Saturday, 31 December 2011

Unproductive employees.

As unemployment declines, the suitability of each succeeding person hired for vacancies also declines. That is because the fewer the unemployed, the less the likelihood of finding someone suited to any given vacancy.

In other words, as unemployment declines the marginal product of labour also declines.

When “suitability” declines to the point where the output of those hired does not cover the minimum wage / union wage / going wage, etc etc, employers tend to resort to consciously or unconsciously poaching each other’s staff. The result is that the price of labour is bid upwards, and inflation kicks in.

The latter problem could be ameliorated by inducing employers to take on relatively unsuitable staff with the assistance of a subsidy.

As to how to identify the “unsuitable”, that is not too difficult. Just let employers claim the subsidy in respect of any employee/s they like, but for a limited period. On expiration of the subsidy for any specific individual, if the employee is GENUINELY unsuitable, the employer will be happy to let them go. In contrast, if the allegedly unsuitable employee is in fact relatively productive, the employer will keep the employee and will be bluffed into paying the full wage.

There are numerous ways employers could game that system, but its not too difficult to think of anti-gaming rules to counteract the gaming.

P.S. 15th Feb. More discussion of the above idea here.


Friday, 30 December 2011

Malcolm Sawyer and government as employer of last resort.

Internet discussion about having government act as employer of last resort (ELR) has flared up in the last week amongst advocates of Modern Monetary Theory. So I thought I’d set out a brief summary of a paper by an opponent of ELR: Malcolm Sawyer (Prof of economics at Leeds University in the UK).

His paper is 14,000 words, so some people might prefer something a bit shorter: the summary below is about a tenth as long. This summary is bound to be inaccurate in some respects. Don’t expect perfection on this blog.

The headings below are the actual headings used in Sawyer’s paper. After each point, I’ve put a brief comment of my own.

Functional Finance and ELR.

i) The value of output from ELR jobs is inherently low, because given full employment, a range of “normal” or regular jobs would exist which are regarded as being more worthwhile than ELR jobs. I.e. given full employment a proportion of (or all ELR) jobs are abandoned, and the relevant labour moves to regular employment.

My answer to that is: “OK, but ELR jobs are still arguably better than nothing.”

ii) Sawyer then divides unemployment up into the usual categories, frictional, structural and demand deficient. Plus he makes the conventional point that where demand deficient unemployment is at a minimum (or if you like, at “NAIRU”), frictional and structural factors are the obstacle to further unemployment reduction. That is, employers cannot find the skill mix they want.

This means that if ELR is used to deal with unemployment when unemployment is a NAIRU, then ELR has a skill mix problem.

My answer to that: “True. That’s one reason I advocate offering the unemployed temporary subsidised places with EXISTING employers, rather than ELR.” See here.

Finance and Money.

i) Sawyer sets out one of the basic ELR claims that used to be put by advocates of Modern Monetary Theory (though they’ve gone quite on this point in recent years.) This is that the costs of ELR can be funded essentially by printing money, and then controlling inflation by the sale of government bonds. But as Sawyer rightly points out, the money printing idea leads to a never ending expansion in the amount of “money plus bonds” relative to GDP, which is unsustainable.

ii) Sawyer’s next point, to quote, is “…why restrict the form of government expenditure in this way?” In other words if employment can be expanded simply by printing money, why not print money and use such money to create extra regular or normal jobs?

My answer: “Good point. In other words, the whole idea that money printing can fund ELR is nonsense, as advocates of Modern Monetary Theory now seem to have conceded.”

Costs of ELR proposals.

i) Under this heading Sawyer points out that some estimates of the cost of ELR include just the cost of labour! He claims that the costs of materials, capital equipment and permanent skilled labour are likely to double the costs.

My answer: “Good point.”

ii) Sawyer then gives another reason for costs being underestimated, namely that ELR would actually draw people into the labour force.

My answer: “What of it? This involves employing those who have given up looking for work, and are thus not classified as “unemployed”. There is nothing wrong with employing members of this “hidden unemployed” category.”

Are the Jobs Available?

i) Sawyer claims that ELR jobs need to be jobs which “do not require much skill or which use skills which are widely available in the population (e.g. literacy, ability to drive). Second, the job leads to the production of useful output, but the output is not necessary in that the output is only forthcoming when aggregate demand is low and the ELR jobs are required. Even work on capital projects (which has often been used to provide jobs at times of high unemployment) would not fit the ELR requirements. Apart from logistical problems of speeding up or slowing down capital projects depending on the state of aggregate demand, much of the work on capital projects is skilled work for which wages are usually significantly above the minimum wage. Jobs such as those in education, health service, personal social services, and care would not be good candidates for ELR jobs. Such jobs may well provide valuable public services and could be expanded as part of mainline public expenditure. But they do not provide examples of jobs which can be undertaken at the basic wage and only undertaken when there is a low level of demand in the economy, generating requirements for ELR jobs.”

