Wednesday, 28 June 2017
In an article by Richard Murphy entitled “Has Carney taken leave of his economic senses?” Murphy claims that Carney, governor of the Bank of England is wrong to say that interest rates should be raised given a significant rise in business investment spending.
Murphy says “What Carney is saying is that if business tries to improve UK productivity, or if it tries to increase employment, or if it tries to deliver growth then he will snub it out.”
Well first off, a rise in interest rates WOULD NOT entirely “snub out” that extra investment. The reason is simple and is as follows.
Assuming the economy is currently as near capacity as is feasible without excess inflation kicking in (i.e. NAIRU, which is where Carney seems to think it is, rightly or wrongly), then an £X increase in spending caused by extra investment needs to be countered. But there is no reason that “countering” (i.e. cut in spending) needs to be CONCENTRATED on business investment, and indeed it wouldn’t be in the event of an interest rate increase. That is, a rise in interest rates hits ALL FORMS of capital spending, including the sale of household “capital” items like fridge freezers, cars and TVs.
Thus a rise in interest rates would not entirely negate the above original rise in business investment.
Abandon the inflation target?
Next, Murphy suggests we should dispose of the 2% inflation target. He needs to explain whether that means abandoning all attempts to control inflation or whether it means raising the target to 3% or 4%. The former would be regarded as ridiculous by 99% of economists, while the second is widely seen as a possibility, while being contentious: not something we should do at the drop of a hat.
Let’s rob creditors!
Finally, Murphy says in relation to sticking to the 2% inflation target “And remember, the greatest beneficiary of this policy are the best off because low inflation preserves the real value of the debts the wealthiest are owed by the very many who owe them.”
Well the flaw in that argument was nicely illustrated in the 1970s and 80s. That is, it’s true that the sudden rise in inflation in the 70s hit creditors. But creditors are not completely stupid: they reacted (towards the end of the 70s and 80s) by demanding a higher return for lending out money. In fact the 1980s saw the highest real interest rates for at least half a century, presumably because creditors with memories of having been stung in the 70s, continued to demand high NOMINAL returns on their money despite the fall in inflation in the 80s.
A repetition of that period of high real interest rates lasting several years would of course not benefit the group that Murphy wants to benefit, namely borrowers.
And finally, borrowers are not all paupers: some people borrow a million or two to help them buy five million pound houses.
Tuesday, 27 June 2017
Wednesday, 21 June 2017
That’s this Financial Times article entitled “Outrage at Grenfell Tower is a chance to fix housing policy.” It’s written by Diane Coyle: economics prof at Manchester University, UK.
Her professional colleagues were getting all excited about this article on the internet yesterday. I’m less than impressed.
Essentially her explanation for high house prices is in this passage of hers: “The reason is simple: private developers, on the whole, will never want to increase housing supply enough to bring prices down. They sell too many properties on the promise of capital gains.”
Well Prof Coyle’s first year students ought to be able to spot the flaw there. In case you haven’t spotted it, the flaw is thus.
It’s blindingly obvious that “private developers, on the whole, will never want to increase housing supply enough to bring prices down.” By the same token, used car dealers don’t want the number of cars for sale to increase dramatically: that would cause the price of used cars to fall too quickly for their liking. And fruit sellers don’t want the price of fruit to fall.
But that does not explain, as Prof Coyle suggests it does, why house prices in the UK do not fall. That is, if competitive forces are working properly, they certainly ought to fall.
Moreover private developers didn’t want house prices to fall twenty or forty years ago. Thus the Coyle’s “don’t want prices to fall” theory does not explain the 200% rise in UK house prices in REAL TERMS over the last twenty years compared to Germany where prices have remained stable and even fallen slightly according to some sources. (See The Economist house price index for details.)
One of obvious explanations is that land with permission for house building sells for roughly a HUNDRED TIMES the price of agricultural land. That’s because of artificial restrictions put on such land by the bureaucracy, not because of free markets.
