Saturday, June 12, 2010

Post-Keynesian Solutions - A Reply to a Critic of the Blog

I have recently been given a lesson in the correct terminology for the various forms of Keynesian thought from a regular commentator on the blog, who posts under the title of 'Lord Keynes' (hereafter LK). For a long time now, he has posted comments critical of the perspective of this blog, and demonstrated a strong grasp of the various forms of Keynesian arguments. For a short while, I did engage with his arguments, but found that I ended up doing nothing but engage with his arguments, rather than writing the blog.

The reason for this is that, at whichever point, LK would provide reams of 'evidence' in support of his assertions. In recent times, he has even proposed that, for example, the Austrian economists provide no evidence for their theory, which is clearly not true. What LK and other Keynesians do is pick and mix from the available evidence, present arguments for the defence of their arguments based upon the policy/experience of country 'x' doing policy 'y' with the result 'z'. Typically, what they do is identify an individual policy, and then separate it from the broader context of the policy. In doing so, they appear to provide a cast iron case in favour of their policy.

I do not think that the Keynesians are alone in this, but they seem to be masters of the art. One example oft cited by LK is fairly typical, in which LK suggests that the Scandanavians have managed to be successful despite a large government sector (quoted from the comments section):

Denmark, Sweden and Finland are successful economies that run current account surpluses and that have substantially lower unemployment than the US or the UK, yet nearly half of all GDP is taken as taxes and spent by the government.

Germany, a manufacturing powerhouse and very wealthy country, takes 40.6% of GDP as tax revenue.

The UK is actually around the middle, not the higher end, of the spectrum.

By contrast, Haiti only takes 9.4% of GDP as tax revenue (before the earthquake, I might add), and what is it?? An economic basketcase!
The Haiti case simply makes my point. Apparently here is proof that low government expenditure is bad for your economy. No context, just a figure as 'proof'. We can also take the case of Sweden, which according to the World Economic Forum, is ranked as 4th in the world for competitiveness. The report uses the following pillars for the ranking:

  1. Institutions
  2. Infrastructure
  3. Macroeconomy
  4. Health and primary education
  5. Higher education and training
  6. Market efficiency
  7. Technological readiness
  8. Business sophistication
  9. Innovation
Note that the ranking systems does not include tax against GDP. In the Economic Freedom of the World 2009 report Sweden was ranked 4oth, despite the rankings scoring very negatively for large size of government expenditure with Sweden ranked 127th on this measure. According to a ranking of business regulation, Sweden comes in at number 18 overall, but is also number 7 for trading across borders. According to the IMD world competitiveness rankings, Sweden comes in at the 6th most competitive country in the world.

I can go on. For the informal economy, where people work outside of the official economy, Sweden is ranked = 82nd. According to the Economist Intelligence Unit, Sweden ranks number 2 for 'e-readiness'. Sweden holds 11th place for the number of patents in the US patent system, and ranks 4th in the world overall. Sweden lies at the third best in the world on rankings for perceptions of corruption. The country also rates at number 3 for technological achievement. Sweden has the 6th highest level per capita of spending on research and development, and the second highest aggregated (curiously after Togo as number one). On the technological achievement index, Sweden ranks 4th (creation of technology; diffusion of recent innovations; diffusion of old innovations; and human skills). On the global innovation index, Sweden ranks as number 4 (though this does include government policy such as patent law, and fiscal policy). Sweden is the world's most networked economy.

Of course, what the Keynesians will say is that this is all an achievement of government policy and the large proportion of GDP that goes into the state. However, how can a generous benefits system support, for example, the innovation that is shown here? Is the innovation what allows spending of this size, or is it that the spending causes the innovation. Cause and effect - how do you untangle these? Is the ability for government to spend so much the effect or the cause? I expect that LK will answer some of these rankings with examples of how government action facillitated the ranking. The problem is that this takes the particular context of one country as an exemplar for another country.

When the Keynesians propose country 'x' as an exemplar, they appear to view all countries as having identical strengths and weaknesses, and take no account of, for example, business culture. For those like me, who have worked in US, UK, French and German companies, as well as having worked with the Japanese, the Italians, Swiss, Chinese and so forth, it is apparent that there are real differences in business culture.

For example, hhilst I have worked with Swedish people, I have not done so enough to have a clear perspective on their business and working culture. However, I have had considerable experience of working with another oft cited example from the Keynesians, and that is the Germans. In particular, I have worked for a German multinational. My experience of working with Germans was that I was deeply impressed. They have a culture of thoroughness, of attention to every detail, and this is ideal for a manufacturing base. When compared with a British company, it was all very impressive. It is not just the experience of working within a German company, but also my experience of working with Germans in general. How does this kind of factor fit into explaining the success of country 'x', 'y' or 'z' in the examples given by the Keynesians. The answer is that, because it can not be measured, it does not appear (comments from those who have worked with German business welcomed).

The point I am trying to make here is that policy 'x', 'y' or 'z' does not operate in a vacuum, but in the context of a long history of economic policy, social policy, educational policy, particular resources, particular stages of economic development, and the global economic context of the particular time and so forth. As I have said, the Keynesians are not alone in this, and this is why economics is a matter of such debate. Cause and effect are actually very difficult to identify when looking at any individual policy. It is why opposing schools of economics are able to justify their positions in direct opposition to one another. I will give another example of this generalisation from country 'x' to country 'y' later.

One of the most interesting points that LK is making is that high government expenditure can sit alongside economic success, and this is why he cites the examples of Scandinavia etc. What he does not cite are the counter examples such as the UK. The UK has seen a steady expansion of the size of the state in the UK over the last ten or so years. However, having expanded the state, the UK is now in deep economic trouble. Is this not a counter example to those that he has given? Could it be that there are factors specific to the cited examples that allow them to support such a large state, but the UK lacks those factors? LK will not doubt suggest that the UK state misused their increasing control over the output of the country....

In a recent example, I mentioned the work of Carmen Reinhart and Kenneth Rogoff 'This Time is Different', a book founded upon empirical evidence, and LK immediately responded with a list of authors who have criticised their work. No doubt, the critiques included counter examples, and this is what we always find. For every example, in a complex history of economics, and a complex world, there are always ways to present a counter argument - as there is endless variability in contexts. In the end, what we are always left with, is the underlying theory, and which theory we choose to believe, and which interpretation of the 'facts' is most credible.

For example, LK puts the explanation for post war economic growth as follows (in the comments section):

The sources of post war growth can be found in effective financial regulation (to prevent asset bubbles), discretionary fiscal and monetary policies, and Keynesian demand management.
It is an explanation that has often been offered by LK. Note that the economic growth during this period takes no account of increased productivity of labour, or the many innovations that took place during this period. If we want to see an explanation for why an economy gets richer, would it not be useful to take into account the innovations and technologies? Instead of this, LK looks at the monetary and fiscal policies, and Keynesian demand management as explanations. I will ask a simple question.

If a factory yesterday can make 1000 toasters per hour per unit of labour, but in a years time can make 1200 toaster per hour per unit of labour, does this not represent a real increase in material wealth?

What we have are two different explanations for the same thing; growth in economies in countries like the US and Europe. In my version, we can see real changes in output per worker as new and more efficient production methods, systems and machines are introduced, creating real increases in output per worker (and this includes services), and we can see a real and measurable outcome of such innovation. On the other hand, we can see abstract and indirect theoretical transmission mechanisms that are represented by 'effective financial regulation (to prevent asset bubbles), discretionary fiscal and monetary policies, and Keynesian demand management.' The post world war growth, according to LK is resultant from Keynesian policy....and there is no way to comprehensively disprove his view.

My answer to the LK argument is that economic growth is created by the kinds of innovations that make increases in outputs, and development of new goods and services, possible. Those innovations are created in the competition between suppliers of goods and services, each trying to outdo each other in the market, in a battle for profits and survival. Whilst monetary and fiscal policy might have an influence, along with the regulatory regime, these are not the drivers of economic growth. Instead, they are potential hindrance of economic growth, and the best outcome that they might achieve is a neutral effect upon growth. None of these lead to the innovations that mean that there can be more output of good or service 'x' by worker 'y'.

In other words, government monetary policy, fiscal policy, and regulation do not create the innovations that create real increases in output. In the end, you can choose which is the better explanation of the post war growth. Was it government policy, or a period in which innovation created massive gains in output?

One argument might be that elements of government fiscal policy might have some indirect impacts, such as the proportion of government spending being used in effective and efficient education programs. Some government funded research programs might also lead to innovations that will impact upon output in the economy. However, how those research programs might produce results in comparison to the actual investment in research, in comparison with having the money being used in research by private organisations/individuals, is a question for which there is no neutral answer. For example, elements of the modern Internet flowed from US government defence research, but the application benefits in the civilian Internet were coincidental but huge.

But then again, the huge amount of money poured into defence programs must surely eventually result in some kind of breakthrough...

In proportion to the total of government expenditure, how might we measure such benefits, and how might they be compared to private R&D expenditure? If the money were left in private hands, what kind of economic growth might it achieve? We do not know the answers to such questions, and there is no neutral way of making such an assessment. There is no data that might objectively measure such a thing.

This brings me onto LK's favourite term, which is the idea of 'industrial policy'. This is a bit problematic, as it is always vague and undefined. I will quote some examples from LK:

That is why they need to nationalize banks, tightly regulate them, control allocation of capital to productive investments, adopt aggressive trade and industrial policies and rebuild manufacturing and output of tradable goods and services. (here)

This can be done through social policies to help families as well as immigration and vigorous industrial policy. (here)

It's [the US] main problem is that it allows it multinational corporations to ship its jobs to East Asia.
This can be fixed quite easily through industrial and trade policy or by taxing corporations according to the value added in the US. Yes, that means higher prices for manufactured goods. But it also means employment, investment, stronger industries and a healthy economy. (here)

The rise of China was very little to do with comparative advantage. It rose through aggressive industrial policy.
The UK and US can use aggressive industrial policy as well to rebuild their manufacturing sectors. (here)
Only in one case have I found anything that might explain what industrial policy might really mean, and that is a link provided by Lord Keynes to a Google books page on Taiwan's emergence as a modern economy. Other than suggesting a formula which might, or might not have, contributed to Taiwan's growth, it is all rather vague. If we look at LK's blog, we find a few indirect references:

The only region that showed an increase was East Asia, precisely the region dominated by the protectionist state-led model of industrialization, led by Japan, South Korea, Taiwan, and (from the early 1990s) China. (here)
In another post, LK discusses the New Zealand experience of industrial policy, but never makes clear exactly what that policy was, or how it might have succeeded. Instead, he discusses external factors, and claims that the big fall in GDP was a result of neo-liberalism. Once again, we have a selection of factors that suit the argument being made (if you read the post, it does not mention many of the factors involved, such as what drove the eponymous instigator of the liberal policies known as Rogernomics to declare that the country faced economic ruin - and the instigator was a Labour MP).

