Friday, 25 November 2016

Steve Keen’s odd ideas on debt.

Introduction.   This article replaces an earlier article I did on Keen’s ideas. That article was defective in various ways. Hopefully the material below rectifies that.

Campaigning against debt is easy because the word debt has negative emotional overtones, and for 90% of the population, emotion is everything while logic and facts are irrelevant. Indeed that problem is even bigger in Germany because the word debt in German also means “guilt”. Thus Germans have an even bigger horror of debt than English speakers.

I’ll start by examining Keen’s “Debtwatch Manifesto” published in 2012 and in particular the section entitled “A Modern Jubilee”. Then Keen’s last ideas on debt are considered.

That “Modern Debt Jubilee” section starts thus:

“Michael Hudson’s simple phrase that “Debts that can’t be repaid, won’t be repaid” sums up the economic dilemma of our times. This does not involve sanctioning “moral hazard”, since the real moral hazard was in the behaviour of the finance sector in creating this debt in the first place. Most of this debt should never have been created, since all it did was fund disguised Ponzi Schemes that inflated asset values without adding to society’s productivity.”

Now the claim that “most of this debt should never have been created” is questionable to put it mildly. In the case of mortgages, which form a large proportion of total lending, only about 1% of mortgages in the UK go seriously wrong. So you could perhaps argue that that 1% “should never have been created”. But that’s just being wise after the event. In other words the idea that there is a lending system which can predict with total accuracy which borrowers will come good is unrealistic. The 1% failure rate in the case of mortgages isn't bad at all.

As to small and medium size enterprises, the failure rate there is TWICE that of mortgages. But Keen wants to see more lending going into that allegedly “productive” sector. This is turning out to be a rather muddled argument!

As for Keen’s idea about inflating “asset values without adding to society’s productivity”, I demolished that point here.

Keen’s next two paragraphs in his Debtwatch Manifest are thus.

“The only real question we face is not whether we should or should not repay this debt, but how are we going to go about not repaying it?"

The standard means of reducing debt—personal and corporate bankruptcies for some, slow repayment of debt in depressed economic conditions for others—could have us mired in deleveraging for one and a half decades, given its current rate (see Figure 12).

Now what’s that about “not repaying” debt? As I pointed out above, around 99% of mortgagors are able to repay their debts. Keen seems to have lost contact with reality there.

The second of the latter two paragraphs argues that assuming a significant proportion of debts are going to be repaid, that will have a deflationary effect, thus we face recession for “one and a half decades”, i.e. fifteen years!

Well it’s true that borrowing is stimulatory (and congratulations to Keen for publicising that point). Plus it’s true that the opposite, i.e. repaying loans is “anti-stimulatory” to coin a phrase, as Keen suggests just above. But if there is a lack of demand caused to a rise in debt repayments, that is very easily dealt with by standard stimulatory measures. So what’s the problem? Darned if I know!

Moreover, it’s a bit odd to argue that because variations in lending led to variations in aggregate demand and thus that we need to constrain lending because exactly the same applies various other constituents of demand, for example exports and investment spending. Do we curtail those because purchasers by foreigners of British goods are not absolutely constant, year after year, and investment spending is not constant?

Details of the “Modern Debt Jubilee”.

Keen starts the explanation of the DETAILS of his jubilee idea as follows.

“A Modern Jubilee would create fiat money in the same way as with Quantitative Easing, but would direct that money to the bank accounts of the public with the requirement that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injection would have their debt reduced but not eliminated, while at the other extreme, recipients with no debt would receive a cash injection into their deposit accounts.”

But also, so as to make sure there is no discrimination against non-debtors, they get the same amount of money.

Now there is a problem of astronomic proportions there, which is that the average mortgage in the UK is currently around £100,000. So (doing some VERY CRUDE mental arithmatic) assuming half the households in the country have a mortgage and assuming there are two people per household, that means we print and dish out £100,000 to half the population!

Well inflation would go thru the roof! And even if that was spread over a ten year period, that’s still £10,000 to those lucky recipients of government largesse. Inflation still goes thru the roof!

Later on Keen says “Clearly there are numerous complex issues to be considered in such a policy…” Well you can say that again. But there’s an onus on those making novel proposals like Keen’s to solve those “complex issues” isn't there? Or at the very least they should put enough work in to solving those problems that readers are persuaded the idea is worth considering.

Unfortunately Keen does not so much as BEGIN to solve the above Mugabe style inflation problem.

Money going round in circles.

Another problem with the above massive disbursement of cash, is this: who pays? To illustrate with a simple example, assume half the country are debtors and half are saver / creditors and the amount borrowed or loaned by each person is the same, i.e. £X. Under the Keen scheme £X is given to everyone. But assuming demand is to remain constant, an extra £X in tax would have to be collected from everyone (assuming, to keep things simple, that everyone pays the same amount of tax). Net effect: vast amounts of money going round in circles!

Of course the real world is more complicated than in the latter example. But taking into account the complexities of the real world doesn’t alter the fact that the Keen scheme involves vast amounts of money going round in circles.

Jubilee Shares.

