Victoria Chick and Ann Pettifor show that increased public spending REDUCES the debt.

This is a nice study by the above two authors. They look at the UK national debt and deficit figures since the early 1900s, and show that the effect of “fiscal consolidation” is counter intuitive. That is, attempts to pay back debt are self-defeating: they result in a rising debt.

As they say, “The empirical evidence runs exactly counter to conventional thinking. Fiscal consolidations have not improved the public finances.”

Also Anne Pettifor’s blog looks interesting.


Afterthought (12th June): The claim by Chick and Pettifor that attempts at what is now called “fiscal consolidation” are self-defeating might seem to clash with the claim I have made on numerous occasions, e.g. here, namely that the debt can be reduced or abolished by printing money and buying the debt back (to over simplify a bit). In fact there is no clash. C & P refer to cutting public spending (or raising taxes) and using the money to pay off the debt. In contrast, my proposal is to leave public spending and taxes more or less untouched (but not entirely untouched) and basically pay off the debt, to repeat, with “new” or “printed” money. These are two very different scenarios.

William Dudley of the Fed doesn’t know how to reduce the debt.

A recent speech (1) by William Dudley, president of the New York Fed is mostly quality stuff, but he seems to be unaware that reducing national debts, or at least preventing them expanding, is quite easy.

It is deficits that cause debts to rise, and (as pointed out by Keynes (2) and Milton Friedman (3)) funding a deficit with new money rather than via debt is a perfectly acceptable option. That means the deficit can continue, but the debt declines or at least ceases to grow.

The relevant passage from his speech is as follows (in green and italics).

However, the large size of the fiscal deficit and the rapid increase in the country's federal debt-to-GDP ratio means that this is not sustainable for much longer.

Standard deficit terrorist stuff. He then continues:

Ultimately, the composition of economic activity in the United States needs to be rebalanced. There are two issues here. First, the consumption share of GDP may still be too high. Second, the need for U.S. fiscal consolidation implies that there will have to be offsetting increases in investment and the U.S. trade balance as the recovery proceeds.

To illustrate this second point consider the following accounting identity:
The public sector balance + the private sector balance = the current account balance
Right now the identity holds as roughly:
-10 percent of GDP public sector balance + 7 percent of GDP private sector balance = -3 percent of GDP current account balance.5
If the public sector balance must over time move from around -10 percent to around -3 percent to stabilize the federal debt-to-GDP ratio at tolerable levels, then the private sector balance and the current account balance must move by roughly 7 percentage points of GDP to take up the slack.

The first flaw in this argument is Dudley’s suggestion that the deficit cannot continue because the debt is too large. The answer to that is that, to repeat, a deficit can perfectly well be funded by new money rather than by debt.

Put another way, debt reduction should not be an important or central economic objective. The main economic objective is keeping total numbers employed as high as is consistent with acceptable inflation.

The deficit should be whatever is needed to attain the latter objective. And then, having decided on the deficit, there is the question as to whether to fund it via debt or new money. And the arguments for funding via debt are thin on the ground (and more on this below).


The deficit might need to last another five years.

If households want to continue deleveraging or saving up dollars for the next FIVE YEARS, that does not mean as per Dudley logic that the US government has to go ever deeper into debt. The US government can simply print dollars to supply households with what they want.

Indeed, the present rate of deleveraging will have to continue for another five years or so if households want to reverse the leveraging they undertook between Jan 2005 and Jan 2008. At least that is the case if the first chart here is any guide.

Moreover, since it is money that households are after, it is eminently reasonable to fund the deficit via cash rather than debt.


Central bankers shouldn’t worry about private sector investment.

Dudley then says:

“Assuming that the consumption share of GDP still needs to fall over the medium term, the adjustment in the U.S. private balance will have to occur primarily in terms of rising residential or business fixed investment.

There does seem to be room for business investment to expand significantly when firms become more confident in the economic outlook, provided that the United States remains a competitive location for investment. But residential investment is unlikely to climb very much for some time given the chronic overhang of unsold homes.

If these two sectors cannot take up all the slack created by necessary fiscal retrenchment in the years ahead—as seems likely—then the U.S. trade balance will need to improve as well. This implies that emerging market economies (EMSs) will no longer be able to rely on expanding U.S. demand as a key driver of their own economic growth.”

In other words he is saying that if the injection by the public sector into the private sector ceases, some other injection (and investment is all he can think of) must take its place. Well the flaw in this argument is that, despite what it says in economics text books, injection can take the form of demand for consumer goods just as much as investment goods. Indeed, there is not even a sharp dividing line between the two: is something that lasts one year a consumer good or an investment good? What about two years . . three years?