What we have here is some very vague suggestions from LK, that are never fully elaborated. I used Google to search my site for industrial policy comments from LK, and could not find anything which might explain how this industrial policy might really work. There are certainly indications that the intent is to introduce capital controls, impose tariffs (direct or indirect) and to control industrial sectors - as well as hinting at mercantilist policy. However, I will not comment on these here, as they are only speculation.

Then there is the Keynesian perfectly circular arguments for government borrowing. These are the arguments that government borrowing is unconstrained, and that government borrowing might be a way to lead an economy out of recession. According to LK, there is no limit to government borrowing, and that government borrowing creates economic 'growth'. This is a recent comment from LK, in which he claims 'proof' that economic stimulus works:

Secondly, the Western countries have returned to mild growth and are not contracting: this is proof of the success of fiscal policy (you are mistaken to say that Keynesian stimulus can never be proved “wrong”: if we got a major depression and negative growth in the face of large fiscal stimulus, then this WOULD demonstrate that something is wrong with the Keynesian theory).
The most interesting thing here is that LK actually thinks that the consumption of borrowed resource represents economic growth. The simplest way to illustrate why this is such an odd idea is to pull away any restraints on borrowing. For the sake of illustration, let's imagine that the US had a credit line of an additional $1 trillion this year, in addition to their current huge borrowing, and that the US utilised that credit line. If they did so, they could start any number of huge projects, all utilising that borrowed money, and there would not just be GDP growth, there would be a massive boom in the economy. GDP growth would sky rocket.

If this is the case, why not just borrow that additional $1 trillion. The economy would boom, tax revenue would boom, and the economic growth would mean that the debt to GDP ratio would fall, suggesting that the debt is more serviceable. If this is the case, then it would seem that, the more that is borrowed, the greater the economic growth, and the more successful the economy. On this basis, every economy should add ever more borrowing every year to ensure endless economic growth. After all, the growth reduces the debt to GDP ratio, and increases the tax revenues to ensure repayment of the debt. Here is a recent example of this thinking from Krugman, offering a critique of German austerity measures:

"But that doesn't make sense. Even if you manage to save 80 billion euros – which you won't, because the budget cuts will hurt your economy and reduce revenues – the interest payments on that much debt would be less than a tenth of a per cent of your GDP. So the austerity you're pursuing will threaten economic recovery while doing next to nothing to improve your long-run budget position."
So here you have it - cutting a budget deficit hurts tax revenues. This is so circular, that I find it beyond belief that any person might suggest this as a realistic approach to economics. If government borrows money, and that borrowed money enters the economy, then more activity will take place, which will create more government tax revenue, meaning that the government can claim that the economy is growing whilst improving their ability to service the debt that they used to start the whole process.

It is a perfectly circular system. It is an economic perpetual motion machine. So what is the problem with this economic perpetual motion machine?

The trick to understanding this is not to think of government borrowing money, but of borrowing of resources. When a government borrows money from overseas, they are actually borrowing the output of that overseas country. For example, if borrowing from the Gulf states, it is the equivalent of borrowing oil. When that oil enters into the economy, it allows for increased activity in the economy as the oil is consumed. At each stage of activity in the economy, a percentage of that oil is consumed and that oil is a contributor to the output within the economy. It is a system in which real resources are being consumed. The problem here is that the consumption is consumption of Saudi Arabian output, not US output. In consuming the oil, the measurement is not of US output, but is a measure of US output + Saudi Arabian output.

All the time this consumption is taking place, there is an accumulation of an obligation to provide goods and services in the future to repay the loan of oil in the future. Those goods and services will necessarily require the consumption of resources (including oil) in the future to repay the loan of oil. If this is the case, then a percentage of the total resources of the US must be allocated to making this repayment. If those resources are being utilised to repay the loan of oil, then they will not be available for internal consumption. Remember, the oil resources that were borrowed have been consumed.

What all of this tranlates into is that, if you borrow and consume huge amounts of resource, it is possible to achieve growth in activity. I can not argue with this. It is self-evidently true. It is very easy to generate activity with borrowed resources. Just borrow more and more, and you will generate ever more activity. That this is the case does not in any way imply that this is a good long term strategy for an economy. It is actually the easiest thing to do - borrow money to create activity. It is so easy that we might think a monkey could do it. It is not clever, it is not sophisticated, and you do not need to have a PhD in economics to understand that if you throw enough borrowed resources into an economy, it will create activity. But where does it leave you, but with an obligation to repay that resource in the future.

What about if the borrowed resource is used for investment? It may be that some of those oil resources were borrowed and used to create new output, for example, building a factory. If this is the case, it might be that the factory will later produce goods and services that might help pay for the borrowed oil. The question here is to ask whether this is actually what is taking place? Are the gargantuan sums of borrowed money being directed into investment or consumption?

If it were the case that the huge sums of money were being wisely invested in new and productive investments, we would see a massive growth in the US economy as a result of the investments. However, we can not see any such resultant growth, but instead see the US limping along, with no real signs of recovery.

The answer of LK to this problem is to suggest that the massive stimulus spending is not being correctly utilised, and should be used for infrastructure projects/ other projects specified by the wise sages of post-Keynesianism. What I always find interesting about such proposals is that, if these projects were of genuine economic benefit, why were they not undertaken before? After all, all governments want economic growth, and there is no reason why such projects might produce such a return in the good times as in the bad times. What has changed? By curious coincidence, these projects move from being unconvincing in the good times, to convincing in the bad times. In other words, the value of the projects is being subjectively reassessed in the bad times. What was a poor investment becomes a good investment.

As an interesting example, LK cites the case of the success of the stimulus in China as follows:

First: the tremendous success of Keynesian stimulus in China and Australia.
To repeat a previous post:

In the face of a massive collapse in their export-led growth economy, what did China do?

They implemented a massive $586 billion dollar Keynesian stimulus – and then got a very impressive recovery, so impressive in fact that with growth in the first quarter of 2010 at 11.9%, there is talk that they may need to cool down the economy.

Does that sound like a “failure”?

Australia also implemented a large Keynesian fiscal stimulus, which worked very well, and it benefited from China's stimulus as well.

Conclusion? Countries that are close trade partners benefit tremendously from Keynesian stimulus in both countries.

Your failure to even address this point severely undermines your whole argument.

I am not sure whether LK has been to China, but there are large swathes of China that genuinely lack infrastructure. As one example of the government spending on infrastructure, the last time I was in China, I went along a pot-holed track and could see a massive new highway being built alongside it. The road was opening up a large area of Sichuan province to the rest of China, and would thereby pull that region into the Chinese economic system. There was little potential for economic development of the area prior to the road being built, as the communications were simply too poor to allow any growth. When I viewed the road being built, there could be little doubt that it was a genuine investment which would allow the people of the region to contribute to economic growth in the future.

You may note the difference here. In an emerging economy such as China, there are many projects that are not only attractive, but actually essential. This is not to say that all investments in infrastructure in China will repay the investment (it is a very corrupt country), but that it is easy to find good investment projects. Even before the crisis, China was investing heavily in such projects (as there were so many that were necessary) and they have just accelerated this process. Unlike a developed economy, these projects were self-evidently a good investment before the 'bad' times. Furthermore, China is a current account surplus country, meaning that it can pay for these projects without the risks in having to borrow the resources of other countries to fund the projects.

What we will see from the Keynesians is that they will suddenly find hundreds, if not thousands, of projects that have been crying out for investment. They appear as if by magic, as soon as there is a downturn. In the case of an emerging economy like China, many of the projects will be of great value, but in a developed economy, they are unlikely to be anything but of marginal benefit at best. In using China as an example, LK does exactly what I discussed earlier. He takes a case out of context to 'prove' his point, but in reality, proves nothing. I believe that I have answered LK completely here, and his use of this example just illustrates my point about context. Any comparison of the situation of China and a country like the US is pointless.

What of all those unemployed? According to the Keynesian arguments, all of these people are sitting around as unproductive resource. Would it not be better to employ this idle resource?

It is a tempting argument, if only for the dignity of the unemployed workers (which is a concern I share). However, in employing these people, for example in infrastructure projects, they are not a resource that is being used productively, but rather a resource which costs more resource to appear to be productive. If the infratructure project is not viable as an investment, then the additional resources needed to emply these workers mean that they are just consuming additional resources in their employment. Compared with having the unemployed worker sitting at home (for example on benefits) this represents a net increase in resource consumption per person who is employed on the project compared with being unemployed at home.

'Yes', in the short term, a person can appear to be gainfully employed, but at what cost for the future?

To illustrate the point, prior to the crisis exploding, there was high employment in many developed economies as a result of the credit boom. All of those people appeared to be engaged in productive and useful employment. However, the apparently productive employment was resultant from the borrowing of resources from other countries, and the consumption of these resources. Each of these people employed as a result of the credit boom looked every bit like they were making a net contribution to the economy, but many of them were just facilitators of consumption of the output of other countries. Their net contribution to the economy was actually negative, as they were part of a system in which consumption exceeded output. The result is the massive debt overhang in many developed countries. The Keynesian stimuli just offers more of the same. Just as the private debt overhang led to unemployment now, the government debt overhang will create unemployment in the future. It is just a delay, not a solution.