Next, there’s a section with the above heading. Keen considers ways of short circuiting the obvious feed-back mechanism that exists with asset bubbles. That mechanism is: “asset prices rise, which makes them a better form of collateral, so people borrow more to purchase more of the asset, etc, etc.” Clearly dealing with feed-back mechanisms is desirable, but I won’t consider Keen’s ideas there.

Full reserve banking.

In the next section, Keen says that full reserve banking might help promote stability, but he is skeptical of it. He says “I don’t see the banking system’s capacity to create money as the causa causans of crises, so much as the uses to which that money is put. As Schumpeter explains so well, the endogenous creation of money by the banking sector gives entrepreneurs spending power that exceeds that coming out of “the circular flow” alone. When the money created is put to Schumpeterian uses, it is an integral part of the inherent dynamic of capitalism. The problem comes when that money is created instead for Ponzi Finance reasons, and inflates asset prices rather than enabling the creation of new assets.”

Well as regards Schumpter’s point that full reserve banking gives “entrepreneurs spending power” etc, of course it does. But that is only a merit if there is no way of providing the economy with “spending power”, and of course THERE IS an alternative, as indeed Keen himself points out, namely having the state print and spend money into the economy as and when required.

Keen’s next criticism of full reserve is this. “My caution with respect to full reserve banking systems is that this endogenous expansion of spending power would become the responsibility of the State alone. Here, though I am a proponent of government counter-cyclical spending, I am sceptical about the capacity of government agencies to get the creation of money right at all times. This is not to say that the private sector has done a better job—far from it! But the private banking system will always be there—even if changed in nature—ready to exploit any slipups in government behaviour that can be used to justify a return to the system we are currently in.”

Well the big problem with that argument is that given a less than perfect response from the state to a recession (and doubtless the state will never be PERFECT in that regard) the plain fact is that private banks JUST DON’T rectify the situation: in fact they exacerbate the problems. That is, commercial / private banks act in a PRO-CYCLICAL manner, not an anti-cyclical manner. E.g. come a recession, private banks far from lending MORE, which is what we would like them to do, actually do the OPPOSITE, i.e. lend less and even CALL IN loans.

Keen’s latest ideas.

His latest ideas on debt (far as I know) are in a Forbes article published on the 9th November 2016 and entitled “To Make America Great Again…”.

This article is along much the same lines as the above “Debtwatch” article: i.e. it claims that debt is THE fundamental economic problem. The second paragraph reads as follows.

“The private debt mound sitting on top of American households and businesses is the reason demand is depressed right now. With that debt mountain weighing them down, firms are reluctant to borrow and invest, while households are reluctant to use credit to consume.”

Well first, it’s very debatable as to whether “demand is depressed right now”: at least unemployment in America is back to its pre-crisis level. Moreover, consensus of opinion is that the Fed will probably raise interest rates next month. On that basis the Fed thinks the economy is near capacity.

Second, the argument that there’s a problem because households and firms won’t borrow more because they’ve already borrowed as much as they think they ought to, is an odd argument. But the Keen solution is that we have vast amounts of money going round in circles for years on end, or more likely decades on end, so that firms and households can then borrow more and get back to where they started! That’s my definition of a farce.

Of course the OBJECTIVE of Keen’s “loads of money going round in circles” scheme is to raise demand, and assuming more demand is required, that objective is clearly justified. But where demand needs to be raised, what on Earth is wrong with standard stimulatory measures: interest rate cuts, fiscal stimulus, helicopter drops or whatever you think is best? 

And finally, please note that in criticising Keen's claim that we need to urgently do something about debt, I am NOT suggesting we don't need to do more about inequalities. In fact those two (debts and inequalities) are to a significant extent SEPARATE problems. That is, not all debtors are poor: there are multi millionaires who have borrowed millions to buy large houses or fund their businesses. And there are relatively poor pensioners who have saved up a few thousand: they are creditors.

Thursday, 24 November 2016

The Vickers commission’s big mistake.

The UK’s main official enquiry into the 2007/8 bank crisis was the Independent Commission on Banking: sometimes called the “Vickers commission” after its chairman, Sir John Vickers.

The commission opposed full reserve banking on the grounds that it would result in less borrowing and lending. See sections 3.21 and 3.22. (Full reserve is a system under which only the central bank or government prints money: private banks are not allowed to.)

Unfortunately, the mere fact that some change results in less of one type of economic activity (e.g. borrowing), and more of another is not a reason to criticise the change: the CRUCIAL question is this. What is the OPTIMUM assortment of the latter forms of activity. As I’ve pointed out a dozen times before, the concept “optimum” seems to be too difficult for many economists.

As to how alternative forms of economic activity arise when there is less borrowing and lending, that’s easy: any deflationary effect stemming from less borrowing can be made good by standard forms of stimulus. And there is no need to increase national debt in order to do that: as Keynes pointed out, stimulus can be funded by new base money rather than extra debt. In short, there is no need for increased government debt.

As to what the optimum or GDP maximising assortment of different forms of economic activity is, well in the absence of good evidence of market failure, it’s reasonable to assume it’s the assortment that prevails in a free market.

Now in a free market, money lenders (aka banks) do not have any sort of artificial advantage or privilege over other corporations. But under the existing bank system, commercial banks DO HAVE such privileges.

