Sunday, 17 February 2013
Professional economists are tumbling to the merits of helicoptering. What took them so long?
As advocates of Modern Monetary Theory (MMT) have been pointing out for some time, the government / central bank machine (GCBM) is not financially constrained. That is, it can simply print money and spend it into the economy (and/or cut taxes) whenever it wants.
To be more accurate, the debt and deficit are no constraint whatever: the only constraint is inflation.
Helicopter drops simply combine fiscal and monetary stimulus, as indeed Mervyn King pointed out. (See para starting “There has been some talk..”).
Another professional economist to get interested in helicoptering is Simon Wren-Lewis.
While King agrees that helicoptering equals combining monetary and fiscal stimulus, he is not in favour of actually effecting the combination: i.e. he favours retaining the split. But his reasons are hopeless. I’ll explain why in a few days time hopefully.
For now, though, far as I’m concerned, the reasons for separating fiscal from monetary stimulus are hilariously stupid. I set them out a year ago here. But here they are again (re-phrased a bit).
1. Adjusting interest rates is a form of monetary policy, BUT interest rate adjustments are DISTORTIONARY. An interest rate change works only via households or firms which are significantly reliant on variable rate loans: i.e. those reliant on FIXED rate loans or not reliant on loans at all are not affected by an interest rate change. Thus this policy makes no more sense than boosting an economy only via people with black hair, with blondes, red-heads, etc waiting for a trickle-down effect.
2. QE, another form of monetary policy, has the same defect: it works only via a limited proportion of the population, that is, the rich.
3. The idea that there is a close relationship between interest rates and the ACTUAL availability of credit has been shown to be TOTAL NONSENSE over the last two years. That is, rates are currently at record low levels, but banks are reluctant to lend.
4. There is no relationship between central bank base rates and the rates charged by credit card operators. Also see here.
5. The Radcliffe Report on monetary policy in the U.K. published in 1960 concluded that ‘there can be no reliance on interest rate policy as a major short-term stabiliser of demand’.
6. Low interest rates allegedly encourage investment. Unfortunately those making investments look at LONG TERM rates, not the fact that the central bank has recently cut rates and will probably raise them again in two years’ time. And that applies both to firms investing in productive capacity and people who borrow with a view to buying houses. Although there is one exception to the latter point, as follows.
While most people will not buy houses just because interest rates have dropped for a couple of years, there ARE those NINJA mortgage suckers who bought houses on the basis of near zero interests for the first year or two. I.e. there ARE idiots out there. So in that the “low interest rates encourages investment” argument DOES WORK, it works by encouraging idiots to behave irresponsibly!!! Now that’s a ringing endorsement for “low interest rates encourage investment” argument - I don’t think.
7. An interest rate reduction is an inducement to borrow and invest in assets, which tends to cause asset price bubbles. In contrast, a straightforward change in government net spending has less of a “bubble blowing” effect. That is, if the additional net spending is directed at a cross section of the population (not just the wealthy), there will not be a significant asset bubble effect.
8. The optimum price for borrowed money (i.e. the optimum rate of interest) is determined by the same sort of factors that determine the optimum price for concrete, steel or any other commodity: supply and demand. To put that in economics jargon, the rate of interest is optimised when the marginal disutility of forgone consumption by savers equals the marginal utility or marginal benefit from the investments that those savers fund.
If government interferes with this free market rate of interest, then the total amount invested will not be optimum. GDP will not be maximised.
9. Low interest rates can have a DEFLATIONARY effect (pointed out by Warren Mosler). If rates are cut, the central bank will then pay out less by way of interest. That is, less new money will be injected into the private sector. (But that effect depends on the rules governing the relevant central bank, Treasury, etc. To illustrate, in some countries a rate reduction may NOT automatically reduce the above injection. That is, the reduction may be treated as a reduced budgetary expense for the Treasury, which in turn is expected to collect less tax to compensate. In this case the above deflationary effect would not operate.)
10. Interest rates charged by commercial banks for mortgagtes etc can be slow to respond to changes in central bank base rates.
11. The idea that reduced interest rates encourage investment is rendered irrelevant by the fact that in a recession, more investment is exactly what is NOT needed. In recessions (certainly in SHORT recessions) there is more than the usual amount of capital equipment lying idle! Of course it takes TIME to manufacture or create real investments like machinery or factories, and assuming an economy will return to trend growth shortly after a recession, employers need to make sure they are not SHORT of capital equipment after a recession. But employers do not need governments to tell them this. Nor will irrelevant little inducements like 2% changes in interest rates do much to optimise any given employer’s investment strategy.