My answer: “Good point.”

ii) Sawyers says, “ELR jobs have to be provided virtually instantaneously, for if they are not then someone requiring an ELR job would be unemployed (in reality if not in name). If the capital equipment, material inputs, and supervisory labour for a job are not immediately forthcoming (or standing idly by), then this job cannot be "switched on" to meet ELR job requirements.” And having capital equipment and skilled labour “standing idly by” is a waste of resources.

My answer: “Good point. That’s one reason temporary subsidised jobs with existing employers are better than ELR: the capital equipment (and skilled labour) is already there.”

iii) Next, Sawyer says “an ELR job which did draw on material inputs to a significant degree would generate demand (for those materials) in the non-ELR sector.”

My answer: “Quite right. And that’s one flaw in the claim that ELR is non-inflationary. Or put another way, to create ELR jobs with any sort of respectable output, materials and capital equipment have to be withdrawn from the regular economy. The advocates of ELR never quantify this destruction of regular employment when computing the output of ELR jobs: they just sweep this problem under the carpet.”

iv) Next, Sawyer points to the fact that unemployment can be particularly high in particular geographical areas, or suddenly rise in such areas because of the closure of a local large employer. As he points out, while there may be an argument for having a SMALL proportion of the population doing ELR type work over the country as a whole, having a LARGE proportion doing same in high unemployment areas would tend to result in pointless types of work.

My answer: “Valid point.”

ELR, Underemployment, and Unemployment.

i) Sawyer claims that if the wage on ELR type work exceeds the value of the output on such work, then the relevant employees are making a “net claim” on the rest of the economy.

My answer: “Not a good criticism. The alternative is to have the relevant people unemployed, in which case their “net claim” is probably LARGER!”

ii) Training. In the para starting “To illustrate the significance of these figures…” Sawyer gets the point (not appreciated by many ERL enthusiasts) that there is clash between on the one hand the relatively fast turnover of the unemployed and presumably equally fast turnover of ELR employees, and on the other hand, the requirement that any half decent training on ELR schemes has to last for a considerable or specific period. That is, money spent on a training course that pupils abandon half way thru, is money that is largely wasted.

This deficiency has been substantiated by empirical studies done around Europe over the last twenty years which shows that straightforward subsidised work produces better results than training on ELR schemes.

iii) Next, Sawyer points to the fact that ELR employees have to be available at a moment’s notice for mainstream jobs, which would lead to inefficiencies on ELR projects.

My answer: “True, but that is not a desperately strong criticism since peripheral or relatively unskilled employees in mainstream employment also tend to leave at a moment’s notice.”

ELR, the NAIRU, and Inflation.

i) Where ELR is voluntary, its attractions for those partaking must be superior to the attractions of unemployment. Ergo the RELATIVE attractions of regular employment are reduced. To this extent, NAIRU under ELR (sometimes called NAIBER) will be higher than in the absence of ELR.

My answer: “Correct. I tumbled to this point decades ago as did the Swedish labour market economist, Calmfors, who entitled the effect “Calmfor’s Iron Law of Active Labour Market Policy. The only way round this problem is to introduce what might be called a “workfare” element into ELR: i.e. “do this job else your unemployment benefit gets cut”.


Monday, 19 December 2011

Vickers does not separate safe from unsafe bank activities.

Roll of drums, fanfare, etc. It’s just been announced that the Vickers proposals on banking are to be implemented in the UK. And everyone thinks that safe banking activities will be separated from unsafe activities. Well people believe whatever they’re told, I suppose.

Vickers actually puts both risky and non-risky activities inside the much vaunted “ring-fence”, when the whole object of the exercise is to separate the two.

For example, it is generally thought that money deposited in banks by small depositors like you and me should be 100% safe (though that idea is flawed, as I’ll explain below). So these deposits are inside the fence. But so too are loans to small and medium size enterprises: clearly not an entirely safe activity! But it gets worse. The report is not even clear on whether deposits from and loans to large companies should be inside or outside the fence. (1st paragraph on p.12).

Or as Jill Treanor, the Guardian’s City editor put it, “The commission is vague about whether banking to large companies should be in or outside the ring-fence.”

If Vickers & Co could not make up their mind on that basic and simple point, why did they even publish their report?