The right to create or print money is a privilege which is quite clearly enjoyed by banks, but not other types of corporation. For example see this article by Richard Werner entitled “How do banks create money…” on the legal underpinning for private banks’ right to print money.

But even in the absence of the latter legislation, the idea that traditional banking is a legitimate free market activity does not stand inspection, and for the following reasons.

In a totally free market, there might seem to be no good reason to stop anyone setting up a “bank” and doing what banks normally do: i.e. accept deposits and make loans. But actually there is a fundamental problem there:  if depositors’ money is loaned on, that money cannot possibly be 100% safe: indeed the litany of bank failures thru history is proof that such money is far from entirely safe.

But money is something which by definition is entirely safe: for example a £10 note is as safe it is possible to get (apart from the fact that it loses a small amount of value every year due to inflation). In contrast, a liability of a corporation which is less than totally safe is not money: it’s more in the nature of a share or bond issued by the corporation.

Or to take another example, a gold coin (which has been a popular form of money throughout history) is near totally safe: it’s highly unlikely that gold will lose most of its value.

In short, where a bank lends on depositors’ money at the same time as claiming that money is safe, the bank is guilty of mis-representation, fraud, or something of that sort. And a free market is normally understood to be a system in which fraud is not allowed.

Or as Adam Levitin put it in the opening sentence of the abstract of his paper “Safe Banking”, “Banking is based on two fundamentally irreconcilable functions: safekeeping of deposits and relending of deposits.”

Of course depositors’ money can be made totally safe if it backed by some sort of FDIC type government run insurance system. However that 100% safety is only obtained by the right that the state has to rob taxpayers of near infinitely large amounts of money, in the event of several large bank failures, and that is quite clearly a subsidy. And subsidies do not make economic sense.

And there is a second way in which private banks are subsidised. It’s the above mentioned fact that they have the right to print money.

That is, if you’re a money lender and you can obtain money to lend out simply by printing it, well that’s better than having to obtain the money you want by normal methods: earning it or borrowing it at the prevailing rate of interest!

To repeat, subsidies do not make economic sense. They result in GDP not being maximised.

That is all very basic economics. Sir John Vickers, former chief economist at the Bank of England, and his Vickers commission colleagues ought to have thought of that subsidy point and taken it into account in the commission’s arguments. Had they done so, they would have come to the conclusion that the entire existing bank system is rotten and has been for centuries. So the existing bank system and the Vickers report are fundamentally flawed. The GDP maximising, and far safer bank system is a system under which private money printing is banned: that’s full reserve banking.

Vickers’s flawed “intermediation” argument.

Finally, there is one argument put in the above mentioned sections of the Vickers report which is flawed. It appears at the start of section 3.21 and reads, “If ring-fenced banks were not able to perform their core economic function of intermediating between deposits and loans, the economic costs would be very high.21”

The “21” is a reference to a footnote which reads “A number of prominent economic analyses consider the reasons for the existence of financial intermediaries – i.e. why lending is not simply done directly through markets and why it is useful to have institutions which both take deposits and make loans. The existence of such financial intermediaries is frequently thought to be associated with an asymmetry of information between lenders and depositors. In particular, the delegated monitoring theory says that institutions which both take deposits and make loans economise on the costs of monitoring borrowers (Diamond, D.W., 1984, Financial intermediation and delegated monitoring, Review of Economic Studies, 51(3), pp.393-414).”

Well the flaw in that argument is that full reserve banking (or “limited purpose banking” as Vickers calls it in the relevant section) does not do away with “intermediation”. All it does is to dispose of the above mentioned fraud, and it does that simply by ensuring that when saver / lenders want their money loaned on, the bank where they place their savings cannot make the above mentioned fraudulent promise to return £X to the saver / lender for every £X deposited. That is, the saver / lender has to purchase something like a bond or share in the relevant bank, and, if the relevant loans go wrong, the saver / lender carries the loss.

Wednesday, 23 November 2016

Ed Balls’s ideas on central banks are no match for Positive Money / Richard Werner ideas.

Ed Balls is a former economic secretary to the Treasury in the UK. He recently co-authored a paper entitled “Central bank independence revisited: after the financial crisis, what should a model central bank look like?” The other co-authors were two Harvard economists.

I like Ed Balls: he has a sense of humour. But this paper is just a dreary and very long regurgitation of the conventional wisdom or something very near the conventional wisdom. I’ve tried to make the review of the paper below interesting, but I’ve struggled.

According to the 1,400 word summary, the first main idea in the paper is that what it calls “operational independence” (the ability of a CB to choose which instruments to use on control inflation etc) “has been associated with significant improvements in price stability”. In contrast what they call “political independence” - the freedom of CBs to choose their “goals and personnel” - is NOT CORRELATED with price stability.

Well now that’s a big of dog’s dinner, isn't it? For example the main new “instrument” used by CBs since the 2007/8 crisis has been QE, but the Bank of England chose not to exercise any “operational independence” it had in that it sought and got permission from the then UK finance minister (Alistair Darling) before embarking on QE.

