole object of the exercise: imparting stimulus. THE EXACT EXTENT of this crowding out is disputed, but to the extent that it is a problem, the central bank can easily counteract the undesirable effect by cutting interest rates – which it does by creating money and buying up government debt.

BUT HANG ON……… What’s going on here is that the government / central bank machine is implementing the Abba Lerner “create money and spend it into the economy” policy!!!!!!!

Alternatively, to the extent that “borrow and spend” DOES WORK without a crowding out effect, there is another problem: what in God’s name is the point of government borrowing something (i.e. money) when it can create money in infinite amounts any time it likes and at no cost? You ever heard of anything so daft?

12. A novel argument in favour of using monetary policy alone was produced recently by Nick Rowe. This is that fiscal is already doing a huge amount, in the form of taking thousands of micro economic decisions a day - like deciding where to build bridges, to cite Rowe’s example. Thus, allegedly, we cannot impose more burdens on fiscal.

Well the answer to that argument is that the amount of work currently being done by any system has nothing to do with whether it should be given more work to do, or whether the latter work should be allocated to some other system. For example the fact that the military is already spending billions on warships, aircraft and so on has nothing to do with whether the military or the police should be responsible for dealing a riot or natural disaster. If the military are best at the job, they should do it, and be given the necessary funds. If the police are best at the job, they should do it, and get the relevant funds. Period. Full stop. End of argument.

Moreover, having fiscal influence demand is not difficult (contrary to James Bullard’s claims, (p.1). It is not a “burden” on fiscal. Britain has altered its VAT rate twice during the current recession. I’ve heard nothing about excessive bureaucratic costs involved in doing this.

By the way, Bullard makes just about every mistake it is possible to make in his paper. For example he claims government debt is a burden on future generations (p.17). For a demolition of this idea, see here. Bullard also got a drubbing on Warren Mosler’s site recently.

Incidentally, the Fed does have what might be called a “political excuse” for the low interest rate policy it has adopted over the last few years. This is the refusal by Congress to allow enough stimulus. In contrast, the Bank of England and some other central banks have fewer excuses for implementing interest rate reductions and QE.

13. Keynes said, “I am now somewhat skeptical of the success of a merely monetary policy directed towards influencing the rate of interest...it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital...will be too great to be offset by any practicable changes in the rate of interest." Keynes’s General Theory – near the end of Ch 12. (h/t to skeptonomist).

14. It is sometimes argued that monetary policy (interest rate adjustments at any rate) can be made quickly, i.e. fiscal changes take longer to implement.

That point is irrelevant. The IMPORTANT question is TOTAL TIME LAG between the decision to implement a policy and the actual effect. I’ve seen eighteen months cited as the relevant figure for interest rate adjustments, whereas the evidence indicates that a significant proportion of the additional cash that wage earners find in their pay packets as a result of a reduction in employees’ contribution to a payroll tax reduction will be spent IMMEDIATELY. For the evidence, see here, here, here and here.

Also, in that fiscal policy consists of expanding the PUBLIC SECTOR, the effect ought to be pretty well IMMEDIATE. That is, if government decides to hire additional people, the effect comes just as quickly as people can be interviewed, and given the means to get on with whatever job they are doing.

15. Borrowing from abroad.

Borrowing is an alternative to raised taxes, and where government borrows, some of the money is inevitably lent by foreigners. But there is a problem there, which is that money flowing into a country from abroad temporarily boosts living standards in the country. And that standard of living boost will be reversed if and when the money is repaid.

Now those standard of living “gyrations”, have nothing to do with solving the basic problem, namely raising employment. The gyrations are an unnecessary and complicating factor. Plus, the temporary boost to living standards poses big temptations for politicians: it enables them to raise living standards while in office, while the mess is left for their successors to sort out.

16. There is disagreement amongst economists as to how effective monetary and fiscal policies are. That little problem can be solved by doing both policies at once. If one policy I much more effective than another, it doesn’t matter: the COMBINATION is guaranteed to have an effect. 

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P.S. (10th June 2012). Some research done by G. L. S. Shackle concluded that the connection between interest changes and investment was weak. The entrepreneurs questioned said that estimated profits “must greatly exceed the cost of borrowing if the investment in question is to be made”.

(Hat tip to Macroresiliance.)


P.S. (16th July 2012). Reason No.17. The effect of interest rate adjustments is hindered by foreign currency movements. E.g. a rise in interest rates designed to damp down an overheated economy draws foreign capital into the relevant county, which reduces the desired effect. In contrast, a straight cut in government spending (a la MMT) has the opposite effect, if anything, on internationally mobile capital. That is, given a cut in demand in a particular country, capital will tend to leave the country in search of better opportunities elsewhere.