Loans and equity: how different are they?

As regards separating so called investment banking from other bank activities, there is another problem, which is that the line between “investing” in a company and “lending” to a company is very blurred. To illustrate, a loan which is last in line for reimbursement in the event of bankruptcy and/or where the so called interest is related to profits is very close to “investing” i.e. taking an equity stake. Lawyers will have a field day here.

So it’s no surprise that there is an article on the Legal Recruitment site entitled, “Vickers review puts lawyers centre stage”.

Or as Martin Jacomb, former chancellor of the University of Buckingham put it in the Financial Times, “The ring-fencing proposal involves much detailed regulation.”

Why did Vickers get in this muddle?

Why, if the object of the exercise is to separate the safe and risky, does Vickers mix them up inside their famous ring fence? The explanation lies in a piece of economics which the Vickers & Co clearly did not grasp. And this revolves round what they call “trapped deposits” (e.g. see p.277). I’ll explain.

Deposits, or at least some of them, need to be safe. At the same time, lending out money is clearly not 100% safe. Thus there is an absolutely fundamental conflict between safe deposits and lending.

If one solves this problem with excessive restrictions on the types of loan that banks can make with “safe deposit money”, the relevant money is liable to become what Vickers calls “trapped”. And this, according to Vickers, would reduce the supply of credit (paragraph A3.29).

Well obviously it WOULD reduce the supply of credit, all else equal. But (and this is the point that Vickers does not get) if restrictions are put on the way money can be used, there is nothing to stop a central bank / government expanding the money supply to compensate for this.

Indeed, central banks have massively increased the supply of central bank created money (monetary base) in response to the crunch. Perhaps Vickers & Co weren’t aware of this.

But that all raises a question, namely what is the point of expanding the money supply and then putting restrictions on how money can be used? Answer is that it enables us to get a clear distinction between money that is supposed to be 100% safe and money which the possessor of said money wants to have invested, and which in consequence is not 100% safe: exactly what Vickers & Co aim to do but fail to do.

Or in the words of Mervyn King, “If there is a need for genuinely safe deposits, the only way they can be provided . . . is to insist such deposits do not coexist with risky assets”.

Quite right. I.e. what we need is a system under which those who deposit money in banks have a choice. If they want 100% safety, that’s fine: but they cannot at the same time reap the benefits of having their money invested in a less than 100% safe manner. That involves a free lunch, and someone somewhere pays for that free lunch: cross subsidisation is involved.

Alternatively, if depositors want their bank to lend out their money, nothing wrong there. The money is being put to good use, so depositors can get a decent rate of interest. But they cannot at the same time ask for 100% safety. And since their money has been locked up in some business or a mortgage, they cannot ask for instant access to their money either.

We have a choice. Face reality, which will dispense with cross-subsidisation. Or second, we can live in la-la land where we indulge in the belief that we can have our cake and eat it. But the result is cross-subsidisation.


Saturday, 17 December 2011

Peter Schiff, Paul Krugman, and the baby-sitting co-op.

Peter Schiff, the well known loudmouth tries to refute the idea behind Paul Krugman’s baby sitting co-op article. (Hat tip to Stefan Karlsson.)

Schiff begins with about twenty or thirty insults before getting to the crux of the argument. That together with Schiff’s loud and excitable voice makes me suspect that Schiff’s real skill is getting drunk and picking fights with fellow drinkers, rather than economics.

Schiff then claims the babysitting coop failed because too many coupons were issued: complete nonsense! At least there is nothing in Krugman’s article about the co-op failing for this reason. (Although the average mentally retarded six year old has doubtless worked out that if excess amounts of money/coupons are issued, there will be a problem, i.e. inflation.)

Schiff then claims that a fundamental flaw in the baby sitting co-op is that baby-sitting hours are priced the same regardless of whether it’s a weekday, weekend, New Year’s Day, etc etc. Perhaps Schiff or anyone else can explain why this “same price regardless” system applies to millions of products in every economy round the world, and without any big problems.

Of course “price discrimination” as economists call it, and as is explained in introductory economics text books, makes sense and is profitable for vendors as long as the administration costs are not too high. But this discrimination is not essential for an economy to function.

The one area where Schiff is half right is his claim that escaping recessions that result from bubbles simply by printing money will lead (if history is any guide) to another bubble sooner or later. Problem with that argument is that most of the human race have worked that one out, and no thanks to Schiff: that’s why we are busy tightening up bank regulations! Doh!