As for the other main instrument used by CBs to control inflation, namely interest rate adjustments, most CBs have been using that instrument for decades. So what does “operational independence” amount to? Nothing much!

Second, and as regards “political independence” and “goals and personnel”, the basic “goal” of CBs has for decades been to keep inflation near the 2% target. Or put another way, the aim has been to maximise employment (by cutting interest rates) in as far as that is compatible with acceptable inflation, which of course is one of the main aims of ANY government, whether it has an independent or totally non-independent CB. So there again, what does “political independence” amount to? Not much, far as I can see.

The authors then say they want to “locate new powers inside the central bank, while minimizing potential conflicts with monetary policy and limiting political threats to the legitimacy of central banks’ operational independence.” And the first element of that policy consists of the now very conventional idea that existing arrangements for monetary and fiscal policy are OK when interest rates are well above zero, but at the zero bound, monetary / fiscal coordination is needed.

Also that conflicts with the policy advocated by supporters of Modern Monetary Theory (MMT) which in turn is much the same policy advocated in the submission to the UK’s Vickers commission by Positive Money, Prof Richard Werner and the New Economics Foundation (PM/RW/NEF). And that consists of implementing monetary / fiscal coordination ALL THE TIME: i.e. the idea is that demand should be controlled all the time simply by adjusting the amount of money that the state prints and spends.

So who is right there?

Well I suggest it’s MMTers and PM/RW/NEF. Reason is (as I explained here) that in order to be able to cut interest rates, the state first has to artificially boost them. But that amounts to a clear and unwarranted interference with market forces: that is, the normal assumption in economics is that prices should be at free market prices, unless there are obvious social reasons for thinking otherwise. To that extent, interest rate adjustments are a nonsense (which is not to say they should NEVER be used, e.g. where there is a need for a DRASTIC dose of deflation or the opposite, i.e. stimulus).

In addition, PM/RW/NEF provide plenty of other evidence and reasons for thinking that interest rate adjustments are a defective tool.

Ergo the best role for the state is (as suggested by PM/RW/NEF) to simply print and spend money as required (and/or cut taxes). As to how that job is split between central banks and politicians / treasuries, there again, the Pos Money / Werner solution has all the beauty and simplicity and E=MC2.

That is, the basic principle should be to have TECHNICAL decisions taken by technicians and POLITICAL decisions taken by politicians. Thus PM/RW/NEF advocate that the decision as to how large the TOTAL SIZE of a stimulus package (i.e. the deficit) should be should be up to technicians (e.g. some committee of economists at the central bank). Though as PM/RW/NEF point out, whether that committee is a CB committee is base somewhere else is unimportant: it could be based at the treasury, as long as it is reasonably independent of political influence.

In contrast, the decision as to what proportion of GDP is allocated to public spending and how that is split as between education, infrastructure, defence, etc is clearly a POLITICAL decision, which should thus be taken by politicians.

In short, the fiscal/monetary split which economists have argued about for about a century is one big red herring, to put it politely. Or to put it less politely, it’s a system under which two separate bodies, central bank and “treasury / politicians” each have a say on the total amount of a stimulus package and that makes as much sense as car with two steering wheels controlled by a man and woman in the middle of a marital row.  A much more important split is between technical and political decisions, a distinction which the existing system makes a compete hash of.

And finally it should be noted that while PM/RW/NEF advocate full reserve banking in their paper, the above new split of responsibilities as between treasuries and CBs is perfectly compatible with the existing or “fractional reserve” bank system as it is sometimes called.

Tuesday, 22 November 2016

Random charts VI

I like charts. A picture is worth a thousand words, and charts are a sort of picture. But of course charts can mislead, just as the written word can mislead. So: view at your peril.

Monday, 21 November 2016

The NIESR trotts out some old canards on government borrowing.

The National Institute of Economic and Social Research has just published an article by Prof Roger Farmer entitled “Three Facts About Debts and Deficits”. Farmer goes off the rails with his third fact.

The first “fact” or claim comes in a section entitled “UK Public Sector Debt is Not Large”. I agree with that. Farmer shows this chart to back his claim.

As the chart illustrates, UK public debt is currently small compared to what it was in the early 1800s and the first half of the 1900s.

Farmer’s second “fact” is set out in a section entitled “Governments Do Not Repay Debt: They Grow Out of It.” That’s also OK by me, except that even if there was no growth, governments STILL wouldn’t basically repay debt (although there might the odd year in which there is a net repayment of debt).

The reason has to do with inflation. That is, assuming the debt/GDP ratio remains constant (which it more or less does in the VERY LONG term) that debt will be eroded by inflation. Thus on the above “long term” assumption, the debt will need to be constantly topped up: that is, government will need to constantly incur more debt (in nominal terms but not real terms).

The third fact.

However, it’s in relation to the third fact that Farmer goes much further off the rails. The relevant section is entitled “Government Debt Should Not Be Zero. Ever!”

The reason Farmer gives is that government needs to borrow in order to invest.

That is actually a fallacy which the average taxi driver can see thru. That is if the average taxi driver wants a new taxi and has more than enough cash to buy it, he won’t borrow and quite right: he’ll pay cash for the taxi. In short, borrowing makes sense if you’re short of cash, but not otherwise. Indeed, a significant proportion of industrial investment is paid for via retained earnings, i.e. cash, rather than via borrowing.

