Saturday, 19 August 2017
While negative interest rates probably raise demand, they are not an efficient or “GDP maximising” way of doing so: it’s better to simply have the state create more base money and spend that into the economy and/or cut taxes, while interest is left at a zero or slightly positive level. Two of the reasons negative rates are not efficient are thus.
First, negative rates in theory make negative output viable: not what we need. At the very least, they make “very low return on capital” forms of activity viable.
Second, governments or “states” in effect offer a service to everyone, namely what amounts to a savings bank for those who want a stock of base money (or, much the same thing, government debt). GDP is maximised where goods and services are offered at a price which is close to the cost of supplying those goods and services. And the cost of offering the latter “savings bank” service is near zero. Ergo to maximise GDP, there should be little or no positive or negative interest paid to / charged to those with accounts at the “savings bank”.
The reason normally given for negative rates is that rates are now so low that central banks do not have much scope for cutting rates come a recession, without going for negative rates. There is actually no need for negative rates because, as pointed out by MMTers, government of a country that issues its own currency is master of all it surveys: it can implement any level of stimulus it likes and combine that with any rate of interest it likes.
The latter “MMT” policy DOES require cooperation between fiscal authorities (i.e. politicians) and the central bank. But it’s hard to see anything wrong with two arms of government cooperating. Plus Bernanke backs the “cooperation” idea in this Bloomberg article. As for the idea that that cooperation might result in politicians getting too near the printing press, politicians can actually be kept away from the press under a “cooperative” system. Reasons are below.
Do negative rates actually work?
One problem with negative rates is that they may not actually be an effective anti-recessionary tool at all. Reason is thus.
The main idea behind negative rates is that if people are charged in proportion to their stock of cash, they’ll try to spend away that stock, which in turn should boost demand. But there’s another possibility: people may have some target amount of cash they want to hold, so if X% of that target is taken away from them, they’ll respond by saving so as to return their stock of cash to their target. And the effect of saving is to REDUCE demand!
But a more fundamental problem with negative rates is that they may not maximise GDP. Reason is thus.
It is widely accepted in economics that GDP is maximised where products are available at a price which is near the cost of production. It makes sense to have the price of gold hundreds of times higher per kg than the price of steel: reason is it costs far more per kg to produce gold. Obviously each firm aims to make a profit, but competitive forces keep those profits down to acceptable levels normally, which results in the price of most products being near the cost of production.
Now what’s the cost to the state (i.e. government and/or central bank) of maintaining a stock of cash for each household, firm, etc? It’s almost nothing!
Incidentally I’m assuming that the state does actually make savings accounts available for all. That’s not quite the reality, but it very nearly is. E.g. in the UK there’s a state run savings bank “National Savings and Investments”. NSI provides some of the services available from a regular bank but certainly not all of those services. Plus most people in most countries are free to buy government debt, which amounts to much the same thing as putting money into a term account at a state run savings bank. (NSI actually invests only in UK government debt).
As Warren Mosler and Martin Wolf (chief economics commentator at the Financial Times) said, government debt is almost the same thing as base money.
So to keep things simple, let’s just assume the state has a savings bank for anyone wanting to keep a stock of base money. It would clearly be OK for such a bank to charge for ADMINISTRATION COSTS, as indeed existing commercial banks do.
But there is no obvious reason to charge interest on the money in such accounts, i.e. charge negative interest, if the price of the product is to be close to the cost of making the product available. Moreover, and as regards positive rates (i.e. paying interest to those holding state liabilities) Milton Friedman and Warren Mosler argued that the natural rate of interest is zero: that is, they argued that there is no reason for government to issue interest yielding liabilities. So to summarise, if we ignore administration costs, there are good reasons for thinking that neither positive nor negative interst should be paid on state run savings accounts, i.e. on “state liabilities”.
But assuming the latter “zero interest” policy is adopted, how then do we implement stimulus? Well that’s easy: have the state print money and spend it (and/or cut taxes). That way the private sector ends up with a bigger stock of cash (base money to be exact), which induces the private sector to spend more. And that’s the form of stimulus Friedman advocated in his 1948 paper ”A Monetary and Fiscal Framework…”. Though he advocated the same unvarying amount of stimulus per year, an idea not widely accepted nowadays.
