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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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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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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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.
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 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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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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