To spell that out in detail for the benefit of people with Schiff’s non-existent knowledge of economics, it was excessive and irresponsible borrowing that contributed to (or were the basic cause of) the credit crunch. Hence the need for tighter bank regulation.

But then it is precisely right wingers, like Schiff who tend to oppose more regulation, and left wingers like Krugman who tend to back tighter regulation.

The irony will be way above the head of Schiff the loudmouth.


Correction, 18th Dec: Krugman’s Slate article DID SAY that the co-op issued too many tokens, but DIDN’T SAY that the co-op collapsed for this reason.


Friday, 16 December 2011

Economics Professors who don’t realise central banks can print money.

This might sound bizarre, but there are numerous so called professional economists who don’t understand that central banks can print money.

To be more exact, these economists, if asked “Can central banks print money?” would probably answer “Yes”. But they then proceed to write articles based on the assumption that central banks CANNOT print money. It’s weird. (I’ll deal with their articles in detail below.)

Indeed, Modern Monetary Theory (MMT) is little more than an attempt to push the above point, namely that given excess unemployment, it’s a good idea for a government / central bank machine to print money and spend it. As Abba Lerner, arguably the founding father of MMT rightly pointed out, “Fundamentally the new theory, like almost every important discovery, is extremely simple. Indeed it is this simplicity which makes the public suspect it as too slick......What progress the theory has made so far has been achieved not by simplifying it but by dressing it up to make it more complicated and accompanying the presentation with impressive but irrelevant statistics.”

Quite. In addition to the “public”, universities are full of academics who won’t believe anything unless a hundred words are used where one will do. Those academics don’t like simple solutions to problems: that might put them out of work. And their own job security takes precedence over reducing unemployment or reducing poverty.

Article No 1: Financial Times leader.

This leading article in the FT argues that Britain’s debt ought to be reduced, or at least the rate of increase slowed down. And the reason given is old shibboleth that doing so impresses “investors” (3rd para) and enables Britain to borrow at relatively low rates.

As regards borrowing and spending for stimulus purposes what's the problem if "investors" don't want to lend? Whence the assumption that a monetarily sovereign country needs to borrow when it can perfectly well print money? See what I mean? The article assumes it is not possible to print.

As Keynes and Milton Friedman pointed out, a deficit can be funded EITHER by borrowed OR printed money.

And as regards the structural deficit/debt, much the same applies: that is a monetarily sovereign country can just print its way out of trouble. Of course the printing could prove too inflationary, but that’s no problem: all that is needed is some sort of DEFLATIONARY measure, like increased taxation, to counter the inflationary effect. Net effect: zero. That is, the debt comes down, while demand and employment remain unaffected.

2. Jeffrey Sachs.

At the end of the second paragraph of this article by Sachs, he claims, “Keynesian thinking presumes that the financial markets will readily buy government bonds to finance the stimulus.” Complete bo**ocks! Keynes made it perfectly clear that deficits can be funded EITHER BY BORROWED OR PRINTED MONEY!!!!!

Re Keynes, see 2nd half of 5th paragraph here.

And Sachs was the youngest ever “Professor of Economics” at Harvard. Apparently studying economics is not a requirement for the latter post.

3. Willem Buiter.

In this article, Buiter makes the bizarre claim that “The U.S. like every country that has independent monetary authority, when it has an unsustainable fiscal situation, has two options. One is default, right, and the other . . . . is inflation.

Bo**ocks again! There is a third option: just stop borrowing and go for whatever combination of 1, increased tax / reduced public spending, and 2, printing is suitable.

Buiter is actually half aware of the fact that central banks can print when he says, “Permanent monetisation of the vast deficits anticipated in the US and the UK would be highly inflationary.” Well of course! But that’s just a man of straw argument. It takes the print idea to an absurd extreme.

In contrast, the above mentioned COMBINATION of printing and tax increases would not, if implemented in a competent manner, cause excess inflation.

4. Jared Bernstein.

In this article, Bernstein claims, “As I’ve stressed throughout, debt is not just important—it is an essential tool of economic growth.”

NO IT IS NOT. Friedman set out a monetary system in which there is NO GOVERNMENT DEBT AT ALL!!!!!!! Warren Mosler advocates a similar system.

Re Friedman, see paragraph starting “Under the proposal…” (p.250) here.

Bernstein sits on the Congressional Budget Office's advisory committee, but as far as I can see from the summary of his career on Wiki, he has never studied economics. As I said above, a knowledge of economics does not seem to be an essential requirement when appointing people to jobs where you’d think a knowledge of the subject is essential. And the poor and unemployed pay a heavy price for this.

