Economic illiteracy - from two professional economists.

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Gary Becker and Richard Posner, two economists provide some strange analysis of the current recession. They advocate the old myth, which I thought had been disposed of in the 1930s, namely that cutting wages would help raise employment or cure the recession.

The nonsense starts in their para which begins “Keynes and many earlier economists emphasized that unemployment rises during recessions because nominal wage rates...”

The suggestion here is that simple micro economic ideas about supply, demand and price apply at the macroeconomic level. That is the suggestion appears to be that if wages dropped 10% or so, demand for labour would rise 10% or so (assuming for the sake of simplicity that we have elasticities of supply and demand for labour of unity).

This is precisely the idea that Keynes debunked. As he rightly pointed out, if wages drop by X%, this means that demand will drop by significant proportion of X%, since wages are the single biggest component of demand. That means MORE UNEMPLOYMENT at least initially. However, as Keynes righly pointed out, competitive forces will result in employers dropping prices by about X%, which means everyone is pretty well back where they started. Net effect on unemployment: about zero.

The only net effect of the above farce is the Pigou effect. That is the above drop in prices raises the real value of money, which equals an increase in the real value of household savings. This WILL stimulate demand, but as Keynes pointed out, “wages are sticky downwards” thus the Pigou effect takes an unacceptably long time to work.

The other piece of nonsense by Becker and Posner is in their last para where they claim that extra stimulus requires expanding the national debt and that the latter is some sort of problem. This is a much more widely held view than the above “cutting wages” idea.

Well if you want stimulus and you think extra national debt is a problem, then stimulate WITHOUT extra debt. That’s what the UK did in 2009. Magic! How was it done? The answer is that the entire deficit in 2009 (more or less) was quantitatively eased. I.e. the government central bank machine just printed £200bn of extra money.

Of course this involves a NOMINAL debt: an extra £200bn owed by the UK Treasury to the Bank of England. But this is a huge paper shuffling nonsense (the purpose of which is to get round some silly European Union regulations, as I understand it). The government debt or “gilts” in the hands of the Bank of England might just as well be shredded.

For more on this see 13th Oct post below, “£200bn off the national debt.....” and the “Governments should stop borrowing” link top right above.

Give us austerity and fiscal rectitude, Miss Whiplash.

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There is just one thing wrong with Martin Wolf’s article in today’s Financial Times: the title, which is “Give us austerity and fiscal rectitude, but not quite yet”.

This bolsters the general impression that the tax rises or public spending cuts needed to get the deficit under control will hurt. They won’t, and for the following reason (which is actually a repetition of a point made below in previous posts).

There is no point in fiscal rectitude till it looks as though lack of fiscal rectitude will be inflationary, i.e. until unemployment has fallen, and looks like falling too far too fast.

Assuming the “rectitude” takes the form of extra taxes, this involves taking money from people which they effectively couldn’t spend in they wanted to. That is, if the money was left in their pocket, the result would be inflation which would make them WORSE off.

If financial journalists did a bit more to get this point across to the population at large, that would make it easier to raise taxes or cut public spending when the time comes.

Carry Trade.

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The US dollar is currently a bl**ding nuisance for half the countries on planet Earth. Low interest rates and easy money in the US are currently resulting in carry trade which results in dollars flowing into many other countries. This makes it difficult for such countries to maintain the exchange rates they want, and the availability of credit that they want.

But interest rates in the UK are no different to the US. And the amount of quantitative easing in the UK is roughly the same (as a proportion of GDP) as in the US. Yet the British pound is not nearly as popular with “carry traders”. Why the difference?

Possibly the explanation is as follows. Around 99% of the bonds quantitatively eased in the UK are UK government bonds (i.e. “gilts”). In contrast, in the US, the equivalent proportion seems to be about 20%, with the remaining bonds being private sector bonds.

Now there is a difference. The UK policy in effect puts money into the pockets of ordinary UK citizens and businesses big and small. The US policy puts money into the hands of professional investors: rich individuals and institutions.

Now the average UK household and average UK small business is not going to run out and spend its recently expanded bank balance on strange South American shares or bonds. In contrast, professional investors are more likely to.

Put that another way, the US has given professional gamblers more money to gamble with.