And if we particularly want to raise interest rates at some given level of demand (e.g. the “full employment” level of demand), that is also easily done: just “print and spend” as above but to an excessive extent, and then deal with the resulting excess demand by raising interest rates (which can be done by having government or central bank, i.e. “the state”, borrow more). That of course is not consistent with the Friedman / Mosler claim that government should pay no interest on it’s liabilities. But never mind: the point is that if a government PARTICULARLY WANTS raise interest rates, it has the power to do so. And indeed there could well be an argument for doing that in an emergency: e.g. if there was a serious outbreak of Greenspan’s “irrational exuberance”, then demand might have to be reined in in a hurry, and an interest rate hike would be one way of doing that.
Dispose of interest rate adjustments?
It was implied just above that interest rate adjustments should be abandoned (except perhaps in emergencies) and that stimulus should be done by adjusting the amount of new money created and spent. That certainly conflicts with the conventional wisdom, but it actually makes sense for the following reasons.
First, come a recession, there is no obvious reason why a fall in borrowing and lending is necessarily the cause of the problem: the cause could be a fall in some other element of aggregate demand, e.g. consumer confidence or exports. And second, even if borrowing and lending HAVE FALLEN, that could be for perfectly good reasons.
Indeed, a classic example of that was the bank crisis ten years ago: that was sparked off by excessive and irresponsible lending, followed by a sudden realization by banks that they’d lent to too many no hopers (e.g. NINJA mortgagors). So the sensible thing for them to do was rein in loans. But that caused a recession. So what did central banks do? They cut interest rates so as to encourage more lending: exactly what wasn’t needed! Might as well try curing an alcoholic by giving him crates of free whiskey!
A free market would boost the monetary base in a recession.
Another point in favor of largely abandoning interest rate adjustments and implementing base money adjustments instead is that that is what would happen in a perfectly functioning free market. That is in such a market, the price of goods, services and labor would fall in a recession. That in turn would mean a rise in the real value of the monetary base, which in turn would encourage spending.
That phenomenon does not work too well in the real world because as Keyes put it, “wages are sticky downwards”. But never mind: instead of raising the value of each dollar making up the base, the NUMBER OF dollars making up the base can be increased instead.
Having claimed above that GDP is not maximised where employers make a charge for a product which is not related to costs, it should be possible to point to exactly how that failure to maximise GDP comes about where the state makes an unwarranted charge to those holding state liabilities, i.e. charges negative interest. Well here goes.
Say I can borrow at minus 4%. I could then buy 100 houses, keep them for a year, burn down two of them just for fun, sell the remaining 96, and come away with a 2% profit! Crazy: that amounts to what might be called “negative output”.
Of course that’s a silly example. But there is a serious point there: under a negative interest rate regime, forms of negative output or “wealth destroying” output then become viable. At the very least, forms of output become viable which would not be viable at the Friedman / Mosler zero rate, or a higher rate.
Politicians and the printing press.
Having suggested it can be an idea for the state to simply print money and spend it and/or cut taxes, there is an obvious problem there namely that that requires cooperation between the central bank and politicians, thus politicians get closer to the printing press. Does that matter?
Well the evidence seems to be that in most countries the degree of independence of the central bank (i.e. how close it is to politicians) does not influence inflation – see chart below which is taken from an article by Bill Mitchell.
However, like most people I suspect, I’d rather keep politicians away from the press. And doing that under a regime where it is possible to “print and spend” is not difficult. All that needs to be done is to give the responsibility for determining the amount to be printed to the central bank (or some independent committee of economists), while politicians retain the right to determine what proportion of GDP goes to public spending. Indeed, that’s not vastly different from the existing system in that an independent central bank has the last word on how much stimulus there shall be: e.g. under the existing system, if the central bank thinks politicians have implemented too much fiscal stimulus, the central bank well negate that by raising interest rates.
Under a system where the central bank determines the amount of stimulus, but stimulus is effected simply by creating and spending new base money (or cutting taxes), the central bank might say “public spending needs to exceed tax by 2% of GDP this year and here’s the money that enables that to be done”. Politicians would then have the choice as to whether to effect that by having public spending equal to 30% of GDP and tax equal to 28% of GDP. Or they could go for 40% and 38%, etc.