But governments have a near inexhaustible source of cash, namely the long suffering taxpayer. Plus to some extent they can print money to fund their expenditure. Ergo governments are not short of cash, ergo the arguments for government borrowing are starting to look decidedly weak. Indeed, Milton Friedman and Warren Mosler argued that there should be no government borrowing at all: i.e. that all government spending, including investment spending should be funded by “tax and print”.

Plus the Swiss academic Kersten Kellerman went into this question in more detail than Friedman and Mosler in a paper in the European Journal of Politcal Economy and came to the same conclusion, namely that government borrowing is not the best option.

Sharing the burden across generations.

Farmer also falls for the popular myth that government borrowing enables the cost of an investment to be shared across the generations who benefit from the investment. As he puts it, “The benefits of public capital expenditures are enjoyed not only by the current generation of people, who must sacrifice consumption to pay for them, but also by future generations who will travel on the rail networks, drive on the roads, fly to and from the airports and drive over the bridges that were built by previous generations.”

The first flaw in that argument is that the total amount of investment done by governments nowadays is roughly constant from year to year if one includes ALL TYPES of investment: e.g. investment in military hardware. Plus education is one huge investment. To that extent it is a waste of time trying to accurately estimate how much burden should be born by which generation: i.e. we might just as well pay for all investment out of “tax and print” and have done with it.

Second, it’s a plain physical impossibility to use steel and concrete produced by the blood sweat and tears of people in 2030 to build a bridge in 2016. That involves time travel.

The only way round that physical impossibility as explained by Nick Rowe is to have the youngsters in each decade support or subsidise the oldies in that decade. Here’s an illustration.

Public investments are made in the 2020s thanks to work by those of working age in the 2020s. Government borrows from those individuals. In the 2030s, new entrants the labour force have to buy relevant bonds off those who retire in the 2030s. And in the 2040s, new entrants to the labour force have to buy bonds off those who retire in the 2040s.

That way, new entrants to the labour force in the 2040s effectively pay for the investments made in the 2020s.  Time travel is possible after all! But there is a catch as follows.

That process via which youngsters in the 2040s support those who retire in the 2040s occurs anyway via sundry pension systems! And it doesn’t make any difference whether the pension schemes invest in bonds or whether the pension schemes are like the UK’s state pension scheme which is what’s known as “pay as you go”: i.e. taxpayers in each year support pensioners in that year under pay as you go schemes without any bonds being bought.

All in all, trying to apportion the cost of investments made in 2016 to youngsters in 2030 or 2050 is a dog’s dinner: it’s a waste of time.

Sunday, 20 November 2016

Does it matter if QE increases inequality?

This post is a re-write of a post with a very similar title published two or three weeks ago (on 3rd November 2016). Reason for this duplication is that the 3rd Nov. version contains several mistakes and I want to put them right. I’ll delete that 3rd Nov version (though it’s still available at Seeking Alpha site). Rectifying the mistakes actually involves altering very little of the text, but I like, as far as possible, getting everything right. So here goes.

Positive Money (PM) had a campaign recently to draw attention to the fact that QE increases inequality. As for the reason for the latter effect, that’s simple enough: QE involves giving cash to holders of government debt in exchange for that debt, i.e. Gilts in the UK and Treasuries in the US. That means saver / investors have cash to spare, some of which will flow to alternative investments like the stock exchange, housing, etc. That causes shares, houses etc to rise in value, which benefits owners of those assets, i.e. the better off. Plus there is no doubt a GDP increasing effect: some investors will make other investments which will boost demand and raise employment.

Malcolm Sawyer (economics prof at Leeds in the UK) thinks PM is wrong:

I asked Sawyer at the beginning of November on Twitter if he had set out any reasons for his latter claim, but haven’t had a reply so far. I also cannot find anything of relevance by Sawyer as a result of Googling. Anyway, my take on this question is thusly.

One response given by Mark Carney (governor of the Bank of England) to the above inequality charge was that “Every monetary policy action has distributional consequences. It is not for the central bank to address these.”

That’s not a bad point, but it’s a bit of a “passive and after the event” response. I.e. hopefully the BoE made it clear to government when QE was first mooted that it would increase inequality. Then the responsibility for letting inequality rise would lie exactly where it ought to lie: with politicians. I.e. if the BoE did not make that 100% clear, then the BoE could possibly be charged with being party to a wicked evil plot to increase inequality, and central banks are not supposed to be political.

Would QE money have been better spent on something else?

PM’s argument here is that QE money (which comes to just under £7,000 per head in the UK) could have been spent on something more beneficial than making the rich richer, plus more jobs would have been created, plus the effect on GDP would have been greater. (Incidentally, the above £7,000 figure is about right according to my back of the envelope calculations).

Indeed one way of spending that money would be to simply give it to UK citizens, as suggested in this PM tweet.

The empirical evidence is that households spend very roughly half of windfalls and save half. And spending about £3,500 per person would doubtless have been more stimulatory than QE, but it would also be too inflationary, I’d guess.

