Saturday, March 31, 2012

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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