Put another way, if demand by the US private sector for US private sector produced stuff expands or speeds up sufficiently, the injection from government can just cease. Period. Full stop. As to how this extra demand by the private sector breaks down as between consumer and investment goods – who cares? We don’t need central bankers worrying about that. The free market can sort that out for itself.

Thus the idea that a smallish demand for investment goods necessitates reducing the flow of dollars out of the US to EMEs does not add up. Put another way, if EMEs want to save up dollars, let them! Of course Uncle Sam will have to print dollars to supply EMEs with the dollars they want. And would require a continued but smaller deficit. But that’s not a problem.

In fact, being able to churn out bits of paper with “$100” printed on them (to put it figuratively) and exchange those bits of paper for real goods and services is great. Even better, the value of the bits of paper can be degraded by inflation. Wish I could do that! Put yet another way, anyone in the position to do some seigniorage can make good money. That’s what banks do, and if the US gets its act together, it can be the world’s banker for a few years yet before the Yuan becomes the world’s reserve currency.


Why fund a deficit via debt rather than with new money?

The first nonsensical aspect of funding via debt is that it amounts to asking to become indebted to other countries. That is, foreigners can buy one’s national debt. E.g. China holds a big chunk of U.S. debt.

Now there is nothing wrong with a microeconomic entity like a household or firm borrowing from abroad. But there is a problem when government does this, which is as follows.

Where government collects insufficient tax to cover its spending, it has to borrow instead. And the purpose of the borrowing is to provide a demand reducing effect to counteract the demand increasing (and possibly inflationary) effect that would come from just printing money to cover the tax shortfall.

But if a country borrows from abroad, it is debatable as to how much of a demand reducing effect there is. Certainly if some foreign entity brings money into the debtor country SPECIFICALLY to lend to the debtor government, there is no demand reducing effect at all! That leads to the farcical situation of the debtor country paying interest to the foreign entity, and then having to borrow as much again from domestic entities so as to get the demand reducing effect!

Of course in the real world, things aren’t that simple. For example the dollars that China allocates to US national debt are (at a guess) dollars that China would be holding anyway as a result of China’s export fetish. Nevertheless, capital moves freely across national boundaries nowadays. And you can be sure that as soon as some country announces a desire to borrow, potential lenders around the world take a look at what’s on offer.

A second daft aspect of funding a deficit via debt rather than new money is this. Regardless of whether a government borrows from domestic or foreign entities, what’s the point in a government borrowing money, and paying interest for the privilege, when it can produce such money itself for free anytime? That is as daft as a dairy farmer buying milk in a shop when there is a hundred gallon tank of milk outside the farmer’s back door.


Money printing causes inflation?

The rest of this post explains why money printing does not necessarily exacerbate inflation. So readers who know why additional money does not necessarily mean inflation can stop reading here.

The fact that governments can and do print money does not of course mean they can print it willy nilly. On the other hand the idea that money supply increases necessarily lead to increased inflation is also nonsense. For example the U.S. monetary base has TREBBELED in the last two years: totally unprecedented. But inflation, just as many of us predicted, remains at a level that is very near the post WWII average. Plus the big money is not betting on increased inflation in the near future, if the yield on various Treasuries is anything to go by.

So how much money can be printed before inflation is exacerbated (either straight away or in a few years) and how should such money be allocated? Well the answer to that question can be explained to a fifteen year old in about five minutes. The answer is thus.

New or printed money will only exacerbate inflation if and when it gets spent in serious quantities and at a serious speed. I.e. if the money just sits in deposit accounts or under mattresses, it has no effect.


Money in banks is not always loaned out.

As to the idea that a money supply increase when it is plonked in bank deposit accounts will be loaned out and thus cause a rise in demand and/or inflation, well that idea flies in the face of both the evidence and the theory.

As to the evidence, banks currently have record reserves: which they are not lending out with any great enthusiasm!!!

As to the theory (and this explains WHY banks are not lending freely) banks lend when they see viable lending opportunities: for example businesses with bulging order books. Put another way, given a healthy level of aggregate demand, banks will lend. (Incidentally, this point highlights the absurdity of rescuing Wall Street rather than Main Street, and then expecting instant recovery as a result.)

So how much money should be printed? Well how about the government / central bank machine printing money and allocating the new money between private and public sectors in the ratio that these sectors currently form as a proportion of GDP: roughly two thirds for the private sector and one third for the public sector.