P.S. (24th July, 2012). There is more evidence on the non-relationship between central bank rates and interest rates charged by credit card operators here:

http://www.guardian.co.uk/money/2011/may/05/credit-card-interest-rates-13-year-high


P.S. (15th Sept 2012). Reason No.18. Using interest rates to regulate an economy exacerbates asset price bubbles. Reason is that when the private sector shifts a significant portion of its spending to asset price purchase from other types of spending there is not necessarily any effect on inflation because the increased inflation stemming from the increased price of the relevant asset(s) will tend to be cancelled out by reduced inflation in other areas. Thus the central bank leaves interest rates unchanged, which in turn makes it easier to borrow and speculate in the relevant asset.

In contrast, if government and central bank ignore interest rates and regulate the economy by creating money and spending it into the economy when required (or raising taxes and “unprinting” money when required), then interest rates would rise in response to borrowing funded asset speculation.

Not that that would bring a total end to asset bubbles, but it would certainly help.


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States didn’t actually spend stimulus money.

This is a significant bit of research by John Taylor. He claims that states did not actually spend stimulus money. The incompetence is staggering.

That is an important lesson for the next recession. I.e. it is no use just taking the horse to water: you’ve got to make it drink as well. States need to be specifically told not to sack staff (which is what did in this recession), and if anything, to actually take on additional staff, as well as increasing their spending.

Also Taylor argues in a separate post that other forms of stimulus are ineffective because of consumption smoothing. Or as he puts it, “This is exactly what the permanent income or life cycle theories of Milton Friedman and Franco Modigliani tell us. People largely saved the injection of cash.”

Now there is a problem there. If everyone smooths their consumption to perfection, recessions would be almost unheard of! Households which found themselves underwater would carry on spending as before. And if they did reduce spending a bit, those who lost income as a result of less demand coming from underwater households would not cut their weekly spending either.

Well I don’t buy it. Recessions DO OCCUR.

Plus there are four studies here which DO FIND a relationship (surprise, surprise) between changes in household income and changes in household expenditure. See:

http://onlinelibrary.wiley.com/doi/10.1111/j.1745-6606.1984.tb00322.x/abstract

http://www.nber.org/digest/mar09/w14753.html

http://www.kellogg.northwestern.edu/faculty/parker/htm/research/johnsonparkersouleles2005.pdf

http://finance.wharton.upenn.edu/~rlwctr/papers/0801.pdf


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Look after demand, and funding for businesses looks after itself.

The British establishment continues to hyperventilate about the alleged shortage of bank lending to businesses. E.g. see here, here, here,or here.

Well here is some news for the establishment: the banking industry is heavily subsidised. Thus it needs to contract. So if we want to allocate resources optimally, we need to get used to a smaller bank industry. And that bit of news will have the establishment soiling their pants, given that they are so keen on banks funding small and medium sized businesses.

According to Andrew Haldane of the Bank of England, the too big to fail subsidy is significantly larger than bank profits. See 3rd paragraph under the heading “Implicit subsidies” here:

According to Mervyn King, the bank industry has expanded by a whapping factor of ten relative to GDP over the last fifty years. That is, total bank balance sheets have expanded from 50% of GDP fifty years ago to five times GDP nowadays.

But mysteriously, economic growth fifty years ago was perfectly respectable.

So contrary to the above claims by the establishment, optimum allocation of resources (i.e. maximising economic growth) will come from treating banks like any other business, and boosting demand by enough to bring us back to full employment.

Anyone with a grasp of economics knows what changes will ensue, but I’ll run through them for the benefit of those who are not sure. Also anyone with a grasp of the subject knows how to bring bank subsidies to an end, but I’ll explain how to do it below as well for those who don’t know. In short, those with a grasp of economics can stop reading now – except for a quick point about the title of this post: “Look after demand, and funding for businesses looks after itself”.

That phrase is of course a variation on Keynes’s dictum: “Look after unemployment, and the budget will look after itself”. And the latter two phrases also amount to much the same as Mosler’s law: “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.” (See near top of Warren Mosler’s site.)


The changes brought by a smaller bank industry.

Stopping bank subsidies will raise the cost of borrowing. That in turn means businesses will have to put more reliance on other forms of funding: equity, friends and family, retained profits. But the total capital available to businesses will nevertheless decline. That means business will have to go for less capital intensive forms of production. Plus some relatively capital intensive forms of economic activity will become uneconomic, while labour intensive activities will tend to expand.