12. X. Some research done by G. L. S. Shackle concluded that the connection between interest changes and investment was weak. The entrepreneurs questioned said that estimated profits “must greatly exceed the cost of borrowing if the investment in question is to be made”.
13. The effect of interest rate adjustments is hindered by foreign currency movements. E.g. a rise in interest rates designed to damp down an overheated economy draws foreign capital into the relevant county, which reduces the desired effect. In contrast, a straight cut in government spending (a la MMT) has the opposite effect, if anything, on internationally mobile capital. That is, given a cut in demand in a particular country, capital will tend to leave the country in search of better opportunities elsewhere.
14. Keynes said, “I am now somewhat skeptical of the success of a merely monetary policy directed towards influencing the rate of interest...it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital...will be too great to be offset by any practicable changes in the rate of interest." Keynes’s General Theory – near the end of Ch 12. (h/t to skeptonomist).
15. A novel argument in favour of using monetary policy alone was produced recently by Nick Rowe. This is that fiscal is already doing a huge amount, in the form of taking thousands of micro economic decisions a day - like deciding where to build bridges, to cite Rowe’s example. Thus, allegedly, we cannot impose more burdens on fiscal.
Well the answer to that argument is that the amount of work currently being done by any system has nothing to do with whether it should be given more work to do, or whether the latter work should be allocated to some other system. For example the fact that the military is already spending billions on warships, aircraft and so on has nothing to do with whether the military or the police should be responsible for dealing a riot or natural disaster. If the military are best at the job, they should do it, and be given the necessary funds. If the police are best at the job, they should do it, and get the relevant funds. Period. Full stop. End of argument.
16. Where government borrows, some of the money is inevitably lent by foreigners. But there is a problem there, which is that money flowing into a country from abroad temporarily boosts living standards in the country. And that standard of living boost will be reversed if and when the money is repaid. That is politically unpopular, which makes the reversal difficult.
Put another way, the borrowing enables incumbent politicians to raise living standards while in office, while the mess is left for their successors to sort out.
Now for using fiscal stimulus on its own.
1. The “spend” part of “borrow and spend” is stimulatory, while the borrow part has the OPPOSITE EFFECT: it’s deflationary. Thus borrow and spend is a bit like throwing dirt over your car before cleaning it: bonkers.
2. Crowding out: that is, fact that when government borrows, that tends to raise interest rates, which has a deflationary effect, which negates the whole object of the exercise: imparting stimulus. THE EXACT EXTENT of this crowding out is disputed, but to the extent that it is a problem, the central bank can easily counteract the undesirable effect by cutting interest rates – which it does by creating money and buying up government debt.
BUT HANG ON……… What’s going on here is that gcbm is creating money and spending it into the economy: i.e. it’s an admission that the correct policy is to merge monetary and fiscal policy!!!
Alternatively, to the extent that “borrow and spend” DOES WORK without a crowding out effect, there is another problem: what is the point of government borrowing something (i.e. money) when it can create money in infinite amounts any time it likes and at no cost? You ever heard of anything so daft?
3. It is sometimes argued that monetary policy (interest rate adjustments at any rate) can be made quickly, i.e. fiscal changes take longer to implement.
That point is irrelevant. The IMPORTANT question is TOTAL TIME LAG between the decision to implement a policy and the actual effect. I’ve seen eighteen months cited as the relevant figure for interest rate adjustments, whereas the evidence indicates that a significant proportion of the additional cash that wage earners find in their pay packets as a result of a reduction in employees’ contribution to a payroll tax reduction will be spent IMMEDIATELY. For the evidence, see here, here, here and here.
Also, in that fiscal policy consists of expanding the PUBLIC SECTOR, the effect ought to be pretty well IMMEDIATE. That is, if government decides to hire additional people, the effect comes just as quickly as people can be interviewed, and given the means to get on with whatever job they are doing.
4. There is disagreement amongst economists as to how effective monetary and fiscal policies are. That little problem can be solved by doing both policies at once. If one policy I much more effective than another, it doesn’t matter: the COMBINATION is guaranteed to have an effect. That is, helicoptering works.