And what do you know? That’s exactly the system advocated by Positive Money, the New Economics Foundation and Prof Richard Werner in this work. Bernanke also expressed sympathy with that sort of system. To be exact, in this Fortune article, Bernanke suggested the central bank should determine the AMOUNT of money to be created and spent, while (as suggested above) politicians take the essentially POLITICAL decisions: whether to distribute the largess in the form of more public spending or tax cuts, and if the former, how much goes to education, health, defence, etc. See para starting “A possible arrangement…” halfway down.
Sunday, 13 August 2017
It’s this recent article in the Telegraph entitled “Our zeal to punish the bankers only stoked the Great Recession”.
Tim Congdon has the impressive sounding title of: “Chairman of the Institute of International Monetary Research at the University of Buckingham”. Unfortunately his ideas have never been equally impressive, as I’ve explain in earlier articles on this blog.
The basic point he has banged on about for many years (and in his Telegraph article) is that GDP is related to the money supply, ergo (so his argument goes) if the money supply is expanded, GDP rises. Ergo it is essential for commercial banks to be encouraged to lend more (as the title of the above article implies).
The flaws in that idea should be obvious enough to anyone with a decent grasp of economics, but for the benefit of readers not sure what the flaw is, I’ll run through it.
Two sorts of money.
The problem with Congdon’s argument is that there are two very different forms of money: central bank issued money and private bank issued money. The former is a net asset as far as the private sector is concerned. To illustrate, one way of expanding the private sector’s stock of CB money would be for the CB to print dollar bills or pound notes and to have government hand them out in the form of extra unemployment benefit or increased state pensions.
That would induce pensioners etc to spend more.
In contrast, there is commercial bank issued money. That money comes into being when a commercial bank grants a loan. But note that while it’s nice for the borrower to have $X at their disposal as a result of the loan, the borrower is of course indebted to the bank. So on balance the borrower is no better off (unlike the above mentioned pensioners.) Or to quote a commonly used phrase (which Congdon has presumably not caught up with), commercial bank issued money “nets to nothing”. Certainly there is no mention of the two basic forms of money in Congdon’s article.
Congdon is correct to suggest that increasing either form will increase demand. The reason why pensioners etc spend more when they find more pound notes in their wallets is obvious enough. As to how and why increased loans by commercial banks raises demand, that should be equally obvious: if I borrow $Y with a view to having a house built, that will increase demand for bricks, timber, bricklayers, plumbers and so on.
For more details on how, why and the extent to which increased bank loans increases demand, Steve Keen’s short and very readable book “Can we avoid another financial crisis” is a good source.
To summarise so far, if we want to increase demand, that is easily done EITHER by expanding the stock of central bank money or the stock of commercial bank money. And the way governments normally induce commercial banks to lend more to their customers is to cut interest rates.
Why expand the amount of dodgy private money?
There is however a glaring problem with privately issued money: the private banks which issue it, not to put too fine a point on it, are big time criminals. To be more exact, total fines and out of court settlements paid by US banks in recent years in the US comes to a staggering $200bn or so. And then there’s the small matter of the risky practices they indulged in which caused the worst recession since World War II.
So, contrary to Congdon’s suggestions, there are EXTREMELY GOOD reasons for clamping down on various commercial bank practices. And as for Congdon’s complaint that that exacerbates recessions, the simple answer to that is to expand the private sector’s stock of CENTRAL bank money: exactly what various governments have actually done in recent years.
It could be argued that the WAY in which the private sector’s stock of central bank money has been expanded, namely QE, has not been very effective because QE is just an asset swap. That is, the central bank prints $Z worth money and buys up $Z of government debt. And from that you might concluded that private sector net assets have remained about constant.
Actually that’s a bit misleading. Reason is that prior to QE and during the initial stages of QE there was a much larger than normal government deficit. And a deficit consists of: “government borrows $A and gives lenders $A of government bonds and spends $A back into the private sector. Lo and behold the private sector’s stock of paper assets rises by $A! Then comes QE, which consists of “central bank prints $A and buys back $A of bonds. Net result: the private sector has $A more cash (just like the above mentioned pensioners).
