Tuesday, 29 December 2009

Chinese Premier, Wen Jiabao, learns from Goebbles.

Goebbles (Hitler’s propaganda minister) suggested that if you want to tell a lie, tell a whapper – i.e. don't tell a small lie. People often don’t notice “whapper” lies (for very roughly the same reason as they often “can’t see the wood for the trees” - though the "wood and tree" idiom is not quite the right one!).

Wen Jiabao has claimed that efforts by other countries to get China to revalue its currency are an attempt to contain China’s development. Jiabao’s REAL motive for an undervalued currency probably has more to do with the fact that that an undervalued currency puts purchasing power into the hands of the country’s political elite rather than into the hands of its citizens. And politicians in those ironically named “communist” countries have an even bigger distain for ordinary citizens than Marie Antoinette had for HER subjects.

An undervalued currency results in a big build up in a country’s foreign currency reserves, which (big surprise) the elite politicians in the country concerned control. I.e. they can use these reserves to further their political aims (e.g. put political pressure on other countries or buy lots of lovely foreign manufactured military hardware, etc).

In contrast, a currency revaluation puts purchasing power into the hands of ordinary citizens: e.g. it enables them to go on foreign holidays, or purchase foreign produced consumer goods more easily.

And not only that but the idea that a revaluation would stymie China’s development is bunk. China’s development has come primarily from, first, applying Western technology, and second, from its OWN savings (unlike many developing countries, which have relied on FOREIGN capital.) Revaluing would result in Chinese manufacturers selling fewer consumer goods to the US, and more to Chinese citizens. This of itself would have zero effect on Chinese development.

The other very old trick that Jiabao is playing here is justifying his claims by reference to an external enemy.

It’s a pity that China’s leading politician is the same sort of lying shyster as leading politicians elsewhere on planet Earth.

Sunday, 20 December 2009

Prof. Dani Rodik re-invents Selective Employment Tax?

If you’re looking for daft taxes, the so called “Selective Employment Tax” implemented in the UK in 1966 takes some beating. This tax was “selective” in that it was biased in favour of manufacturing and against services.

The rationale was always obscure. Allegedly the UK Labour government of the day was worried about well qualified school and university leavers rejecting manufacturing jobs and taking service sector jobs: like those well paid “service sector jobs” that Labour governments themselves create in ever expanding numbers.

There was also the argument that more manufactured output is exported than is the case with services. Plus there was the argument that output per head expands faster in the long run in manufacturing than in the services sector. Ergo the more manufacturing you have, the faster is economic growth.

The latter argument has re-surfaced in an article on the “Vox” site entitled “Making room for China in the world economy” by Prof. Dani Rodrik. He advocates some sort of bias in favour of manufacturing for China: an over valued currency or some sort of subsidy for manufacturing.

To illustrate the flaw in the above “output per hour” argument, let’s start with a closed economy and consider computing. Output per head in this industry (in terms of computing power manufactured per worker-hour) has expanded by about a hundred fold in the last twenty years. But does this mean that it makes sense for everyone to spend half their income on personal computers?

The latter conclusion is to go back to pre-Say economics. Jean-Baptiste Say’s big insight was that the value of products is determined by what the customer wants to pay for them, not by the cost of production (though doubtless plenty of ancient Egyptians tumbled to this one).

I.e. at the margin, worker-hours should be devoted to producing whatever the consumer pays the most for.

Turning now to open economies, the first problem is that the pro-manufacturing argument applies not just to China, but to half the rest of the world. Now if half (or the whole) of the rest of the world have pro-manufacturing subsidies, the subsidies all cancel out! At least the above mentioned “export” argument is severely dented.

The next flaw in the pro-manufacturing argument is the fact that it measures GDP on the basis of how much is produced as measured in terms of the producing country’s own currency. The big weakness here is that if the currency is undervalued, those doing the production are paid less for their efforts than if the currency had a realistic value on world markets.

To illustrate, revalue the Yuan, and ten million Chinese farmers will be able to purchase the TV set or the PC they previously could not afford. This is because the revaluation will cut exports by Chinese electronics goods manufacturers, thus the latter will look for alternative customers. Plus the revaluation makes the Yuan worth more in terms of dollars, thus these manufacturers are likely to find Chinese farmers’ Yuans an acceptable substitute for US households’ dollars.

Rodik's argument is a good illustration of a common mistake in economics: targeting what is sometimes called an “intermediate objective”. The fundamental economic objective is maximising real wages per hour of work (within environmental constraints). The above argument targets PRODUCTION. Production is not the fundamental objective: the fundamental objective is CONSUMPTION.

As Dani Rodrik points out, his ideas fall foul of World Trade Organisation rules. My answer is that there is method in the WTO’s madness – though doubtless large numbers of unemployables screaming students might beg to differ.

Saturday, 19 December 2009

The Krugman v. Sethi minimum wage argument – let’s all wade in.

There has been an argument over the last week or so between Paul Krugman, Rajiv Sethi and others on the question as to whether cutting minimum wages would boost employment.

Latest to join in is Stefan Karlsson who is definitely not at his best in this post. (S.Karlsson’s best is extremely good.)

Stefan’s first mistake (his 2nd para) is to claim that the idea that minimum wage cuts won’t raise employment is an idea adhered to by present day “leftist” economists. Not true. One of the big contributions to economics made by Keynes and others in the 1930s was to point out the flaws in the “wage cuts raise employment” argument. Nowadays there is widespread acceptance of these flaws.

In his 6th para (“Secondly, even if...”) Stefan seems to say, quite rightly, that wage bargaining is a “zero sum game” between employers and employees in that whatever employees lose by a reduced minimum wage, employers gain.

In his 7th para (“And since income...”) Stefan then claims that lower labour costs in the US will induce foreigners to buy more US produced stuff, hence the minimum wage cut WILL raise employment. But hang on – Stefan has just admitted that wage bargaining is a zero sum game: i.e. the TOTAL cost of producing a widget in the US is not influenced by the proportion of GDP going to employees as compared to that going to employers.

Moreover, even if the above increased demand from abroad DID occur, it STILL would not influence employment in the long run. Reason is that the US balance of payments must balance in the long run. To illustrate with a simple example, assume the US external trade position is exactly in balance immediately before the minimum wage cut. Then the cut takes place, and demand from abroad increases. At some point the US dollar will appreciate, to get the trade position back into balance. That will involve REDUCED demand from abroad for US products and/or reduced exports from the US to elsewhere.

Then in the second sentence of the same para (“And since income...”), Stefan claims that “That same substitution effect would increase demand for products made by American workers by American capitalists”. I.e. “capitalists” have more money to spend, thus they increase demand. But wait a minute – where did these “capitalists” get their extra money from? They got it from employees as part of the “zero sum game”.

Well if “capitalists” spend more because their income has increased, then employees are going to spend LESS because their income has declined, seems to me! Net effect: about zero.

Getting more technical.

Having said all that, there actually IS a mechanism via which a minimum wage cut WOULD raise employment. Very brief and crude exposition of this argument is thus.

Employers raise numbers they employ to the point where the output of the last or least productive person employed equals the minimum wage (or the union wage in a union dominated environment). And no, I’m not confusing micro with macro. Thus if the minimum wage is reduced, employers would expand the numbers they employ.

There is no automatic mechanism here for increasing aggregate demand. But if having reduced the minimum wage, demand WERE increased, then employment would rise.

This wheeze is NOT a cure for the current recession. The problem at the moment is sheer lack of demand. But if and when unemployment reverts to more normal levels, then the above minimum wage point starts to become relevant. That is, it could facilitate an increase in demand with less inflation than would otherwise be the case.

But there is a problem: the above involves people working for a wage that is regarded as unacceptably low on social grounds. Solution: in work benefits, or some form of employment subsidy.

Some ideas on how this might work here. But a better exposition is in the pipeline. Watch this space.

Thursday, 17 December 2009

The “liquidity trap” is bunk, cr*p and drivel all rolled into one.

The New Palgrave Dictionary of Economics starts its definition of the liquidity trap as “A liquidity trap is defined as a situation in which the short-term nominal interest rate is zero. The old Keynesian literature emphasized that increasing money supply has no effect in a liquidity trap so that monetary policy is ineffective.”

Wikipidia’s definition is not much different. It starts thus. “The term liquidity trap is used in Keynesian economics to refer to a situation where the demand for money becomes infinitely elastic, i.e. where the demand curve is horizontal, so that further injections of money into the economy will not serve to further lower interest rates. Under the narrow version of Keynesian theory in which this arises, it is specified that monetary policy affects the economy only through its effect on interest rates. Therefore, if the economy enters a liquidity trap area -- and further increases in the money stock will fail to further lower interest rates -- monetary policy will be unable to stimulate the economy.”

