It’s Hard Being a Bear (Part Six)?Good Alternative Theory?
on September 27th, 2009 at 9:44 am
If the economy does in fact recover from the Global Financial Crisis—without private debt levels once again rising relative to GDP—then my approach to economics will be proven wrong.
But this won’t prove conventional neoclassical economic theory right, because, for very different reasons to those that I put forward, modern neoclassical economics argues that the government policy to improve the economy is ineffective. The success of a government rescue would thus contradict neoclassical economics just as much—or maybe even more—than it would contradict my analysis.
The actual reasons for this belief are arcane, but this choice quote from leading neoclassicals Thomas Sargent and Neil Wallace puts the dominant neoclassical case in a nutshell:
In this system, there is no sense in which the authority has the option to conduct countercyclical policy. To exploit the Phillips Curve [a relationship between unemployment and inflation], it must somehow trick the public. But by virtue of the assumption that expectations are rational, there is no feedback rule that the authority can employ and expect to be able systematically to fool the public. This means that the authority cannot expect to exploit the Phillips Curve even for one period. Thus, combining the natural rate hypothesis with the assumption that expectations are rational transforms the former from a curiosity with perhaps remote policy implications into an hypothesis with immediate and drastic implications about the feasibility of pursuing countercyclical policy.’ (“Rational Expectations And The Theory Of Economic Policy”, Journal of Monetary Economics, Vol. 2 (1976) pp. 177-78; emphases added)
The neoclassical confidence that the government can’t beneficially affect the economy is thus based on the insane assumption of “rational agents” who live in a world that is permanently in equilibrium, and whose expectations about the future are accurate—something that Ross Gittins’s recent column did a good job of critiquing. The real world is inhabited by real, fallible human beings, who are prone to bouts of irrational exuberance, susceptible to Ponzi Schemes disguised as investment, and who live in a world in permanent disequilibrium and with an uncertain future, in which their expectations are almost always wrong. They are therefore incapable of predicting and therefore neutralizing the impact of government policy, as neoclassical theory assumes that “rational agents” do.
There are other strands in neoclassical theory that argue there is some role for the government in controlling the economy—notably the so-called Taylor Rule which argues that the Central Bank can control the economy by fine tuning the interest rate. Taylor himself is arguing that deviation from his rule—when the Federal Reserve under Greenspan held interest rates at near zero after the burst of the DotCom bubble in 2000 – is what caused the crisis. I disagree, but that’s a topic for a later day.
The general proposition remains that in its overall bias, neoclassical theory argues that the government can’t beneficially influence the economy—and therefore that if there is a genuine, sustainable recovery as a consequence of the government stimulus packages, that contradicts neoclassical economics even more than it would contradict my approach.
That means that if there is a “winning” economic theory out there, then it must be one that argues that government action alone can help an economy recover from a crisis, and indeed maintain output growth at a level that will maintain full employment.
There is one “neoclassical” theory that argues this, which most economists—reflecting their non-existent training in the history of their own discipline—actually think is Keynesian. This is the so-called “IS-LM” model, which argues that the government can manipulate employment via fiscal policy. Neoclassicals are likely to retreat to this model—and declare themselves “Born Again Keynesians” in the process—without realizing that the originator of this model, John Hicks, rejected it on very sound grounds almost 30 years ago.
Hicks realized that his model attempts to represent the economy using just two markets—goods and money—when there is of course another important market: that for labour. He omitted the labour market from his model on the basis of what neoclassical economists call “Walras’ Law”. This is the proposition that, if all but one market in an economy are in equilibrium, then that final market must also be in equilibrium.[1]
Writing in 1979 in the non-orthodox Journal of Post Keynesian Economics, Hicks realized this flaw (and several others) in this logic: it can apply only when the economy is in equilibrium—when both the goods market AND the money market are in balance. That, in terms of the model, is where the two curves cross. But the model is used to simulate what is supposed to happen when one or both markets are not in equilibrium, or when one curve—normally the IS curve—is shifted by deliberate government policy, such as running a deficit during an economic crisis. Therefore it is used to try to describe what happens in disequilibrium.