On the other hand, other material produced by Positive Money suggests spending much less, e.g. this video (at 4 minutes, 40 seconds). BTW thanks to Vincent Richardson (PM supporter) for the latter information.

Bang per buck.

As for the second alleged merit of the PM alternative to QE, namely that it results in a bigger increase in GDP per pound of stimulus, does that matter?

Well the answer is no, and for a reason pointed out by Milton Friedman, namely that stimulus dollars cost nothing in real terms, thus it doesn't matter how many jobs or increased GDP you get per £ or $ of stimulus. E.g. if stimulus comes in the form of literal helicopter money (printing £10 notes and dropping them from the sky) the cost of those notes is negligible relative to the face value.

The important objectives are to bring full employment and maximise GDP in the process. To illustrate, suppose there are two alternative ways of doing stimulus, both of which bring employment up to the full employment level. One involves printing and spending £200m and that increases GDP by £10m, and the second involves printing and spending £100m and that increases GDP by £9m, which should you go for?

Well it might seem that the second option is better value for money  because although GDP is increased by less, the costs of getting that extra GDP seem to be far less than with the latter first option.

Well the flaw there is, as Friedman pointed out, that the “costs” are entirely illusory. Thus the first option is best.

So, if the BoE thought the GDP maximising option was QE rather than spending the money in infrastructure or whatever, it then doesn't make any sense to say "but if we'd spent that money on infrastructure etc, we'd have got more jobs and GDP". Reason is that demand would have risen too far and we'd have got excess inflation that way. I.e. if the "more jobs per pound of stimulus" is the best way to go, then you need to employ fewer pounds, else excess inflation will ensue.

Why not QE the entire national debt?

Finally, QE is arguably not as bad might seem from the above points on inequality. That is, there are arguments for having no national debt at all (arguments set out for example by Milton Friedman and Warren Mosler). Thus continuing with QE and even accelerating it, while taking countermeasures to deal with inequality increasing effect WOULD arguably make sense.

But having said that abolishing national debt (i.e. replacing it with base money) arguably makes sense, QE in the form of having the central bank buy up corporate bonds is a different matter. Taking COMMERCIAL risks is not what central banks were set up for. PM has been actively opposing that, and I agree with them there


P.S. (4th Dec, 2016).    A friend of mine who has been in touch with Positive Money says they didn't intend to suggest that £6,000+ should be doled out to everyone in the UK. The idea was just to give an idea of the amount of money involved in QE. However, PM weren't very clear on that point in the above tweet. Room for improvement there I think.

Saturday, 12 November 2016

My original (?) idea as to why the optimum rate of interest is zero.

I argued in two recent posts on this blog that the optimum rate of interest is zero. See here and here. The first post argued that my idea was the same as the basic idea in a paper by Warren Mosler and Matthew Forstater (published in 2004) and entitled “The Natural Rate of Interest is Zero”.

My basic argument is that the state should issue enough money into the private sector or the economy generally to induce people to spend at a rate that brings full employment, but it should not issue so much that it then has to borrow some of that money back at interest with a view to constraining demand: that results in an artificial increase in the rate of interest. At least zero should be the rate of interest to aim for: that’s not to say, given the constant shocks that hit economies that zero will always be obtained.

However in a recent exchanged of comments with “JKH” on the Worthwhile Canadian Initiative blog, JKH claims that my above argument is not the same as Mosler and Forstater’s. Incidentally I’m not sure exactly who JKH is, but I seem to remember he taught at the Manchester Business School in the UK at one point.

Anyway, if JKH is right, that means my idea might be original. On the other hand Warren Mosler tells me my idea is the same as his. So I’m in a quandry at the moment – untill I have time to go thru Mosler and Forstater’s paper in detail again. And I don’t see myself having time – ever….:-)

Incidentally, the above is not to argue that the rate charged for mortgages etc should be zero: loans between private sector entities will always involve risk, so for that and other reasons, such loans will always be at a rate which is ABOVE zero.

P.S. (28th Nov. 2016).    Mosler sets out the idea that governments should borrow nothing because to do so distorts interest rates in the second last para of a Huffington article entitled “Proposals for the banking system.”

He says, “I would cease all issuance of Treasury securities. Instead any deficit spending would accumulate as excess reserve balances at the Fed. No public purpose is served by the issuance of Treasury securities with a non convertible currency and floating exchange rate policy. Issuing Treasury securities only serves to support the term structure of interest rates at higher levels than would be the case. And, as longer term rates are the realm of investment, higher term rates only serve to adversely distort the price structure of all goods and services.”
I agree that government borrowing artificially raises interest rates, but don’t see that the “term structure” is necessarily distorted. But maybe I’ve missed something.


Thursday, 10 November 2016

Steve Keen’s strange ideas on debt.

I decided this article left considerable room for improvement, so I’ve scrubbed it and re-written it. Please see here.

Tuesday, 8 November 2016

Borrowing to BUILD houses is no more productive than borrowing to buy EXISTING ones.

Some monetary reformers claim that borrowing to fund the production of a real asset like a machine or house creates more jobs than borrowing to buy an existing asset, which in the case of housing for example, allegedly tends to promote house price bubbles. Ergo, so the argument goes, preference should be given to the former type of loans.