The private debt accumulation led to lots of employment in unsustainable sectors, such that resources were directed into an unsustainable economic structure. When the structure collapsed, unemployment went up. However, the stimuli measures have sought to turn this back, but by doing the same thing as the original problem. By trying to support an economy based upon borrowing, which entrenches an unsustainable structure.

This is the other problem with the Keynesian solution; it evades the underlying problems in an economy. If we think of the net over-consumption in the economy, it must be the case that, at some point, the balance must be reversed to pay back the previous over-consumption. By borrowing more money, the structure of the economy is left in a form in which large sectors of the economy are structured towards the over-consumption. If people are employed on infrastructure projects that represent a consumption of resource (not an investment), then the sectors of the economy that are supported by over-consumption are left in place. These sectors continue to have resources directed at them. Replacing private borrowing with government borrowing just leaves the same structure in place, completely unreformed.

This kind of problem, however, is not apparent at the time of the stimulus spending. In fact, none of these problems are apparent at the time of spending the stimulus money. This is why LK can claim success, as he has done, for recent bouts of stimulus spending. LK points to country 'x' and says look how they have returned to growth having spent 'x' amount of money on a major stimulus. As I have said earlier, it is no wonder that pouring masses of borrowed resource into an economy will stimulate activity. It really does not take much to see the cause and effect, but it is a different matter to see the long term consequences.

So why does LK think this will work long term? I will quote from one of his recent comments:

That the effect of a stimulus is “transient” is an utterly trivial point. Of course it is.
The whole point is to temporarily stimulate the economy back into growth, so that demand for private goods will be restored and private business confidence and output will rise - which creates a self-sustaining economic expansion.
Output of what will rise? If you are stimulating with borrowed resources, yes, output will rise, but it will rise in the sectors of the economy which otherwise can not support themselves. You are simply entrenching the structural problems, as I discussed earlier. It is not self-sustaining, as the parts of the economy that are supported by overconsumption remain in place. They can only be supported by ongoing borrowing for consumption.

I have noted in previous posts that, as economies such as the US and UK returned to so-called growth, we could see a commensurate deterioration in the trade balance. No doubt, all of the consumption fuelled by the borrowing will support the economy for a little longer, but the underlying structural problems are kept in place at the cost of accumulation of debt. It is a transient effect, and this in not an 'utterly trivial point' as LK claims. It is exactly the point. As soon as the stimulus is withdrawn, the economy will return to the problems that have not been addressed. This brings me to another point.

LK criticised me recently as follows (my words quoted in italics):

If the fiscal stimulus runs out of steam, have another one, and another one, and another one. If it is not working, a larger one will do the trick. If the larger one does not do the trick, then there is an even larger one that might be do the trick. In nobody will lend, print money. If that does not work, just print more.

I assume this is mainly meant to be rhetoric?
If not, which countries have tried 6 stimulus packages that failed? Answer: none.
Have any countries tried 5, 4, or 3 stimulus packages that failed? Answer: none.
In fact, have any countries even tried 2 stimulus packages yet??
Yes, Japan. It has long been using all of the tools advocated by LK. And when these did not work, the cry is that they should have done more of 'x' and 'y', they stopped the stimuli at the wrong time etc. No doubt LK will claim that Japan did not apply their various stimuli correctly...or they should have pushed on through with more of the same. More bridges to nowhere....

And this leads me on to the next problem, which is the idea that government borrowing is different from private borrowing:

In the real world, the government controls monetary policy. Its debt isn’t even remotely like private debt. An entity that has the power to create money cannot go bankrupt.
It can certainly use too many real resources, cause inflation in boom times, increase the external deficit unsustainably, or stupidly borrow money from private markets when it has no need to.
Within this argument, we see that LK is a supporter of printing money (or he will no doubt use the weasal term quantitative (QE) easing). I agree that borrowing money on private markets is foolish, but that is because I do not agree with the borrowing of money in the first place. However, the proposal of LK appears to be that the best route is to simply print money, and utilise this rather than money borrowed from private markets. As we know, this is what the UK was doing until recently. For those of us who pointed out this was inflationary, we are now being vindicated. The UK is indeed now subject to growing inflation, despite the 'output gap', despite the fall off in private credit. In fact, the UK is importing inflation due to the decline in the value of the pound, and this despite the Bank of England's continuous predictions of deflation. The only question remaining is how far the inflation might climb (although the austerity measures being proposed may put a halt to the inflation).

The problem is this. If you start down the road of printing money to finance deficits, you eventually create inflation. The transmission method of the inflation may be through currency depreciation, may be through a boom in credit, asset price appreciation or a host of different conduits. It may be that the effects are delayed, for example where the UK banks used the process of QE to rebuild reserves. However, eventually, the new money appears in the economy. When it does so, it must be sterilised, or it will lead to inflation, and here is the problem. In order to sterilise the money, the Bank of England must sell assets to destroy the newly created money, which means selling gilts. In doing so, the process of QE just becomes a delaying mechanism, as those gilts must be sold in private markets. Either that of the Bank of England must print money to sell the gilts to itself, thereby defeating the purpose of the sale (though I would not be surprised at such a lunatic policy).

It is an incoherent idea to suggest that a government does not eventually need to turn to private markets to finance their deficits. And if the private markets do not want to buy? What happens then? The money created remains in the system....and the inflation will follow...

And this is why government debt is like any other debt. Sure, a government can not go bankrupt in that they have no money, but a country can end up with a worthless currency that can not be used to exchange for goods and services. In order for a government to borrow, the potential lenders have to, in the end, believe that they will have the borrowing repaid in a value that exceeds their lending. So a government can print money, and default on its debts indirectly. However, a default is a default is a default, regardless of the specific form of the default. The more a government borrows, the greater the call of the creditors on the future output of the borrowing country. If the output does not increase faster than the borrowing (not including the output that is itself resultant from the borrowing), then, at some point in the future, there will be a loss of output for internal use in the borrowing country. Either that, or the country defaults on debt (for example paying with printed money).

And when a country defaults, with outright or indirect default, the credit will stop, or will be offered at high interest rates to reflect the risk. Whichever the case, the private debt markets will impose a fiscal discipline on the government. It is not that the private markets are evil and anti-democratic. They have a reasonable expectation of repayment when they lend money. If there is any evil (though I do not like this word) it is governments seeking to bribe their voters with borrowed money today which will have to be repaid by others in the future. It is the lie that this is sustainable and can be continued with no future consequence. I keep coming back to the point - it is easy, if not lazy, to just keep borrowing more money, in order to support a failing economy. Pouring borrowed money into an economy is the easiest thing in the world, but it is the repayment of the borrowing in the future that is the challenge.

A good example of this lazy and dishonest approach to economic management are the state pension schemes. As every year goes by, the liabilities steadily accumulate. As they do so, governments pretend they are not there, as confronting the problems of the accumulating debt would not be popular. The pensions will, one day, need to be paid, and that liability is going to become the liability of the following generation. It is no different from borrowing to build a hospital, or a new road. In both cases, the benefits accrue to one group now, at the cost of future tax payers. In the case of pensions, the provision of savings to support the pension schemes would come at a cost of less activity in the economy now. Less 'growth'. In the case of the hospital built with borrowed money, the same thing. In all cases, someone is going to have to pay for these benefits, just not the people who are enjoying the benefits.

This is the Keynesian policy writ large. The avoidance of only consuming what you can produce. Beneath all of the sophisticated arguments, it all comes to this central point. If you borrow, you must repay. I do not believe in government borrowing at all, but borrowing more than your underlying growth of wealth creating capacity means that someone in the future must pay for your consumption now. This is morally bankrupt and irresponsible.

And then I come to the question of why governments borrow in the first place. If there is unemployment, why borrow the money to alleviate the problem. Why not just tax more and use the taxes to pay for the unemployed? The reason is that the high tax would be unpopular. Why borrow to build a new hospital. Because paying for the hospital directly would be reflected in higher taxes for the users of the hospital. How much better to spend borrowed money and call it 'investment' or other euphimisms for passing on cost to those in the future. And for people like LK, they offer sophisticated arguments, endless cherry-picked evidence to hide the fact that if you consume more than you produce, unless your output increases above the rate of your borrowing, someone is going to pay in the future.

Someone in the future is going to have less, so that you can have more now.

There are many other arguments made by LK, and many other Keynesians. Within all of their arguments, we always come back to the same themes. Government borrowing is the solution to all ills, and if governments can not borrow now, they can always print money. It is the endless pushing of today's problems into the future. It is exactly like the pensions problem. Do not confront difficulties now, just leave them to the future. But this is the great attraction of Keynesian economics. It is why defenders of Keynesian policy gain so much support.

However, as one commentator put it in the Telegraph, the days of spend now pay later are over. Later is now. Many governments are now facing the point where the markets are asking how governments plan to pay back the money they have borrowed. In the world of LK, he proposes that the answer is to ignore the markets, and print money instead, ignoring that one day, like it or not, the markets must buy the debt. No doubt, printing money might delay the problem a little longer, avoid the absolute need for economic restructuring, but only at ever greater cost later. This is the problem with the soltuions offered - they delay confronting the problems to create a greater later cost.

I fully expect reams of counter argument from LK. He will, insist that his case is right, will contest the Swedish point, and so forth. However, for the readers of this blog, just think about the perpetual motion machine of government borrowing creating economic growth. Borrowing to consume now creates wealth in the future. Wise 'investments' appear from thin air. Think of the way in which China offers 'proof', entirely free of context. Think about the pension deficit, of how easy it is to pass the buck. Think of the arguments about how governments do not need the private markets for borrowing as they can just print money. Think how easy it is to pour money into an economy, but how difficult it is to pay back.

It is a lazy economics dressed up with sophistication and misdirection. It is easy to have a party on borrowed money, but less easy to deal with payment in the future. It is very easy to spend the money of future generations and have good times now. Any idiot can do this. The true genius of Keynesian economics is that they can dress this up so well with theory. In the end, my argument rests on one key point. If you consume more than you can produce through borrowing on an ongoing basis, you have a problem, and you can only delay facing that problem for so long.

Note: LK has written extensively on mnay subjects and, even with such a long post, I have not covered them all. In fact, to give a full response to LK would take a lifetime, so I leave this reply partly unfinished. I also note that LK has added some substance in his recent comments on industrial policy. Unfortunately, added after this post was written, and I really do not want to revise the section. This was time consuming enough.