This is all nonsense on stilts. It is clap trap. Do advocates of the liquidity trap seriously think that if every household in the country was given £10,000 in cash there’d be no effect? What do people do when they win a lottery? The average mentally retarded three year old knows the answer that: lottery winners SPEND their winnings (or a sizeable chunk of it). Bryan Caplan makes a similar point here.

So why are many economists incapable of solving a problem that the average mentally retarded three year old can solve? The answer is probably that economists have an interest in NOT solving economic problems. That is, solve an economic problem, and there will be fewer jobs for economists. At the very least, academic economists have an interest in exuding hot air, drivel and waffle: holding on to one’s job as a professional economist requires publishing a certain amount of material per year, even if one has nothing useful to say.

The theologians in the middle ages who argued about how many angels could dance on a pinhead (rather than solve the real problems facing the world they lived in) were similarly motivated. That is, for theologians in the middle ages, arguing about angels and pin heads kept them in food, wine, and shelter.

By way of keeping the debate on the liquidity trap going, economists often point to the fact that Japan greatly increased its money supply in the 1990s to little effect. Well of course there wasn’t much effect: this money supply increase was done via quantitative easing. That is Japan’s central bank gave people cash in exchange for the latter’s bonds. Well what’s the big difference between cash and bonds? Not much. They are both fairly liquid forms of saving. That’s why there was little effect.

Increasing the money supply and giving it all to people who are determined to put it on their compost heap and rot it down into compost will have no effect. But to argue from this that ALL money supply increases have no effect, is clearly nonsense. At least for mentally retarded three year olds, the nonsense is clear enough.

Finally, it should be said that some definitions of the liquidity trap consist of the idea that recessions can persist despite interest rates being zero – in which case fiscal policies are required. That is, some advocates of the liquidity trap are arguably well aware of the fact that printing enough money and dishing it out to households will solve the problem. But I suspect that many of the aforementioned advocates are not aware of this point.

Afterthought (25th Nov. 2010): Nice to see Scott Sumner agreeing.

Tuesday, 15 December 2009

Do Aggregate Demand - Aggregate Supply diagrams mean anything?

Krugman refers to a paper by Gauti Eggertsson. This itself is based on simple Aggregate Demand – Aggregate Supply diagrams: much the same as micro economic supply – demand diagrams for apples, etc.

These AD-AS diagrams appear in many text books but I regard them as meaningless. Will someone please please please explain what they mean?

For example Eggertson says (p.13) “A tax cut shifts down the AS curve. Why? Now people want to work more since they get more money in their pocket for each hour worked.”

This is bunk. First, people in low wage countries work much the same hours as people in wealthier countries, thus in the long run this tax cut will not influence hours people want to work (though there could be a short term temporary effect). Second, assuming the Eggertson exercise is budget neutral, government must make up for the tax cut somehow. For example it may increase indirect taxes. But this puts wage earners back where they started in real terms!

Alternatively the tax cut is NOT budget neutral: i.e. it represents a net increase in the deficit. Which in turn means the real effect comes from the increased deficit.

So what does the AD-AS diagram amount to in this case? NOTHING !!

Does anyone know of any instance in which AD-AS diagrams actually mean anything?

P.S. Thought my suspicious were well founded. See here.

P.P.S. (21st December) This argument is now turning into World War III.

Friday, 11 December 2009

Arnold Kling's brainwave.

Arnold Kling has produced a great idea for producing jobs, as follows.

“Cut the employer contribution to the payroll tax. In the short run, this will reduce labor costs and increase profits. This will lead firms to expand and to raise employment. In the long run, it will lead to higher wages. When recovery comes, you can either bring back the payroll tax or replace it with a less regressive tax.” And that’s it.

Why on earth would increased profits “raise employment”? It is obvious that IF increased profits result from increased orders (i.e. increased demand) then employment will rise. But in this case the increased employment results from the increased demand, not from the increased profits as such.

Put another way, anything with artificially increases profits (like a payroll tax reduction) will have no effect on employment whatever if it does not increase demand. Since Kling does not tell us whether his reduced payroll tax is budge neutral or not, it is entirely unclear as to whether his proposal WILL involve an increase in demand.

Does he understand macroeconomics?

Tuesday, 8 December 2009

Wall Street Journal’s strange choice of blogs.

WSJ staff have been hard at work – at least that’s what they’d like you to think. They probably also want the boss (Rupert Merdoch) to think likewise.

Apparently they have “sifted through the sea of economics blogs and determined the top 25”. Just one problem: the fellow responsible for the blog that comes third from top on their list (Brad Setser) announced his intention to cease blogging on 4th August 2009 (apart from one post on 22nd September). See here.

There is nothing wrong with Setzer's blog. But when you've read a blog and it's several months old, staring at a brick wall becomes relatively interesting by comparison.

Monday, 7 December 2009

Nonsense from the Heritage Foundation.

“What creates jobs? Entrepreneurs with ideas for new or better ways of doing things who successfully put their business plans into action.” At least this is what creates jobs according to James Sherk and Rea Henderman of the Heritage Foundation. You can almost hear the trumpets playing along with the latter answer to the above question, so as to give a general feeling of uplift and gung-ho.

Trouble is, this is all poppycock. To illustrate, we lay bricks nowadays in pretty much the same way as in Roman times 2,000 years ago. But amazingly there are hundreds of thousands of bricklayers employed in the US, and even more throughout the rest of the world: a complete mystery.

In more general terms, it is a moot point as to whether increased efficiency expands or contracts numbers employed in a particular industry. Obviously “better ways of doing things” cuts costs and hence prices. But whether this results in an expansion in numbers employed depends on the elasticity of demand for the product in question.

If demand is relatively inelastic, the decline in numbers employed because of the increased efficiency will outweigh any increase in demand resulting from reduced prices.

These two conservative plonkers also tell us that “As long as entrepreneurs remain reluctant to invest, job creation will lag.” Really? So the fact of investing creates jobs? Fascinating.

Why does the fact of investing in a new car plant increase demand for cars? Darned if I know.

To be fair, a lack of investment COULD be a constraint on economic growth in the US once employment levels get near the 2006-7 levels. This is because the US has slightly REDUCED its total stock of physical investments since that date. But just at the moment, there is any amount of idle plant, machinery, factory and office block ready and waiting to be used.

Sunday, 6 December 2009

Monday, 30 November 2009

Economic illiteracy - from two professional economists.

Gary Becker and Richard Posner, two economists provide some strange analysis of the current recession. They advocate the old myth, which I thought had been disposed of in the 1930s, namely that cutting wages would help raise employment or cure the recession.

The nonsense starts in their para which begins “Keynes and many earlier economists emphasized that unemployment rises during recessions because nominal wage rates...”

The suggestion here is that simple micro economic ideas about supply, demand and price apply at the macroeconomic level. That is the suggestion appears to be that if wages dropped 10% or so, demand for labour would rise 10% or so (assuming for the sake of simplicity that we have elasticities of supply and demand for labour of unity).

This is precisely the idea that Keynes debunked. As he rightly pointed out, if wages drop by X%, this means that demand will drop by significant proportion of X%, since wages are the single biggest component of demand. That means MORE UNEMPLOYMENT at least initially. However, as Keynes righly pointed out, competitive forces will result in employers dropping prices by about X%, which means everyone is pretty well back where they started. Net effect on unemployment: about zero.

The only net effect of the above farce is the Pigou effect. That is the above drop in prices raises the real value of money, which equals an increase in the real value of household savings. This WILL stimulate demand, but as Keynes pointed out, “wages are sticky downwards” thus the Pigou effect takes an unacceptably long time to work.

The other piece of nonsense by Becker and Posner is in their last para where they claim that extra stimulus requires expanding the national debt and that the latter is some sort of problem. This is a much more widely held view than the above “cutting wages” idea.

Well if you want stimulus and you think extra national debt is a problem, then stimulate WITHOUT extra debt. That’s what the UK did in 2009. Magic! How was it done? The answer is that the entire deficit in 2009 (more or less) was quantitatively eased. I.e. the government central bank machine just printed £200bn of extra money.

Of course this involves a NOMINAL debt: an extra £200bn owed by the UK Treasury to the Bank of England. But this is a huge paper shuffling nonsense (the purpose of which is to get round some silly European Union regulations, as I understand it). The government debt or “gilts” in the hands of the Bank of England might just as well be shredded.

For more on this see 13th Oct post below, “£200bn off the national debt.....” and the “Governments should stop borrowing” link top right above.

Wednesday, 25 November 2009

Give us austerity and fiscal rectitude, Miss Whiplash.

There is just one thing wrong with Martin Wolf’s article in today’s Financial Times: the title, which is “Give us austerity and fiscal rectitude, but not quite yet”.

This bolsters the general impression that the tax rises or public spending cuts needed to get the deficit under control will hurt. They won’t, and for the following reason (which is actually a repetition of a point made below in previous posts).

