Wednesday, 14 February 2018

UK government gets more money via borrowing than from tax??

Well that’s the claim made by Ann Pettifor in an article entitled “Do tax revenues finance government spending? To quote, she says:

“…governments do not finance their investments, or even their activity, from tax revenues. Most of the government’s big expenditures are financed via the issuance of gilts – government bonds.”

Actually it’s the other way round, to put it mildly: i.e. governments get vastly more from tax than they do from borrowing. Reasons and calculations are as follows.

The first slight problem involved in quantifying things in this area is that the amount of borrowing governments do varies hugely depending on whether the economy is in recession, or the opposite, i.e. overheating. Thus to get a rough idea as to how much the UK government gets from borrowing and tax, I’ll take a relatively long period, that is, 1965 to the present: just over 50 years.

I’ve actually chosen that particular period because the debt/GDP ratio was 90% at the start and at the end of that period. (See first and second charts below) I.e. I’ve chosen that period because it keeps things simple. That might seem a cheat, but actually as you see by the end of this article, the actual amount of cheating is negligible. (Charts are taken from this site.)

Next, we need to compare real GDP in 1965 with GDP in 2017. According to this source, UK GDP expanded about two and a half times in real terms between 1965 and 2017.

Thus the increase in government borrowing between 1965 and 2017 was 0.9(2.5-1.0)=1.36x(1965GDP). Thus over that 52 year period, government got an amount of money from borrowing each year which on average equaled 1.36/52 times 1965GDP, which comes to 0.026 times 1965GDP: about 1/40th of GDP.

As to the proportion of GDP allocated to public spending, that’s hovered around 40% for a long time – see chart here.

So to summarise, 40% of GDP is allocated to public spending, and as for the money to fund that that comes from borrowing, that’s about 2.6% of GDP. 40/2.6= about 15. So about 1/15th of public spending is funded via borrowing, with the rest (over 90%) necessarily coming from tax.

Returning to the question as to how much of a cheat is involved in  choosing the period 1965 to 2017, the answer is: “not much”. That’s because one could go back another 50 years or so to around 1918 when the debt was also around 90% of GDP. (See above chart). That would make the total period a century: hardly unrepresentative.

Conclusion: the amount of money government gets from tax is roughly fifteen times what it gets from borrowing – unless I’ve dropped a clanger, which is not impossible...:-)

Tuesday, 13 February 2018

Random charts - 53.

Large pink text  on the charts below was added by me.

Monday, 12 February 2018

Warren Mosler’s bank reform ideas.


Warren Mosler produced some ideas for bank reform in a Huffington article in 2011. Title of the article is “Proposals for the banking system.”

While I agree with many of WM’s ideas (e.g. I support MMT which I think he founded), I’m not sure about his ideas on bank reform. The basic weakness in his proposals is that they amount to a subsidy of private banks. For example he argues that deposit insurance should be funded by taxpayers, not as at present, by commercial banks. (Incidentally WM spent much of his career working in the financial sector, so that may help explain his sympathetic attitude to that sector.)

Deposit  insurance.

Anyway, the first paragraph reads, “U.S. banks are public/private partnerships, established for the public purpose of providing loans based on credit analysis. Supporting this type of lending on an ongoing, stable basis demands a source of funding that is not market dependent. Hence most of the world’s banking systems include some form of government deposit insurance, as well as a central bank standing by to loan to its member banks.”

The second half of that para suggests that the purpose of deposit insurance is to ensure borrowers’ access to credit is not interrupted. In fact the basic purpose of deposit insurance is as per the description on the tin: it’s to insure deposits.

Indeed the failure of one or two small or medium size banks would not seriously interrupt borrowers’ access to credit: they can simply apply to other banks for loans. Obviously if the bank you normally deal with gets into trouble that may involve a finite interruption to your access to credit, but other banks are not going to turn you away when you apply for credit: no bank or any other business turns down extra sales.

In contrast, there is the possibility of the entire bank system collapsing, as seemed likely in the recent crisis. That clearly would interrupt borrowers’ access to credit. But that problem is not dealt with via deposit insurance in the normal sense of the word: it’s dealt with by central bank “lender of last resort” facilities (mentioned in WM’s above para).