77 comments:

  1. Government knows best!

    http://www.cnbc.com/id/37786852

    No doubt, this will be accused of hysterical scare mongering....

    ReplyDelete
  2. Well, let's agree that there are 2 main schools of thought on 'to stimulate or not to stimulate', with highly intelligent people on both sides of the argument.

    As an attempt to settle this one way or 'tother, maybe it would help to imagine an extreme case where the 'correct answer' may be found to be fairly obvious.

    Imagine we had a real heavyweight consumer slowdown, where the population at large really cut spending down to the bone, only forking out on whatever they found absolutely neccessary. ( Basic food, clothes, heating bills , some transport ) & gave up altogether on anything remotely discretionary ( exotic holidays , gadgets, fashion, entertainment, exotic foodstuffs, exotic hairdos, exotic cars, exotic houses, .... ) .

    First obvious effect : a high street crash, with shops closing up wholesale. ( or should i say retail?) Restaurants, hairdressers, furniture stores, estate agents, travel agents... all but the Primarks of the world gurgle down the ecomonic toilet, leaving more thousands unemployed , and now themselves unable to spend, thus reinforcing the problem & leading to a new round of shop closures...
    Tax revenues plummet, bank accounts start to fill up with unspent money ( saved for the coming rainy day) .. but the consumer doesn't borrow this money, no, on the contrary the shell shocked, white faced consumer eats his Tesco Essentials pizza under the light of a single 40 watt energy saving bulb and watches tv 7 nights a week covered in a blanket with the heat turned down.

    Money is pulled from stocks & everyone clamours to buy gilts at some paltry rate because at least that way they know they will get their money back.

    And the banks join in on this Gilt buying frenzy because they no longer have takers for 25% APR loans.

    So what is the govt to do ? The consumer has stopped spending & as a result the economy is ( to coin a phrase) 'black-holing'.

    They can , as their conservative advisors tell them, 'cut the national debt!' as a priority measure and actually join in on pulling demand ( & hence jobs & spending) out of the economy , & the predictable result will be a *worsening* of the situation ( if that were conceivable).

    Or they can essentially *take the place of the (absent) consumer & SPEND as if our lives depended on it. ( Which, I hope it's obvious, they do).

    *The time to cut deficits is when the going is GOOD*. ( I agree this was not done when it was & it's hard to see how in a democracy - where politicians promise almost anything to get themselves elected into those expense account laden jobs in parliamment - it's hard to believe they ever will ..)

    But... we are where we are and *cutting out the last remaining consumer * ( the govt) would be insane.

    As if the captain of some ship in the most horrendous gale , with the ship about to roll over, paradoxically decided that now was the ideal time to sell off the lifeboats & the sails & the compass & the sextant & cut half the crew because otherwise he *might not be able - at some unspecified point in the future - to afford the interest payments on the running costs of the ship * ..

    Well, I hope it's obvious that the time for these 'austerity measures' is NOT when the ship is on the rocks in the middle of the economic night when panic is all around & there is serious doubt the ship will make it through the storm.

    If the ship ever makes back to some halfway decent port THEN will be the time to maybe rethink the operating basis of HMS Britannia.

    To cut NOW, with the sharks circling and the waves getting higher, because of some vague feeling that *at some unspecified future time * the bond vigilantes might (might !) move in would be literally insane.

    ReplyDelete
  3. CynicusEconomicus said...

    "" Government knows best! http://www.cnbc.com/id/37786852
    No doubt, this will be accused of hysterical scare mongering...."

    You're right.
    No doubt at all !

    ReplyDelete
  4. ChaingangCharlie: An interesting point of view and argument.

    However, what you miss is the 'why?' of consumers cutting back and saving. It is because so many of the have houses filled with goods that they thought they could pay for by using their houses as ATMs. They thought they did not need to save as they have 'property' to bail them out. They actually need to pay down the debt and actually save money for the future.

    If the government replaces this consumption, they are just doing the same thing as the consumers did in the first place. They are not borrowing money on their own account, they are borrowing on behalf of those same consumers who are now paying down their debts and saving, but who will eventually have to pay back the borrowing in taxation.

    Governments do not borrow money on their own account. They borrow on behalf of you, me and all the other people in the society, including some who are not even born yet. Government debt is our debt. It does not belong to some abstract entity. It is a commitment that one day, through the tax system, you and I will pay back the money.

    So what you mean here is that government can indirectly continue the behaviour that put us in the mess in the first place. We can meanwhile pretend that, because we did not sign the loan agreement, it is not our future problem.

    The trouble is that, when we accept the government borrowing, we are indeed signing those loan agreements. It is the great and attractive lie of the Keynesians - that it is the government that borrows money, not us.

    The economy is not a ship, as your analogy suggests. It is not a horrendous gale that presents the problem, but the lack of care and maintenance of the ship that threatens the safety of the ship. Rather than address the failure to maintain the ship, the Keynesian solution is to fix the engine with a piece of masking tape and relax. No need to get the engine open and fix the real problem, as the masking tape will hold it together a bit longer.

    I would suggest that, to leave the engine unrepaired is the real insanity.

    ReplyDelete
  5. A very enjoyable, well argued and stimulating post. It is great to see all your ideas mustered here in response to the Keynesian position.

    I hope I can address the major issues one by one:

    On the Sources of Post WWII Growth

    Note that the economic growth during this period takes no account of increased productivity of labour, or the many innovations that took place during this period. If we want to see an explanation for why an economy gets richer, would it not be useful to take into account the innovations and technologies?

    Of course productivity of labour had a major role.
    My view does take account of innovations and technologies – and shows that with a greater role for the state in R&D we got faster and better innovation.
    Furthermore, full employment actually incentivises productivity gains through technology and automation, because, when the cost of labour is high, businesses are forced to look for cheaper technological solutions.
    A low wage country with a huge labour surplus where life is cheap and workers replaceable greatly reduces the incentive for technological innovation.
    Our high-wage post-WWII manufacturing economies produced great technical innovation.

    If a factory yesterday can make 1000 toasters per hour per unit of labour, but in a years time can make 1200 toaster per hour per unit of labour, does this not represent a real increase in material wealth?

    Of course it does. I don’t think I have ever denied this fact.
    However, even with these productivity gains, if unemployment and demand is low, you won’t find buyers for the commodities – you need demand management to release the full benefits of increased productivity. The elimination of depressions, debt deflation and a much less volatile business cycle was the framework in which these gains were realised.
    Economic stability and a floor below which GDP could not fall through welfare and fiscal stimulus was a powerful stabilizing element.

    Financial regulation directed investment precisely to productive areas of the economy where these productivity gains could be made – instead of to asset bubbles.

    In my version, we can see real changes in output per worker as new and more efficient production methods, systems and machines are introduced, creating real increases in output per worker (and this includes services), and we can see a real and measurable outcome of such innovation

    The process you describe also occurred in the 1920s and 1930s – yet these were periods far from full employment or significantly rising real wages. In order for the country to benefit from productivity gains, you need to prevent depression and asset bubbles, and make demand for these goods exists.

    If the money were left in private hands, what kind of economic growth might it achieve?

    In the absence of effective financial regulation, I think we had a very powerful demonstration of what happens in the last 10 years: “investment” in asset bubbles and other speculation at the expense of investments in the real economy.

    ReplyDelete
  6. On Industrial Policy

    This brings me onto LK's favourite term, which is the idea of 'industrial policy'. This is a bit problematic, as it is always vague and undefined.

    I am surprised that my posts on industrial policy are supposedly “vague and undefined.”
    Reviewing my previous comments it is clear I have given detailed comments on industrial policy, both in theory and in practice.

    In my first comment here

    http://cynicuseconomicus.blogspot.com/2009/01/uk-bank-bailout-round-2-begins.html

    I give a detailed list of the policies of East Asian industrial policy.

    Only in one case have I found anything that might explain what industrial policy might really mean

    I have just posted plan for industrial policy in the US on the most recent blog post.

    In another post, LK discusses the New Zealand experience of industrial policy, but never makes clear exactly what that policy was, or how it might have succeeded

    Actually the point of that post was to show that the fall in New Zealand’s per capita GDP cannot be ascribed to a failed industrial policy, as some people believe. The “Think Big” project clearly did fail in a number of important ways.

    There are certainly indications that the intent is to introduce capital controls, impose tariffs (direct or indirect) and to control industrial sectors - as well as hinting at mercantilist policy.

    I think this blog has repeatedly described China’s industrial policy. You refer to it as “mercantilism.”
    I assume you don’t deny the existence – and effectiveness – of this mercantilist industrial policy. Though you don’t say so in your comments, you seem to suggest that industrial policy can never work has never been successfully done anywhere. However, doesn’t China’s success show that it can?

    ReplyDelete
  7. On Deficit Spending

    According to LK, there is no limit to government borrowing

    On the contrary, I argue that governments should not by constrained by “borrowing” from private markets. If the government is monetising its deficit by central bank money creation this isn’t borrowing.

    I have also repeated said that there are limits to government spending.

    Those limits are a particular country’s available resources, capacity utilization, unemployment and external balance.


    The most interesting thing here is that LK actually thinks that the consumption of borrowed resource represents economic growth.

    If you believe that borrowed money can never create economic growth, then how can the private sector possibly create economic growth by borrowing money from domestic markets or overseas?? Logically, this argument would force you to admit that any private sector “growth” funded by borrowing is not really growth either. You then have the bizarre conclusion that no economic growth can ever result from private or public borrowing.

    For example, 19th century American economic development done by the private sector was funded by foreign capital (and much British capital). Or we to then say that none of this private sector “growth” was actually growth, because they borrowed money from overseas?

    If this is the case, why not just borrow that additional $1 trillion. The economy would boom, ….. On this basis, every economy should add ever more borrowing every year to ensure endless economic growth

    Because borrowing in every year would cause excessive inflation and run up against available resource constraints.


    It is a perfectly circular system. It is an economic perpetual motion machine. So what is the problem with this economic perpetual motion machine?