As this Forbes article put it in relation to the relatively low cost of housing in Germany, “A key to the story is that German municipal authorities consistently increase housing supply by releasing land for development on a regular basis.”
Incidentally, I’m not advocating a TOTAL free market in land usage. On the other hand the above mentioned hundred to one ratio is ridiculous.
To make the Coyle “don’t want prices to fall” theory stick, it has to be shown that house builders can actually ENFORCE their desire, e.g. by indulging in monopoly or cartel type practices. Indeed, the idea that builders do engage in such practices is quite popular. But Coyle doesn’t even mention that idea!
Now the first problem with that cartel idea is that it does not at least on the face of it explain the above mentioned 200% rise in real UK house prices in the last 20 years. That is, if these cartels exist, why are much more prevalent now than 20 or 40 years ago? There’s no obvious explanation.
Second, cartels if they exist, must be organised in each locality. For example a big oversupply of houses in Edinburgh will not have much influence on house prices in London, 300 miles away. Thus there must be hundreds of cartels for the cartel theory to work, as others have pointed out. Plus cartels do need to be ORGANISED. For example there are regular reports in the press about what the OPEC cartel is doing. Their meetings are perfectly open and publicised beforehand.
But in the case of the above mysterious house building cartels, we never hear of any prosecutions. I don’t remember reading about a single such cartel meeting. Strange, given that there are allegedly hundreds of them!! You’d think a few of them would slip up occasionally and send a letter or email that gets uncovered and reveals what they’re up to!
The reality I suggest, is that these mysterious cartels just don’t exist. I also suggest that the explanation for the UK’s high house prices is not “simple”, as Prof Coyle claims it is and in particular, her above mentioned “simple” explanation for the problem is badly flawed.
Unlike Prof Coyle I don’t have a “simple” explanation. But there are probably half a dozen factors which have much to do with it, e.g. the following.
1. Population increase which itself is caused largely by immigration.
2. An increase in the number of people who want to and can afford to live alone.
3. The above mentioned artificial restriction on the supply of land with permission for house building.
4. The fall in interest rates over the last 20 years.
5. Increase in the number of interest only mortgages. That increase seems to have more or less come to a halt since the crisis, but interest only mortgages certainly help explain house price increases UP TO the 2008 crisis.
6. The fact that the building industry just cannot be expanded quickly: it takes at least ten years to produce an experienced building site manager.
7. The collapse of social housing construction around 1980.
It’s not at all clear which the main culprits are here, but certainly the UK could make big inroads into high house prices by making more land available for house building.
Tuesday, 20 June 2017
Or so says the author of an article at the “Asymptosis” dated 3rd May. I normally respond to that sort of thing in the comments after the relevant article of course. But comments are closed. I’m fairly sure they were closed shortly after the article was published. So I’ll respond here.
As to who runs the Asymptosis blog and/or who authored the above article, well he or she seems to be very coy about their identity. That, together with the fact of closing comments shortly after criticising someone makes “Asymptosis” look like a bit of a small minded individual.
Anyway…. Asymptosis takes issue with this passage of mine:
“If the private sector’s stock of saving is what it wants at current rates of interest, then additional public spending will push savings above the latter desired level, which will result in the private sector trying to spend the surplus away (hot potato effect).”
Asymptosis disputes that idea and on the grounds that in receipt of extra cash, households will purchase other assets which will drive up the price of those assets. Net result: households’ “cash:other assets” ratio returns to its preferred level. Thus, so Asymptosis claims, there is no long term additional spending effect.
There is however a flaw in Asymposis’s argument: the latter eventual outcome will raise households’ TOTAL asset to income ratio above it’s preferred level. Indeed, that point is implicit in the above initial quote. Ergo household spending will rise in an attempt to revert to the preferred level.