Now the big problem with last resort loans is that while such loans are supposed to be at Walter Bagehot’s famous “penalty rate”, in the real world (no doubt party due to political pressure and bribes paid by banksters to politicians) the actual rate is a sweetheart rate, to put it mildly. The actual rate for the hundreds of billions worth of loans made by the Fed to banks in the recent crisis was near enough zero, which is a MONSTER subsidy for private banks. As it explains in the introductory economics text books, GDP is not maximised where an industry is subsidised, unless there is a good social case for a subsidy, as there is for example in the case of kid’s education.

WM returns to the question as to how to treat large banks in trouble later in his article. I’m dealing with his points in the order in which they appear in his article, so I’ll deal with his other points about large banks in trouble a few paragraphs hence.

100% reserves.

WM’s next para contains a slight mistake where it says “No bank can operate with 100% reserves.” Well that depends on your definition of the word “bank”. If you mean an institution which funds loans via deposits, then WM is correct. On the other hand there is such a thing as “100% reserve banking” (advocated by Milton Friedman and others). Under that system, deposits are all lodged at the central bank, while loans are funded via equity. (That’s “deposits” in the sense of: “money which is supposed to be totally safe”.)

A few sentences later, WM says “The hard lesson of banking history is that the liability side of banking is not the place for market discipline. Therefore, with banks funded without limit by government insured deposits and loans from the central bank, discipline is entirely on the asset side.”

Well the first problem with that idea is that WM does not provide any actual examples of “discipline” being imposed via the liability side and that being a disaster. Moreover, every bank regulator in the World far as I can see believes that some regulation of the liability side of banks’ balance sheets is justified: for example all recent attempts to re-jig bank regulations involve increasing banks’ capital ratios, or at least discuss the possibility of increasing those ratios.

Eight restrictions.

Next, WM lists eight restrictions which he thinks should be imposed on banks, some of which I like and some not. For example he opposes “off balance sheet” stuff and quite right: the purpose of a balance sheet is to give an accurate picture of a corporation’s assets and liabilities at some point in time. Thus off balance sheet items are plain simple deception, far as I can see. I gather off balance sheet stuff is virtually banned in Spain.

In contrast, restriction No.5 is that US banks should not be allowed to lend offshore. That’s a strange idea: banking is very much an international business.

But more important than the merits of individual restrictions suggested by WM is the point that all these restrictions amount to a move in the direction of full reserve banking. Reasons are thus.

Under full reserve (or 100% reserves as Milton Friedman called it), entities which accept deposits cannot take any risks at all with those deposits: an idea which is entirely logical. A deposit is supposed to be totally safe, but that is plain incompatible with lending on deposited money because loaned out money is NEVER entirely safe.

As to risky activities under full reserve, those are funded via equity. Now WM is saying that entities funded by deposits or mainly via deposits should not be allowed to engage in sundry risky activities. That in turn means that those activities will inevitably be funded by other entities which are funded via equity.

So why not go the whole hog and just ban entities funded via deposits from all risky activities? Well the standard answer to that given by supporters of the existing bank system is that that ban would reduce the amount of credit creation: i.e. reduce the amount of money created by commercial banks. But there’s a simple answer to that: have the state supply whatever amount of money is needed to lubricate the economy, which is a job the state (i.e. central bank plus government) already does to some extent. (Roughly 10% of the money supply is currently central bank rather than commercial bank issued money.)

Moreover, as I explain here, the right that commercial banks to fund loans via deposits actually amounts to letting them print or “create” money, and that’s a subsidy of commercial / private banks. (My article is entitled “Taxpayers subsidise private money creation.” (Journal of Economics Bibliography).

Proposals for the FDIC.

The next section of WM’s article is entitled as above, i.e. “Proposals for the FDIC” and it consists of three items.

Item No.2 is odd: WM argues that deposit insurance should not be charged to banks, i.e. he claims that taxpayers in general should fund deposit insurance. There again, I imagine every bank regulator in the world disagrees with that idea.

In short, having taxpayers fund deposit insurance is a blatant subsidy of the bank industry. The shipping industry carries the cost of insuring its ships. Banks should act likewise.

Proposals for the Federal Reserve.