The change WILL CAUSE a temporary rise in unemployment because a new set of skills will be required, and it takes time to learn new skills. But enduring a period during which unemployment is higher than it otherwise would have been is entirely justified if it leads to a better allocation of resources.


Ending or reducing bank subsidies.

Those who deposit money in banks can currently “have their cake and eat it”. That is, they reap the benefits of having their money used by their bank in a commercial manner, while being insulated (thanks to the taxpayer) from the risks normally associated with commercial activity. This is a farce, and it should be stopped. For more details, see here.

Leftie dimwits claim the U.K. government’s Work Programme involves “unpaid” work.

The Guardian is always a rich source of loony left nonsense in the U.K. And always keen to side with the downtrodden workers in their unequal struggle with wicked exploitative capitalistic employers, numerous Guardian articles have recently claimed that the UK government’s Work Programme involves “unpaid work”. E.g. see here, here and here.

Well, people on this scheme are not “unpaid”: they continue to get benfits.

Of course there is an argument to be had as to what the hourly rate of pay and/or weekly pay should be in schemes of this sort. But to say that the work is “unpaid” is just nonsense.

Moreover, benefits for many people in the UK are often at such a level that there is little difference between what they get living on benefits and doing a minimum wage job. So it can’t even be claimed that the pay on this scheme for some of those involved is much different to what they’d get on minimum wage work.


What about the “unpaid” work done by taxpayers?

A further piont which is a mile above the heads of the aforesaid leftie dimwits is thus. If one person sits around doing nothing while claiming benefits and consuming food, fuel, etc then someone else has to do some work to produce and market said food, fuel and so on.

That is – and this really is the revelation of the century – food, fuel and so on do not float down from heaven or appear from nowhere.

In short, where one person is allowed to live on benefits, someone else has to do “unpaid” work to produce said food, fuel, etc.

But lefties for some reason see fit to foam at the mouth in realtion to the “unpaid” work done by Work Experience people, but seem totally unconcerned about the “unpaid” work done by those funding people living on benefits.


Research . . . evidence?

As for any awareness of the vast amount of research done since WWII into the effect of schemes of this sort, Guardian journalists appear to be blissfully ignorant. But then the job of journalists has always been primarily to sit at their desks and make it up as they go along.

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The Eurozone’s balmy 0.5% deficit limit.

The EZ wants structural deficits to be no more than 0.5%, with a maximum total deficit for any country of 3%. (A “structural deficit” is the deficit that exists when an economy is at capacity.)

There is a simple flaw in the 0.5% deficit limit. You need the maths skills of a five year old to understand it. I’ve set it out several times before on this blog. But I’ll do it again.

The EZ, like most monetarily sovereign countries / areas, targets a rate of inflation of about 2%. (I’ll treat the EZ as a nation by the way.)

That means that the national debt and monetary base of the nation will shrink at 2% a year unless the debt and base are regularly topped up in nominal terms. And that means enough deficit to effect the topping up. So let’s do some back of the envelope calculations so as to see how big the deficit needs to be to effect this topping up.

Say the debt and base are 50% of GDP. Given the 2% rate of inflation, the deficit needs to be 1% of GDP, (50% of 2%). Which is DOUBLE the above 0.5%!!! But it gets worse.

Assuming economic growth of let’s say 2%, yet another 1% worth of deficit is need (50% times 2% again).

So the total structural deficit needs to be 2% of GDP, not 0.5%.

Or have I missed something?

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A little mistake by Brad DeLong which Abba Lerner would not have made.

Brad DeLong argues that excess unemployment leads to a semi-permanent loss of productive potential because employers fail to invest the amount that would be suitable at full employment. Thus, so he argues, having government borrow and spend now is highly beneficial because in addition to the normal and not too spectacular increased GDP that comes from “borrow and spend”, the above loss of productive potential is avoided. And the latter is where the real benefit of borrowing and spending in 2012 comes in.

That is his basic arument and there is nothing wrong with it. But at the end of his article, he makes a slight mistake. He argues that current low interest rates make “borrow and spend” even more worthwhile than normal, because borrowing costs are currently low.

The flaw in that argument is that interest payments are just TRANSFERS, which are not a REAL cost. That cannot be set against or compared to any increased REAL output that comes from borrow and spend.

That is, when government borrows, interest is paid to those who have lent to government. While the people who PAY for this interest are taxpayers. But that is simply a TRANSFER between two groups of people: the net cost to the nation is nothing, or thereabouts.