Bernstein incidentally also trots out the old myth that if government makes worthwhile investments, that justifies the borrowing needed to fund such investment. Bo**ocks again. Bernstein needs to read a paper by Kersten Kellermann on this subject.


Afterthought – 17th Dec.   Re the final paragraph above, perhaps I should have added that the most fundamental reason that any entity borrows to make an investment is that it does not have the necessary cash available. E.g. if you want a £15k car and have well over £15k in the bank it probably won’t make sense for you to borrow £15k.

And governments have an almost limitless source of cash available: the taxpayer. Thus the most basic reason for borrowing to make an investment does not make sense in the case of governments. But of course there are other relevant points to consider, as Kellermann explains. 

Afterthought (22nd Dec). There is another example of the “central banks can’t print” thinking in an article by Robert J. Samuelson in the Washington Post.

Samuelson is not a professional economist, but he is influential all the same. He claims in his article that “Standard Keynesian remedies for downturns — spend more and tax less — presume the willingness of bond markets to finance the resulting deficits at reasonable interest rates.”

Afterthought, 6th March, 2012. Here is another example of a “Prof.” claiming that government must either borrow or tax in order to spend. It’s John Cochrane, professor at the University of Chicago Booth School of Business.

See paragraph starting “But where did the money come from?


Thursday, 15 December 2011

Draghi believes in the confidence fairy!

Contratulations to Andrea Terzi for highlighting the fact that Mario Draghi, president of the European Central Bank believes in the confidence fairy. He also seems to believe (equally ridiculous) that Europe can export its way out of trouble.

For the uninitiated, the “confidence fairy” is a somewhat sarcastic name given to a common belief amongst economic conservatives, namely that a stiff dose of fiscal responsibility will result in such a surge of confidence in a country, that its problems will be solved in short order.

Yes, you can see the beneficial effects of the confidence fairy in Greece – I don’t think.

But it gets better: Draghi also thinks employment will rise in Europe if Europe becomes more competitive. Er . . . that will just destroy jobs elsewhere in the world won’t it? Or more likely, the result of increased exports from Europe to the rest of the world will raise the value of the Euro relative to other currencies which will bring trade between Europe and the rest of the world back into balance. The words “back”, “where” and “started” spring to mind.

Still, if you are captain of a sinking ship, I suppose you have to sound cheerful. Though what good that does, God knows. Being realistic would do more good, I’d have thought.


Wednesday, 14 December 2011

The Fed made a profit out of TARP?

The crooks and swindlers that make up the elite in the U.S. like to claim that the Fed made a profit out of TARP. The claim is of course nonsense. But it’s important to be clear as to why.

The institution which issues a nation’s currency – i.e. the institution which has the right to engage in seignorage – can hardly avoid making a profit. That is why – gasps of amazement – it is profitable to turn out one’s own $100 bills, £20 notes, etc.

Even if one only LENDS OUT bundles of $100 bills at interest, rather than turning them out and refusing to ever take them back, there is still profit to be made on the interest. And that is where part of the Fed’s “profit on TARP” comes from.

However, the money lent out could equally well have been lent to households, small businesses, local government, etc etc. Thus the fact a profit was made by lending TARP money to large banks and the well-connected is not a justification for lending to banks and the well connected.

PLUS, the money lent out under TARP was lent at a ludicrously low rate of interest: a huge misallocation of resources.

Indeed, the fact that central bank makes a so called profit from lending is not even an argument for lending, since the money created could just as easily be spent directly into the economy: on education, infrastructure, etc. Alternatively, the new money could be used to reduce taxes.

This raises the question as to what is the best way to allocate “new money”.

The new money CAN BE USED to increase lending. For example, the new money itself can be lent out, as was the case with TARP. Alternatively the new money can be used to ENCOURAGE new lending: by reducing interest rates or implementing QE.

But whence the assumption that economic expansion is best implemented via more borrowing rather than a straight increase in spending? Do the authorities (or the crooks and swindlers) ever have any EVIDENCE that increased borrowing is preferable to a straight increase in current spending? Of course not: most of them are too stupid to realise that the question even needs asking.

Moreover, a straight increase in current spending will AUTOMATICALLY lead to increased borrowing and investment where those concerned think borrowing and investment is warranted. Firms making widgets are far better judges of whether it makes sense for them to borrow and make an investment than the crooks, swindlers and morons that make up the elite.

And it’s not just the PRIVATE SECTOR than can decide for itself when investment is warranted: public sector entities like local government or highway authorities are equally capable of making “borrow and invest” decisions.


Tuesday, 13 December 2011

Modern Monetary Theory in England 1,000 years ago?