But in disequilibrium—anywhere on the diagram apart from where the two curves cross—Walras’ Law can’t be used to ignore what’s happening in the labour market. So even working from Hicks’s model, neoclassical economists would need to consider disequilibrium dynamics of 3 or more markets. Hicks damningly concluded that:
the only way in which IS-LM analysis usefully survives – as anything more than a classroom gadget, to be superseded, later on, by something better – is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate. (Hicks, J. 1981, ‘IS-LM: An Explanation’, Journal of Post Keynesian Economics, vol. 3, no. 2, p. 152; my emphasis)
Yet as Gittins pointed out, and as Paul Krugman himself recently confirmed, neoclassical economists are so obsessed with equilibrium methods that they will shy away from thinking in disequilibrium terms. As Krugman put it, right after critiquing neoclassical economics for being braindead, “I, for one, am not going to banish maximization-and-equilibrium from my toolbox”.
I’m sorry Paul, but stick with those tools and you’ll never come to grips with Minsky’s Financial Instability Hypothesis, let alone the actual disequilibrium dynamics of the real economy.
So there is no coherent neoclassical theory that can take solace from the success of the government stimulus packages, should they avert a deep recession and cause a sustained recovery without a rise in the private debt to GDP ratio.[2] If there is to be a winner in this debate, it has to be a non-neoclassical school of thought.
There is such a school of thought which has developed in Post Keynesian literature recently. Known as Chartalism, it argues that the government can and should maintain deficits to ensure full employment.
Chartalism rejects neoclassical economics, as I do. However it takes a very different approach to analyzing the monetary system, putting the emphasis upon government money creation whereas I focus upon private credit creation. It is therefore in one sense a rival approach to the “Circuitist” School which I see myself as part of. But it could also be that both groups are right, as in the parable of the blind men and the elephant: we’ve got hold of the same animal, but since one of us has a leg and the other a trunk, we think we’re holding on to vastly different creatures.
That said, I do have numerous issues with the Chartalist approach, but I haven’t studied its literature closely enough yet to write a critique. [3] I also could have distorted their arguments if I had attempted a summary of their views. So what I decided instead to do is to ask a leading Chartalist, Professor Bill Mitchell from the University of Newcastle, to write a précis of the Chartalist argument (Bill also has a blog on this approach to economics).
This précis follows. I emphasise in closing my own comments that, if there is a genuine recovery not involving rising private debt to GDP levels, then Chartalism is the only theory left standing. Neoclassical economics is dead.
The fundamental principles of modern monetary economics, By Bill Mitchell, Professor of Economics, University of Newcastle
The following discussion outlines the macroeconomic principles underpinning modern monetary theory (sometimes referred to as Chartalism).
The modern monetary system is characterised by a floating exchange rate (so monetary policy is freed from the need to defend foreign exchange reserves) and the monopoly provision of fiat currency. The monopolist is the national government. Most countries now operate monetary systems that have these characteristics.
Under a fiat currency system, the monetary unit defined by the government has no intrinsic worth. It cannot be legally converted by government, for example, into gold as it was under the gold standard. The viability of the fiat currency is ensured by the fact that it is the only unit which is acceptable for payment of taxes and other financial demands of the government.
The analogy that mainstream macroeconomics draws between private household budgets and the national government budget is thus false. Households, the users of the currency, must finance their spending prior to the fact. However, government, as the issuer of the currency, must spend first (credit private bank accounts) before it can subsequently tax (debit private accounts). Government spending is therefore the source of the funds the private sector requires to pay its taxes and to net save, and it is not inherently revenue constrained.
So statements such as “the federal government is spending taxpayers’ funds” are totally inapplicable to operational reality of our monetary system. Taxation acts to withdraw spending power from the private sector but does not provide any extra financial capacity for public spending.
As a matter of national accounting, the federal government deficit (surplus) equals the non-government surplus (deficit). In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending. The federal government via net spending (deficits) is the only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save and hence eliminate unemployment. Additionally, and contrary to mainstream economic rhetoric, the systematic pursuit of government budget surpluses is necessarily manifested as systematic declines in private sector savings.
We often read that the appropriate fiscal stance is to balance the federal budget over the business cycle. Some economists claim the goals should be to run a surplus on average over the cycle allowing for deficits in extreme downturns. Both goals would be fiscally irresponsible in Australia’s situation where our current account is typically in deficit. If the government balanced the budget on average and the current account deficit was in deficit over the business cycle then the private domestic sector would on average be in deficit (dis-saving) over that cycle. The decreasing levels of net private savings financing the government surplus increasingly leverage the private sector. The deteriorating debt to income ratios which result will eventually see the system succumb to ongoing demand-draining fiscal drag through a slow-down in real activity.