To illustrate, suppose one had the option of increasing GDP in such a way that the interest so called “cost” actually EXCEEDED the rise in GDP. According to DeLong (as I understand him) that option would not be worthwhile.

I say it WOULD BE worthwhile, because the increase in GDP is a REAL benefit, whereas the interest rate so called “cost” has no effect whatever on total incomes for the population as a whole: to repeat, it simply boosts the income of one lot of people at the expense of another lot.

But . . . going ahead with “borrow and spend” in those circumstances would lead to a rise in governemnt debt, and possibly an exponential rise. Shock horror.

So there must be something wrong with the DeLong model. And what is wrong is that the basic idea of borrowing so as to fund government spending is one big nonsense. As Abba Lerner, said, in a recession, government should simply create new money and spend it into the economy.

Or as I put it two years ago on this blog, “Borrowing is particularly nonsensical given that when a government borrows, it borrows “stuff” (i.e. money) which it can produce an infinite supply of at no cost. Government borrowing money is a bit like a dairy farmer buying milk at the supermarket when there is a thousand gallon tank of milk a few yards from his house.”

If government “prints” instead of borrowing, that disposes of interest payments. Thus the only question for government is: “Will printing and spending (and/or cutting taxes) boost GDP without exacerbating inflation too much?”

As to which DEPARTMENT of government ought to take this stimulus decision, it is technical decision, a mile above the heads of politicians. Thus the decision is best taken by the central bank or some fiscal committee made up of economists (fallible as they are).

In contrast, there is the decision as to whether the stimulus takes the form of extra public spending or tax cuts. That is a POLITICAL decision which ought to be left to politicians and the democratic process.


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The sectoral balance equation again.

That ‘s the equation (I – S) + (G – T) + (X – M) = 0

There has been much discussion about this since my last post on this topic. E.g. here.

I’m sticking to my original point, namely that “I” (investment) should be scrubbed from the equation. But my reasons are now better thought out. They are as follows.

The sectoral balance equation must work as long as it refers simply to movements of cash or the movement of goods and services. But the two cannot be mixed.

Reason is that if goods worth $X move from sector A to sector B, the relevant entities in sector B certainly OUGHT to pay for the goods, but they might not. Moreover, even if they do pay, they might not pay during the time period under consideration.

The equation must work where it refers, for example, just to movements of cash, because a movement of cash from one sector must be matched by a movement of cash into another. (And if you want to do the equation on a goods and services basis, rather than a cash basis, then the same point applies: a movement of goods from one sector must equal a movement into another sector).

So if we go for a cash basis, then the defintions of I,S,G etc must be such that they clearly refer to movements of cash and nothing else.

For example, the definiton of exports (X) in the equation CANNOT BE the conventional one which is something like “value of goods sold to foreigners”. It must be something like “payments by foreigners to domestic entities for ANY reason including payments by foreigners for goods supplied by domestic entities”.


Investment should be scrubbed from the equation.

As for the idea that “investment” ought to be in the equation, I’m sticking to my point that investment should be scrubbed from the equation. Reasons are as follows.

If one private sector entity purchases an investment item from another, cash does not leave the private sector, so that particular “investment” is irrelevant to the equation. In contrast, if a private sector entity purchases an investment item off governemnt (e.g. some land), then cash crosses a sectoral boundary. Thus it must be included in the equation somehow.

One way of doing this is to scrub “investment” from the equation and replace it with something like “ non-tax payments made by private sector entities to governemnt for goods or services supplied by government”.

Alternatively, investment can be scrubbed from the equation, and “tax” could be replaced with “all cash received by government including tax and payments to government not normally classified as tax”.

And the final nail in the “investment coffin” is that it is perfectly possible for a private sector entity to make an investment without purchasing anything from anyone – never mind purchasing stuff from another sector. For example if the value of shares I own rise, that increases my “investments”, but I haven’t purchased anything from anyone to bring that about. Or if I make an improvement to my house which will last say ten years, and using materials I’ve got lying around in my garage, that is an investment which needn’t involve a purchase from anyone during the relevant time period.

Here endeth the lesson. 

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P.S. (3rd March). (X-M) and (G-T) are by their very nature CHANGES to a stock, i.e. a flow. That means that if “I” is scrubbed from the equation (leaving just S), then S must also refer to a “change in a stock” (i.e. a change in the total of private sector cash savings). Thus the equation is arguably best written:
∆S + (G-T) + (X-M) = 0
(h/t to Paulie46)




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