And finally, for anyone interested in delving a bit further into Congdon’s ideas, there is a transcript of a discussion between him and Prof Robert Skidelsky here in which Skidelsky tries to explain to Congdon the error of his ways.
Wednesday, 9 August 2017
Sunday, 6 August 2017
Thursday, 3 August 2017
Job Guarantee (JG) is a name for what are sometimes called “make work” schemes. “The Job Creation Programme” which operated in the UK about 40 years ago was one of many examples. And the WPA in the US in the 1930s was another example.
I’ve been arguing for twenty years that if Job Guarantee schemes take the form that they did under the WPA, namely having large numbers of unemployed people work on specially set up schemes, there is a danger that the ratio of unskilled to skilled employees is too high, with disastrously low levels of productivity being the result. For example I argued that point quite recently here.
The fact that productivity was not too bad on many WPA schemes in the 1930s proves nothing. Reason is that given VERY HIGH levels of unemployment (as existed in the 1930s), there is a decent availability of skilled labour from the ranks of the unemployed. But JG is not a good solution for VERY HIGH unemployment levels: the best solution there is simply to run a bigger deficit, as Keynes explained. Ergo where JG performs the role for which it is ideally suited (reducing unemployment even further where unemployment is relatively low) the latter “skilled / unskilled” danger exists. (Unfortunately that point is too subtle for many of the windbags inside and outside academia who witter on about JG).
Anyway, some local government people turned up in my neighbourhood recently and said they were going to employ some youths on probation to fill potholes in a road near where I live (see picture below which was taken after the holes had been filled).
For the benefit of non-Brits, probation is a system in the UK for dealing with miscreant youths: they are given supervised work, and so on. So it’s SIMILAR to JG but clearly not EXACTLY the same.
Now this road has a slight slope on it (left to right in the picture) which means that excess rainwater runs down the right hand side, out of the way of vehicles. That’s desirable because if water stands in the middle of a hardcore or dirt-track road, car tyres force water out of the pot-holes at high velocity, which forces hardcore out of the holes and makes them worse.
So I told one of the men in charge that that slope needs to be retained. And what d’yer know? They ended up giving parts of the road a slope the wrong way or giving it no slope at all, with the result that water will accumulate in the middle of the road. Least that’s what my spirit level says – see second picture.
The ratio of “unskilled miscreant youths” to “normal intelligent adults” looked to me to be about two to one.
The moral is that, as explained in the economic text books, if the amount of skilled labour in any economic activity, including JG, declines to much below normal levels, productivity falls dramatically, even where a simple job like filling pot-holes is involved.
Ergo JG people should be subsidised into work with EXISTING EMPLOYERS, not concentrated on specially set up schemes which involve high levels of unskilled, low IQ labour.
Unfortunately, and to repeat, that’s all a mile above the heads of most of those who witter on about the potential wonders of JG.
Wednesday, 2 August 2017
Those who want the UK to stay in the UK, i.e. “remainers”, often argue that it is important to be able to trade with countries which are geographically close. As I pointed out here recently, that idea looks a bit silly in light of the fact that the average distance travelled by Australia’s exports and imports is around 6,000 miles. Same goes for New Zealand.
Further significant characteristics of NZ in this connection, are that it has a similar land mass to the UK, it speaks the same language, it has a similar culture plus it is slightly better off than the UK: at least GDP per head is a bit higher. And its population is a mere five million.
Now that all rather blows a hole in the idea that the UK needs a constant flow of immigrants from the EU or indeed from elsewhere. That is, if there was significant net EMIGRATION from the UK for the next twenty years, such that its population declined to five million, it would then be very similar to New Zealand: better off than it is now!!
Tuesday, 1 August 2017
Monday, 31 July 2017
Unless you’ve been living on another planet for the last ten years, you’ll be aware that universities have lost the reputation they once had for free speech and open debate. This new “academic bigotry”, to coin a phrase is nicely described in this Spectator article. I particularly like the opening paragraph.
I actually dealt with this subject a month or two ago on this blog, and mentioned that comments on LSE blog articles seem not to get published if they criticise relevant articles.