In other words, adopting a growth strategy that relies on increasingly leveraging the private sector is unsustainable. The only way the private domestic sector can save if there is a current account deficit is for the government sector to run deficits up to the desired private saving. Government deficits “finance” private saving by ensuring that aggregate spending is sufficient to generate the level of output and income that will bring forth the private desired saving levels.
Unemployment occurs when net government spending is too low. As a matter of accounting, for aggregate output to be sold, total spending must equal total income (whether actual income generated in production is fully spent or not each period). Involuntary unemployment is idle labour unable to find a buyer at the current money wage. In the absence of government spending, unemployment arises when the private sector, in aggregate, desires to spend less of the monetary unit of account than it earns. Nominal (or real) wage cuts per se do not clear the labour market, unless they somehow eliminate the private sector desire to net save and increase spending. Thus, unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.
How large should the deficit be? To achieve full employment net government spending has to be equal to the non-government desire to net save to ensure there is no aggregate demand gap. Unlike the mainstream rhetoric, insolvency is never an issue with deficits. The only danger with fiscal policy is inflation which would arise if the government pushed nominal spending growth above the real capacity of the economy to absorb it.
If governments are not revenue constrained why do they borrow? We have to differentiate voluntary constraints governments impose on themselves (which reflect ideological dispositions) from the underlying mechanics of the banking system in a fiat monetary system.
In terms of the latter, while the federal government is not financially constrained it still might issue debt to control its liquidity impacts on the private sector. Government spending and purchases of government bonds by the central bank add liquidity, while taxation and sales of government securities drain private liquidity. These transactions influence the cash position of the system on a daily basis and on any one day they can result in a system surplus (deficit) due to the outflow of funds from the official sector being above (below) the funds inflow to the official sector. The system cash position has crucial implications for the central bank, which targets the level of short-term interest rates as its monetary policy position. Budget deficits result in system-wide surpluses (excess bank reserves).
Competition between the commercial banks to create better earning opportunities on the surplus reserves then puts downward pressure on the cash rate (as they try to off-load the excess reserves in the overnight interbank market). So budget deficits actually put downward pressure on short-term interest rates which is contrary to all the claims made by mainstream economics.
If the central bank desires to maintain the current positive target cash rate then it must drain this surplus liquidity by selling government debt. In other words, government debt functions as interest rate support via the maintenance of desired reserve levels in the commercial banking system and not as a source of funds to finance government spending.
However, the central bank could equally just pay the commercial banks the target rate of interest on all overnight reserves which would achieve the same end without the need to issue debt. So there is no intrinsic reason for a sovereign government to borrow to “finance” its net spending.
The reality is, however, that the neo-liberal era has forced the governments to adopt voluntary constraints on its fiscal activity which are tantamount to those that operated during the gold standard period.
So the federal government now issues debt to the private markets via an auction system $-for-$ with net government spending (deficits). This allegedly imposes “fiscal discipline” on the government (it is totally unnecessary from a financial perspective) because the rising debt becomes a political issue. In conclusion, much of the deficit-debt hysteria that defines the current macroeconomic debate is based on false premises about the way the monetary system operates and the financial constraints on government spending.
Modern monetary theory provides a sound basis for understanding the intrinsic opportunities available to governments in a fiat monetary system and exposes most of the constraints that are imposed on the conduct of fiscal policy as being of an ideological origin.
[1] I reject this argument, but again that’s a story for another day.
[2] There is one Neoclassical School that Krugman believes is validated by the success of the stimulus packages, so called New Keynesianism. Yet again I think that’s wrong, and yet again it’s a topic for another day.
[3] This critique by a Spanish academic indicates that Chartalism is disputed within the broad Post Keynesian school of thought; however I should note that some Chartalists regard this critique as a caricature of their views.
PS if you’d like this essay in PDF format, click here.
That’s a very fine summary by Bill Mitchell. It’s the first time I’ve understood that Chartalism is the same as modern monetary theory. I assumed there was some sort of intersection, but didn’t realize they were actually the same thing.
So I assume that means the following economists are Chartalists:
Bill Mitchell
Scott Fullwiler
Warren Mosler
Randall Wray
Bear with me if I don’t come up all the proper economic names and terms. But as a layperson, what’s one of the most frustrating things about the Global Depression? This delusion that endlessly running up the debt won’t cause a problem. All we need to do is throw enough money at the problem. And then life will be wonderful.