So as regards the latter, government just prints money and spends it on the usual public sector items: schools, law enforcement, etc.

As the regards the private sector, the new money needs to go to the ultimate source of all demand: the consumer. A payroll tax reduction would do the job.

And wouldn’t you know it – one of the leading lights of Modern Monetary Theory, Warren Mosler (4), has been advocating a payroll tax reduction since the recession began.

Unfortunately the incompetents actually in charge have allocated new money (via QE) to the people LEAST likely to spend it: bond holders, i.e. the rich: a shambles!

As to HOW MUCH money to print and distribute, there are no sure answers to this, and for the simple reason that households’ behaviour is not all that predictable. Nor is the behaviour of businesses, politicians, or any other group. In other words the effects of a deficit funded by new money are just as uncertain as the effects of a deficit funded by borrowed money. Either policy can lead to excess demand and thus inflation, or to too little demand and thus excess unemployment.

So how about just carrying on with the current deficit, funded with new money rather than borrowed money, and see what happens? If inflation looms, that can be controlled by “unprinting” money: that is, for example raising taxes and extinguishing the money collected.


References.

1. Dudley: http://www.newyorkfed.org/newsevents/speeches/2011/dud110607.html

2. Keynes: http://www.scribd.com/doc/33886843/Keynes-NYT-Dec-31-1933
(2nd half of 5th para).

3. Friedman: http://nb.vse.cz/~BARTONP/mae911/friedman.pdf (p.250)

4. Mosler: http://www.hardassetsinvestor.com/videos/1868-warren-mosler-payroll-tax-holiday-needed.html?showall=&start=1


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Bond holders in the Bank of Ireland who got a mouthwatering 13.75% for years complain about haircuts!

Even had these creditors of the Bank of Ireland received a more normal return on their investment, I wouldn’t have given a hoot if their entire investment had been wiped out. That’s free markets for you. Or it used to be: nowadays, the rich aren’t allowed to lose money. The latter is a privilege reserved for the poor or those with less good political connections.

Hat tip to Mark Wadsworth.

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Two new forms of money.

Two new forms of money. First, kilowatt hour tokens:

Second, “Bitcoins”.

I’m not convinced. But I love people who produce new, imaginative or eccentric ideas. See what you think.

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Verbal garbage from Bernanke.

Here is a paragraph from a speech by Bernanke (in italics). If you dose off half way thru (and I wouldn’t blame you), you could skip to my less than flattering comments below.

Of course the head of a central bank holds a politically sensitive position, thus when reading their material it is necessary to read between the lines. Possibly Bernanke is just saying (in convoluted language) “we’ve got to do something about the deficit". At the same time, possibly he actually means what he says here:

The prospect of increasing fiscal drag on the recovery highlights one of the many difficult trade-offs faced by fiscal policymakers: If the nation is to have a healthy economic future, policymakers urgently need to put the federal government's finances on a sustainable trajectory. But, on the other hand, a sharp fiscal consolidation focused on the very near term could be self-defeating if it were to undercut the still-fragile recovery. The solution to this dilemma, I believe, lies in recognizing that our nation's fiscal problems are inherently long-term in nature. Consequently, the appropriate response is to move quickly to enact a credible, long-term plan for fiscal consolidation. By taking decisions today that lead to fiscal consolidation over a longer horizon, policymakers can avoid a sudden fiscal contraction that could put the recovery at risk. At the same time, establishing a credible plan for reducing future deficits now would not only enhance economic performance in the long run, but could also yield near-term benefits by leading to lower long-term interest rates and increased consumer and business confidence.

First, as regards “fiscal drag”, the latter is simply the tendency as GDP rises in money terms (as distinct from real terms) for more people to pay more income tax. This “fiscal drag” phenomenon goes on ALL THE TIME!!!! It happens regardless of whether there is a recession or no recession. It happens whether there is a deficit or a surplus. So why on earth does Bernanke mention it? Presumably just to pad out his speech with important sounding phrases like “fiscal drag”. (Incidentally, beware of the Wiki definition of fiscal drag. It’s wrong. It’s nice to see this definition contains an MMT phrase, “net savings desires”, but it’s much more important to get definitions right.)

Next, Bernanke tells us that a “sharp fiscal consolidation” would reduce demand, which is allegedly a “dilemma”. (By the way, the phrase “fiscal consolidation” sounds important, doesn’t it?)

Anyway, he has the solution for this “dilemma”. (Thank God for that). He says “The solution to this dilemma, I believe, lies in recognizing that our nation's fiscal problems are inherently long-term in nature.” Complete bunk!