I look forward to a response from Asymptosis. Comments after this article will not be closed for a very long time....:-)
Monday, 19 June 2017
Martin Wolf (chief economics commentator at the Financial Times) seems to have fallen for the above popular mantra in a recent article. He said: “It makes sense to run a still smaller deficit when debt is high..”. Every MMTer knows the flaw in that statement and I’ve explained the flaw in that idea a dozen times on this blog. But I’d do it again. Here goes.
First, while the UK debt / GDP ratio is high compared to RECENT decades it is SMALL compared to what it was in the 1950s. Plus it is small compared to Japan’s debt / GDP ratio. So is the UK debt too large or too small? It’s clear that simply comparing it to recent decades or a few decades earlier tells us ABSOLUTELY NOTHING!!
A more intelligent question is: what basic principles should determine the size of the debt? Well here’s a few ideas on “basic principles”.
The government of a country which issues its own currency does not have a huge amount of freedom of choice when it comes to deciding how much liability to issue in the form of base money and national debt, or “safe assets” as the latter two are sometimes called.
If the private sector has less than its preferred stock of safe assets, it will try to save in order to accumulate the stock it wants, and that is deflationary: it tends to result in Keynes’s “paradox of thrift” unemployment.
Alternatively, if the private sector has MORE THAN its preferred stock of safe assets, it will try to spend away the excess, which is likely to result in excess demand and inflation.
Ergo, if government does not provide the private sector with approximately the stock of safe assets it wants, there’ll be trouble.
But governments do have SOME ROOM for manoeuvre as regards that stock: that is, they can issue or incur a relatively large stock without the private sector being tempted to spend away the excess if the interest paid on that stock is relatively high.
As MMTers keep pointing out, the government of a country which issues its own currency has complete control over the rate of interest it pays on its debt, so an important question is: what’s the best rate to pay? The answer given by Milton Friedman and Warren Mosler (founder of MMT) was “zero”. I.e. they argued that there was no point in government paying anyone just to hoard an excessive stock of money.
Friedman and Moser were right or least nearly right: that is it could be argued there’s a case for paying SOME interest on the debt, but a sufficiently small rate that the REAL or inflation adjusted rate is less than zero. That way government profits at the expense of its so called creditors. I don’t see much wrong with that.
So…to get back to Martin Wolf’s above claim, the important question is not whether the debt is high compared to recent decades, but whether an excessive rate of interest is being paid to those holding the current stock of debt. Well in the case of the UK and most other developed economies the rate is within the bounds suggested above: i.e. above zero but below the rate of inflation. However, the rate is a bit nearer to the rate of inflation than zero, so for that reason I suggest the debt should be reduced a bit. And that is easily done by printing money and buying back some of the debt, while dealing with any inflationary consequences of that by raising taxes and/or cutting public spending.
Sunday, 18 June 2017
Saturday, 17 June 2017
Reasons for the above are as follows.
There’s a currently popular idea which runs thus. Interest rate adjustments are a good way of adjusting demand, but when interest rates are near zero, there is an obvious problem, namely that interest rates can’t be cut (unless negative interest rates are implemented, and it’s widely accepted they’re a bit dodgy).
Ergo fiscal stimulus should be applied so as to raise demand to a sufficiently large extent that central banks have to raise interest rates to damp down some of that demand. Hey presto: central banks can then cut interest rates come another recession.
For an example of that sort of thinking see the second paragraph of an article by Simon Wren-Lewis (Oxford economics prof) entitled “Could austerity’s impact be persistent”. In particular, note this passage of his: “a temporary fiscal stimulus can reliably get interest rates off their lower bound.”
Now there’s an obvious flaw in that argument, as follows.
If fiscal stimulus is a “reliable” way of raising demand, why not just use it to an extent that cuts unemployment to its lowest feasible level (NAURU if you like) and leave it at that? I.e. why implement EXCESS fiscal stimulus so that interest rates have to be artificially raised, which of course means that home buyers have to pay an artificially high rate of interest?
And that is the basic reason behind the idea in the title of this article, namely that home buyers have to pay extra interest on their mortgages in order to enable central banks to implement monetary policy – adjust interest rates, etc.