The politicians won’t talk about it. The corporate controlled MSM won’t talk about it. A year ago I made the mistake of watching CNBC for about ten minutes. And I saw a CEO actually say that by year’s end the market would go from roughyl 7,500 to 13,000 in three months. And I thought, does he feel at all ridiculous by saying that? Probably not.
One thing that Obama will never say? We must have single-payer health care because these corporations are causing the deaths of innocent people. I know Max Keiser loves to rant about “the corporate terrorists”, they should be tried at th Hague and other rants to get high hit rates. But look at an underlying factor here.
Astronomical health care costs are contributing to the debt and slowing down the economy. Millions of people say they’re pissed at these corporations. Yet, there are no riots in the streets. No “revolution”. Why not?
Because it’s the Tony Benn Idea: How do you keep a population under control? Keep them in debt and ill-informed. (And no, this was not a paid endorsement of Steve’s book). Instead, many are so stressed out about being made redundant, homeless or dying due to no health care that they’re afraid to strike back. The Power Elite know this and exploit the hell out of this to maintain their profit margin.
FYI: In the past three years, 500,000 have emigrated from the U.K. Also, in the early 1930′s, roughly 100,000 Americans were ready to emigrate to Russia. If protectionism is still low for many Western countries immigration policies, prove to me that these numbers won’t go up.
I know, lots of hypotheticals here. Then again, it’s a chat show presenter’s dream come true. Post away.
The Chartalist ideas as depicted by Dr. Mitchell appear idiotic on their face to this noneconomist.
The idea that issuing or authorizing fiat currency is “spending” is wrong. Then, the idea that government deficits equals private savings is wrong. It’s very easy to consider a situation in which the government has outstanding a stable money supply with a stable population, and the government administers a system of courts and a small army and navy, collecting import taxes to support this government. At the same time, the private sector is productive and sells its goods internally and overseas, garnering monies from foreign countries (either their fiat currencies or gold) as the savings.
My sense as a mildly informed layman is that both the Keen and Chartalist theories are lacking. There is “good debt” and “bad debt”. The bad debt that fueled wasted home construction and unsound corporate acquisitions led to this latest depression. However, a hard-working labor force that consumes less than it produces can raise its level of production at a profit. The “banked” profit can either go into reducing debt levels, capital spending, gold under the mattress, etc.
Unfortunately, policy-makers are in fundamental agreement with Drs. Keen and Mitchell that an increase in debt from SOME entity is needed for a “permanent” escape from the GFC.
I believe that the government is in league with the Merchants of Debt.
My prediction is that the current hair of the dog strategy of increased debt levels will work just as well as it does for alcoholics. It COULD work, but only if a new set of lenders and borrowers suddently used the newly-lent funds to do new and creative/economicall productive things.
MIGHT this happen?
Yes it might. But I’ll take the “under”.
I’m having a hard time getting my head around Chartalism.
Is the argument that we are already in a de facto Chartalist system, and the central banks’ machinations are just adding an unnecessary layer of complexity?
By this explanation, “taxation acts to withdraw spending power from the private sector but does not provide any extra financial capacity for public spending…”, is the argument that taxation is just a means of soaking up excess liquidity due to the previous spending? In that case, couldn’t government debt be seen as soaking up excess liquidity by taxing future taxpayers?
Steve – I’d be very interested to read your more detailed thoughts on Chartalism as, on the face of it, I find the summary by Prof Mitchell to be quite compelling.
As a non-economist, the biggest difference I see between your analysis and this summary of chartalism is private credit creation. The chartalist view assumes that only the government can create money so this would imply a full-reserve banking system. Your analysis accepts the current regime of private credit creation being the dominant source of currency and determines the likely behaviour of such a system.
Personally, I find myself drawn to the Chartalist’s view of the world and support the idea that fractional reserve banking should be abolished. Money should be created, not borrowed, by the government.
Am I missing something here?
I’ve been meaning to comment in more detail on Steve Keen’s famous “Cavaliers” post and some of his papers, but haven’t found the time to do so properly.
For what it’s worth, my sense is that Steve’s endogenous money model should be totally compatible with the Chartalist operational model. There are some wrinkles related to Steve’s interesting accounting for loan repayments, but I don’t think they contradict anything fundamental about the operational foundations for the modern monetary theory.