There is some dispute as to EXACTLY what Modern Monetary Theory (MMT) consists of. But I’ll assume it’s the idea that in a monetarily sovereign country the government / central bank machine can simply create money and spend it into the economy as appropriate (and do the reverse if inflation looms).

This idea seems to have been in operation in England in the 1,100s. See 5 minutes into this video clip:

This piece of history also supports Chartalism. Chartalism (if I’ve got this right) is the idea that the state’s money derives its value and dominance from the fact that the state imposes taxes, which are payable only in the state’s money. Thus private sector entities HAVE TO get hold of the state’s money in order to pay taxes.


Monday, 12 December 2011

MMT and Positive Money ideas in the Financial Times.

Letter in today’s Financial Times which is very much in line with Modern MonetaryTheory (MMT) and Positive Money’s ideas, namely that in a recession the government / central bank machine should simply create new money and spend it into the economy (and/or cut taxes).

The letter goes off the rails at one or two points, I think, but it’s good to see MMT and Pos Mon ideas out there.

In contrast to the above ideas, the authorities’ response to a credit crunch brought about by excessive and irresponsible borrowing was to cut interest rates and implement QE so as to encourage more borrowing. You couldn’t make it up, could you?


Sunday, 11 December 2011

Bank subsidies are partially YOUR fault !!!!

The UK’s Independent Commission on Banking (ICB) estimated the too big to fail subsidy that UK banks get as being worth well over £10bn a year. That is roughly £150 a year for each UK inhabitant. So why does this subsidy arise?

The answer lies partially in a piece of chicanery which suits banks and suits everyone who deposits money in banks – that’s you and me. This is that we want our money to be 100% secure: that is we want government (i.e. taxpayers) come to the rescue when a bank goes bust. While at the same time we want the benefits and interest that comes from engaging in commercial activity: i.e. letting banks lend on our money in a less than 100% safe manner. We want to have our cake and eat it.

Mervyn King described this process as “alchemy”. Quite right. “Chicanery” . . . “alchemy” . . . either word will do me.

He also said, “If there is a need for genuinely safe deposits, the only way they can be provided… to insist such deposits do not coexist with risky assets”. Right again.

One solution to this problem is to make depositors come clean: that is, force them to be honest and say whether they want their money to be 100% safe, or whether they want it invested, in which case it will NOT BE entirely safe. In other words we need two basic types of account which for want of better words I’ll call “safe” accounts and “investment” accounts.

Safe account money would NOT BE invested, hence it would earn little or no interest, but it WOULD be “instant access”. Just to make sure this money is 100% safe, it could be deposited at the central bank. In contrast, investment account money WOULD earn significant interest, but it would not be instant access, plus there would be no taxpayer funded recompense if the relevant bank went bust.

As a result, there’d be little need for any bank subsidy. As regards safe money, that would be safe (absent blatant criminality). And as to investment account money, there’d be no government rescue if the bank went bust.

The above “two account” system would not of course ENTIRELY dispose of all the risks posed by banks: banks could still pose a systemic risk. But the two account system would certainly help. Moreover, the “too big to fail” problem can be mitigated by preventing any one bank growing too big.

The two account system might seem to constrain private banks’ freedom to lend (though of course under fractional reserve they have a large measure of freedom to create money out of thin air and lend it out when they see fit). Alternatively, under full reserve, the two account system would certainly seem to constrain banks’ freedom to lend. And indeed the ICB fell hook line and sinker for this “constraint” argument.

But any such constraint is not a problem, because the central bank can easily expand the monetary base to compensate for any such constraint.

The main solution advocated by the ICB was to increase banks’ capital. The problem with that is that shareholders are not saints: they want a commercial return on capital. So the cost of that extra capital is inevitably passed on to bank customers – depositors and those borrowing from banks.

So the ICB solution amounts to a game of pass the parcel, with the net result being not vastly different to the two account solution, in that the cost of the risk that investment inevitably involves is dumped onto depositors and those borrowing from banks. The weakness in the ICB solution is that depositors who are prepared to take a risk are not fully rewarded for doing so: part of the “reward” is donated to those who want to indulge in the above mentioned chicanery or “alchemy”.


Thursday, 8 December 2011

No nativity scene in DC.

Subject: Supreme Court rules no Nativity scene in DC

Date: Wed, 9 Nov 2011 11:06:34 -0800

The Supreme Court has ruled that there cannot be a Nativity Scene in the United States' Capital this Christmas season.

This isn't for any religious reason. They simply have not been able to find
three Wise Men in the Nation's Capitol.