    The crucial missing factor in your analysis is the return to sustainable growth that means that further budget deficits are not necessary.


    The trick to understanding this is not to think of government borrowing money, but of borrowing of resources. When a government borrows money from overseas, they are actually borrowing the output of that overseas country.

    They are not borrowing output. They are borrowing money.
    Money can be used to buy output or financial assets or real assets.
    When you attract foreign exchange via a capital account surplus (“borrow” this money), the foreigners have bought a financial asset or real asset in your economy. They have an asset in exchange for their money and a return.
    They might sell this asset and take their money to another country and buy a different asset (which of course happens all the time). No claim on output ever happens.
    I wonder why do you ignore the role of financial markets?
    We live in a world of current accounts (goods and services) and capital accounts (real and financial assets). Alot of money just gets moved around between financial and real assets between different countries – no claim on actual output happens.

    All the time this consumption is taking place, there is an accumulation of an obligation to provide goods and services in the future to repay the loan of oil in the future,

    But thereisn’t an obligation to provide goods and services. There might be, but alot of the time people are exchanging money for assets (real or financial) or vice versa.

    This argument doesn’t work.

    ReplyDelete
  8. Thank you so much for putting in the time to counter the arguments that LK keeps posting. His constant barrage of "facts", coupled with the "reasons" and always ending up with,

    "this is so easy, all the government has to do is to print interest free money and we'll all be wealthy and have jobs"

    has been annoying and confusing me for so long. Annoying because these MMT guys have wrapped up their ideas in such a way that they are almost impervious, and any questions are hurled back by statements implying I am stupid in not understanding what is, to them, blatantly obvious.

    ReplyDelete
  9. cynicus said :
    "If the government replaces this [consumer] consumption, they are just doing the same thing as the consumers did in the first place. They are not borrowing money on their own account, they are borrowing on behalf of those same consumers who are now paying down their debts and saving, but who will eventually have to pay back the borrowing in taxation. "

    It intrigues me , to follow the flow of cash here. If we imagine a pile of consumer bank accounts slowly filling up with 'saved' money , then we have a lot of banks with a lot of money on their hands and they are going to find something to do with that cash.
    In the current environment, they are not going to be lending it out to business start ups. Nor on consumer loans. So , what do you think will become of these large piles of unemployed cash ?
    Seems to me a large percentage is inevitably going to be invested in gilts (where else can it go ?) , and thus the ability to spend ( on which the economy depends ) now lies with the govt.
    ( And this is one reason why interest rates on govt borrowing will not be rising very far very soon - lending to the govt is about the safest thing anyone can do with their cash, and risk is, as they say 'off' ).
    Now, if the govt , following your advice, simply hoards all this pent up spending power, then we get into a self stoking downward spiral ( cf Ireland right now) which will inevitably lead to a further crash in consumer spending, a further leg down in consumer saving ( due to - & also leading to - yet further increased unemployment ) , ... basically a horrific self induced downward spiral.

    You can see it is the mirror image of a 'bubble'.
    A kind of self reinforcing , downward, 'anti-bubble'.

    I don't get how anyone could seriously think this could possibly be 'a good thing'( or even the least painful of a grim set of available 'bad things').

    The time for govt to cut spending is *when the consumer is increasing her spending*, not before.

    ReplyDelete
  10. For those of us who pointed out this was inflationary, we are now being vindicated.

    The lastest figures about UK inflation show disinflation:

    http://www.statistics.gov.uk/cci/nugget.asp?id=19

    I can’t help but point out a previous post:

    However it is spun, it is apparent that government borrowing is being funded through the printing of money, the weasel worded 'quantitative easing'. However it is spun, it is fundamentally no different from Zimbabwe, Argentina or the Weimar Republic. Resorting to the printing press is the action of a bankrupt government.

    http://cynicuseconomicus.blogspot.com/2009/07/more-on-printing-money-in-uk.html

    With no accelerating inflation in the UK (that is, disinflation now), such comparisons were and are exaggerated.

    The only question remaining is how far the inflation might climb

    But the UK is now in disinflation (and that was before actual austerity).

    When it does so, it must be sterilised, or it will lead to inflation, and here is the problem ... It is an incoherent idea to suggest that a government does not eventually need to turn to private markets to finance their deficits. And if the private markets do not want to buy? What happens then? The money created remains in the system....and the inflation will follow...

    Money can be drained and essentially destroyed by budget surpluses and tax increases.

    And for people like LK, they offer sophisticated arguments, endless cherry-picked evidence to hide the fact that if you consume more than you produce, unless your output increases above the rate of your borrowing, someone is going to pay in the future.

    As I have shown above, a country pays for its excess imports (= current account deficits) through capital account surplues. It gives foreigners financial assets and real assets in exchange for their money. There is no necessary claim on output at all.

    ReplyDelete
  11. Comments 5

    What I always find interesting about such proposals is that, if these projects were of genuine economic benefit, why were they not undertaken before? After all, all governments want economic growth, and there is no reason why such projects might produce such a return in the good times as in the bad times.

    There is an obvious and immediate answer to this: in times of economic prosperity, these large public works would take away resources from the private sector, push capacity utilization above its limit and cause inflation.

    In a recession or serve recession, resources are idle, labour is idle and capacity utilization is low. The private sector by definition is not using these resources. Inflationary pressures are falling. This is precisely the time to undertake large public works

    You say

    1. I am not sure whether LK has been to China, but there are large swathes of China that genuinely lack infrastructure.

    2. In an emerging economy such as China, there are many projects that are not only attractive, but actually essential

    3. Furthermore, China is a current account surplus country, meaning that it can pay for these projects without the risks in having to borrow the resources of other countries to fund the projects.

    I can only say that this seems to be a tacit admission from you that developing countries with current account surpluses can benefit tremendously from Keynesian fiscal stimulus in downturns - and that this will probably be successful.

    Any comparison of the situation of China and a country like the US is pointless.

    They are certainly different countries and you have to be careful about comparisons.

    But actually you are wrong that the US has no need for mass public works.

    The US public infrastructure is crumbling.
    The American Society of Civil Engineers (ASCE) has been warning about it for years:

    The nation's roads, bridges, levees, schools, water supply and other infrastructure are in such bad shape that it would take $2.2 trillion over five years to bring them up to speed.

    http://www.scientificamerican.com/blog/post.cfm?id=us-infrastructure-crumbling-2009-01-28

    The time to do it is now.

    This is why LK can claim success, as he has done, for recent bouts of stimulus spending. LK points to country 'x' and says look how they have returned to growth having spent 'x' amount of money on a major stimulus.

    Your comments above appear to imply that developing countries with current account surpluses (and space for public works) can benefit tremendously from Keynesian fiscal stimulus. Are you unwilling to even concede that Keynesianism is a successful policy in these cases (e.g., China and Brazil)?
    A great deal of the rest of the post is founded on the argument that public debt is different from private debt.

    Of course, if you believe this, then your arguments are consistent and logical.
    Anyone who does not accept it will find not it convincing.

    But this just brings us back to the question of whether public debt is qualitatively different from private debt – a different debate.

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  12. Lord Keynes,

    You state 'I have also repeated said that there are limits to government spending.

    Those limits are a particular country’s available resources, capacity utilization, unemployment and external balance.'

    At least please do your homework for the UK figures to tell us what you believe this limit is.

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  13. LK: I have outlined some **brief** responses to some of your points below. I will not take the debate any further than this, as I do not have the time to match the sheer volume that you will no doubt produce in response.

    Comment 1:

    You say:

    'It is great to see all your ideas mustered here in response to the Keynesian position.'

    This is not the case, just a few points. There is much more that could be said, but time is always the problem.

    With regards to the sources of growth after WWII, your position on this prior to my post was quite clear. You claimed that post WWII growth was down to good policy. However, I am happy that you now acknowledge the role of innovation.

    However, following this acceptance of the role of innovation, you go on to suggest that government can encourage innovation when using your preferred ideas. However, you ignore that, one of the great periods of innovation, the 18th century also saw great innovation and increases in productivity under a classical economic framework.

    No doubt you will point to the increased speed of innovation under 'your system'. However, each major innovation will lead to accelerated innovations and efficiency. If taking the example of plastics, these allow for far more efficient production of a huge number of goods. Or the computer, which allows so many innovations, it is a real driver of long term economic growth. Each major innovation leads to new innovations, creating an upward spiral of innovation.

    You then make an argument that Keynesian solutions are necessary for growth of innovation to continue. However, there were periods in the 19th century when output grew (through deflationary periods as well) where unemployment was relatively high. This was in a period of time when there was no Keynesian economics. Nevertheless, output and innovations grew at a startling rate (from a relatively low base).

    Continued.....

    ReplyDelete
  14. Post 2: On industrial policy.

    I will quote you as follows:

    'I think this blog has repeatedly described China’s industrial policy. You refer to it as “mercantilism.”
    I assume you don’t deny the existence – and effectiveness – of this mercantilist industrial policy. Though you don’t say so in your comments, you seem to suggest that industrial policy can never work has never been successfully done anywhere. However, doesn’t China’s success show that it can?'

    So what we are coming to is a belief that mercantilism might work for the developed world? Do I understand this correctly? My answer is to shut out those countries that pursue mercantilist policy. The reason for this is that I actually believe that trade between countries is a good thing. If a country uses mercantilist policies, they threaten the trading system (why trade is 'good' is beyond a brief comment).

    If your answer is for each country to seek to manipulate the systems of trade without rules or obligations, then I am rather cynical about how long it would be before trade started to collapse. China has 'gotten away with it', which is down to the weakness of politicians (and now possibly due to the economic power of China achieved through accumulation of reserves). However, in a system where everyone tries the same thing, there is no system.

    Your idea is an excellent way of destroying the trading system. My approach is to reform it, and enforce fair trade, to make the system work. I will let readers choose which is the better approach (assuming that they agree that free and fair trade is a good thing).

    Comment 3:

    You say:

    'On the contrary, I argue that governments should not by constrained by “borrowing” from private markets. If the government is monetising its deficit by central bank money creation this isn’t borrowing.'