I think the rubber hits the road on comparison in getting a grasp on the kinds of real economy constraints that are the ultimate true constraints for the Chartalist/MMT model of desired net non government saving, and then comparing that dynamic with Steve’s modeling of gross debt dynamics.
Pragmatist,
Chartalists do include credit money creation in the so-called horizontal money flow. But credit money is (usually fully) balanced by debt and cannot be used to pay taxes.
You need to visit prof Mitchell’s site – it is all explained there very clearly.
Thanks ak – I’m having a look around at that now.
I’m interested to see how they propose that privately-created credit can be distinguished from high-powered fiat money. Our current system considers them legally interchangeable.
Certainly an interesting read. Mitchell presents some very controversial arguments. I’m not sure how he can so confidently assert that government debt (surplus) balances out private-sector surplus (debt). Are Australians somehow not allowed to transact with people from other nations? I took a business trip to Australia this year, and inadvertently spent some money I brought from the US. I apologize, but it seems that I may have thrown your entire financial system out of whack
Speaking as a non-economist, with a hard-science background, this is why so many engineers and scientists refer to economics as “The Dismal Science”. Were I to make such a convoluted, circular argument in my field, the response of all my peers would be, “That’s great. Now what proof do you have of that?”
And by “proof”, they would be talking about experimental data. I think it’s great that Steve puts such rigor into dynamic modeling of economic theories, but even that’s only a start. Models should be used to exercise theories, and help us design actual experiments, which in combination with the models, actually yield answers.
Of course, this Mitchell article surely isn’t the whole of his writings on the subject, and maybe his other work includes ample data to back up these ideas. But, in my field, I couldn’t even imagine penning a few paragraphs of the type of conjecture that this piece includes, without appeasing my skeptics with actual data.
I know it’s difficult to design and run economic experiments that are really realistic, but I have two responses to that:
a) Statistics has some pretty wonderful tools for separating out variables, even when you don’t have an experiment (per se) that has perfectly isolated the ones you want to analyze
b) if it turns out that a particular theory just CAN’T be absolutely verified experimentally, then economists need to stop speaking in such certitudes about their theories.
Physics has string theory (difficult to design experiments to validate), but we don’t let physicists dictate policy on the basis of their completely unproven ideas.
ak @7,
Why can’t you use credit money to pay taxes? I’ve actually done it before, so in fact, I know this to be an incorrect statement.
Seriously, the ratio of credit money in the economy to fiat money is vastly higher than the ratio of total GDP to tax revenues. So, if you can’t pay taxes with credit money, where do tax revenues come out of?
A few have already questioned the government debt = non-govt surplus point made by Bill, so allow me to elaborate.
To begin, this is an accounting identity. Disagreeing with it is akin to disagreeing with gravity. That it seems so foreign to so many has more to do with the paucity of understanding of basic accounting that persists among economists, the financial press, and those that follow the writings of both groups.
How does the accounting identity work? Consider international trade; does it make sense to you that not every country in the world could have a trade surplus? It should. If there is at least 1 country with a trade surplus, then there is, by accounting identity, at least 1 country with a trade deficit.
Now, extend that to a national economy with a government sector and a non-government sector. By definition, if the government sector has a surplus . . . with whom does it have that surplus? With the private sector, which by definition must be in deficit. And vice versa, of course.
To be most precise, we can use three sectors for an economy: a government sector, a domestic private sector, and an international sector (current account balance). The identity (data can be derived from any national flow of funds account) as the domestic private sector’s net saving = govt sector deficit + current account balance.
Again, this is an accounting identity, not theory and not refutable anymore than 2+2=4 is refutable.
A number of researchers have published the data periodically demonstrating the identity, most of them associated with publishing the periodic Strategic Analysis at the Levy Institute (www.levy.org). For those interested, I did a post to the KC blog on this with US data through 2009 q1 in July (http://neweconomicperspectives.blogspot.com/2009/07/sector-financial-balances-model-of_26.html) which also cited a number of other related and recent posts.
Best,
Scott Fullwiler
When taxes are paid, both reserve balances and deposits are debited.
Doctorx – “The idea that issuing or authorizing fiat currency is “spending” is wrong. Then, the idea that government deficits equals private savings is wrong.”