Under the heading “Proposals for the Federal Reserve”, WM says:

“The Fed should lend unsecured to member banks, and in unlimited quantities at its target fed funds rate, by simply trading in the fed funds market. There is no reason to do otherwise. Currently the Fed will only loan to its banks on a fully collateralized basis. However, this is both redundant and disruptive. The Fed demanding collateral when it lends is redundant because all bank assets are already fully regulated by Federal regulators.”

Well the first problem there is the latter sentence: if bank assets really were “fully regulated”, no bank would every make silly loans I assume (thought that depends on exactly what “fully regulated” means).

As to the idea that the Fed should lend at the Fed funds rate, the problem there is that that rate is a sweetheart rate given that the corporations doing the borrowing are in trouble. (Banks themselves charge relatively high rates to any customer which appears to be in  trouble, and quite right.)

For an idea of what would constitute a realistic free market rate for a large loan to a large bank during the recent crisis we need look no further than the $5bn loan made by Warren Buffet to Goldman Sachs in September 2008. The loan involved an interest rate of 10%. In contrast, the Fed funds rate at that date was around 2% and sank to 0% shortly afterwards. To put it mildly, there’s a bit of a difference there!

WM also claims banks should not have to provide collateral in exchange for such loans. In contrast Warren Buffet (as you’d expect) did demand collateral. To summarise, we seem to have three options here. First the ultra-generous treatment of banks advocated by WM. Second, there’s the less generous treatment actually implemented by the Fed during the recent crisis. Third, there is what might be called the “brutal free market” treatment advocated by Walter Bagehot and Warren Buffet.

To repeat, the standard view in economics is that market forces should prevail, unless there are very clear reasons for thinking otherwise. And certainly in the case of large banks, there appears to be a good “reason for thinking otherwise”, namely that if large banks are given the “Buffet” treatment during a crisis, that may drive banks to insolvency.

However that insolvency only arises because of the basic nature of the existing bank system, sometimes called fractional reserve banking. That system allows commercial banks to use debt (deposits and bonds) to fund loans. And that is simply asking for trouble: it involves having liabilities that are fixed in value combined with assets (i.e. loans) which can fall dramatically in value when it turns out that silly loans have been made.

The attraction of using debt to fund a bank (or indeed any business) is that debt holders demand a slightly smaller return on their money than shareholders. But if the corollary is that taxpayers have to rescue large banks periodically, then in effect we have a system where banks are allowed to reap extra profits by taking extra risks, while the taxpayer picks up the pieces when the risks do not pay off. That is a nonsensical arrangement.

A better system is one where banks have to use equity to fund loans: that way it’s impossible for banks to go insolvent. I.e. if a bank makes silly loans and it turns out the value of those loans is only say 80% of book value, all that happens is that the value of the equity falls to about 80% of book value. That bank does not go bust.

At the same time, depositors who want their money to be totally safe are offered accounts where relevant monies really are totally safe: the money is simply lodged with the central bank or government. And that is the 100% reserve system advocated by Milton Friedman and others.

That system may well mean interest rates rise, but assuming they rise to a genuine free market level, then GDP ought to be higher at that higher rate than at the ultra-low rates that have prevailed for the last decade. And as for any deflationary effect of higher interest rates, that is easily dealt with by running a larger deficit.

And finally, low interest rates are not an unmixed blessing. Low rates mean more loans and hence more debt: and every socially concerned do-gooder has been complaining about the excessive amount of debt for the last five years or so. Plus low rates tend to encourage bubbles.

Saturday, 10 February 2018

Cancelling student debt is stimulatory. So what?

A very silly paper has just been published by the Levy Economics Institute entitled “The Macroeconomic Effects of Student Debt Cancellation”. One of the basic points made is that if student debt is  wiped out and government prints loads of money and hands it the universities or banks who lose out because they’re no longer getting money from debt repayment, the effect will be stimulatory: i.e. demand will be raised and jobs created (assuming the economy is not yet at capacity).

The flaw in that idea is that stimulus will occur WHATEVER group of people or organisations government gives money to. Makes no difference whether the money is given to Wall Street bankers, winos and drug addicts or old ladies with blue rinses – the effect will be the same: demand rises. That however is not an argument for handing money to old ladies with blue rinses, or any other group.