    You are right, if, and only if, the bonds that are purchased with printed money are never sold onto the market in order to reverse the expansion of the money supply. However, if not, then there must be borrowing. It is as per the point made in my post.

    However, if the central bank monetises deficits, and does not later 'sterilise' the monetisation, then there must be eventual inflation as a result.

    So are you proposing monetising deficits, and never returning the bonds purchased with printed money to the market? Is that really what you are proposing? If not, then the government is borrowing money, but just delaying the date that this borrowing has to be presented to the market. Just more delaying tactics....

    In your next point, you set up a straw man as follows:

    'If you believe that borrowed money can never create economic growth, then how can the private sector possibly create economic growth by borrowing money from domestic markets or overseas?? Logically, this argument would force you to admit that any private sector “growth” funded by borrowing is not really growth either. You then have the bizarre conclusion that no economic growth can ever result from private or public borrowing.'

    Even in my post I acknowledge that even government based research might lead to innovation and increase in output (though question how effective it might be). What I am arguing against is borrowing to consume, not borrowing to invest.

    Continued.....

    ReplyDelete
  15. This is another quote, with my comments quoted by brackets(you quoting me):

    '[If this is the case, why not just borrow that additional $1 trillion. The economy would boom, ….. On this basis, every economy should add ever more borrowing every year to ensure endless economic growth]

    Because borrowing in every year would cause excessive inflation and run up against available resource constraints.'

    Here we come to the crux. Your wise and wonderful post-Keynesian sages will be able to control all of this. they know the 'right amount' of borrowing that can be managed. The trouble is that, the markets do not agree with your wise sages, and are telling countries that they have reached their limit. You claim that governments can ignore the bond markets, but then I have already discusses why this is not the case.

    The bond markets have a different idea to you. They are looking at ability to repay, not inflation and resource constraints. And they do not want repayment in inflated money. As, one way or another, you must deal with these markets, borrowing more than they think you can repay is not possible.

    However, let's look at your argument as it stands. This is a comment from one another commentator:

    "You state 'I have also repeated said that there are limits to government spending.

    Those limits are a particular country’s available resources, capacity utilization, unemployment and external balance.'

    At least please do your homework for the UK figures to tell us what you believe this limit is."

    It is a fair comment. You see, what I notice from all of the post-Keynesians is assertions that there is a limit, but never actually any hard limit. As countries like the US and UK approach 100% of GDP, they argue for more borrowing. At what point, really at what point, will they stop asking for this? In the case of the UK, for example, absolute interest on borrowing is already rising to painful levels:

    "Annual interest payments on UK government debt, already £40bn, are set to reach £70bn by 2015 – what the country spends on schools and transport – as the national debt jumps. "

    http://www.telegraph.co.uk/finance/comment/liamhalligan/7840486/Budget-2010-Courage-and-conviction-needed-to-tackle-the-worst-crisis-since-1976.html

    So, what is your answer? How much in the way of interest payments do you propose as acceptable? At what point should the UK stop? At 110%, 150% or 250% of GDP?

    This is not government repayments of debt, but the taxpayers who are repaying this debt. Each GBP of interest payments has to come from the taxpayers. Each GBP spent on paying interest is not going to be available to pay for other resources.

    Continued.....

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  16. The question of the cost of the UK's Interest Burden on Gilts as a Percentage of GDP is a very good point. I have a new post on it here for the curious:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/projections-of-uks-interest-burden-on.html.


    A sample:
    Most recently, Cynicus Economicus has drawn attention to the fact that the cost of servicing the UK’s interest payments on government debt might become a serious problem ....
    Annual interest payments on UK government debt, already £40bn, are set to reach £70bn by 2015.
    These numbers seem shocking, but that this does not give us the true measure of this burden: its percentage of UK GDP.

    For this, we need to go to the Office for Budget Responsibility (OBR) report published on the 14 June 2010. The absolutely crucial figure is given on p. 53 of the report:

    [the] central government debt interest as a percentage of GDP increases over the forecast period from 2.9 per cent in 2010-11, to 3.7 per cent in 2014–15. The key determinant of this rise is the sustained high levels of borrowing over this period. The average annual growth rate in debt interest payments from 2010-11 to 2014-15 is 12 per cent.

    So in fact the burden of interest payments on gilts is projected to be about 3.7% of GDP in 2014–2015. This isn’t a catastrophe – it is less than the burden in the 1980s and early 1950s.

    And remember that this is a pre-budget forecast, so this is the burden if we assume no austerity measures.

    It is perfectly obvious that this burden will not be historically high. The cost of interest servicing as a percentage of GDP was higher throughout all of the 1980s under Thatcher, and only slightly higher than in 1996-1999 (where it was about 3.5%). The UK did not collapse under the weight of interest servicing under Thatcher. Why would it now? Why is this hysterically touted as a disaster?

    ReplyDelete
  17. Reply In two parts:

    Part 1:

    In my response to the idea that we are borrowing output, you go on to say:

    "They are not borrowing output. They are borrowing money.
    Money can be used to buy output or financial assets or real assets.
    When you attract foreign exchange via a capital account surplus (“borrow” this money), the foreigners have bought a financial asset or real asset in your economy. They have an asset in exchange for their money and a return.
    They might sell this asset and take their money to another country and buy a different asset (which of course happens all the time). No claim on output ever happens.
    I wonder why do you ignore the role of financial markets?
    We live in a world of current accounts (goods and services) and capital accounts (real and financial assets). Alot of money just gets moved around between financial and real assets between different countries – no claim on actual output happens."

    It seems that you are saying that lenders are lending with no expectation of interest in return. If this is the case, why lend? You seek to confuse this with talk of purchasing assets, which I will deal with later.

    When a creditor lends a country money, they do so in the expectation that the money will be returned to a value that will allow them to purchase goods and services to a value equivalent at the time of the lending + interest. They do not want money, but the ability to purchase goods and services (or assets) in the country that is the destination of the lending.

    In other words, they do not want notional money, but money which will give them this return.

    As for what is lent, it is money, but that money allows for the purchase of the goods of the lending country. Alternatively, if the goods or services are not available from the lending country, the lending country's currency might be used to buy goods and services from another country, which in turn will purchase goods and services from the origination country.

    When the repayment of lending is due, the government will need to make that repayment by taxing individuals and businesses in the debtor country. The government then hands that money onto the creditor. The creditor has 'x' amount of money from the repayment to use to buy the output of the debtor country. The taxpayers have 'x' amount less to buy the goods and services from the output of their country.

    Part of the output of the country has been transferred to the creditor. As I said, they do not want money, they want output.

    Alternatively, rather than use the money returned in repayment to directly purchase output, they might decide to purchase the output indirectly by purchasing an asset. In doing so, they take greater risk for the potential reward of securing even more of the country's output.

    When making an investment in an asset, you do so in the hope that it will give a return to purchase more output than if you just spent the money there and then. Alternatively, you might use that money to buy yet more assets, to make even greater returns. In all cases, you want more than you put in. And that 'more' is more of output denominated in the currency of the investment. That means, output from the country of the currency.

    (there are of course indirect uses of the currency, but we will leave it on this basis for the moment, except to say that the currency is eventually used to buy output).

    ReplyDelete
  18. Part 2

    Your argument seeks to bury this simple process in sophistry. Whilst there is huge complexity in finance and global economics, the expectations of lenders is universal. If they do not believe that the value they lend will be returned with interest, they will not lend. In the case of any lending, this is always the case.

    That return must come from somewhere, and that has to be from diversion of output from the borrower to the lender. In the case of an individual, they might have to pay a portion of their wages, in the case of a country, a portion of the total tax collected. In both cases, they are passing the potential to purchase the output of the economy to somebody else.

    People do not want money, they want the ability to purchase goods and services, or assets that will allow them to purchase goods or services.

    ReplyDelete
  19. Lord Keynes:

    I will leave it there, as the post itself and time taken to respond to you is simply too much. As I have previously discovered, I will never have the time to keep up with the volume that you present. Even as I take time to answer one comment, you are creating new comments.

    Instead, I will highlight how in the previous comment in which I have highlighted the sophistry that was used to bury a simple reality of the relationship between lenders and borrowers. I hope that I have made my point, but will leave readers to decide.

    ReplyDelete
  20. "I think we should expect a lot more austerity theater than actual austerity, for better and for worse. Expect central bankers especially to preach austerity while intervening madly in the shadows. That’s just what they do.
    *** By the same reasoning, we should expect policymakers to justify their actions with a lot of intuitive but awful theory. As the Modern Monetary Theorists remind us, the analogy between a fiat-currency-issuing government and a budget-constrained household is poor. It is, nevertheless, the framework under which most citizens and savers understand government accounts, and forms the basis of conventional discourse.***

    Irrespective of what is a better or worse description of reality, it is safer for policymakers to frame their communication in terms of conventional theory than to promote a profoundly destabilizing paradigm shift. Expect President Obama to keep talking about how we are “out of money” even though he knows better."

    http://www.interfluidity.com/v2/862.html

    ReplyDelete
  21. Reply to George

    At least please do your homework for the UK figures to tell us what you believe this limit is.

    I have answered you here:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/projections-of-uks-interest-burden-on.html

    ReplyDelete
  22. The trouble is that, the markets do not agree with your wise sages, and are telling countries that they have reached their limit.

    The markets have driven up yields on some PIIGS debt. The UK and the US have historically low bond yields, as I have shown in the new blog post.

    Moreover, these are the same markets that bought toxic mortgage and asset backed securities with gusto.

    The irrationality and herd behaviour in financial markets is hardly an argument for kowtowing to them or implementing savage austerity.

    It's like saying that when a rumour of fire in a crowded theatre causes a stampede, security guards and manangement should not use all means at their disposal to stop a panic that could result in many injuries - just because some spooked people have "chosen" to run for the exits.

    ReplyDelete
  23. I couldn't post on LK's site as he doesn't allow name/url comments, so will comment here instead:

    Bearing in mind that gross income tax receipts for 08/09 was around 150bn. Based on LK's figures, previously we had about a third of income tax receipts was spent on interest payments and this could rise to about a half in 2015.

    Imagine without this debt we could cut everybody's tax bill by half!