There is no point in fiscal rectitude till it looks as though lack of fiscal rectitude will be inflationary, i.e. until unemployment has fallen, and looks like falling too far too fast.

Assuming the “rectitude” takes the form of extra taxes, this involves taking money from people which they effectively couldn’t spend in they wanted to. That is, if the money was left in their pocket, the result would be inflation which would make them WORSE off.

If financial journalists did a bit more to get this point across to the population at large, that would make it easier to raise taxes or cut public spending when the time comes.

Monday, 23 November 2009

Carry Trade.

The US dollar is currently a bl**ding nuisance for half the countries on planet Earth. Low interest rates and easy money in the US are currently resulting in carry trade which results in dollars flowing into many other countries. This makes it difficult for such countries to maintain the exchange rates they want, and the availability of credit that they want.

But interest rates in the UK are no different to the US. And the amount of quantitative easing in the UK is roughly the same (as a proportion of GDP) as in the US. Yet the British pound is not nearly as popular with “carry traders”. Why the difference?

Possibly the explanation is as follows. Around 99% of the bonds quantitatively eased in the UK are UK government bonds (i.e. “gilts”). In contrast, in the US, the equivalent proportion seems to be about 20%, with the remaining bonds being private sector bonds.

Now there is a difference. The UK policy in effect puts money into the pockets of ordinary UK citizens and businesses big and small. The US policy puts money into the hands of professional investors: rich individuals and institutions.

Now the average UK household and average UK small business is not going to run out and spend its recently expanded bank balance on strange South American shares or bonds. In contrast, professional investors are more likely to.

Put that another way, the US has given professional gamblers more money to gamble with.

Moreover, why does the US have a “Troubled Asset Relief Program” (TARP) – and why do other countries have an equivalent? If some rich individual or institution has made bad investments, then s*d them.

The US should have channelled 100% of stimulus money to Main Street and ignored Wall Steet. If that had resulted in a hundred and bankers and stockbrokers jumping from tenth storey windows, who cares?

In this connection the warning by the IMF that any more handouts for the financial sector could lead to violence looks apt.

Thursday, 19 November 2009

The Washington D.C. baby sitting economy: it suffered a recession and solved it !

In the early 1970s a group of parents with young children in Washington formed a babysitting club. Parents wanting to go out for the evening would get one or other spouse from another family to come and baby sit.

But few people do anything for free in this world, so this club created its own currency, baby sitting tokens. Parents would give one token for each hour’s babysitting to the baby sitter.

But this mini economy ran into a problem: it had a recession! It suffered from relatively high unemployment. What happened was that most couples wanted to keep a stock of tokens to give them the flexibility to go out several times a week without having to baby sit for anyone else.

This lead to a reluctance to baby sit for anyone else because that would mean parting with tokens. And this in turn meant that those wanting to baby sit couldn’t find any customers: they suffered involuntary unemployment.

The solution they came up with was to give their economy some stimulus. They printed and distributed more babysitting tokens (i.e. money). And that solved the problem. Those wanting to baby sit found it much easier to find customers. And those wanting to keep tokens in reserve were happy as well.

Paul Krugman in describing this said “This story tells you more about what economic slumps are and why they happen than you will get from reading 500 pages of William Greider and a year's worth of Wall Street Journal editorials.” (Greider is a former assistant managing editor at the Washington Post).

Wednesday, 18 November 2009

In 1866 US banks thought it would be in their interest to cause a depression, so they did.

In 1866 US banks thought it would be in their interest to cause a depression, so they did.

In 1995-2005 US banks though it would be... etc etc you get the picture.

It would be over simple to suggest the two episodes are identical. But the parallels are thought provoking.

For verification of the 1866 episode see here and scroll down to heading entitled “The Return of the Gold Standard (1866 - 1881).

Tuesday, 17 November 2009

Who are the dummies: the US government or the Chinese?

The Chinese pile up a vast hoard of US Treasuries, which artificially raises the value of the Yuan. This cannot go on for ever. When this process slows down or stops (or horror of horrors, goes into reverse), the US dollar is guaranteed to lose value relative to the Yuan (other things being equal). And then the Chinese complain when this happens!

This is a bit like an alcoholic blaming some else for damage to his liver.

As to the US government, it is equally stupid (thanks largely to “balance the budget” anti-deficit conservative Republicans). Reasons are thus. The recession has occurred largely because of excess debt. People and businesses have learned their lesson and are trying to repay this debt (or “deleverage”). Thus what households and businesses need is dollars with which to repay their debts.

So what does the US government do? Print billions of extra dollars and give it to banks in the hopes that banks will – of all things !!!! – lend it to businesses and households. Just what the latter don’t want !!!

If Laurel was Chinese president, and Hardy was US president, we would have fewer problems.

Monday, 16 November 2009

The WPA has nothing to do with money printing.

Bill Mitchell, Warren Mosler and L.Randal Wray between them have devoted about a million words to advocating WPA type schemes - (WPA was a large scale “make work” scheme set up in the US 1930s). And the above trio claim that such schemes can reduce unemployment to near zero. To a significant extent their arguments are based on the fact that that a country that issues its own currency has more freedom of manoeuvre when it comes to stimulating its economy than a country in a common currency area. That is, the argument to a significant extent is: “the amount that needs to be spent to get a large scale WPA system going is small (or at worst equal to) the amount of extra money that an “own currency issuing” country can print each year, without exacerbating inflation.”

Malcolm Sawyer has attacked the above WPA idea. But there is one flaw in the above argument that Sawyer hasn’t spotted (at least not in the paper you get to from the latter link). The flaw is thus.

Freedom to print money and stimulate one’s economy is not an argument for stimulating it in any particular way, e.g. the WPA way. Indeed, the above trio of authors suggest various other ways of simulating economies using printed money. Thus money printing has nothing to do with the arguments for or against WPA. The question as to whether to implement WPA type schemes is entirely dependent on its merits compared to other forms of employment creation.

Quad Erat Demonstrandum. Or put it another way, the above trio are not grumpy enough – see 13th Nov post immediately below.

Saturday, 14 November 2009

Grumpy People Think Logically !

Australian psychologist, Joe Forgas, has discovered that grumpy people think more logically than others and take better decisions. Well, speaking as a miserable, cynical, anti-social bastard, I always thought I was a cut above the rest of humanity. Nice to have it confirmed.

That’s why I enjoy the dismal science.

Friday, 13 November 2009

The Irrelevance of Bang per Buck.

Economists spend millions every year trying work out how many jobs are created by different forms of spending. They are wasting their time and your money. This subject is of particular relevance just now because according to the Wall Street Journal (as pointed out in the 26th Oct post below) “the Obama administration is searching for ways to boost job growth without adding to the federal budget deficit.” In short, they’ll be looking for bang per buck.

And here is a laborious attempt to calculate bang per buck from a couple of years ago (thanks to George Washington for this link).

In an economy where those in charge understood economics, bang per buck would be irrelevant. Of course the reality is that we live in a world where leading politicians do not understand some of the basic ideas in economics, like the difference between macro and micro economics. That is, we live in a world where leading politicians think that government budgets work the same way as household budgets.

Given this ignorance, it is probably inevitable that bang per buck will have to be considered. However, assuming an ideal world where politicians understood economics, bang per buck is irrelevant for the following reasons.

There is only ONE ultimate cost: a labour. To illustrate, the cost of any product is made up of labour, machinery, materials, etc. But the latter machinery and material costs themselves break down into - yes, you guessed it - labour, machinery, materials, etc. Work your way back far enough and there is only one cost: labour.

Thus it makes little difference how a given amount of money is spent - the number of jobs created will ultimately be much the same.

Counting entrepreneurs as “labour”.

Having said all that, I have to confess to using the word “labour” in a broader sense than normal. It is widely recognised in economics that GDP can be broken down into three elements: labour, interest and profits. Labour normally takes about 75% of the cake. In saying above that there is only ONE ultimate cost, labour, I am counting the “wage” of entrepreneurs (i.e. profits) as a form of labour. And I’m counting the rewards for money lenders, i.e. interest, as the “wage” of money lenders, or banks. In short I am using the word “labour” in a broader sense than is normal.

However, the vast majority of entrepreneurs don’t just sit around all day letting the profits roll in. Most are hard working “labourers” much like their employees. As to money lending, the bulk of the cost here again does not involve rich individuals sitting around while the interest rolls in. The bulk of the cost is made up of very mundane items like maintaining bank buildings, and employing people to check up on the credit worthiness of potential borrowers.

And finally, for those who don’t like the idea of counting profit and interest as labour, this objection won’t get you anywhere because there is no reason to assume that the profit and interest content of what seem to be “good bang per buck” areas of the economy are any different to poorer bang per buck areas. Put another way, instead of saying, as above, that 100% of the ultimate cost of everything is labour, I just change my argument to saying that about 75% of the ultimate cost of everything is labour.

