ECB to do QE?

European Central Bank might do Quantitative Easing.

That raises a question as follows. Stimulus can be implemented by, 1, cutting interest rates (the favoured ECB tool to date), 2, by standard fiscal policy (borrow and spend) or 3, combining fiscal and monetary policy, i.e. simply having the government / central bank machine print money and spend it (and / or cut taxes) – advocated by Positive Money and others.

So there must be some optimum combination of the above three. So what is that optimum?

Well strikes me the optimum rate of interest is the free market rate, which casts doubt  on No.1. Moreover, interest rate adjustments if they work at all are DISTORTIONARY: that is the bring stimulus just via or primarily via investment spending. You might as well boost an economy just via extra car production and expenditure on restaurants. Moreover, the evidence is that interest rate adjustments don’t actually work. See here and here.

So interest rate adjustments are a farce.

Fiscal stimulus.

That consists of borrowing and spending. Now what’s the point of implementing a stimulatory measure (more spending) and then partially negating that with more borrowing? Isn't that the definition of lunacy?

Moreover, there is much disagreement as to how big the latter “self negating” effect traditional fiscal stimulus is (often referred to as “interest rate crowding out”). But (and here it all gets even more farcical), assuming stimulus is needed, the last thing a central bank will do is to let interest rates rise: indeed it will probably cut them. And that is effected by printing money and buying some or all the debt just created by the above fiscal stimulus…….which comes to the same thing, or much the same thing as No.3. Speaking of which…..

That leaves No.3: simply having the government and central bank print new money and spend it, and/or cut taxes. And that was suggested / advocated by Keynes.  Plus that policy comes to the same thing as fiscal policy followed by QE. Conclusion: the ECB is moving in the right direction.

Political and technical questions.

Of course the latter “print and spend” wheeze seems to raise a problem as follows. Those in charge of quantifying the amount of stimulus are often a bunch of professional economists (e.g. the Bank of England’s Monetary Policy Committee or the Office for Budgetary Responsibility). But deciding exactly what any stimulus money should be spent on is an obviously POLITICAL question.

Well the answer to that little problem isn't difficult: have the professionals do the technical stuff, like quantifying the amount of stimulus needed, while politicians do the strictly political stuff, like deciding exactly what stimulus money is spent on.

In fact that was all thought out by Positive Money, Prof. Richard Werner & Co. three or four years ago.

Reversing stimulus.

A possible defence of pure monetary policy is that it is easy to reverse. Well dollar for dollar it certainly IS EASIER to reverse than fiscal policy (that is, having the central bank buy or sell government bonds does not involve political problems, whereas reversing fiscal policy, e.g. by raising income tax or sales taxes or cutting public spending can involve political problems).

Well the answer to that is that “print and spend” is far more effective, dollar for dollar, than monetary policy. Thus while reversing monetary policy is relatively easy, each dollar of monetary policy is relative ineffective. So the “difficult to reverse” criticism of “print and spend” is not much of a criticism.

Moreover, the UK lowered and then raised it’s sales tax (VAT) during the crisis, and no one turned a hair.

Applying that to the Eurozone (EZ).

Applying the above “print and spend” policy to the EZ as a whole (i.e. a collection of national governments which are not averse to quarrelling with each other) would be more difficult that applying it to a monetarily sovereign country like the UK. But it wouldn’t be impossible.

It would be a case of saying to each individual EZ government, “you can’t borrow any longer, and you can only net spend what we, the Euro authorities (ECB in particular) say you can net spend”. That would cause some resentment in some countries, but then there’s no shortage of resentment at the moment in periphery countries at the austerity being imposed on those countries.

Vince Cable blunders.

Vince Cable, the UK’s “Business Secretary”, is currently in the lime light because he sold off (i.e. privatised) the postalsystem, Royal Mail at much less than market value.

But there is a more serious and damaging policy he has pursued for a year or two, namely opposing improvements in bank capitalratios, with a view to encouraging more private bank lending: i.e. boosting the already elevated levels of private debt. Now those elevated levels of private debt were one of the main factors behind the crunch!