Note that that is not, repeat not to say that student debt should not be cancelled. The pros and cons of doing that are quite separate from the very silly and obvious point that handing out loads of money will raise demand.

Even if the above student debt cancellation is funded via a general rise in tax instead of being funded via money printing, there could easily be a rise in demand, but that is still irrelevant. If money is taken off people or organisations with a low propensity to spend and given to people and organisations with a higher propensity to spend, the effect is clearly a rise in demand. An example of that is taxing the rich and giving the money to the poor.

But the same point applies there as made a couple of paragraphs above. That is, while there may well be good reasons for raising taxes on the rich and giving more to the poor, the above “propensity” point is not one of those “good reasons”.

The multiplier.

The Levy paper attaches much importance to the so called “multiplier”: that’s the ratio of increased GDP resulting from some increase in spending compared to the size of the latter increased bout of spending.

To the na├»ve (and that includes the Levy authors) it might seem that the larger the rise in GDP for a given dollop of increased spending the better. The flaw in that argument is that stimulus or if you like “printing money and spending it” costs nothing in real terms. Thus if two dollars have to be created and spent for each dollar increase in GDP rather than one dollar of “print and spend” it really doesn’t matter because printing dollars (or creating them via keyboard strokes) costs nothing. As Milton Friedman put it, "It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances."

For more on the nonsense that is the multiplier, see my article on that subject: “The Multiplier is Irrelevant.”

Friday, 9 February 2018

Silly arguments against People’s QE.

Let’s start with an argument put by Nick Rowe, associate professor of economics at Carleton University, Ottawa. His claim that Peoples’ QE (PQE) doesn’t work is in this article at the “Canadian Worthwhile Initiative” blog entitled “Fiscal Offset of Silly QE”. The crucial part of his argument is this (his item No.2):

“Suppose the government of Canada normally buys 10 new Canadian bridges at $1 billion each. Then the Bank of Canada prints $3 billion, and instead of lending it to the government (buying government bonds) like it normally does, it buys 3 new Canadian bridges. The government will now buy 7 new bridges instead of 10. The net result on building of bridges, and everything else, is zero. The only difference is that the Bank of Canada is doing part of the government's shopping for it.”

Well now, it just ain’t true to say that the Bank of Canada (or any other central bank) “normally prints $3billion and buys government bonds”. The latter exercise is known as “QE” which is a stimulatory measure only implemented in a recession, i.e. when a large increase in demand is required. So Rowe is not doing the correct comparison, i.e. he is not comparing a “no stimulus” scenario to an “allegedly stimulatory scenario thanks to PQE”. That is, he is comparing two methods of effecting stimulus. His “discovery” that there is not much difference between the two is thus hardly surprising.

Second, (and perhaps I’m just repeating the latter point) Rowe assumes a total spend of $10bn in each case. Well the whole point of PQE is that relevant spending is additional to what would normally have taken place. I.e. come a recession, government says “Instead of building ten bridges, let’s build eleven, plus we’ll spend more on a range of other items, and/or we’ll cut taxes, and that will all  be funded with freshly printed money.”

Tony Yates.

A second anti-PQE argument appears in a Guardian article by Tony Yates (economics prof at Birmingham University). The article is entitled: “Corbyn's QE for the people jeopardises the Bank of England's independence.”

The first answer to his “jeopardises the BoE’s independence” is: “what if it does?”  The BoE was not independent before Gordon Brown gave it independence in 1997. Was the sky constantly falling in prior to 1997? Not that I remember.

I do actually favour central bank independence (or should I say “nominal independence”, because the exact extent of so called “central bank independence” is always debatable). But as intimated above, an independent central bank regime and a non-independent central bank regime do not seem to be Earth shatteringly different.

Second (as explained by Positive Money and co-authors) if keeping politicians away from the printing press is seen as desirable, an independent central bank is not the only way of doing that. An alternative is some sort of independent committee of economists (which may or may not be based at the central bank) who determine the AMOUNT of stimulus (e.g. PQE).

There is plenty more nonsense in Yates’s article and I don’t have time  for all of it. But here’s one more bit of nonsense.