A search for a Virgin continues.

There was no problem, however, finding enough asses to fill the stable.


The Euro will fail.

Assuming Euro leaders DO MANAGE to get some sort of fiscal union agreed, what of it? That fiscal union will in effect be much the same as the current arrangement, in that it will involve imposing austerity on uncompetitive countries. And the austerity will have to last years before such countries become competitive, by which time they’ll either have been reduced to anarchy or will have opted to leave the EZ.

And COMPETITIVENESS is the CRUCIAL point, as Martin Wolf explains, not deficits or debts. That’s why I advocated an instant devaluation of periphery currencies here in September. The latter solution would be expensive and difficult to organise, but it’s the least bad solution, I think.

Expect long boring articles in newspapers making the above point in the months and years to come.


Wednesday, 7 December 2011

LSE “professor” of economics doesn’t know what a structural deficit is.

According to Professor John Van Reenen, Director of the London School of Economics’s Centre for Economic Performance, “The UK currently has a structural deficit of around 8.8 per cent of GDP. But this has not been due to some unfunded spending splurge since 1997, but rather because Britain has just suffered the deepest recession since the 1930s.”

Hang on . . . . . a structural deficit is a deficit (or part of the total deficit) which is NOT attributable to a recession!

At least Reuters defines and structural deficit as “The portion of a country's budget deficit that is not the result of changes in the economic cycle. The structural deficit will exist even when the economy is at the peak of the cycle.”

And Wiki’s definition is essentially the same: “a structural deficit exists even when the economy is at its potential”

The Financial Times Lexicon’s definition is slightly different, not that this will be any solace for the Professor. The FT definition is “A budget deficit that results from a fundamental imbalance in government receipts and expenditures, as opposed to one based on one-off or short-term factors”. This of course amounts to the same thing as the Reuters and Wiki definition if by “short-term factors” one means “cyclical” or “credit crunch induced”. But the FT definition could be clearer on this point.


Tuesday, 6 December 2011

Willem Buiter is not 100% clued up.

Builter has written an article claiming the prospects for growth worldwide are near non-existant. (h/t to Credit Writedowns.)

Buiter says amongst many other things that “The US also may be technically able to use fiscal expansion to stimulate demand, but even if markets continue to be tolerant, political gridlock makes it impossible.”

That implies that there is a problem if “markets” become intolerant, which is certainly a popular view. But Buiter fails to tell us what the problem is (probably because he can’t).

If “markets” won’t to lend to a monetarily sovereign country, like the US, other than at high rates of interest, what of it? If such a country wants to implement some stimulus, it can fund the stimulus by printing money rather than by borrowing it, as Keynes and Milton Friedman pointed out.

In contrast to stimulus deficits or debts, there are structural deficits, and debts. If structural debt needs to be rolled over, no problem: structural deficits, by definition, do not impart stimulus. Ergo abolishing a structural deficit, or paying off a structural debt involves no “anti-stimulus” or any of that dreaded “austerity”. At least that’s the case if one goes by the Reuter’s and Wiki definition of “structural”. And the Financial Times Lexicon definition isn’t all that different.

For more on this, see:


Monday, 5 December 2011

“In the Black Labour”: are fiscal conservatism and social justice compatible?

This paper entitled “In the Black Labour” published by “Policy Network” leaves room for improvement. It argues that the political left in Britain should be fiscally conservative so that the left gains credibility with voters. (h/t to Stumbling and Mumbling).

Advocates of Modern Monetary Theory, Bill Mitchell and Rodger Mitchell in particular often rail against the way in which self-styled “progressives” have adopted the economic illiteracy of the political right. Mitchell and Mitchell are correct. (The two Mitchells are not relatives, by the way.)

The “black Labour” paper is of course correct to say that the political left in the UK needs to come clean with voters as to what it intends doing about the deficit and debt. But it is wrong to say (p.4) that “one option might be a commitment to deliver a surplus on the public finances towards the end of a concrete timescale such as the lifetime of a single parliament.”

Any country or political party which “commits” itself to a surplus at some point in the future needs to study some economics.

First, there is a very simple reason why most governments will run deficits most of the time (which in practice is what they have actually done over the last century or more). The reason is this. Given the 2% inflation target, the monetary base and national debt will contract in real terms at 2% a year unless they are topped up. Assuming for the sake of simplicity that both are to remain constant as a proportion of GDP, they’ll have to be topped up every year. And that “topping up” can only come from a deficit.

And not only that, but assuming some sort of economic growth in real terms, even more “topping up” will be needed to keep the base and debt constant as a proportion of GDP. That’s quite a lot of deficit.