When the government issues fiat currency it is spending because the non-government sector (made up of the private sector and the foreign sector) receives the fiat currency that is issued. The issued fiat currency is a savings for the non-government sector. When a government deficit spends, it adds to the net savings of the non-government sector $ for $. Government deficits equal non-government savings.
Bob_in_MA – “Is the argument that we are already in a de facto Chartalist system, and the central banks’ machinations are just adding an unnecessary layer of complexity?”
Australia, like the US and other countries, is a country where the Chartalist system is operational (floating exchange rate and a sovereign government as the monopoly issuer of the fiat currency). I agree that governments are making things more complex than they need to be. To target overnight interest rates, central banks could choose to pay the target rate of interest on bank reserves instead of buying and selling government securities.
“By this explanation, “taxation acts to withdraw spending power from the private sector but does not provide any extra financial capacity for public spending…”, is the argument that taxation is just a means of soaking up excess liquidity due to the previous spending? In that case, couldn’t government debt be seen as soaking up excess liquidity by taxing future taxpayers?”
The argument is taxation is not needed for the federal government to spend. This is because the government is the monopoly issuer of the currency whereas taxpayers are users of the currency. The users of the currency (taxpayers) have to finance their spending (borrow or use past savings), but the government (issuer of the currency) does not have to finance its spending.
Taxation and the sale of government debt soak up (reduce) private liquidity. Taxation has more of a role to play than just reducing liquidity. Taxation gives the fiat currency value because we are required to pay taxes in Australian dollars. We must acquire Australian dollars to pay our taxes. Taxation reduces the non-government surplus as it takes net savings away. OTOH, government debt does not have any impact on the non-government surplus (other than interest payments). Government debt can be purchased by a decrease in other assets held. Nothing ‘net’ is created as an asset decreases and another asset increases (the government debt) by an equal amount. It is a change in the type of asset held. Interest payments from the government debt increase the government deficit.
Thanks for publishing other aspects of the debate Steve: Bill Mitchell’s precis highlights a need for clarity to better understand the actualities of private credit creation vs. goverment money creation. I wish this theme were more universally explored by economists.
Would it be true to say then, that banks are directly in competition with governments to ‘own’ the money supply – issuing loans (whereby the banks transform credit into gambling stakes and real assets) vs. government money creation? Government may spend first but banks loan a lot more? This would explain the malficient stranglehold Wall St. has on the US government – another mechanism that should be serialised on national TV?
In this world people of self-will (selfish, ambitious) overpower people of good-will (desirous of the greater good) and the masses are swayed by both. That to me is the basis of any economic system, all theories aside.
I believe this is what must change through understanding and over time: I agree that selfishness and ambition are necessary growth factors in people as they lead to physical discipline, stabilisation of the emotional nature, and development of the mind – all necessary factors in the growth and integration of the personality – however we only have one planet and each other – capitalism in its present form is obviously un-sustainable, and constrains the greater good.
I hear that Martin Weiss has joined the “inflationist’s” camp. Interesting…..
http://www.marketoracle.co.uk/Article13695.html
It seems we do not yet know entirely what money is or how it is created. Do I overstate the case? I may come back to that question in another post.
It seems that Steve Keen is perhaps getting slightly anxious that his theory may be refuted. I think there is little danger of that. The system, left to itself, would have been in freefall by now. What we are seeing is what I call “Dead Liger Bounce”.
The liger is a hybrid cross between a male lion and a tigress and is the largest of all extant felines. In terms of hybridism and gigantism, the liger provides us with an appropriate metaphor for the world economy. It is now generally assumed that our hybrid or mixed economy (often incorrectly characterised as a straightforward free market economy) has recovered definitively from the Global Financial Crisis. In reality, we are simply seeing that dead ligers bounce higher than dead cats.
Massive coordinated govt action around the world has semi-averted the crisis for the time being. I say semi-averted because I don’t see too many healthy numbers coming out of the USA. All the fundamental problems remain in place. Debt at an impossible level and no way out except deleveraging or debt moratoria.
Into this add impending climate change and resource depletion. It’s not a good mix.
Here’s the first bit of my commentry on this post.
Bill: “So statements such as “the federal government is spending taxpayers’ funds” are totally inapplicable to operational reality of our monetary system. Taxation acts to withdraw spending power from the private sector but does not provide any extra financial capacity for public spending.”