    The government has already raised taxes and is trying to cut costs to balance the budget. I don't think the taxpayer will accept further tax hikes.

    ReplyDelete
  24. "When it does so, it must be sterilised, or it will lead to inflation,"

    This is a reduction ad absurdum argument. The problem with monetarists is that they don't understand their own macro theories.

    The quantity theory of money is just that - a theory. However it is expressed as Money x Velocity = Price x Output.

    The axioms are that velocity is always the same, and output is always at the maximum capacity of the economy. Given those are static increasing money causes inflation.

    Unfortunately the econometric data is that velocity is not static - it moves around all over the place, and the market is not efficient to ensure that the economy is at full capacity - it's an ideological myth. We have workers stood idle that could be doing something, and machines in mothballs.

    So the assertion that 'increasing money = inflation' is simply truth by repeated assertion based on an attempt to impose an ideology on reality with zero data to back it up.

    Yes eventually creating money will cause inflation when you exceed the productive capacity of the real economy. If you are demand managing then you need to have mechanisms to deal with overheating. I would propose a land value tax charged to freeholders with a rate managed by the Bank of England. This would replace the 'blunt stick' of interest rate policy that clobbers UK business investment due to our obsession with land.

    Yes creating money and spending it on the wrong things (such as bonds via QE) will create inflation. That's because you are supplying fuel to the broken financial system rather than the real economy.

    What you need to do is spend it directly lower down, replacing the failed 'trickle down' policy with a 'bubble up' one. Avoid the failed financial markets.

    And yes that needs to be better than digging holes and filling them back in (which where I come from used to be called 'mining', but that's beside the point). The public sector should create long lived assets with its new money. So increasing skill levels would be good, as would housing, moving overhead cables to underground ones in the far flung reach of the country, etc.

    Having said all that we shall see. The austerity measures now going in place will reduce the government spend. AIUI The theory goes that net private debt must now increase or net imports must go down. If that doesn't happen the economy will contract causing unemployment.

    ReplyDelete
  25. "If they do not believe that the value they lend will be returned with interest, they will not lend. In the case of any lending, this is always the case."

    Again this is equating micro decisions with macro and it doesn't work like that.

    The causality is the other way.

    If Britain decided to create money to pay interest on bonds and to settle them, then all that would happen would be an exchange rate adjustment until our imports and exports balanced. By definition at that point we are earning as much in foreign currency as we are spending.

    Remember that foreigners need sterling to buy UK goods. They will exchange their currency for sterling at the prevailing rate if the real item they are after is better value than an item from a competing nation. There will always be a demand for sterling as long as we have an export market.

    ReplyDelete
  26. "
    So, what is your answer? How much in the way of interest payments do you propose as acceptable? At what point should the UK stop? At 110%, 150% or 250% of GDP?"

    You don't borrow, you create money and spend it, then you tax and destroy it to keep inflation under control (preferably via an 'automatic stabiliser' like a land value tax).

    A sovereign government doesn't need to borrow, can settle bonds at any value of its yield curve and can control the market completely in its own bonds if it wants to - as long as the currency is free floating. If and when it does that, the foreigners takes the hit as does the saver in this country.

    All the 'deficit' is the accounting flip side of the private sector 'savings' and the import imbalance. At the moment the private sector is saving like mad (probably paring down debt), or purchasing tat from China. Cutting the structural deficit will move a lot of it to the automatic stabilisers (unemployment benefit etc).

    What the policy makers are hoping is that we'll stop buying tat from China

    ReplyDelete
    Replies
    1. Hallo sir.

      It seems that you have studied these issues a great deal – quite impressive. I was wondering if you could point me in the direction of some information describing the economic theory, which you apply in arriving at these conclusions? I personally would like to learn more about this myself.

      Also could you point to some papers supporting that the changes you prescribe would actually work in the desired way?

      Thank you and have nice day!

      Delete
  27. "They are not borrowing output. They are borrowing money.
    Money can be used to buy output or financial assets or real assets."


    Reminds me of this classic:

    There was this guy who bought a truckload of sardines at a penny a tin. He resold them for two cents a tin to somebody else, who resold them for three cents a tin to somebody else, who resold them for four cents a tin to a fourth person. Shortly after, the market for sardines collapsed and the fourth guy couldn't sell them, so he figured he may as well eat them. He opened the first tin and the sardines were rotten, the same with the second and third.

    "Great," he thought to himself. "I can give them back and not suffer a loss." So he went to the guy who sold him the sardines for four cents a tin and said: "Those sardines you sold me were rotten. Here they are. Give me back my money." The guy who sold the sardines looked at him with pity and said: "Oh, you don't understand. Those weren't eating sardines, those were trading sardines."

    ReplyDelete
  28. Very relevant interview with David Blanchflower on Bbg :

    http://noir.bloomberg.com/avp/avp.htm?N=av&T=Blanchflower%20Says%20U.K.%20Double%20Dip%20%60Absolutely%20Certain%27&clipSRC=mms://media2.bloomberg.com/cache/v20YwOlQ78Gs.asf

    ReplyDelete
  29. I recently read Peter Schiff's new book "How and Economy Grows and Why it Crashes" and I'd have to say that that does a really good job explaining the Austrian case over that of the Keynesians.

    The story is simple and funny and starts off with a basic island economy where 3 men spend each day trying to catch a fish with their bare hands so they can survive.

    Then one day Able has the brilliant idea to create a net.. he underconsumes and goes hungry one day, but then the next day he is able to catch twice as many fish..with this innovation the island economy's output has doubled.

    The economy grows and grows, thanks to innovations in time saving devices and innovations in finance. Eventually a few generations later the islanders form their own government. At first the government is a help to the economy. It enforces people's property rights and protects the island from attack. But later it starts getting corrupt and ends up destroying the economy with its policies. The politicians simply love Keynesian policies because it allows them to promise everything to their constituents at no cost or pain.

    A lot of topics that have been mentioned in this article have been addressed, such as the huge difference between borrowing for consumption vs. borrowing for investment. Also that human demand is limitless, and it is the ability to produce that unlocks this demand..not throwing money at people to stimulate demand.

    I would highly recommend everyone who is interested in the debate between Austrians vs. Keynesians to read the book, or to anyone who simply wants a refreshing and concise view on how economics works.. And Cynicus, if you want I'd even buy it for you since I'd love to hear your feedback on it! (Send me an email at patcomwiz@yahoo.com if you're interested.)

    ReplyDelete
  30. MattinShanghai has sent me the following comment which I will split into 3 parts (he can not post due to being in China and firewall problems):

    MattinShanghai Part 1:

    I read with interest your numerous exchanges with "Lord Keynes". I agree with one of your commentators that although the frequency and length of his comments are sometimes overwhelming, marginalizing him (as someone suggested) would greatly diminish the quality of the discussion here. If some people are annoyed by them, I would suggest simply scrolling past.

    LK's comments have a lot of interesting material and often make good points. As to the Keynesian position which he advocates here, I must confess that I have not completely made up my mind about it. As LK himself stated, there are many strands of "Keynesian-ism", which have little in common with each other. Having said that, I think that his distinction between household spending and government spending (as echoed also by Chaingangcharlie) seems to be valid. There is also a big difference between a government issuing currency and borrowing money in the private markets, but that's a separate discussion. But what I would like to see in his comments is less quotations and links to other websites, but more discussion of the issues at hand "in his own words".

    What I found annoying about LK's posts is that his replies and comments (up to very recently) were all along very similar (although the links often led to interesting information). This is the pattern:

    Commentator X: "Our government has been spending too much for too long, and now the debts have to be repaid by us all. One simply cannot live beyond one's means indefinitely" (or variations on similar themes).

    LK: "Nonsense. Govt borrowing and spending is nothing like household spending. Sovereign governments can print as much money as they like". (To be fair to LK, this statement, which usually elicits howls of protest from the "free marketeers" on this blog, is then qualified by further statements about the transient nature of the stimulus, the need for proper "industrial policy", addressing trade imbalances through tariffs, withdrawal of the stimulus when conditions return to growth to avoid inflation etc., but these are added as afterthoughts rather than the core of LK's arguments)

    Then follow numerous references to countries which successfully steered their economies to greater prosperity, despite the often huge role of the state in doing so (Japan, Scandinavia, Taiwan, S. Korea, China, etc.).

    The logical fallacy of this argument is that it only establishes the fact that budget deficits, large involvement of the state in the economy, "industrial policy" etc. do not **necessarily** lead to collapse, and might actually play a role in stimulating long-term prosperity (in some cases). What is not mentioned are counterexamples (Weimar Germany, N. Korea, Zimbabwe etc.) where such collapse did occur, despite the fact that governments were (and are) heavily involved in those economies. So citing the success stories does not establish the fact that large state involvement is a necessary or sufficient condition for prosperity.

    ReplyDelete
  31. MattinShanghai Part 2:

    Taking a broader look, it seems to me that the frustrating thing about these kinds of discussions is a certain narrowness of outlook, which I would call 'economism'. The assumption is that economies follow quasi-natural "laws", and the laws are universal in application (the famous "physics envy" of economists). If the "laws" are universal, then solutions to practical economic problems based on these "laws" are also universal. Since the world is a much messier place than the various schools of economics allow, and the same data can always be interpreted in many different ways, it is difficult to reach any kind of consensus between the competing approaches, as the exchanges between CE and LK show, although the recent elaborations by LK on the more "positive" sides of his solutions have made the discussion much more interesting.

    I think that one of the major concerns that CE has repeatedly expressed in his posts can be summarized as: "How can a gutted, post-industrial UK economy maintain the high standard of living it has been accustomed to, given that "growth" in the previous decades has been driven entirely by borrowing by the state and households?". I can understand his frustration with LK's many (well documented) statements, that borrowing in itself is not necessarily bad. Or that governments do not **need** to borrow money in private markets. Unfortunately, we are not Japan, or Korea, or China, or Canada. And this brings us to the core of the issue, on which CE touched upon - the structure of societies matters.