Yates’s third paragraph reads “On the face of it, this (i.e. PQE) appears to get rid of the nasty business of having to finance worthy stuff by running deficits, and later, even worse, paying back the debt with taxation revenue.” Now wait a moment: having the central bank print money with the government then spending that money (or in the Corbyn version, using that money to buy bonds) IS A DEFICIT!!!!!!! I.e. Yates’s claim that PQE Corbyn style might dispose of the deficit is nonsense.

Tim Worstall.

A third anti-PQE argument appears in a Forbes article by Tim Worstall entitled “Peoples' QE Is Also Silly QE And Won't Work”.

Worstall cites an argument which Scott Sumner trots out ad nausiam. Sumner is an economist who teaches at Bentley University in Waltham, Massachusetts. Sumner’s argument is that fiscal stimulus (and PQE is at least to some extent a form of fiscal stimulus) is no use because a central bank will just negate that (with interest rate rises) if it thinks the effects are too inflationary.

Well the simple answer to that is that if the central bank DOESN’T think a dose of fiscal stimulus is excessive, then it won’t negate it! Doh!

I.e. Sumner’s argument is a bit like saying that a following wind won’t help an airliner cross the Atlantic because airliners normally aim for very precisely timed landing slots at their destination airport, so a following wind will just cause the pilot to power down the engines a bit.

For more on the nonsense that is monetary offset, see my article “Monetary offset is a joke”.

X Conclusion.

The moral is that economists often know lots about economics, but that is useless without a firm grasp of common sense.

Thursday, 8 February 2018

The Institute for New Economic Thinking.

I’ve long been puzzled as what the George Soros funded “Institute for New Economic Thinking” has produced which is “new”.  So I’m much amused by this description of an INET conference by Francis Coppola. She says:

“In the last two days we have had panel after panel of old white men discussing economic theories developed by old white men, many of them dead. Economic beliefs that I thought had been comprehensively debunked have reappeared, dressed up as "new thinking".

“It started to go wrong in the very first panel. Six white men and a token woman (this has been the general form of panels throughout the conference) discussing the economic stagnation of the last decade. Steven Fazzari and Adair Turner made some interesting comments, but the rest of the panel was terminally unoriginal. I lost interest quite quickly, turned to Twitter for light relief and got involved in a far more interesting discussion about whether or not banks earn seigniorage from lending, how we could measure this and whether it constitutes a hidden subsidy that should be removed. That discussion on Twitter sparked an even more interesting debate in the foyer of the Edinburgh International Conference Centre about banking reform. As a result, I now have some serious reading, thinking and writing to do, because I really do think banks need radical reform and it seems to have dropped off the agenda. But it didn't come from the INET conference. It came from Twitter.”

As regards “old white men”, doesn't that constitute ageism and sexism? Whether an idea emanates from someone who is old, young, male, female or “dead” is irrelevant. The only important question is whether the the idea is a good one or not.

On the positive side, I’m delighted to see Francis hone in on the question as to “whether or not banks earn seigniorage from lending, how we could measure this and whether it constitutes a hidden subsidy..”. I hope she does some articles on that in the near future.

That’s actually a CRUCIALLY IMPORTANT question. Only seriously clever people like Francis (and me of course – ha ha) have cottoned onto that. In contrast, the duffers charged with regulating banks scarcely know what a bank is.

Sunday, 4 February 2018

Artificial interest rate adjustments do not make sense.

(Stop press: this article is also at the Seeking Alpha site.)


There is a glaring flaw in using artificial interest rate adjustments to regulate demand: the GDP maximising rate of interest is presumably the free market rate, thus in order to maximise GDP, artificial interference with interest rates should be minimised. That in turn means demand is best regulated by fiscal means.

As to “fiscal” in the sense “government borrows money and spends it”, that is defective because the fact of borrowing has a deflationary effect: the opposite of the intended stimulatory effect. Thus the best form of stimulus is one of the forms suggested by Keynes in the early 1930s, namely to have the state print money and spend it, and/or cut taxes.

Under the latter system, treasuries or politicians could be given access to the printing press, i.e. be given control of how large a dose of stimulus the economy gets each year. Alternatively it is not difficult to delegate that “amount of stimulus” decision to a committee of economists, while politicians retain the right to take strictly political decisions, like what proportion of GDP is allocated to public spending.