Splitting hairs over what taxation is and is not may seem pointless to some economists if the outcomes are not changed, but I do think that perhaps this change in language regarding taxation is the starting point for the political revival of the moribund left. God knows these parties need a new message!
“As a matter of national accounting, the federal government deficit (surplus) equals the non-government surplus (deficit).”
Also obvious to those with a modicum of economic understanding. However, as above, how to communicate this to the remaining 99.99% who do the voting?
“In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending. “
Why can’t they save by placing funds in some foreign economy?
“The federal government via net spending (deficits) is the only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save and hence eliminate unemployment.”
The understanding that unless spending=saving unemployment and wasted economic output will ensue is also lost on most people, even those thinking they know something about economics. Once again wrapping all this up in layman terms is critical.
Also consider that in an energy constrained future full employment is not desirable. Full employment is also not desirable in my view if it requires make-work to be created to achieve it. What is make-work and what is not? Well that is a matter for society to decide.
“ Involuntary unemployment is idle labour unable to find a buyer at the current money wage. In the absence of government spending, unemployment arises when the private sector, in aggregate, desires to spend less of the monetary unit of account than it earns. Nominal (or real) wage cuts per se do not clear the labour market, unless they somehow eliminate the private sector desire to net save and increase spending. Thus, unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.”
This is exactly the argument of CH Douglas and the social creditors. They advocated a citizens income funded by government seigniorage which would restore to the private sector the ability to buy all its output.
Here’s my problem. Private sector savings basically equate to profits. Profits are the difference between economic growth and wages growth. If government clears the labour market then won’t wages have to rise to become equivalent to growth, which will remove profits.
This is what neo-liberal economics is for – to protect the ability for the private sector to generate profits.
Count me out of those who are arguing for an increase in debt as a solution doctorx! My call has always been for debt reduction.
I was interested to learn in yesterdays Financial Sense news hour part 3 the last 15min, that US banks only provide 27% of the total credit.
The majority goes to things like:
Overseas lenders 22%
Life Insurance 10%
Money Market 9%
Mutual Finds 8%
Fed 4%
Pension funds 4%
Savings and Loans 4%
etc.
Also consumer credit is smaller than government credit.
I wonder how that effects credit models?
- Ernie.
Dear Prof. Keen and all,
I have been following your DebtWatch for a while now and I finally decided to write, after reading your “It’s Hard Being a Bear (Part Six)”.
I am no economist, as many other posters, it seems. So, for what is worth, I believe your theory of investor behavior is highly plausible. Frighteningly so, in fact. And believe me when I say this, I would like you to be wrong.
So, I would say, it is still premature to admit defeat, although the very fact of being able to contemplate this possibility clearly separates you from the bunch of self-proclaimed pundits that have taken us all for a ride.
I do believe Mr. Rudd is onto something when he keeps saying that “we’re not out of the woods, yet”. The G20 has placed some limitations on executive remunerations (see link below), but nobody says anything about limiting the size of banks (retail or investment). This may not be relevant for the immediate future, but it’s not a good omen in the long run.
Fat-cat bankers in firing line as payouts reined in
ANNE DAVIES HERALD CORRESPONDENT. SMH, September 27, 2009.
http://www.smh.com.au/business/fatcat-bankers-in-firing-line-as-payouts-reined-in-20090926-g76e.html
Finally, I would suggest you and all other posters not to underestimate the capacity neoclassical economists have to rationalize even their most appalling failures. In John Cochrane’s article you linked in a previous post and in The Economist’s Lucas Roundtable (see the link below) I have seen ardent defenses of the EMH.
Economics focus
In defense of the dismal science
From The Economist print edition. Aug 6th 2009
http://www.economist.com/businessfinance/economicsfocus/displaystory.cfm?story_id=14165405
It turns out now that this hypothesis was actually confirmed by the US housing bubble: the failure of neoclassical economists to forecast it can be explained because prices already incorporated all information available, thus there was no information available that could be used to forecast the crisis. If economists had any information that the bubble would burst next week, they would have acted on this information now, bursting the bubble now, not next week…
It’s very sad thing when a high-profile man like Prof. Lucas (who in all likelihood is a very clever and decent bloke) finds himself on grounds as shaky as those.
I don’t question the accounting identity Scott,
In the spirit of n8r0n’s comments though, what I do question is its relevance to the data.