It really is jaw dropping: we had one of the worst crashes since 1929 about five years ago: caused by irresponsible and excessive bank lending and inadequate capital buffers. And that was followed by about four years of excess unemployment. And what does the UK’s “Business Secretary” want to do? See a repeat of the whole charade in five or ten years’ time!

Of course the reasons he opposes capital ratio improvements are obvious. There are three reasons as follows.

1. Corruption.

Politicians and political parties the world over receive millions from banksters, designed amongst other things to thwart better bank regulation.  Or as Senator Dick Durbin put it, “Banks are still the most powerful lobby on Capitol Hill . . . . . and frankly they own the place”.

2. Ignorance.

Politicians often think that because shareholders want a higher return on their money than depositors or bondholders, that therefor increasing capital ratios increases the cost of funding banks. And banksters encourage politicians in that belief. However, as Messers Miller and Modiglianiexplained, there is a very simple reason for thinking that bank funding costs do not change much when capital ratios change.

And it’s not just me that claims bankers are into the above intellectual dishonesty, i.e. that they’re a bunch of liars. Robert Jenkins, member of the Financial Policy Committee described banks’ opposition to improved capital ratios as “intellectuallydishonest”. (That was the front page leading story in the Financial Times, incidentally.)

Increased bank charges due to the removal of bank subsidies are OK.

There is however ONE REASON why bank costs (and hence charges made to their customers) would rise. But it’s an entirely acceptable reason, and as follows.

Grossly inadequate capital ratios are risky, and who carries that risk? Well the taxpayer carries a fair chunk of it: witness the hundreds of billions of taxpayers’ money used to bail out banks. So… if capital ratios are increased, that effectively means a reduced subsidy for banks. Thus bank costs and charges rise a bit.

But subsidies ARE NOT JUSTIFIED, unless someone can produce a very good social reason for a subsidy. Indeed, improved capital ratios would, as Vince Cable claims, reduce bank lending. But that would not reduce GDP. That is, assuming the latter standard piece of economics is correct (i.e. that subsidies misallocate resources), then improved capital ratios would actually INCREASE GDP.

Put that another way, if banks are subsidised, then interest charged to borrower / investors will be artificially low: i.e. below optimum. So…. remove the subsidy, an interest charged will be optimum, or at least nearer the optimum.

3. The belief that only private banks can create credit/money.

Vince Cable almost certainly doesn’t understand that the economy can be stimulated simply by creating and net spending more base money (i.e. CENTRAL BANK created money). By “net spending” I mean government spending net of tax collected. I.e. those on the political left would want more government spending, while those on the right would want less tax, so the term “net spending” covers both what a left of centre government would want to do and ditto for a right of centre government.

In other words, Cable thinks that stimulus can only come from private banks – i.e. from more private debt.

The reality of course, as Keynes pointed out, is that stimulus can be implemented simply by printing and net spending more central bank created money into the economy. That “Keynsian” point is also made in this Positive Moneyitem.

Abolish minimum wage laws?

Ryan Bourne argues that the minimum wage should be abolished for various categories of less productive employees, e.g. the long term unemployed and youths.

I favour that GENERAL PRINCIPLE, i.e. abolishing the min wage for the unproductive while ensuring their take home pay is up to socially acceptable levels via in-work benefits (i.e. an employment subsidy). But Ryan Bourne’s way of implementing the principle is possibly not the best. To illustrate, there are plenty of youths who are productive enough to make employing them at the min wage a viable proposition. Plus there are plenty of middle aged people who have been unemployed for LESS THAN a year WHO ARE unproductive: at least in that their lack of skills or some other factor means it may take them a long time to find a job where THEY ARE productive.

So a better way of effecting the principle would be to allow ANY employer to employ ANYONE at a sub min wage rate (or even pay no wage at all), but with the proviso that public employment agencies have the right to remove relevant employees from such employment when such agencies find what they think is more productive work for the individuals involved.