Having said that, there are a number of possible excuses for the latter bizarre policy, and the pros and cons of those excuses are a bit complicated. However it is argued below that those excuses do not really stand scrutiny. So if you want to just get the BASIC message of this article (as contained in the above heading) then stop reading now.
In contrast, if you’re interested in the latter excuses and some of their pros and cons, read on.
Monetary policy works quicker than fiscal?
If interest rate adjustments worked particularly QUICKLY, there might be something to be said for the above “high interest” policy. But according to a Bank of England article, interest rates take a year to have their full effect.
Another potential argument for the high interest rates is that fiscal changes take too long because they have to wait till politicians have spent months arguing about them before they can be implemented. Well that just ain’t true: during the recent crisis the UK cut and then raised the sales tax VAT and all without politicians (apart from the UK’s finance minister) having a say in the matter.
Put another way, it is perfectly feasible to have an element of variability in SOME tax and public spending items (if not all of them) which can be used in emergency, as long as democratically elected politicians retain the right to determine the proportion of GDP going to public spending IN THE LONG RUN. Plus those politicians have a right to determine what proportion of public spending, in the long run, goes to education, law enforcement, defence, etc.
Another argument against interest rate adjustments is that there is no obvious reason why, given a recession, the cause is inadequate lending and investment rather than a fall in one of the other elements of aggregate demand, like consumer spending or exports. Plus even if lending and investment HAVE FALLEN, they may have fallen for perfectly good reasons. I.e. to justify an ARTIFICIAL cut in interest rates it is necessary to prove interest rates have been boosted for no good reason, that is, that they are ARTIFICIALLY high.
Return to “normal” interest rates?
Yet another argument for raising interest rates is that the current low rates are unusual by historical standards, ergo, for unspecified reasons, we need to return to “normal” rates of interest.
Well a big problem with that idea is that quite possibly the rates of interest that have prevailed for the last century or so have not been normal at all: they’ve been artificially high. And the reason for suspecting that is that interest rates have without doubt been boosted by the vast sums that governments borrow.
And that in turn begs the question as to whether governments ought to borrow. Well Milton Friedman and Warren Mosler (founder of MMT) argued that they shouldn’t borrow. Plus Mosler argued that the natural rate of interest is zero – which if correct, means the current low rates of interest are actually the “normal” or GDP maximising rates. (That’s on the assumption normally made in economics, namely that the GDP maximising price of anything is the free market price, unless there are obvious social reasons for thinking otherwise.)
This is a complicated issue, but I suspect the clincher argument for thinking government borrowing is unjustified is thus.
Government facilitates lending and borrowing.
Government borrowing is effectively just a way of giving people a choice as to how they pay for public spending: that is, instead of everyone paying up front, some people can pay relatively little, and instead, pay interest (via tax) to those who pay MORE THAN their “upfront” amount. (The people who pay more are who buy government debt/bonds).
Thus in effect, government borrowing is a grandiose scheme which enables those with cash to spare to lend to those who want to borrow. But would be lenders and borrowers are free to lend and borrow to each other ANYWAY! So why the need for a special government scheme to facilitate the process?
It could of course be argued that government borrowing makes the latter process easier: it enables lending to take place at a lower rate of interest than would otherwise obtain because government bonds are totally secure, plus government is a very efficient debt collector (collector of debts from those who owe interest / tax). But that efficiency of government relies on the coercive powers that government has: e.g. if government needs to repay its creditors, it can simply grab money by force off taxpayers.
In contrast, those who lend to fund genuine free market loans (e.g. for a mortgage) do not enjoy the same coercive powers. For example a normal creditor can grab property off debtors, but the creditor cannot send the debtor to prison. Nor can a normal creditor grab money off the population at large via tax.
To summarise, government borrowing does amount to a grandiose scheme under which those with cash to spare can lend to those who want to borrow, but there is no justification for that government intervention in the “lending and borrowing” market.