There is a glaring flaw in using artificial interest rate adjustments to regulate demand. The flaw stems from a principle widely accepted in economics, namely that GDP is maximised where prices are determined by market forces, unless there is an obvious reason for thinking otherwise, i.e. unless “market failure” can be demonstrated, to use the jargon. So on the basis of the latter principle, interest rates ought to be left to find their own level.

It might seem that it can argued that the mere fact of a recession persisting is evidence that interest rates have not fallen far or fast enough and hence that artificial interest rate cuts are justified. However that idea is only valid if it can be shown that there is some sort of obstruction in the way of interest rate reductions, i.e. market failure. And it is far from clear what that obstruction might be. That is, the market for loans and savings would seem on the face of it to be very much of a free market: savers shop around for the best deal as do borrowers.

Artificial interest rate adjustments might be justified if they work much more quickly and/or predictably that fiscal stimulus. But there is not much evidence of that: see for example Dyson (2010) p.10.

Of course it might seem that fiscal adjustments work slowly because of the behaviour of Congress in the US where politicians sometimes spend months haggling over changes to tax or public spending. On the other hand in the UK tax adjustments are sometimes announced by the UK finance minister on budget day and come into effect the very next day. Certainly there is no reason in principle why, given a need for stimulus, a finance minister cannot have some freedom to make instant adjustments to tax or public spending, while politicians retain the right to change those adjustments at their leisure, if  they so wish.

Also in the US, many arguments in Congress about changes to tax and public spending are at root arguments about whether to adjust the deficit and hence the national debt. As is shown below, it is perfectly feasible to have a system where deficit decisions are taken by technocrats, while strictly political decisions remain with politicians. So if the latter idea was implemented, much of the argument that clogs up Congress at the moment would vanish.

Abolishing interest rate adjustments was advocated by Friedman (1948): at least he advocated an end to public borrowing which effectively means an end to interest rate adjustments. That idea was also advocated by Mosler (2011). Or to be more accurate, under Mosler’s “item 3” he advocates a permanent zero interest rate (i.e. government pays no interest on its liabilities). That, to repeat, means an end to interest rate adjustments. See also Mosler (2004) which also advocates a permanent zero rate.

The Pigou effect.

In contrast to interest rates and the above point that there are no obvious obstructions to market forces adjusting interest rates, there is another free market cure for recessions which is quite clearly obstructed. That’s the so called “Pigou effect”: that’s the fact that in a perfectly functioning or almost perfectly functioning free market and given a recession, prices and wages would fall (in terms of dollars, Euros, etc). That in turn would increase the real value of money (base money to be exact), which in turn would encourage spending.

In addition, the real value of government debt would rise, which would also increase the real value of the private sector’s paper wealth, all else equal. However, as explained for example by Wolf (2014, para starting “The purchases of equities…”) government debt and base money are virtually the same thing. So to summarise, in a perfect market and given a recession, the real value of the private sector’s stock of money and near money rises.

Note incidentally that base money is a net asset as far as the private sector is concerned, whereas commercial bank issued money is not: reason is that for every dollar of money created by commercial banks, there is a dollar of debt owed by a private sector entity. Hence the emphasis on base money above.

However, there is an obvious obstruction to the Pigou effect in the real world, namely Keynes’s “wages are sticky downwards” phenomenon. That is, any attempt to cut money wages in the real world is opposed both trade unions and non–unionised workers. However that obstruction should not be a big problem since it is easy to increase the private sector’s stock of base money by having the state (i.e. government and central bank) create new money and spend it and/ or cut taxes. (The word “state” is used here to refer to government and central bank considered as one unit).

Indeed Keynes (1933, 5th para) suggested doing just that. Incidentally, note that the fact of the state printing new money and spending it and/or cutting taxes has a fiscal as well as monetary effect. The fiscal effect arises partly from the fact of the number of public sector employees being increased more or less immediately when extra teachers etc are employed (assuming some of the new money funds extra pubic spending). As to the monetary effect: the latter “print and spend” exercise increases the private sector’s stock of base money which, as noted above, tends to encourage spending. And there is also public spending in the form of direct transfers of money to households (unemployment benefit, state pensions, etc). Incidentally, the above idea of Keynes’s, namely having the state print money and spend it and/or cut taxes amounts to the same as what is often called “QE for the people” nowadays.