Back to the main argument.

Getting back to the main argument, I’ve hopefully established that the number of jobs created by a given amount of spending is much the same regardless of what form the spending takes. But even if the number of jobs are NOT the same, bang per buck is still irrelevant. This is because inflation only becomes a problem when unemployed has dropped far enough (dropped to NAIRU to use the technical acronym – Non Accelerating Inflation Rate of Unemployment). And if a particular form of spending does NOT create many jobs, then it is not inflationary, which in turn means the relevant government or central bank can just print more money and spend it so as to create more jobs. Alternatively, if a government does not want to print more money, it can go for the Keynsian “borrow and spend” option.

The important point here is that advocates of bang per buck are attempting to get what they see as “value for money”: i.e. lots of jobs for a given cost or sacrifice. The flaw in this argument is that printing money (or borrowing and spending) are not a REAL cost, assuming the exercise is done responsibly. (Of course when lunatics like Robert Mugabwe gain control of printing presses, then there is a real cost for the country concerned). But printing extra money to lubricate an economy does not cost in real terms when it is done responsibly.

In the words of Edward Lazear, chairman of the President’s Council of Economic Advisers in a recent Wall Street Journal article, “Historically, recoveries have a consistent pattern: productivity grows first, then jobs are created, and finally wages rise.” I.e. wages (and thus inflation) do rise significantly till unemployment has fallen to too low a level.

It can of course be argued that there are factors contributing to inflation other than labour shortages. For example inflation can rise simply because of inflationary expectations, that is inflation can be a self fulfilling prophesy. But governments can only act on the basis that the population will not make silly self fulfilling prophesies. If the population does make such prophesies, then too bad. Government would then have to rein in demand, and force a period of relatively high unemployment until the “prophesy” madness abated. Arguably Paul Volcker spent a fair amount of time doing just this.

It can also be argued that when an economy is near capacity, it is not just labour shortages that cause inflation, but also material and equipment shortages. In answer to this I would cite the fact that the official unemployment figure in Switzerland in the 1960s dropped to zero on two occasions. Thus it looks as though material and equipment shortages do not become serious till unemployment reaches very low levels.

Moreover, material or equipment shortages can be alleviated, often as not, by importing the necessary stuff.


Another area where the “bang per buck is all nonsense” argument might seem to go astray is where a form of spending involves a large import content. In this case many of the jobs created will be abroad. On the other hand, this just depresses the value of the currency of the country concerned relative to other currencies, which in turn brings extra orders for exports, which in turn creates jobs.

Employment subsidies.

Another very different area where “bang per buck” is a nuisance is subsidies. Subsidies can be divided into two types: marginal and intra-marginal. The former subsidise just the additional units produced as a result of a subsidy – an example of this is the “tax credit” idea currently doing the rounds in the US: the idea that firms should be subsidised in proportion to the number of ADDITIONAL jobs they create.

In contrast, intra-marginal subsidies aim at ALL members of a particular category of labour (or ALL units produced, if it is a physical product that is subsidised). For example the UK used to subsidise all labour in high unemployment areas in the UK. And for another example, most agricultural subsidies subsidise ALL wheat, potatoes, etc produced.

Now intra-marginal subsidies appear to involve a large amount of waste in that taxpayer money assists the production of stuff that would have been produced anyway (or employees who would have been employed anyway). However, this is not a waste in REAL TERMS. It is simply money going round in circles.

To illustrate, if a government subsidises all cars produced, this government first has to tax citizens. Then it gives the money to car manufacturers (or dealers), which reduces the price of cars. Which makes cars cheaper for citizens (who funded the subsidy in the first place!).

Of course this exercise does have an element of real cost: bureaucrats are needed to collect the tax, distribute it to car dealers, etc. There is also possibly a real cost in that the relative price of different products have been distorted. But apart from that, there is not much of a real cost involved.

Wednesday, 11 November 2009

Rubbish Ideas From The Earth Institute, Columbia University.

Director of The Earth Institute, Jeffrey Sachs, thinks he has the solution to US unemployment. His ideas are set out in the Financial Times, 11th November, under the title “Obama has lost his way on jobs”. The latter title, pretty much a statement of the obvious, is the only thing right with this article.

Sachs’s first solution to unemployment is increased exports. Well, the dollar depreciation is already doing this to some extent, as he points out. But he wants to boost this with “government support for export financing, for example extended to credit-constrained low-income countries”. So he wants to pay other people to buy US goods, or lend them the money to buy US goods. Pure genius!

This idea has great possibilities. For example, are you looking for work? Then why not lend some employer the money to pay you your wages? There has to be a catch in this idea, but I’m darned if I can spot it.

Sachs’s second brilliant idea is a “massive expansion of education spending and job training”. Well if inadequate training is a bar to full employment, how come the US had more or less full employment between say 2000 and 2005? After all educational standards were not significantly different then to now. Current standards of education and training are clearly not a bar to full employment.

This is not to deny the possibility that educational standards should be higher. Calculating the optimum amount to spend on education is not easy, but if it can be shown that more education pays for itself, then go for it. But this has little to do with the sudden rise in unemployment over the last two years. And it has equally little to do with the question as to how to get those people thrown out of work back into jobs as quick as possible.

Incidentally, when looking at studies into the question as to whether more education pays for itself, be VERY WARY of the large number of totally useless studies around which fail to control for the social background of those studied. I’ll explain that. Many if not a majority of studies into the benefit of university education simply look at the better pay that graduates get, compared to non-graduates and base their calculations on this. Unfortunately, graduates tend to come from stable and/or middle class family backgrounds, and people from this sort of background tend to earn decent salaries EVEN IF THEY DON’T GO TO UNIVERSITY.

So: studies which don’t control for social background are useless. But such studies keep hundreds employed at the taxpayers’ expense. I’d prefer to have people dig holes in the ground and fill them up all day long: at least the fatuousness of the latter is obvious and out in the open (in more than one sense).

Returning from fatuous educational institutions in general to a specific and not entirely un-fatuous educational institution, namely Columbia University, Sachs’s third brainwave for employment creation is investment in low carbon gismos and paraphernalia, plus infrastructure (roads, rail, etc).

Well obviously we need to go for low carbon energy production. But this tends to be high tech: it’s production requires a fairly narrow range of skills, and creating those skills takes time. Doubtless more people should acquire these skills. But this relatively small sector of the economy on its own will have a negligible effect on total unemployment.

As for infrastructure projects, these take years to plan, and cannot be simply turned on and turned off willy nilly. It seems that Sachs has not heard of the phrase “shovel ready”, in which case he should not be writing on this subject.

Saturday, 7 November 2009

Calmfor’s Iron Law of Active Labour Market Policy.

Amongst the billion words of hot air a day that is written on economics worldwide, it is worth remembering the basic laws of economics. Some are as beautiful and simple as E=MC2.

Lars Calmfors is a Swedish economist whose main interest is labour makets. His iron law of Active Labour Market Policy (ALMP) refers to a characteristic of make work schemes, like the WPA that operated in the United States in the 1930s.

The characteristic or problem with these schemes is that if people are attracted to these schemes by generous pay or conditions, their motive to search for regular work is necessarily reduced.

Assuming unemployment is anywhere near NAIRU, the effect of this reduced aggregate labour supply will be inflationary, which means that demand will have to be reduced, which in turn means that the jobs created by the make work scheme will be, at least to some extent, at the expense of regular jobs.

Alternatively, if people are coerced into joining make work schemes because of what might be called a “workfare” sanction, their job search efforts are not reduced, thus the jobs created by the make work scheme have a better chance of not being at the expense of normal jobs.

Of course to get this beneficial effect, the make work employment must not hinder the job searching. But the majority of job changers in the US find (or at least used to find) their new jobs before leaving their old jobs, so job searching at the same time as working cannot be too difficult.* Also the actual time so called job searchers spend looking for work per week is minute: no excuse for taking the entire week off.

And that is the “iron law”: attract people to WPA type schemes by generous pay etc, and the price will be that these jobs are at the expense of normal jobs.

* J.P.Mattila produced evidence on the proportion of job changers finding their new job before quitting their old job: “Job Quitting and Frictional Unemployment”, American Economic Review, March, pp. 235-39.

Friday, 6 November 2009

Quantifying the effect of QE is pointless.


Hundreds of economist and commentators are spending valuable time and your money trying to work out the effect of Quantitative Easing. They are wasting their time. The reason is thus.

QE is taking place at the same time as a budget deficit in the UK. As it happens the size of the deficit in the UK in 2009 is roughly the same as the amount quantitatively eased.

The budget deficit consists of the following. 1, government borrows money from the private sector, 2, government gives private sector Gilts in return, 3, government spends the money. As to QE, this consists of reversing items 1 and 2. So the only net effect is 3: i.e. “print money and spend it”.