Second, as Keynes correctly observed “look after unemployment, and the budget will look after itself”. Put another way, “committing” oneself to a particular level of deficit or surplus five years hence is PLAIN DAFT. If there is a fit of irrational exuberance, a surplus will be in order. Conversely, if the private sector continues to act in a conservative fashion, i.e. continues to deleverage and save (save up money, that is), then a deficit will be in order.

That elementary lesson in deficits and debts will doubtless leave a lingering doubt in the minds of the fiscally conservative, namely that if the deficit persists, then the debt will on the face of it continue to rise. Well the answer to that is as follows. If the markets continue to be willing to purchase debt at a rate of interest that is equal to or less than the rate of inflation, then more fool the markets. The UK (or any monetarily sovereign country) can continue to sell the markets bum steers – I mean debt.

Alternatively, if the markets want a significantly positive rate of interest, then we just stick two fingers up at the markets and fund the deficit with printed money rather than borrowed money. As I’ve said dozens of times on this blog, both Keynes and Milton Friedman pointed out that a deficit can be funded with EITHER printed money OR borrowed money: whichever is most appropriate.

Presumably I’ll have to point this out another trillion times before the message gets thru.


Sunday, 4 December 2011

QE: Mervyn King versus Andrea Leadsom.

Battle of wits between, on one side, Mervyn King governor of the Bank of England plus another BoE official, and on the other side, UK politician Andrea Leadsom. I’ve tried to summarise the exchange of views below. Or for the video, see here (starting at around 43 minutes. (Put your cursor on the bar just below the “movie” to bring up the slide bar which enables you to start half way thru the “movie”.)


Ms Leadsom tries to establish that when a central bank buys government bonds in the market (as under QE) and then sells them back at a lower price, the central bank makes a loss. Mervyn King and friend give evasive and suspiciously complicated answers.

Using conventional accounting, obviously the central bank makes a loss. But there is really no such thing as a central bank making a profit or loss: the job of a central bank is simply to feed money into the economy in a recession, and withdraw money when inflation looms.

When a central bank is trying to impart stimulus (as under QE), it is arguably a positive benefit if it “makes a loss”: in doing so, it feeds more money into the economy than if it made a so called profit.

The far more serious question is this. Should central banks be feeding money into the pockets of the wealthy: those who hold government bonds? That is, shouldn’t the government and central bank (considered as a single unit) feed money into Main Street during a recession, rather than into Wall Street?

So Mervyn King’s response to Ms Leadsom should have been “What if the BoE does make a loss: so much he better”. And Ms Leadsom’s accusation should really have been “What in God’s name do you think you are doing enriching the already stinking rich people who work in the City of London, rather than boosting every British high street?”.

Least that’s the way I see it.


Afterthought (same day). Warren Mosler made the point that a central bank should be likened to the umpire in a game of tennis: that is, someone who dishes out points (money) as appropriate. As Warren explained, those “points” do not come from anywhere. And the umpire in a game of tennis does not “lose” anything by awarding points. Put another way, the umpire does not “make a loss” as a result of awarding points.


Saturday, 3 December 2011

Tony Blair oozes sincerity and displays his ignorance about the Euro.

Pretty boy Tony Blair expresses his views about the Euro in this interview. Unless you are seriously short of anything useful to do, don’t bother watching it. He simply makes the point that Euro politicians have REACTED to events rather been IN CHARGE of events, and this has induced markets to bet against the Euro and its periphery in particular.

Well I think everyone, including inmates of mental institutions have worked that out.

Which raises the question as to why the Wall Street Journal bothered publicising the interview. Well the answer is that if you are a journalist working for a newspaper, you can’t go wrong commissioning an article or publicising an interview with a big name – even if the big name is obviously senile or hopelessly ignorant.

In contrast, if someone has some seriously original or intelligent ideas about some economic problems, it’s best to give them a wide berth. Dean Baker spends much of his time pointing to the appalling nonsense that appears in some of America’s leading newspapers.

Such a pity.


Friday, 2 December 2011

Krugman doesn’t fully understand Europe.

Krugman is not up to his usual high standards in this article. He claims the EZ’s problem is insufficient demand.

Well demand is OK in the core countries. Inflation is near the 2% target, so while demand could be bumped up a little perhaps, it cannot be increased dramatically.

The big problem is the uncompetitive periphery. If demand for the EZ is increased enough to bring full employment in the periphery, that means excess inflation in the core. And Germans wouldn’t like that.

I.e. the central problem, missed by Krugman, is the disparity in competitiveness.