In a flow sense, a government deficit in a given time period corresponds to the net accumulation of private sector monetary assets in that period, if there is no other source of money or if those other sources create a balance of money and debt. Of course there is another source of money–money endogenously created by the private banking system–and on the data, there is not a balance of money and debt creation there (so that the two net to zero) but a surplus of debt creation over money, so that the two sum to a substantial negative.
Yet the system functions (albeit it’s c#cking up now): our actual monetary system appears to function with net negative financial assets. Using the broadest measure of money the USA ever published (does it rile you that the Fed has stopped recording M3? Sure annoys me!), total debt was 2.25 times M3 in the 1950s, and was 4.3 times M3 when the data collection stopped in 2006 (the ratios of only private debt to M3 were respectively 1.25 and 3.3). So even at a time when Minsky described the USA as financially robust, debt exceeded money: the system functioned well with net negative financial assets.
It therefore appears to me that what we need to explain is how a monetary economy can function with net negative financial assets–or more strictly, with monetary debts substantially exceeding money holdings.
I’ve done that with my Circuit models, in which debt exceeds money (when defined to exclude the banking sector’s own transaction accounts). I also have an extension I haven’t yet published where I have a non-bank financial sector, which creates debt without creating money.
I would like to know how the Chartalist perspective handles the empirical fact of net negative financial assets in a monetary economy.
From my point of view, one of the things the government does when it runs a deficit is reduce the excess of debt over money, which is an important policy measure to reduce financial fragility. But I don’t see the fact that only the government can create net financial assets as a crucial argument for the importance of a Chartalist perspective, because our system always seems to function with net negative financial assets–and it has occasionally secured full employment without government deficits as well.
Thanks Marco2,
And don’t worry, I’m not admitting defeat–merely pointing out that if the data does prove me wrong, then it doesn’t prove neoclassical economics right.
Thanks also for locating that Lucas article. I frequently accuse neoclassical economists of ignoring arguments or data that are contrary to their beliefs, but even this doesn’t do Lucas’s bizarre delusion justice. Here’s an excerpt–please read it in full tout le monde, especially the bits I’ve put in bold:
That preposterous claim can be refuted by none other than “Mr Fama”, from the paper Eugene F. Fama and Kenneth R. French, “The Capital Asset Pricing Model: Theory and Evidence”, in the Journal of Economic Perspectives, Volume 18 (2004) Pages 25-46:
Here we have Lucas saying how fabulously the EMH/CAPM fitted the data, while the guy he cites as his source abandoned it five years earlier on the basis that it didn’t fit the data! Anyone without access to the academic literature might think that this distinguished economist knew what he was talking about. And pigs might fly…
I return to my remarks about economists on ABC TV recently–that they should be paid less than plumbers (OK, excepting me and my Post Keynesian buddies, but for us being paid like plumbers would be a pay rise).
Sorry for the excessive blood pressure here guys, but I’m now down in Adelaide for the 38th Australian Economists Conference, and I face spending three days surrounded by neoclassical economists…
You can fool all of the people some of the time, and some people all of the time. This is indeed the approach that government takes with countercyclical stabilisation and fooling some people is enough.
The real problem is whether government can make better decisions than the marketplace. Of course, people are not rational, but then Prime Ministers and Treasurers are hoping to win the next election on the votes of those exact same irrational people (and this is presuming that anyone can actually define what “rational” means, I assure you no one can). Governments are most commonly seeking short term political gain, rather than considering the long term interests of the nation.
Given that nearly all the Western nations are deploying stimulus and bailout packages in some form or another, where will the theory go if it appears to fail in some cases and work in others?
The marketplace clearly believes there is too much debt in the world and too little substance backing that debt. It is attempting to clear itself of this rubbish but governments are in the political position of being embarrassed by such actions so they want to override the market decision. This cannot work long-term (hopefully everyone accepts this fact) short term might win another election… long term, who knows, another war maybe?
Following on from steves comments above, I was going to question the idea that the government must spend before the private sector can pay taxes. If we assume loans create deposits, then credit money can be created to pay taxes at any point.
Clearly however, the banks will at some stage require reserves to clear transactions between them and to pay tax on behalf of interest earning customers.
However it seems to me that all that is required for payment of taxes is money free of liabilities, which can be created by the government, but can also be created endogenously in the private sector when interest payments are made on credit money. Those interest payments represent money without liability, and I cannot see how this can be distinguished form money created by the government.