Now the effect of 1 and 2 are hotly debated. The majority view amongst economists is that when government borrows and spends, the effect is reflationary or “stimulatory”. But there is a significant minority view that this policy “crowds out” private spending or investment, resulting in a feeble or non existent stimulation.

As to QE, the effect of this is also hotly debated. For example it can well be argued that the effect is around zero because people or institutions holding Gilts regard this chunk of their wealth as SAVINGS. Thus the fact of turning these Gilts into cash will not result in a spending spree.


As pointed out above, in a “deficit plus QE” scenario, these two paras cancel each other out. The question everyone should address is what is actually happening, namely “government prints money and spends it”.

Is anyone interested in the latter reality, or do you prefer arguing about how many angels can dance on a pinhead?

Wednesday, 4 November 2009

100% full employment?

The idea that government act as Employer of Last Resort (ELR) has been around for centuries, and numerous attempts have been made to implement the idea.

For example there were the work houses of the 17th, 18th and 19th centuries and the WPA in the United Sates in the 1930s.

Those currently keen on the idea include, 1, Warren Mosler, 2, Bill Mitchell and 3, L.Randal Wray. (Note: the three sites that these links lead to are far from being the only works on ERL produced by these authors).

Some trenchant and valid criticisms of ELR have been made by Malcolm Sawyer (1). However Sawyer confines himself to pointing to weaknesses in ELR without remedying those weaknesses. The paragraphs below do a bit of "remedial work".

Those advocating ELR normally assume that the work concerned should be public sector, and on the grounds that such work seems to be non inflationary because no addition to demand is required. Indeed, I don’t have much of a quarrel with Warren Mosler’s claim that ELR can in theory produce 100% full employment (with the emphasis on the "theory"). Though it would be near impossible to guarantee meaningful work for all in a small towns where one dominant employer went bust.

But there a couple of catches.

First, those doing this sort of work will tend to be relatively unskilled, plus they will turn over relatively quickly (if they are to be as available for the regular jobs as when unemployed). And if those doing this work have none of the usual associated factors of production ( permanent skilled supervisory labour, capital equipment, materials, etc) their output will be hopeless. (Hence the nickname the WPA acquired: “we piddle around”).

On the other hand if they DO have significant associated factors of production, this makes the scheme inflationary for much the same reasons as imposing extra demand on the private sector is inflationary. Indeed, ASSUMING WE DO A LIKE FOR LIKE COMPARISON BETWEEN PUBLIC AND PRIVATE SECTORS, there is no difference in the inflationary impact of the two sectors.

To illustrate, assuming an economy is at NAIRU, why is an expansion of the private hospital sector liable to be inflationary? Because it involves extra demand for various skills that are in short supply: doctors, nurses, architects to build more hospitals, labour to make specialised medical equipment, etc etc. Now assume a similar expansion of the public sector hospitals: EXACTLY THE SAME EFFECT !!!

So how come ELR can, at least in theory bring 100% full employment? Well it’s not because the employment is public sector: it’s because ELR (assuming for the moment no associated factors of production) involves, 1, creating jobs where those concerned are as available for normal jobs as when unemployed (i.e. aggregate labour supply is not reduced), and, 2, no additional demand for skilled labour is involved.

Now can't the private sector create jobs with the above two characteristics just as well as the public sector?

Conclusion so far: it doesn’t look as though the above preference for the public sector holds much water. Indeed there is much to be said for private sector ELR work because the private sector is better at employing unskilled labour than the public sector.

The second catch.

The second catch is this. If ELR has a small amount of associated factors of production, output will still be hopeless. But if it has lots of these factors, ELR becomes little different from an existing regular public sector employer. Indeed, and to put this another way, if the output of ELR people is to be maximised, they need to be found jobs in "institutions" or "firms" where the ratio of different factors of production is the same as obtains with normal employers. And what are these "institutions"? Well they are (to all intents and purposes) normal employers! (And NOT specially set up schemes like the work houses or WPA.) Put that another way: why make a distinction between "institutions" that employ ELR labour and normal employers?

So what “relatively unproductive” jobs are there that existing employers might create? Well, it’s not too difficult: sub minimum wage jobs. This is not to suggest that the take home pay per hour’s work of those involved should be below the legal minimum. The point is that for every employer, “employees” are a resource, which like every resource, involves diminishing returns.
That is employers are happy to pay for labour down to the legal minimum, the union wage or whatever. But most employers can perfectly well create further employment (i.e. sub minimum or sub union jobs) as long as employers themselves don’t have to finance such employment (or at least pay the full bill for same).

Do we want relatively unproductive work?

The answer is possibly yes, and for several reasons. 1, it might reduce the bill that taxpayers’ pay to support the unemployed. 2, Second, it is not clear that because employers pay little or nothing for an employee, that the latter’s output is worthless, and this is for two reasons.

First, advocates of more public sector goodies (public health care etc) have never argued that because customers do not pay for the product at the point of delivery, that therefore the output is worthless.

Second, imagine employment is a little above NAIRU. Why are consumers not prepared to pay for the output of those who would find employment were unemployment reduced to NAIRU? Well it’s clearly not because consumers regard such output as worthless: when consumers have the funds, they DO PAY for this output. The reason consumers are’nt prepared to pay for this output is that they CANNOT AFFORD IT because of inadequate aggregate demand!

As to the hoary old myth that people would be better off training than doing low grade work, evidence from round Europe doesn’t support this. That is, the evidence is that, at the margin, subsidised work produces better subsequent employment histories than training. Or to put in plain English, learning by doing is better than many of the half baked training schemes on offer.

1. Employer of Last Resort: Could It Deliver Full Employment and Price Stability?
by Malcolm Sawyer 2003 Journal of Economic Issues, Vol. 37, 2003.

Sunday, 1 November 2009

The deficit terrorists are getting uppity.

“Deficit terrorist” is a phrase used by Warren Mosler to describe someone who disapproves of deficits. DTs have been getting uppity in the last week or so.

Disapproval of a deficit is justified if it can be shown that the deficit concerned is likely to do harm – inflation being the usual “harm”. And certainly some deficits have been a disaster. The UK’s “Barber boom” around 1972 is a famous example: it lead to rampant inflation.

But to prove that a deficit is likely to be inflationary, one must give evidence that the deficit will result in excessive demand. And excessive demand means employers being incapable of meeting demand because of skilled labour shortages, etc. However, the DTs who have been vociferous recently have not only failed to demonstrate this. They don’t even seem to be aware that they need to shown this.

The DTs I have in mind are Stefan Karlsson (Oct 28th post) who endorses a Bloomberg article by Matthew Lynn. The main reasons given by the latter for withdrawing stimulus in the UK are thus.

1. The UK’s National Debt has expanded at an unsustainable rate and needs to be curbed.

Answer: The UK’s alleged National Debt increase is largely a myth – it’s a mirage because the apparent expansion in the National Debt in 2009 is approximately equal to the amount quantitatively eased.

I’ll expand on that. Governments borrow to spend. This involves, 1, cash moving from private sector to government, 2, gilts moving the other way, 3, government spending on usual items government spends money on. Quantitative easing involves reversing 1 & 2. Thus the only net effect is 3.

In short, the increase in the National Debt is largely money owed by the government to the Bank of England. As I pointed out under “200bn off the National Debt at a stroke!” below, this is a bit of a nonsense: it’s a bit like saying your left hand pocket owes your right hand pocket some money.

This is not to deny the possibility that the money printed (at at least some of it) will have to be reined in. It probably will. Nor is this to deny that there is a structural element to the deficit. WHEN the economy recovers, and not before, this structural element will need to be dealt with.

Also, the UK’s debt has not increased in the most serious sense of the phrase, that is indebtedness to foreigners: far from it. Foreigners seem to have reduced their holding of UK National Debt in 2009.

2. Lynn claims the deficit hasn’t worked. Well that’s very hard to prove or disprove. He seems to be making this claim because the UK economy has’nt bounced back to health just yet. Well I would argue that the deficit HAS worked in that had it not been for the deficit, things would be far worse.

3. Lynn deplores the fall in the pound and claims the government should support the pound on the grounds that “A modern, advanced nation can’t devalue its way out of trouble. The idea that the U.K. is going to suddenly build lots of factories that compete with Eastern Europe and China on price is ridiculous. Britain can export plenty of things, but they are high-end, design and technology.....”

The truth is that the UK like every developed economy produces a whole range of goods and services from the very low tech to the ultra high tech. Tourism is one of the UK’s main foreign currency earners (as it is for many developed economies). Now running a hotel is not advanced technology.