That is not to suggest that NON-ACADEMIC authors are any different: the point is that universities are supposed to be all about free speech and open debate. They have a duty to promote those two.
Moreover, it is basically dishonest to allow comments after an article and then fail to publish the comments that disagree with your article. That is, the perhaps naïve assumption made by many readers is that ALL COMMENTS (apart perhaps from grossly offensive or blatantly stupid comments) will be published. I.e. if authors want to publish just complimentary comments, they should say so in their articles. But of course that would make them look stupid. Much better the above mentioned “dishonest” ploy.
Anyway, the latest example “LSE terror of free speech” is this article. I left two critical comments, but neither was published. The moral is: don’t take the absence of criticism in the comments after an article as evidence that those who have read the article approve of it. There may be loads who think the article is rubbish, but the author has chosen not to publish their comments.
Re how many comments I don’t publish on this blog of mine, the answer is “virtually none”, and I’ve no good reason to censor comments in that I find abusive or offensive comments are rare in the extreme. I very occasionally don’t publish a comment which is plain stupid. I do that about once every six months.
The main reason I have comment moderation is to get rid of comments which are clearly off topic and aimed at selling or promoting something: they normally include a link to some firm with some product on offer. A common example (no doubt because this blog is largely concerned with banks, lending, etc) is pay day lenders trying to sell their wares.
But even the latter “commercial” comments are less frequent than they used to be, thus I might switch off comment moderation in the near future and see how it goes.
Stop press (3rd Aug). Bill Mitchell of "Billyblog" who I mentioned in my earlier article on this subject, continues to be a bit selective as to which comments get published. One of mine wasn't published a couple of days ago, though in fairness he has published at least 90% of my comments over the last five years or so.
Sunday, 30 July 2017
Warning: this article (as the above title rather implies) is concerned with a somewhat technical point about the history of economic ideas – not something that is of interest to some people maybe. Anyway…
Seeking Alpha recently published an article of mine entitled “To enable private banks to create and lend out money, households must first be driven into debt.”
The basic argument was that assuming the state has issued enough base money to keep the economy working at capacity, then any attempt by private banks to add to that money supply will be inflationary, which means that in order to keep inflation under control, the state must impose some sort of deflationary measure like raising taxes and confiscating some of the private sector’s stock of base money. That in turn will drive a significant number of households and firms into debt: and potential debtor / borrowers is exactly what money lenders (i.e. private banks) want. In short, private banks solve a problem which they themselves create!
Adam Smith actually considered this issue, but claimed the effect of introducing private money WOULD NOT be inflationary because all of the excess supply of money resulting from private money creation would be spent abroad. That’s in Ch2 Book2 of his “Wealth of Nations”. See the final paragraph below for Smith's actual words.
Adam Smith was certainly a great thinker, but the latter idea about excess quantities of money all being spent abroad is plain bizarre. Certainly A PROPORTION will be spent abroad: indeed, when the average household comes by a windfall, it basically just augments spending on the various items the average household spends money on ANYWAY. That includes housing, cars, restaurant meals, and yes, foreign holidays, imported cars and so on.
And I dare say the PROPORTION of consumer spending that goes on imports in the event of a windfall is HIGHER than the equivalent proportion in the absence of a windfall. But Smith’s idea that 100% of windfall money is devoted to imports or foreign investments is clearly wrong.
Another error Smith makes is that he treats privately issued money as a direct substitute for base money (which consisted of gold in Smith’s day). Base money and privately issued money are very different animals.
Base money is a net asset as viewed by the private sector. In contrast, money issued by private banks is not: reason is that for every dollar of money issued by private banks there is a dollar of debt owed by bank customers to such banks. I.e. private banks, as I explain in my Seeking Alpha article, manage to muscle in on the money creation business only because they can lend at below the prevailing rate of interest. And they can do that because it costs them nothing to come by the home made money they lend out: that is, they do not need to earn or borrow it – they just print it.
Thus the addition to the money supply that private banks are responsible for will not be spent on consumer goods, as Smith implied (and indeed as I implied just above): the extra money will be invested. Indeed, a sizeable proportion of money borrowed from private banks goes to mortgages.