It could be argued that an accurate imitation of the Pigou effect would consist of simple cash transfers to households: a helicopter drop. However, a significant proportion of public spending is “helicopter drop” in nature anyway: unemployment benefits, state pensions etc. Plus a cut in taxation amounts to a helicopter drop. Thus it is debatable as to whether setting up an entirely new system, i.e. a helicopter drop in the traditional sense, complete with thousands of bureaucrats is needed.


Returning to Keynes, in the passage mentioned just above, as well as suggesting that the state print and spend money, he also suggested having the state borrow and spend, which raises the question as to which of those two is better.

Well certainly “borrow and spend” is defective in that the object of the exercise is stimulus, but the effect of borrowing is the opposite: that is the effect is deflationary. Indeed, in the real world, central banks have to artificially counter that defective aspect of borrow and spend: that is, the effect of borrow and spend is probably to raise interest rates, thus central banks normally print money and buy back enough government debt to ensure that interest rates do not rise. And normally, given a recession, they go even further and do enough “print and buy back” to bring about a fall in interest rates.

In short, borrow and spend is defective. About the only excuse for it is that it might seem to be easier to reverse than print and spend: that is, so the argument goes, if the central bank has a stock of government debt, it can always impose a deflationary effect by selling that debt at below the going rate, which in turn withdraws base money from the private sector.

However, in an economy where there is no government debt, there would be nothing to stop a central bank wading into the market and offering to borrow at above the going rate. That ploy might not be allowed in various countries at the moment, but there is no good reason for it not to be allowed, where a quick “reversal” was needed.

Another relevant point here is that reversal in the form of raising taxes or cutting public spending is not always needed in order to effect reversal: reason is that inflation constantly eats away at the real value of the stock of base money and government debt, which amounts to reversal of a sort.

What constitutes no government interference with interest rates?

The claim that government should not interfere with interest rates raises a difficult question, as follows.  Given that governments are extremely large borrowers they clearly have a significant effect on interest rates. That raises the question as to what amount of government borrowing constitutes “non-interference” – or put another way, it raises the question as to what the optimum amount of public borrowing is.

A popular answer to that question is the so called “Golden rule”, i.e. that government borrowing should be limited to funding infrastructure investment and similar. But there is a glaring flaw in that idea, namely that education is a huge investment. But no one ever suggests the entire country’s education budget should be funded via borrowing. Thus the “investment justifies borrowing” argument looks questionable.

Indeed, while numerous economists and politicians fall for the “Golden  rule / investment justifies borrowing” argument, most small businesses and households do not. For example if a taxi driver wants a new taxi and happens to have more than enough cash available to buy it, the taxi driver is unlikely to borrow money and pay interest to a bank so as to fund the purchase of the new taxi given that there is no need for the taxi driver to pay interest to anyone.

In short, what justifies borrowing is shortage of cash, not the fact of making an investment. But the state is never short of cash in the sense that it can grab any amount of cash off taxpayers, plus it can print money, though clearly inflation places a limit to the amount of printing it can do.

Indeed, much if not most of the debt incurred via credit cards is for current consumption rather than the purchase of capital investment items. Whether it’s really in anyone’s interest to incur that sort of debt is of course debatable, but there is much to be said for a system where each consumer decides what is in their own interest, and clearly many consumers think the latter “current consumption debt” is in their interests.

Thus the conclusion would seem to be that there should be no government borrowing at all. Indeed, that is exactly the conclusion reached by Friedman (1948) – see second paragraph under the heading “Operation of the proposal”. Mosler (2011) argued likewise, though Friedman did argue that government borrowing would be justified in emergencies, like war time. And that’s very much in line with the conclusion reached a few paragraphs above, that is, that basically the state should borrow nothing, though if a particularly quick bit of reversal is needed, there is a case for the central bank wading into the market and borrowing at above the going rate.

Should politicians have access to the printing press?