4. Lynn claims the UK should cut taxes on businesses. It is a popular myth that low taxes for businesses benefit business (particularly in a country that issues its own currency). Obviously the initial effect of increasing taxes on business drives some businesses under or drives them out of the country. But that leads to unemployment. Which induces governments to do what? Increase demand, of course. And given a free market, this will drive up the rewards for entrepreneurship relative to the rewards for “employeeship”. Put it another way, assuming the post tax rewards for employership relative to employeeship were optimum before a tax increase on businesses, then this ratio should return to optimum after the tax increase if market forces are working.

Stephan Karlsson (30th Oct post) opposes the stimulus because “it is unsustainable and could create negative after effects.” In support this argument, he cites “cash for clunkers”.
Well there is a world of difference between a government deficit, which is macro economic, and cash for clunkers which is concerned with just one industry, and which is thus largely micro economic.

And it is certainly true, as he points out, that the increase in car sales while the clunker scheme is in effect, will be approximately matched by a fall in car sales when the scheme is withdrawn.
But the answer to this is that a well designed clunker scheme will boost car sales during the worst of a recession and will only hit car sales when the economy recovers: that is, when a fall in car sales is not so much of a problem.

Karlsson also claims that clunker schemes result in the destruction of cars which are economically viable. True. But it replaces them with better fuel consumption cars, which is a plus for the environment.

Having said that, I agree that clunker schemes are pretty stupid. Where the problem is macro economic, subsidising a specific industry is a nonsense.

As to a government deficit (macro economic), what are the “negative after effects”? Ideally there won’t be any.

UK households seem to have decided that the debt binge of the last decade was a bad idea and are now saving as never before. If this means a permanent reduction in household debt/increased desire to save then some or all of the additional money that government has printed can just be left in households’ bank accounts.

Alternatively, if the deficit results in too much economic expansion in six months or a year’s time, then deflationary measures will be needed.

Knowing whether to impose deflationary measures, and if so, when and by how much is a HORRENDOUSLY difficult question. But if the authorities get this right, there won’t be any “negative after effects”. And if government get it wrong, and we do have “negative after effects” what does this prove: that we should do nothing about recessions, and endure a decade of catastrophic unemployment like the 1930s?

And finally, please note that Stefan Karlsson’s blog is normally brilliant. This is the first time I’ve disagreed with him.

Wednesday, 28 October 2009

Start your own bank !

Adam Posen, new member of the Bank of England monetary policy committee, has written a paper claiming that the UK stimulus cannot be withdrawn till UK banks are fixed. He also claims the UK relies too heavily on a small number of large banks and that the latter do not serve small and medium enterprises well when these banks are in trouble.

This is a thoughtful, “plain English” and easy to read paper. But I disagree on two points.

One point missing, as far as I can see, from his paper is that the dominant position of large banks will be reduced automatically, as long as government abstains from giving these banks more than the bare minimum needed to prevent them collapsing: no special intervention from the authorities is required to bring into existence an increased number of small quasi-banks.

There has been evidence over the last year of an increase in the extent to which non bank firms have been lending direct to each other, rather than using banks as middle men. If the middle men are incompetent, why bother with them?

Also there is evidence of more wealthy individuals taking an interest in firms in their immediate neighbourhood, rather than putting money into City of London or Wall Street institutions possibly hundreds of miles where these individuals live. Some point applies: if those working on Wall Street and in the City are Madoffs, “inside traders” and sharks - why bother with them?

Private individuals and non bank firms cannot create money in the same way as the commercial banking system does. If more financing is to be done by the former, rather than by the latter, a bigger monetary base is required, which is what quantitative easing has produced. Thus Posen’s claim that the stimulus will be withdrawn at some point could be wrong: possibly the increased monetary base, or some of it, should remain.

Taxpayer support given to banks should NOT be whatever is required to get them back to where they were pre-crunch. It should be just enough to make sure the country’s money transfer system does not collapse. Having done that, the question as to whether banking activity is conducted by large banks or, at the other extreme, by butchers, bakers and candlestick makers should be left to market forces. Unfortunately this is not what seems to happening in the US: that is, the large institutions seem to be getting preferential treatment.

As to Europe: much the same story.

Monday, 26 October 2009

Obama and David Cameron are clueless.

Obama wrestling with jobs outlook” is a headline in the Wall Street Journal, 23rd October 2009. The article below starts, “....the Obama administration is searching for ways to boost job growth without adding to the federal budget deficit.”

God give me strength. How’s he going to do that? It would be easier to make pigs fly.

And David Cameron, leader of the Tory Party and the UK’s chief economic illiterate, claims that the value added tax cut earlier this year was a bad idea because it added to the deficit! Well running a deficit in a recession is the right thing to do. Cameron has learned nothing from Keynes or the 1930s.

This is very elementary, but a “job” is an activity that involves person X producing something because person Y is prepared to pay for the “something”. If all the “Y” people are saving, rather than spending (which they are at the moment) that means no jobs (or at least a shortage of jobs). Solution: print money and give it to “Y” people – well, every household to be more realistic.
Yes, I know there is an inflationary danger. But the world economy has been blown off course.

When you’ve been blown off course you have to make a correction. You may undercorrect or overcorrect. It would have been far better not to have had to make any correction, but we are where we are. We have to attempt a correction. Doing nothing, or doing far too little is fatuous.

One problem is that the deficit so far, roughly $1.4trillion for the year ended 30th Sept 09 in the US, pales into significance compared to the loss of worth in household balance sheets over the last two years, roughly $10trillion. In short, if another $1trillion was printed and handed to US households, they would still be feeling poor compared to two years ago. But this trillion might improve their cash positions enough to induce the required reduction saving and increased spending. (That’s saving of money, as distinct from saving physical goods or similar assets – two very different things).

On the other hand Janet Tavakoli spells out some good reasons for thinking a further two or three trillion are needed (number of households under water, etc) Bizarrely she claims this cannot be done because the US got cannot borrow this much more. Janet: it doesn’t have to: it can just print the stuff!!!!! Yes, that could be inflationary: every six year old knows that. And its very difficult to know how much to print. But the point is that “borrowing” is not a constraint.

And finally, if there is one thing a government ought to be able to do in a recession it is to maintain employment in areas where it has direct control, e.g. in central and local government. But the US government (doubtless like many other governments) hasn’t even managed that!

As I said: God give me strength. Now I’m off to tear my hair out.

Tuesday, 13 October 2009

£200bn off the National Debt at a stroke!!!

Gordon Brown recently announced a £16bn sale of public assets to reduce the National Debt. Pathetic !! It would be easy to wipe ten times that much (or even more) off the ND at a stroke. Here's how.

The total amount that has been quantitatively eased in 2009 is about £200bn (a bit under that figure, actually). And 99% of what has been quantitatively eased is government debt, i.e. gilts rather than private sector bonds.

We are thus now in the strange position where the “government” (an entity owned by the people) owes the Bank of England (another entity owned by the people) around £200bn. This is as nonsensical as saying I am in debt because my right hand pocket owes my left hand pocket some money.

This means there is a very simple way of knocking £200bn off the National Debt: tell the Bank of England to shred all the gilts in its possession. Yep, it’s that easy. It’s a bit like saying “I’m abandoning this silly business of right hand pocket owing money to right hand pocket, and instead I’ll go for a more rational book keeping system”.

Once the governor of the Bank of England has been forced (at gunpoint if necessary) to shred his gilts, there remains the £200bn or so of monetary base added to the economy in 2009 which of course is potentially inflationary. It would certainly be wise to rein in this money by means of increased taxation (and/or other deflationary measures). But there is yet more good news to come on this tax front. Indeed, this news is as miraculous as the £200bn wiped off the national debt, and it is thus.

There is no point in reining in the above money until it looks like causing inflation. Thus the tax needed to do this is not a tax in the normal sense of the word, i.e. something that makes one worse off. The “reining in tax” simply takes money away from people which, were they to keep it, would actually make them WORSE OFF because it would cause inflation.

So there you have it. £200bn wiped off the national debt with the outstanding problems solved by means of a tax which isn’t really a tax.

I could patent this idea and demand a 1% commission from government for using the idea, which would make me £2bn better off. But I haven’t got time to get down to the patent office.

Saturday, 10 October 2009

Was Abraham Lincoln right about money?

Abraham Lincoln said, “"The government should create, issue and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers. By adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity."

Many economists have expressed similar sentiments (see “References” below). The sentiment, to put in economics jargon, is that fractional reserve banking should not be allowed, or at least that the “fraction” should be much more tightly controlled. That is, the monetary base (i.e. central bank created money) should make up a much larger proportion of the money supply, with commercial bank created money playing a smaller role.

The main advantage to this change is that it would ameliorate the extent to which the money supply varies in a pro-cyclical manner. That is, during booms, commercial banks create more money – just what is not needed. And during recessions, they extinguish money - again, just what is not needed.