Richard Werner seems to back this idea – see Twitter exchange below.

OK, let’s consider this taking housing as an example (and housing is not a bad example given the large proportion of all loans which are for the purchase of houses).

If the existing stock of houses is just enough to meet demand, no houses will be built. But if there is a marginal increase in demand, say in the form of X immigrants arriving plus families, and those immigrants borrow to have X houses built, clearly that will create a fair amount of work for bricklayers, plumbers and so on, which is allegedly beneficial because plenty of employment is created.

In contrast, if the immigrants borrow and buy EXISTING houses, then the price of houses will rise, which in turn will mean the value of houses exceeds the cost of producing them (counting house builders’ profit as a “cost”). Builders will then be induced to start building houses. And how many will they need to build in order to get supply and demand for houses back into balance? Well the answer is pretty obviously X houses! The net effect is the same!

Of course the real world is more complicated than the above over simple scenario, but I don’t see why adding those complexities makes any difference the above conclusion.

For example, it has been alleged that in the UK house builders have set up a cartel which artificially boosts the price of houses. See this Spectator article entitled “Radical reform is the only solution….”, in particular para starting “The UK house-building market….”

Now there is always a limit to how far those who arrange a cartel can exploit the situation before one cartel member breaks ranks and grabs the profits available. So let’s suppose house builders exploit that cartel to the extent of raising house prices by Y%, then much the same argument applies. That is, where demand exactly equals supply (and that will be when houses prices are Y% above the genuine free market price) no house building takes place. Then when the immigrants arrive and buy existing houses, prices will rise. That will induce builders to erect enough houses to bring supply and demand back into balance, i.e. X houses. The end result is the same.

House price bubbles.

The above is not to say that asset price bubbles are not a problem. However, asset price bubbles can inflate even where there is no borrowing at all. To illustrate with an extreme example, it would be perfectly feasible to have an economy where everyone bought their houses for cash. In that scenario, there is nothing to stop one person demanding more for their house than might be expected, at which point the rest of the lemmings that make up the human race might decide to mark up the price of their houses as well.

Tulip mania, house price mania etc can take off anytime regardless of the circumstances.

And finally, having criticised Richard Werner, please note that I am very much a Werner fan. He has produced enough decent and original material to deserve a Nobel prize. He originated the term “quantitative easing”. And the following two works by him are master pieces: simple clear and original.

1.  Towards a Twenty-first Century Banking and Monetary System.

2. How do Banks Create Money….


The twitter exchange: sorry about the poor quality of the images: if you click on them you should get a better view.

Monday, 7 November 2016

Pure fiscal stimulus is flawed, as is pure monetary stimulus. Cooperation between them is best.

By pure fiscal stimulus I mean “government borrows money and spends it, and/or cuts taxes”. But borrowing as such is DEFLATIONARY! Why do something deflationary when the intended effect is the opposite?

By pure monetary stimulus I mean “the state prints money and buys back government bonds so as to cut interest rates or do QE”. But that’s flawed as well. First it assumes that a recession is caused by inadequate lending, borrowing and investment spending when in fact the cause may well be a lack of some other form of spending.

Second, deliberately interfering with the rate of interest means setting interest rates at something other than their free market level, which on the face of it reduces GDP. So in what scenario is there no government interference in interest rates?

Well government borrowing will artificially raise interest rates if such borrowing is not justified. So what forms of government borrowing are justified?

First, as is generally agreed, government should not borrow so as to fund CURRENT spending. As to CAPITAL spending, the arguments for borrowing there are much weaker than is commonly supposed: Milton Friedman and Warren Mosler oppose/d all forms of government borrowing. But if the justification for government borrowing is that it funds capital spending, the state cannot then print money and buy back government bonds with a view to cutting interest rates because that amounts to an “after the event” funding of capital spending via printed money. That’s a self contradiction!

Another nonsense in having the two options “fiscal” and “monetary” is this.  Why have two different organisations charged with the same task, namely adjusting demand? That makes as much sense as a car with two steering wheels each controlled by a different person.

A possible objection to the above argument is that given excess unemployment, the state has to “interfere” in SOME WAY to rectify the situation. Well the answer to that is that having the state print extra money and spend it and/or cut taxes comes to much the same thing as the free market’s cure for excess unemployment. That is, given excess unemployment in a perfectly functioning free market, wages and prices would fall, which would raise the real value of money (base money in particular). And that would induce “money holders” (which is a very large cross section of the population and economy, public and private sectors) to spend more. That effect is known as the “Pigou effect”.

However, the Pigou effect doesn’t work too well in the real world because of the “wages are sticky downwards” effect. But boosting the real value of the total stock of money by having the state print and distribute it in some way comes to the same thing. Ergo, in a sense, the latter policy is not an artificial interference in the economy.


P.S. (A few hours after putting the above online). Another problem with monetary stimulus is that the stimulus, at least initially, is concentrated in the "borrowing and lending" sector of the economy: i.e. the capital goods sector. All else equal, it is better to spread stimulus as widely as possible. Reason is that while the unemployed are not the most skilled section of the workforce, there is nevertheless a wide variety of skills there, thus ideally the unemployed need as wide a variety of jobs to choose from as possible.