To summarise so far, we have reached the conclusion that stimulus is best implemented by having the state print and spend more money and/or cut taxes rather than by interest rate adjustments. But the people who decide matters fiscal are normally politicians and treasuries. And that raises a problem namely that many of us have reservations about giving politicians access to the printing press.

The solution to that problem is not difficult, at least in principle, and is as follows.

The decision as to how much stimulus to impart, i.e. how large the deficit should be, can perfectly well be given to technocrats, i.e. a committee of economists (which could be based at the central bank, or not: it really doesn’t matter). At the same time, strictly political decisions, like what proportion of GDP is allocated to public spending, and how much of that goes to education, defence and so on, can easily be left with politicians. That split of responsibilities as between central banks and politicians is obviously different to the present split, but there is nothing difficult in principle about that new split.

The way the new system would work would be approximately as follows. The committee of economists would tell politicians what the deficit for the next year or so ought to be. Politicians would then decide what combination of tax and public spending put that deficit into effect. For example if the committee said that the deficit should be 5% of GDP over the next year, politicians could meet that objective by having tax equal to 20% of GDP and public spending equal to 25%. Or they could go for 30% and 35%.

Indeed Bernanke (2016) said such a system would be workable. His exact words were as follows.

“A possible arrangement, set up in advance, might work as follows: Ask Congress to create, by statute, a special Treasury account at the Fed, and to give the Fed . . . the sole authority to “fill” the account, perhaps up to some pre-specified limit. At almost all times, the account would be empty; the Fed would use its authority to add funds to the account only when the [Fed] assessed that a [helicopter drop] of specified size was needed to achieve the Fed’s employment and inflation goals.

Should the Fed act, under this proposal, the next step would be for the Congress and the Administration—through the usual, but possibly expedited, legislative process—to determine how to spend the funds (for example, on a tax rebate or on public works).”

That sort of system was also advocated by Dyson (2010) p.10-12. Note that Dyson and co-authors devoted much of their work to advocating full reserve banking. That’s not actually relevant for the purposes of the present discussion in that full reserve is perfectly compatible with the new split of responsibilities advocated here, as is the existing bank system.

Disposing of government debt is easy in principle.

Having advocated a “zero government debt” regime above, some readers may claim that is not too realistic and on the grounds that disposing of government debt is difficult. Certainly there are plenty of self-styled “economics professors” out there who have no idea as to how to drastically reduce the debt. Actually it is very easily done, at least in principle. That is there are no strictly economic or technical difficulties here, though possibly there are political difficulties.

The debt can be made to vanish in a very short space of time by simply printing money and buying it back (i.e. continuing with QE). As to any inflationary effect of that, that is easily dealt with by raising taxes and “unprinting” the money collected. Job done.

The only real difficulty is political: the population clearly objects to raised taxes. Though note that that rise in taxation would have no effect at all on living standards. That is, the sole purpose of the tax is to prevent excess demand, so there is no reason for real wages to fall.

Print money and buy non-government debt assets?

One way of imparting stimulus which could be argued to be an imitation of the Pigou effect is to have the central bank print money and buy assets other than government debt (i.e. private sector assets like corporate bonds): a ploy favoured by Scott Sumner.

The policy advocated in this article, namely printing money and boosting public spending plus cutting taxes is actually nearer to the Pigou effect. Printing money and buying up private sector assets will boost the market price of those assets relative to the price of consumer goods, whereas the policy advocated in this article simply leaves the choice between buying private sector assets versus buying consumer goods to households, employers and government spending departments. Thus the latter policy is presumably the better of the two.



Bernanke, B. (2016). “Here's How Ben Bernanke's "Helicopter Money" Plan Might Work”. Fortune Magazine.

Dyson, B., Greenham, T., Ryan-Collins, J. and Werner R.A. (2010).
“Towards a twenty-first century banking and monetary system.”

Friedman, Milton. (1948) “A Monetary and Fiscal Framework for Economic Stability”.  American Economic Review.

Keynes, J.M. (1933) “An open letter to President Roosevelt”.

Mosler, W. and Forstater, M. (2004)  “The Natural Rate of Interest is Zero”.

Mosler, Warren. (2011)    “Proposals for the banking system”. Huffington.

Wolf, M. (2014) “Warnings from Japan for the Eurozone”. Financial Times.