The latter proviso would help minimise the obvious problem that arises when there is no min wage, namely that employers are tempted to exploit the system by hiring relatively productive employees at a sub min wage rate in the knowledge that the state makes good relevant employees take home pay with in-work benefits, i.e. an employment subsidy. (Not that that problem was of CATASTROPHIC proportions in the days before minimum wage laws were implemented)

And it’s not just employers who are tempted: employees also gain at the taxpayers’ expense in that a subsidised job will tend to be relatively undemanding and easy going, all else equal.

Another way of minimising the problem would be to limit the subsidy to relatively short period: perhaps 3 months or so.

That combination of a maximum period of employment with the help of the subsidy, plus the possibility that the state removes an employee at a moment’s notice would tend to persuade employers to claim the subsidy only in respect of the GENUINELY unproductive. That is, no employer wants to lose a GENUINELY productive employee, while employers are not too bothered about losing GENUINELY unproductive employees.

Another possible condition would be to limit the number of subsidised employees to a small percentage of each employer’s total workforce. And various other rules are easy enough to envisage.

The above system would raise aggregate employment, amongst other reasons, because employers, instead of ceasing to hire further employees when employees’ marginal product was the min wage, would expand their workforces to the point where the marginal product was somewhat less: even zero.

An obvious criticism of the latter system is that it would make for high labour turnover. Well it would. But that’s not entirely undesirable. That is, it’s a good idea for those who cannot find a job at which they are productive, to try a variety of jobs so as to see what suits them.

BNP Paribas could do with a better chief economist.

Advocates of Modern Monetary Theory (and indeed anyone with a grasp of economics) will be splitting the sides at this phrase uttered by Ryutaro Kono, BNP Paribas’s chief economist: “Because fiscal stimulus borrows income from the future for immediate consumption, such policies only compound Japan’s already huge public debt..”  The quote comes from thisFinancial Times article.

What’s going on in Kono’s brain is plain as a pikestaff: like a significant proportion of the World’s elite, he doesn’t get the difference between macro and micro. That is, he is treating government debt like that of a microeconomic entity like a household.

And of course when a household borrows, it normally pays back at some time in the future: i.e. the household’s standard of living is boosted now at the expense of it’s standard of living during the period in which it cuts down on consumption so as to repay the loan. So the “borrowing income from the future” idea applies.

But governments are totally different. Fiscal stimulus consists of the government / central bank machine borrowing $X, spending that sum into the economy and giving $X worth of bonds to those it has borrowed from. Note that the private sector’s net paper assets rise by $X. In fact given that base money and government debt are very similar in nature (they are both liabilities of a sort of the government / central bank machine) let’s really simplify matters, and assume they are identical.

On that assumption, fiscal stimulus consists simply of government printing bits of paper worth $X and spending them. Indeed, Keynes pointed out that it doesn’t make much difference whether stimulus is funded by borrowing or simply printing money.

Payback.

Now comes the dreaded payback – or does it? Well assuming the economy just continues to chug along at more or less full employment, there’s no point in paying back the debt (or having government grab back those bits of paper worth $X that it issued). As to interest on the debt, that’s less than 1% in the case of Japan – or more generally, as long as the REAL or INFLATION ADJUSTED rate of interest is zero or negative, then the above so called “borrowing” costs government nothing in real terms.

On the other hand if the private sector’s newly boosted stock of paper assets induces it to spend excessively and boost inflation, then certainly government needs to raise tax and grab some of those bits of paper. But there is no loss of “income” as Kono suggests. That is, assuming government grabs just the right amount of money back from the private sector, GDP will just continue to chug along at the full employment level.

And finally it could be claimed that the above argument ignores borrowing from the external sector – from foreigners – and that when government borrows from abroad, the effects are different to borrowing from domestic entities. Well fair enough, but in the case of Japan, about 95% of government debt is held by Japanese entities, not foreigners.