At least half the deficit derives simply from the fact that a bunch a school children in Congress are squabbling about taxes, public spending, and related matters. And no one will agree to a decent tax increase unless they get their favourite toy. (That’s the so called structural deficit.)

This “dilemma” could be resolved in 24 hours if members of Congress just grow up and recognise that public spending ought to be funded by tax. The increased taxation that would resolve this “dilemma” would NOT, repeat NOT result in any standard of living hit for US citizens, despite the fact that large numbers of economic illiterates in high places think that some sort of pain or austerity WOULD flow from such tax increases. Reason is as follows.

If government (aka school children) decides to collect $X less in tax than is needed to cover public spending, then on the face of it, government has to borrow $X. (Actually that’s not strictly correct: what government needs to do is borrow an amount such that the demand reducing effect of the borrowing equals the demand increasing effect of $X worth of spending. But I won’t bother with strict accuracy on this point.)

Thus if government increases tax tomorrow by enough to cover all government spending, there’d be NO EFFECT on living standards, GDP, total numbers employed, etc etc. In short, there is no “austerity” or “pain”.

Conclusion so far: in as far as the deficit derives from the above childish behaviour, the “fiscal problems” are not, as Bernanke claims, “inherently long-term in nature.” Rather, the problem is political, and given an outbreak of common sense, could be solved in 24 hours. How long the problem persists is a POLITICAL JUDGEMENT. It could be short term or it could be very long term. But the problem is not “inherently long-term”.

As distinct from the extent to which the deficit derives from childishness, the deficit partially derives from stimulus. Here again, the so called problem is not inherently long-term nor does it make sense to “quickly to enact a credible, long-term plan for fiscal consolidation.” That is because the stimulus part of the deficit is a REACTION to the recession and the latters’ severity and duration (or it should be). I.e. the remedy needs to last as long as the disease lasts.

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More logically challenged economists.

Hard on the heels of the 150 US right wing economists who can’t distinguish between their own personal political views and economics, a group of 52 UK left wing economists and academics have chirped up. The confusion of issues by these 52 individuals is just as bad as in the case of the above 150.

The “52” claim to be concerned about “sustainable growth” and deficit reduction. They don’t say which of the policies they advocate address which of the above two objectives. Anyway they advocate a “green new deal”. Presumably the “green new deal” helps bring about “sustainable growth” – that’s assuming the word “sustainable” is being used in the environmental sense.

Well now, the statement that a “green new deal” will help address problems “sustainable” in the environmental sense is true by definition, isn’t it? It’s a non-statement.

Moreover, why address matters “environmental” and “deficit” in the same letter or article? The two are entirely separate subjects. I.e. had the recession never happened, and we were currently enjoying full employment and no deficit, environmental issues would be just as important. In fact they’d be slightly MORE important because we’d be burning up more of the world’s scarce resources.

As to “targeted industrial policy” (more or less central economic planning), it may well be that the free market’s performance can be improved by having bureaucrats and politicians take major economic decisions (though I doubt it). But this has nothing specifically to do with deficit reduction or the recession. That is, if a bit of “targeted industrial policy” improves things, it will have this beneficial effect recession or no recession – and deficit or no deficit.

Next the 52 want a clamp down on tax avoidance. Same again: nothing specifically do with the recession or the deficit. That is, if it is relatively easy to catch tax avoiders, then fine – let’s go for it. But this will apply, presumably, at full employment.

And finally, the 52 want “real financial reform, job creatiohttp://www.blogger.com/img/blank.gifn, "unsqueezing" the incomes of the majority, the empowerment of workers and a better work-life balance.”

That’s so vague it’s hardly worth commenting on. As to “job creation”, who can argue with that? What are the 52 going to advocate next: apple pie and mother’s milk? The $64k question is EXACTLY HOW TO CREATE JOBS!!!! DOH!

The moral is: if you want to learn to think, don’t go to university :)

Afterthought, 21st June 2011. When I wrote the sentence just above about universities failing to teach students to think, I thought that was a joke. But it seems there is evidence to back this point.



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Economically illiterate economists: they’re everywhere!

150 economically illiterate economists have petitioned Obama to cut public spending. Apparantly is will cure America’s economic ills.

The flaws in this argument are basic, simple, glaring and elementary.

1. If a low level of public spending is essential to a healthy economy, how come some European counties enjoy similar living standards to America, while having levels of public spending relative to GDP that are double that of the U.S.?

2. The decision as to what level of public spending a county has is a POLITICAL decision. It is the basic political difference between left and right. It is a decision that is made at election time, not by economists.

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