This is not to say that this change would do away with economic cycles. The velocity of circulation of money can vary dramatically, thus even where one had for the sake of argument, an absolutely constant money supply, cycles could and probably would still occur. But at least the above system would help iron out the cycles.

Would this change do away with bank failures? No. There is nothing to stop a bank making silly loans under this different regime. But this regime would at least reduce the incidence of bank failures. Bank failures occur to a significant extent because of bubbles: i.e. commercial banks make loans, which boosts asset prices, which makes hitherto apparently risky loans look less risky, thus banks make further loans and create even more money, etc.


Henry Simons, Irving Fisher, and Frank Knight in the 1930s: (See p. 9)

Milton Friedman (See 4th para)

American Monetary Institute.

Wednesday, 7 October 2009

Stabilising Aggregate Demand.

Booms and recessions have followed one another for thousands of years. Certainly ancient Rome had a nasty credit crunch.

There shouldn’t be a problem with organising a constant level of demand from the public sector. Any competent government ought to be able to spend almost exactly the same amount, in real terms or money terms, year after year. Indeed any competent government ought to be able to do vastly better than this and have public spending vary at least to some extent in a counter cyclical manner.

Unfortunately during the 2007-9 recession governments have proved somewhat incompetent in this regard. That is, some governments seem to be under the illusion that just because their income from tax has declined, that therefore they need to cut their own spending. These governments need to go back and re-study basic economics. US government employees (federal, state and local) declined by 130,000 between September 08 and September 09.

In contrast to the public sector, organising a constant level of demand from the private sector is much more difficult: for example consumers have a habit of suddenly going wild with their credit cards for no obvious reason. Alternatively, (as in 2009) they suddenly do the opposite: start saving as never before. Or it’s South Sea Bubbles or tulip mania.

And then there are stock market and house price changes. When these rise, household balance sheets improve, which induces households to spend.

So how do we organise a more constant level of demand from the private sector? Well, we need a tax (or subsidy, come to that) which can be altered relatively quickly. The UK government did this in 2009 when it reduced Value Added Tax. An alternative, suggested by Winterspeak is to vary payroll taxes. (See Winterspeak's 15th and 16th Sept 09 posts.)

A problem with the two latter is that what economists call the “incidence” of the tax falls partially on employers. For example, reduce VAT, and while employers will to some extent pass on the reduction in the form of lower prices, that is not where all the reduction goes: that is, employers will to some extent pocket the reduction. And the problem with this is that employers are not the ultimate source of all demand. The ultimate source of all demand is the consumer. That is, ideally, all stimulus money needs to go directly to the consumer’s pocket.

Another problem with the above two measures is that consumers probably notice a change to their monthly income more quickly than they notice a change to the price of goods resulting from a VAT change. Thus ideally it is consumers’ income that needs to be changed.
In the UK there are three levers government could pull that would immediately change consumers’ income. 1, the state pension. 2. Pay As You Earn income tax deduction that is made from most wage earners’ wage packets. 3. Employee National Insurance contributions.

A fourth possibility is the vast array of other state benefits (e.g. for the unemployed, the temporarily sick and injured, etc). The problem here is the temporary nature of these benefits. That is, sorting out any mistakes or problems in respect of changes to someone’s state pension is probably easier than doing the same in respect of someone’s unemployment benefit. This is because a pensioner is, as it were, constantly in touch with the state via the pension system. In contrast, an unemployed individual is in contact with the relevant part of the state for a limited period. Any mistakes would involve re-contacting the individual, which could be administratively expensive for the state compared to sorting out a problem with a pensioner.

Sunday, 4 October 2009

Banks aren't lending - so what?

Why on earth do governments, having prevented a total collapse of the bank system, want to rely on bank lending to stimulate our economies?

The basic purpose of preventing a collapse of the commercial bank system was to prevent a collapse of the money transmission system (an essential “utility” service, much like electricity or water distribution). That is, the basic purpose was to make sure wage and salary payments, for example, continued to be made, and to make sure household savings accounts did not disappear into thin air.

But there is no need to give the idiots and fraudsters running large banks more than is needed to enable them to continue this basic service. Give them more than this, and they’ll probably just revert to what they’ve been doing for several decades: throwing billions down the drain, if no trillions. The “Savings and Loan” fiasco of the 1980s and 90s cost the US taxpayer over $100bn. The large US banks were essentially bankrupted by the 1980s Latin American debt crisis (see 5th October post at "Washington's Blog"). And now the 2007-9 credit crunch has knocked how much of world economic output: 5%? That is more trillions gone west.

Having given the above bare essential stimulus to banks, all further stimulus should be channelled to the source of all demand. Which is? . . . . .the consumer! Some of us were saying this a year ago: e.g. me, Winterspeak, the IMF (p.6, section 16), Simon Jenkins, James Surowiki, etc.

But senior politicians in charge of large government departments probably think that no one can do anything unless they are (like themselves) in charge of something big (like a government department or a large bank). Well senior politicians need to understand that the average convenience store owner has just as much business sense than the average finance minister.

And the evidence supports this, in a way. That is, small banks have done relatively well during the credit crunch. And in Europe, some firms (with no experience whatsoever of banking, but with cash to spare) have in 2009 increased the extent to which they play the part of banks, for example lending to other firms which they know to be sound businesses.

In a free market, the most efficient should be allowed to expand and on occasions drive the less efficient out of business. If an engineering firm in Detroit is a better judge of the creditworthiness of other engineering firms in Detroit than banks, then banks should under no circumstances get preferential access to taxpayers’ money designed to encourage loans to firms in Detroit.

Another reason politicians may have preferred to give money to millionaire bankers rather than to the peasantry is that what might be called the “informal” banking system that “peasants” would come up with, given half a chance, would probably require a bigger monetary base than the existing “big commercial bank” system. This is because the large commercial bank system can effectively print money. That is, it can build a very large “pyramid of credit” or “pyramid of printed money” on a relatively small monetary base.

Engineering firms in Detroit cannot do this. But this is no reason not to allow engineering firms in Detroit to play the part of banks. Creating monetary base does not cost anything in real terms. Also, while increasing the monetary base may be inflationary OTHER THINGS BEING EQUAL, the effect will not be inflationary where the monetary base is increased because engineering firms in Detroit genuinely NEED that monetary base to engage in banking activities. In short, politicians may be reluctant to allow engineering firms to play the part of banks because politicians fear that the increased monetary base needed will be inflationary. These politicians are wrong.

Saturday, 3 October 2009

Recessions get rid of lame ducks?

Those opposed to the measures being taken to deal with the 2008-9 recession sometimes claim that recessions are desirable in that they get rid of uneconomic firms, or “lame ducks”. An example of this flawed idea appears in a blog by Dr Madsen Pirie of the Adam Smith Institute.

There are two reasons for discounting this idea: one theoretical and one empirical. Taking the former first, if a firm has gradually declining profits or mounting losses, closure or bankruptcy is inevitable at some point, even given no recession. As to empirical evidence, this very much backs up the theoretical point. That is, during recessions, bankruptcies do rise, as would be expected. But they don’t multiply by ten or a hundred. They rise by fifty percent or in relatively bad recessions double or treble. But that’s it.

Friday, 2 October 2009

Let's ditch Keynes and monetarism.

Summary. It is evident from the long running “Keynes versus monetarist” argument that the effect of either policy alone is uncertain. Thus when attempting to stimulate economies we should employ a policy which is neither purely Keynes nor monetarist, namely unfunded deficits (exactly what has taken place in 2009). Conversely, when trying to dampen economic activity with a view to controlling inflation we should go for the opposite of unfunded deficits, that is a government surplus with no corresponding change to tax or borrowing.


The large amount of money printing that has taken place in 2009 has severely dented the idea that an increase in government spending necessarily has to be matched by increased borrowing or taxation. Hopefully this idea has not only been dented, but has been sunk once and for all.

The amount of money printed by the Bank of England is equal to the amount “Quantitatively eased”.

This money printing has been something of a last resort, or a desperate reaction to the severe recession of 2007-9. In fact, this policy makes good sense, even in more normal times. Plus, when governments want to dampen economic activity with a view to controlling inflation, the opposite of money printing, i.e. “money extinguishing” makes good sense.

Plain straightforward government spending with not tax or borrowing to fund the spending (i.e. money printing) is monetarist in that it increases the money supply. It is Keynsian, in that it constitutes an “injection”, or a net addition to aggregate demand (in exactly the same way as a sudden rise in exports raises aggregate demand).

The reason this policy makes sense is that it is both Keynsian and monetarist. Given the long running disagreement between Keynsians and monetarists, the effect of either policy alone is uncertain. Thus the effect of a policy that involves both philosophies should be more certain.

Of course there is ONE HUGE PROBLEM with this “neither Keynsian nor monetarist” policy: hundreds, if not thousands of economists have been kept employed over the decades at your expense and mine arguing about the finer points of the Keynes versus monetarist argument. These people are not going to relinquish this big source of employment lightly. If you earn a living arguing about how many angels can dance on a pinhead, then the last thing you will ever admit is that angels cannot dance on pinheads.