Sunday, 6 November 2016

“Debt free” money won’t solve environmental problems.

This Guardian article by Jason Hickel published yesterday starts with the claim that replacing the GDP yard stick will cut our desire for consumer goodies, and hence cut our consumption of natural resources. (Article title: "To deal with climate change...")

Whaaat? So people don’t want cars for convenient transport: they want them because car production increases GDP? Truly hilarious. And people don’t heat their homes to keep warm: they heat them because burning fossil fuels also increases GDP? If you aren’t laughing your socks off, you should be.

Debt makes economic growth necessary?

Next, the article claims that the fundamental reason why economic growth is needed is so that people can pay off their debts. As the article puts it, “Debt is the reason the economy has to grow in the first place.”

So people don’t go tens of thousands of pounds into debt so as to acquire nice, warm, well decorated houses? Rather, debt appears from nowhere, and people then sweat their guts out building and acquiring houses so as to pay off the debt. This is Alice in Wonderland stuff.

Disposing of debt based money cuts debts?

The article then trotts out the old canard that replacing so called “debt based” money with central bank (CB) issued money will cut debts (and hence cut our consumption because as explained above, we allegedly go out to work to cut debts rather than to acquire consumer goodies).

Before explaining the flaw in that argument, I’ll say something about debt based and non debt based money.

There are two basic forms of money. First there is CB issued money which consists of notes and coins plus credit balances that commercial banks have at the CB. An important characteristic of that money is that it is a NET ASSET as viewed by holders of that money, i.e. the private sector.

Second, there is money issued or created by commercial / private banks. That money is not a net asset as viewed by the private sector: reason is that for every dollar or pound of that money, there is a corresponding dollar or pound of debt owed by someone to a commercial bank. As the saying goes, privately issued money “nets to nothing”.

Thus the first form of money is arguably “debt free”. Some economists have challenged the idea that CB money is debt free, and on the grounds that such money could be said to be a debt owed by the state to the private sector. Basically I don’t agree and for reasons set out here. I.e. the claim that CB money or “base money” as it is sometimes called is debt free pretty much holds water.

Now money thru the centuries has taken a huge variety of different forms: almost everything has at some time or other been used as money: various metals, paper, wood, cowrie shells, cattle, you name it. And indeed, debt can be used as money.

Plus it is perfectly possible to have a system under which the use of debt as a form of money is banned. Indeed, at least four Nobel laureate economists (including Milton Friedman) have advocated that. I back the idea myself.

Unfortunately banning the use of debt as a form of money does not get rid of debts, any more than tons of gold disappeared into thin air when gold was no longer used as money in Britain and elsewhere.

Put another way, if we have a system under which only CB issued money is acceptable, there will still be people with cash to spare and others willing to borrow. And it makes sense for the former to lend to the latter. Indeed, all else equal (i.e. assuming the distribution of wealth, income inequalities and so on remain the same), the total amount of borrowing, lending and debt will remain much the same if we switch to a “central bank money” only system.

Actually there’d be a FINITE, but not large reduction in the total amount of lending, borrowing and debt under a central bank money only system. Reason is that under that system, private banks cannot just print the money the lend out: i.e. under that system, it costs more for private banks to acquire money to lend out, thus interest rates would rise a bit, thus the total amount borrowed and loaned would fall a bit.

As for any deflationary effect of that, that’s easily dealt with by having the state print and spend more money into the economy. The net result is that everyone has more money, but if you DO WANT to borrow, it’ll cost you a bit more. Certainly the UK’s “Independent Commission on Banking” considered the CB money only system, and came to the same conclusion, namely that the cost of borrowing would rise. But in the UK in the 1980s, mortgagors paid almost THREE TIMES the rate of interest that they pay nowadays, but for some strange reason the sky didn’t fall in. Thus I doubt a modest rise in interest rates would be a disaster.

Friday, 4 November 2016

Bank of England worries about the “sustainability” of national debt.

If you want to progress your career, it’s very important to use fashionable phraseology, and the word “sustainable” is very much in vogue at the moment. So congratulations to the BoE authors for that. To be more exact, they are concerned with what they call “sustainability in the long run”.

This short BoE article is concerned with the rise or fall in real (i.e. inflation adjusted) interest payments on the national debt relative to GDP. As the article rightly points out, a rise in interest payments relatively to GDP is not “sustainable”.

Well my answer to that is: “OK, but so what?” I mean an accelerating car is not a sustainable system: it cannot go on accelerating for ever! But that doesn’t prove there is anything wrong with a car accelerating for a while.

Thus the entire “sustainable” concept, fashionable as it may be, is twaddle. The important question (one that MMTers have answered) is: what’s the OPTIMUM size of the debt? Unfortunately as I’ve pointed out several times on this blog, the concept “optimum” is too difficult for most people and for most economists.

So let’s stick with fashionable twaddle like “sustainable” shall we?

Thursday, 3 November 2016

Does it matter that QE increases inequality?

There were several mistakes in this article, so I’ve deleted it and re-written it.