Moreover, why does the US have a “Troubled Asset Relief Program” (TARP) – and why do other countries have an equivalent? If some rich individual or institution has made bad investments, then s*d them.

The US should have channelled 100% of stimulus money to Main Street and ignored Wall Steet. If that had resulted in a hundred and bankers and stockbrokers jumping from tenth storey windows, who cares?

In this connection the warning by the IMF that any more handouts for the financial sector could lead to violence looks apt.

The Washington D.C. baby sitting economy: it suffered a recession and solved it !

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In the early 1970s a group of parents with young children in Washington formed a babysitting club. Parents wanting to go out for the evening would get one or other spouse from another family to come and baby sit.

But few people do anything for free in this world, so this club created its own currency, baby sitting tokens. Parents would give one token for each hour’s babysitting to the baby sitter.

But this mini economy ran into a problem: it had a recession! It suffered from relatively high unemployment. What happened was that most couples wanted to keep a stock of tokens to give them the flexibility to go out several times a week without having to baby sit for anyone else.

This lead to a reluctance to baby sit for anyone else because that would mean parting with tokens. And this in turn meant that those wanting to baby sit couldn’t find any customers: they suffered involuntary unemployment.

The solution they came up with was to give their economy some stimulus. They printed and distributed more babysitting tokens (i.e. money). And that solved the problem. Those wanting to baby sit found it much easier to find customers. And those wanting to keep tokens in reserve were happy as well.

Paul Krugman in describing this said “This story tells you more about what economic slumps are and why they happen than you will get from reading 500 pages of William Greider and a year's worth of Wall Street Journal editorials.” (Greider is a former assistant managing editor at the Washington Post).

In 1866 US banks thought it would be in their interest to cause a depression, so they did.

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In 1866 US banks thought it would be in their interest to cause a depression, so they did.

In 1995-2005 US banks though it would be... etc etc you get the picture.

It would be over simple to suggest the two episodes are identical. But the parallels are thought provoking.

For verification of the 1866 episode see here and scroll down to heading entitled “The Return of the Gold Standard (1866 - 1881).

Who are the dummies: the US government or the Chinese?

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The Chinese pile up a vast hoard of US Treasuries, which artificially raises the value of the Yuan. This cannot go on for ever. When this process slows down or stops (or horror of horrors, goes into reverse), the US dollar is guaranteed to lose value relative to the Yuan (other things being equal). And then the Chinese complain when this happens!

This is a bit like an alcoholic blaming some else for damage to his liver.

As to the US government, it is equally stupid (thanks largely to “balance the budget” anti-deficit conservative Republicans). Reasons are thus. The recession has occurred largely because of excess debt. People and businesses have learned their lesson and are trying to repay this debt (or “deleverage”). Thus what households and businesses need is dollars with which to repay their debts.

So what does the US government do? Print billions of extra dollars and give it to banks in the hopes that banks will – of all things !!!! – lend it to businesses and households. Just what the latter don’t want !!!

If Laurel was Chinese president, and Hardy was US president, we would have fewer problems.

The WPA has nothing to do with money printing.

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Bill Mitchell, Warren Mosler and L.Randal Wray between them have devoted about a million words to advocating WPA type schemes - (WPA was a large scale “make work” scheme set up in the US 1930s). And the above trio claim that such schemes can reduce unemployment to near zero. To a significant extent their arguments are based on the fact that that a country that issues its own currency has more freedom of manoeuvre when it comes to stimulating its economy than a country in a common currency area. That is, the argument to a significant extent is: “the amount that needs to be spent to get a large scale WPA system going is small (or at worst equal to) the amount of extra money that an “own currency issuing” country can print each year, without exacerbating inflation.”

Malcolm Sawyer has attacked the above WPA idea. But there is one flaw in the above argument that Sawyer hasn’t spotted (at least not in the paper you get to from the latter link). The flaw is thus.

Freedom to print money and stimulate one’s economy is not an argument for stimulating it in any particular way, e.g. the WPA way. Indeed, the above trio of authors suggest various other ways of simulating economies using printed money. Thus money printing has nothing to do with the arguments for or against WPA. The question as to whether to implement WPA type schemes is entirely dependent on its merits compared to other forms of employment creation.

Quad Erat Demonstrandum. Or put it another way, the above trio are not grumpy enough – see 13th Nov post immediately below.