Another apparent problem is the inflationary consequence if government does not clamp down as soon as the additional money supply looks like causing excessive inflation. This is a bit like arguing that the power of car engines should be reduced to one percent of their present level, which would mean cars would be unable to move, which in turn would dramatically reduce car accidents. The big problem here is that this safety policy nullifies the whole point of car engines: making cars move.

Put another way, the effect of Keynsian borrow and spend (per pound of spending) is certainly less inflationary than that of an unfunded deficit. But this is hardly a merit. The whole point of stimulatory or reflationary policy is to stimulate or reflate. The benign inflationary effect of Keynsian borrow and spend (if the effect is benign) is simply a reflection of its ineffectiveness per pound of spending.

Put that another way, when aiming to stimulate an economy by a given amount, the total amount of additional spending under an unfunded deficit regime should certainly be less than under a Keynsian B&S regime, because the former is more potent. But it is false logic to call the former more inflationary. The inflationary effect of the two policies is probably much for a given amount of stimulation, or per additional thousand jobs created.

And finally, the potential inflationary effect of an unfunded deficit is pretty much the same as the potential inflationary effect of a sudden rise in export orders: both involve increased spending, and using money that has so to speak come from nowhere. There are few complains when export orders rise.

Thursday, 1 October 2009

No one understands quantitative easing.

Or at least the standard explanation as to how quantitative easing works is flawed.

Summary. The standard explanation as to why quantitative easing (QE) works ignores the crucial difference between QE given constant national debt, and QE given rising national debt. The standard explanation seems to assume the former (not relevant in 2009).

Given constant national debt, obviously QE puts liquidity into the hands of banks, pension funds etc., plus it reduces interest rates. In contrast, there is QE accompanied by Keynsian “borrow and spend” which is what has actually taken place in 2009. In this circumstance, trying to work out the effect of QE alone is pointless because all QE does is to reverse two of the elements of borrow and spend. These two elements are, 1, “cash moves from private sector to government”, 2 “government issues gilts to the suppliers of the cash”. The NET effect of borrow and spend plus QE is simply “government prints money and spends it”.

The latter certainly should be stimulatory for the economy as a whole, but the stimulation will NOT come from increased lending by banks, which is supposed to be the effect of QE. The simulation comes from increased spending by government and consumers.


. First, a few words about the terminology used below are required. When referring to government debt, I’ll use UK parlance, i.e. “gilts”. The equivalent in the US is “treasuries”. Also, QE can consist of buying private sector bonds as well as public sector bonds (i.e. gilts). In practice, in 2009 the Bank of England’s QE has consisted almost exclusively of buying gilts. So to keep things simple, I’ll refer just to gilts and won’t mention private sector bonds from now on.

The standard explanation of QE runs approximately as follows. Central bank prints money and uses it to buy gilts from those in the habit of holding same (banks, pension funds, wealthy individuals, etc). This raises demand for bonds, which reduces interest rates, which should boost aggregate demand. Also those in receipt of this cash will tend to buy other assets, e.g. houses or shares which boosts the housing market and stock exchange. Net result: a boost for the economy.

The problem with this explanation is that it is only a partial view of what has happened in 2009 (certainly as far as the UK is concerned). The whole picture is thus (in bold italics).

In 2009 some countries, including the UK, have substantially increased national debts at the same time engaging in QE.

This is a different kettle of fish to QE alone. With a view to gleaning the net effect of this exercise, let’s look at the various movements of money, government bonds and so on with a view to working out the crucial factor: the NET effect of the above (“increase national debt plus QE”).

Take the “increase national debt” first. Governments go into debt to acquire funds to spend on health, education and the usual public sector items. Or they go into debt because they want to maintain spending despite a fall in tax revenue (e.g. because of a recession).

Increasing national debt consists of the following three movements of cash and gilts. 1. government / central bank machine (gcbm) sends gilts to those willing to purchase same. 2, the latter send cash in return to pay for the gilts. 3, gcbm then spends the cash on education, health etc, thus the money ends up back in the private sector.

As for QE, this simply consists of reversing items 1, and 2 above. Hey presto, the NET effect of “increased national debt plus QE” is just item 3: gcbm printing money and spending it on education , health, etc. At least this is the case to the extent that the total amount of QE is is the same as the rise in the national debt, which in the case of the UK it is approximately (see second graph here).

To repeat, gcbm printing money and spending it on health, education etc is the only net effect. So why do we hear so much technical “City of London” stuff about QE making markets more liquid, reducing interest rates, when the only net effect is “print money and spend it”?

Moreover, QE has had less effect than anticipated: banks who have been in receipt of the proceeds of QE have not spectacularly raised the amounts they are willing to lend. Hardly surprising ! This NET effect does not have an obvious effect on bank behaviour.

The net effect of Keynsian “borrow and spend” i.e. the effect of a rising national debt is to place additional gilts into the hands of those in the normal habit of holding gilts (pension funds, banks etc). In other words the effect of “borrow and spend” is amongst other things to induce banks etc to lend to government. Having done that, banks will not then be falling over themselves to lend even more!

Thus the main effect of QE is arguably just to reverse the crowding out effect. It doesn’t give banks a big incentive to increase lending to businesses.

If the above argument is correct (a very moot point), then it is hardly surprising that the effect of QE has been not as anticipated. Again, on the assumption that the above argument is correct, QE plus "Borrow and spend" WILL have reduced the severity of the recession, but it will have done it via a general stimulation of the economy, including putting more cash into consumers' pockets. It will NOT have done it, and clearly has NOT done it via more bank lending.

Wednesday, 30 September 2009

Has the Fed lost a trillion dollars???

The US central bank (the Federal Reserve - the Fed) has printed a trillion extra dollars in 2009 to ease the credit crunch. But who got the money? Well, seems the Fed - or at least some very senior people at the Fed - er - don't know. See this five minute video clip.

There is also the tricky question as to which illegal activities the Fed has engaged in. The Fed's own attorney is (quite understandably) a bit coy on this issue. See this five minute video clip.

Tuesday, 29 September 2009

National debt is not a burden.

The leading article in today’s Times (London, 29th Sept 2009) trots out the old myth that the national debt will be a constraint on future economic growth and living standards. The article is entitled “An Economic Account”. Sometimes this nonsense takes the form of phrases like “a burden on our children”, and the idea is popular in Tory Party circles.

This blog is not the only work to claim that the national debt is not a burden. Others have made the same point and readers may prefer these other explanations. One is offered by Mark Harrison (Prof of Economics at Warwick) - see his 14th Jan post "Three Myths of the Credit Crunch". Another is offered by Samuel Brittan: The Myth of Taxpayer Cost.

The first somewhat awkward fact that advocates of the “burden” idea must face, is that the national debt is an ASSET so far as those who own government debt are concerned. Put that another way, government debt arises when governments decide to fund their spending by borrowing from a section of the population instead of taxing the population at large. In short, government debt is effectively a debt owed by one section of the population to another.

But exactly and precisely the same thing goes for mortgages (or other debts): the total of all UK mortgages is effectively “a debt owed by one section of the population to another”! But no one seems to regard mortgages as a constraint on economic growth.

Of course not all UK national debt is owned by Brits: about 20% is owned by foreigners. Now 20% is not a big proportion. Moreover Brits own a fair amount of foreign government debt, thus these two roughly speaking cancel out.

What exactly determines economic growth?

The factors that influence or promote economic growth and living standards are well known. Probably the most important is technological improvements. Now how exactly does the fact of one section of the population being indebted to another slow the pace of technological improvement? It doesn’t ! There is next to no cause – effect relationship here !

Another important determinant of economic growth is the standard of education. But this again is almost completely independent of the extent to which one lot of Brits owe money to another lot of Brits.

Another important determinant is labour market efficiency: again, nothing to do with indebtedness !

I’m not saying national debt is good.

Far from it. In this blog I argue that governments should stop borrowing: not because it impoverishes us, but because government debt is about as pointless as farting into cash dispensing machine. Government debt does not do much good. It doesn’t do a huge amount harm either: it’s just a waste of time and bureaucratic effort.

Whence the claim that debt is burden?

Presumably the argument is that government will have to spend taxpayers’ money on debt repayment and interest: money which could have been spent on health, education, etc. Therefore the population allegedly gets less lower grade hospitals and schools (or has to pay more in taxes, which reduces take home pay).

Well the flaw in this argument has already been more or less spelled out above. Payment of interest and capital repayments are just transfers from one section of the population to another. There is precisely and exactly no effect on the living standard of the population as a whole (except for the point made here namely that government debt is essentially a huge paper shuffling exercise which absorbs bureaucrats’ time.)