Adam Smith's actual words.
Let us suppose, for example, that the whole circulating money of some particular country amounted, at a particular time, to one million sterling, that sum being then sufficient for circulating the whole annual produce of their land and labour. Let us sup¬pose, too, that some time thereafter, different banks and bankers issued promissory notes, payable to the bearer, to the extent of one million, reserving in their different coffers two hundred thousand pounds for answering occasional demands. There would remain, therefore, in circulation, eight hundred thousand pounds in gold and silver, and a million of bank notes, or eighteen hundred thousand pounds of paper and money together. But the annual produce of the land and labour of the country had before required only one million to circulate and distribute it to its proper consumers, and that annual pro¬duce cannot be immediately augmented by those operations of banking. One million, therefore, will be sufficient to circulate it after them. The goods to be bought and sold being precisely the same as before, the same quantity of money will be sufficient for buying and selling them. The channel of circulation, if I may be allowed such an expression, will remain precisely the same as before. One million we have supposed sufficient to fill that channel. Whatever, therefore, is poured into it beyond this sum cannot run in it, but must overflow. One million eight hundred thousand pounds are poured into it. Eight hundred thousand pounds, therefore, must overflow, that sum being over and above what can be employed in the circulation of the country. But though this sum cannot be employed at home, it is too valuable to be allowed to lie idle. It will, therefore, be sent abroad, in order to seek that profitable employment which it cannot find at home. But the paper cannot go abroad; because at a distance from the banks which issue it, and from the country in which payment of it can be exacted by law, it will not be received in common payments. Gold and silver, therefore, to the amount of eight hundred thousand pounds will be sent abroad, and the channel of home circulation will remain filled with a million of paper, instead of the million of those metals which filled it before.
Friday, 28 July 2017
The superiority of state issued money can be illustrated by considering two hypothetical economies. In one, people and firms want a form of money, but there is negligible lending and borrowing: a “neither lender nor borrower be” economy if you like. And in the second hypothetical economy, there is a significant amount of lending and borrowing, but very little demand for money (i.e. little demand for idle balances in current / checking accounts).
In the first, the “want money but don’t want to borrow” economy (as in any economy) it would cost nothing to issue base money (i.e. state issued money). 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."
In contrast, where a bank customer wants the bank to supply the customer with a stock of PRIVATELY ISSUED money, the bank has to check up on the credit-worthiness of the customer, perhaps take collateral off the customer, check up on the value of the collateral and allow for bad debts. Those items are significant costs.
Conclusion: the state issued money system is clearly cheaper to operate.
A “little demand for money” economy.
Now let’s consider an economy where there is negligible demand for money, but households and firms do want to engage in a significant amount of lending and borrowing. In that scenario, there is no difference as far as costs go between a “state money” system and private money system. Reason is that the above mentioned costs involved in lending (allowing for bad debts etc) apply in both cases. That is, ANY LENDER has to check up on the credit-worthiness of borrowers.
So to summarise, in the first hypothetical economy, state issued money is better than privately issued money, while in the second hypothetical economy neither a state issued nor a privately issued money system can be said to be better than the other. And since real world economies lie somewhere between the above two hypothetical extremes, it follows that state issued money is better than privately issued money.
Net financial assets.
And there is a final nail in the coffin of private money as follows.
When a private bank creates a dollar of money, it creates a dollar debt at the same time, or as the saying goes, private money “nets to nothing” (e.g. see this article by Bill Mitchell). Put another way, when the state creates money, there is rise in the private sector’s net financial assets, while that is not the case with private money creation.
But the private sector’s propensity to spend is clearly related to its stock of such assets (money in particular), in the same way as the propensity of a household to spend varies with the amount of money it has.
So…in a “private money only” system, the private sector has zero net financial assets, and that’s a problem because it is highly unlikely that a zero stock of net financial assets is enough to induce the private sector to spend at a rate that brings full employment. Put another way, given an attempt to implement a “private money only” system, it is likely the state will have to boost the private sector’s stock of money / financial assets with state issued money so as to bring about full employment.
Conclusion: privately issued money benefits the issuers of that money, i.e. Wall Street bankster / criminals, but no one else.