    As far as the positive suggestions made by LK, they are eminently sensible. I have just finished Stiglitz's latest book "Freefall" about the current financial crisis, and at its end he makes very similar suggestions. I don't agree with CE's assertion that the term "industrial policy" is too woolly. It is pointless to talk about a universal industrial policy, since such policies need to be tailored to the individual characteristics of a particular country. One of the earliest and most successful examples of conscious industrial policy was the Japanese Meiji Restoration in the second half of the XIX c. It transformed a medieval, feudal society into one of the world's greatest industrial powers in little more than 30 years. A similar attempt by the Chinese around the same time resulted in disaster. The differences between the structure of the Japanese and Chinese societies, their geographical, cultural, political, and many other differences made the Japanese model inapplicable to China at the time. Actually, "industrial policy" is only a part of a bigger, long-term "vision thing", that needs to be in place before any industrial policy can be contemplated. It would take too long to articulate here, but the study of the economic history of successful countries and city-states such as Germany, Japan, Taiwan, Korea, China, Singapore, HK provides ample illustrations of how such industrial policies have been (and are) implemented. Sadly, the UK is one of the examples where government abdicated any responsibility for guiding the future direction of the country, leaving the task to "Mr. Market" (a.k.a the financial speculators), with the grim results which we have now.

    ReplyDelete
  32. MattinShanghai Part 3:

    "You want to get to Dublin? Well, I wouldn't start from here."

    So this brings me to one of my key problems with LK's suggestions for improvement. Where is this "vision thing" and corresponding industrial policy going to come from? The bankers? I think not. The stockbrokers, forex traders, insurance guys, pension fund managers, hedge funds? Ditto. The large landowners and property developers? The CofE perhaps? Trade Unions? Well they might support tariffs, but I doubt they have enough clout to convince the remaining lot. I won't even ask about the politicians. Maybe the British Army? But they are busy elsewhere. The peace movement? The reality is that the structure of UK society is currently such that there are no powerful forces here which would find such a sweeping set of changes even remotely attractive, regardless of the long-term benefits that they would bring. Without political will and power to make it happen, it is unlikely that anything will change, unless there is some kind of major, global breakdown. And this is not something I would particularly wish for.

    So how did the other countries do it? Well, it depends on each particular country. Simply put, the situation in some countries is as follows:

    Japan is run by its elite Civil Service, and especially by the MOF (Ministry of Finance). They basically set the various medium and long term goals for the economy and implement them by issuing directives to the banks (which are heavily regulated). The civil servants are not extravagantly paid, but extremely powerful and have high prestige in society (much like high ranking generals in the USA). Because of this, their outlook is very long-term. The elected politicians are just window dressing to make the Americans happy.

    In Taiwan, the industrial policy which led to its economic success was set in motion essentially by a military dictatorship working in collusion with gangsters. 'Nuff said..

    In China of course the driver of industrial policy is the CCP. Although one can say many bad things about this institution, the practical economic results are astounding. They have a crude, but effective means of keeping corrupt officials and businessmen from becoming too corrupt. If an official gets too greedy, he is taken out and shot. Sometimes together with members of his family. China's richest man has just been sentenced to 13 years in jail for "bribery and stock price manipulation". In the UK he would probably receive a knighthood...

    All the best to everybody
    Matt

    ReplyDelete
  33. Reply to MattinShanghai

    I think that his distinction between household spending and government spending (as echoed also by Chaingangcharlie) seems to be valid

    I am glad you agree. The distinction is at the core of neo-chartalism or modern monetary theory (MMT).

    See Bill Mitchell’s blog for more information:

    http://bilbo.economicoutlook.net/blog/

    Remember that MMT is poorly understood even by same mainstream “New Keynesians”, whose macro theory is fundamentally neoclassical.
    Even Krugman doesn’t understand MMT sometimes.

    But what I would like to see in his comments is less quotations and links to other websites, but more discussion of the issues at hand "in his own words"

    My own blog has a number of such posts:

    http://socialdemocracy21stcentury.blogspot.com/

    The logical fallacy of this argument is that it only establishes the fact that budget deficits, large involvement of the state in the economy, "industrial policy" etc. do not **necessarily** lead to collapse, and might actually play a role in stimulating long-term prosperity (in some cases).

    There is no “logical fallacy”.
    Empirical evidence showing the success of Keynesian policies and vibrant economies with large state sectors disproves the tired Austrian view that government intervention always and everywhere leads to failure.
    I am glad you don't subscribe to this type of irrational dogmatism.

    However, I never claim that Keynesian stimulus will work everytime it’s tried. You certainly need to look at structural problems of an economy and external factors.
    If you bother to read earlier comments here on, say, Zimbabwe, you will notice I pointed out that stimulus through budget deficits and printing money was mad in the face of the output shocks they suffered. Instead a demand contraction was required or ending the government's human rights abuses and getting innternational help.

    What is not mentioned are counterexamples (Weimar Germany, N. Korea, Zimbabwe etc.) where such collapse did occur, despite the fact that governments were (and are) heavily involved in those economies.

    Since I don’t advocate command economy communism, the failure of North Korea or other communist states is irrelevant to my economics. I advocate post Keynesian economics with a mixed economy and a large space for private enterprise and regulated markets. I don’t advocate the nationalization of ALL industry or the abolition of private property or the government planning of production and consumption of all commodities.

    And quite frankly in the time in which communism existed there were plenty of communist states with high growth rates and economic development – and then others that failed miserably.

    The communist system was extremely brutal and immoral, and often inefficient as well because planned economies are only as successful as the competence of planners who run them, as well as their internal resources, access to external technology and trade balance and so on.

    For example, the Soviet Union clearly had impressive growth rates in the late 1920s and 1930s down to the 1960s, but that growth was accomplished with very brutal consequences for many people, then it started to have serious economic problems (excessive military spending and insufficient consumer goods and innovation etc) and eventually succumbed to those problems.

    As for Weimar Germany and Zimbabwe I have dealt with the issue of hyperinflation in those countries in other comments here.

    ReplyDelete
  34. The assumption is that economies follow quasi-natural "laws", and the laws are universal in application ... If the "laws" are universal, then solutions to practical economic problems based on these "laws" are also universal

    Post Keynesianism rejects the natural "laws" of neoclassical economics. It states that there are certainly constraints to growth and economic stimulus etc, but that is different from asserting universal law.

    Far from being dogmatic, it recognises that different countries need different policies at different times. "Free trade" is beneficial to some countries and harmful to others. Neoclassicals, by contrast, think it is always beneficial.

    ReplyDelete
  35. I don't agree with CE's assertion that the term "industrial policy" is too woolly. It is pointless to talk about a universal industrial policy, since such policies need to be tailored to the individual characteristics of a particular country

    An excellent point.
    Your other statements about industrial policy are eminently sensible.

    Industrial policies need to tailored to the country that are designed for - there is no universal one.

    No doubt there will be failures as well as successes, since government planners are not perfect, any more than private investors are perfect.

    That fact that some states had a failed indstrial policy requires a careful look at why they failed.

    But this does not refute the underlying validity of industrial policy as an idea and method.

    It's like someone saying that, because some patients with advanced cancer or abnormal genetic profiles do not respond well to modern cancer treatments, then the whole idea of modern scientific medical treatment of cancer should be abandoned for some other system, say, like praying to god.

    Just replace "cancer treatment" with "industrial policy", "patients" with "nations" and "praying to god" with "laissez faire economics", and you can see how ridiculous this argument is.

    ReplyDelete
  36. So this brings me to one of my key problems with LK's suggestions for improvement. Where is this "vision thing" and corresponding industrial policy going to come from?

    The same way that any other serious reform has ever been accomplished.

    As always it needs popular movements, grass roots civil organisations, educated people in the press and academia to put pressure on politial parties and governments to change policy.

    Since the financial collapse of 2008 has already shown the bankrupcy of mainstream economics and the coming austerity will show its continuing miserable failure, there is reason for optimism.

    ReplyDelete
  37. Statement 1:

    No doubt you will point to the increased speed of innovation under 'your system'.

    Absolutely.

    Satement 2:

    However, each major innovation will lead to accelerated innovations and efficiency. ... Or the computer, which allows so many innovations, it is a real driver of long term economic growth. Each major innovation leads to new innovations, creating an upward spiral of innovation.

    Since the modern computer is essentially an invention of the public sector, which paid for most of the costs of developing it, statement 1 seems entirely vindicated:

    Chomsky on the history of computers

    Note that Chomsky here does not object to government R&D per se, just to the peculiarly wasteful US system where it is done in the Pentagon where these sorts of government investments have to be justified with hysteria about the threat of communism or terrorism etc.

    ReplyDelete
  38. Lord Keynes,

    You have not answered my question in your blog 'At least please do your homework for the UK figures to tell us what you believe this limit is.

    I have answered you here:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/projections-of-uks-interest-burden-on.html

    You merely state a percentage of interest payment against governmet spending but fail to acknowledge that this becomes unafordable when lenders demand higher interest rate for the increased risk. In fact, the last Labour government resorted to Quantitative Easing printing of money over and above of any amount borrowed, and you previously have stated that governments can print without limit. What I wish to know from you is both what happens when lenders to government debt decide to charge hihger interest rates, and what is your limit of UK money printing before inflation kicks in?

    ReplyDelete
  39. I have a new post here on the Early British Industrial Revolution and Infant Industry Protectionism: The Case of Cotton Textiles:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/early-british-industrial-revolution-and.html

    ReplyDelete
  40. Lord Keynes,

    In your new blog, you still do not state a figure for acceptable non-inflationary UK borrowing and QE money printing which considering you claim to have all the answers, the published UK statistics should enable you to give specific numbers.

    Furthermore your statements:

    'I have pointed out in the previous post that yields are low now precisely because the government has the tools at its disposal to control yields and hence the cost of its additional borrowing', 'the government has the power to control the yield curve', 'The answer is that governments can decide for themselves what the coupon rate and yield rate will be', and 'if my plan to nationalize the banks that accepted bailout money were implemented, then they could also purchase the issuance of new government bonds'

    The above statements just confirm that Keynesian policies are nothing but a Ponzi scheme of debt money creation with the government borrowing from itself via the bailed out banks. You also ignore foreign investors who will demand higher interest rates as they see this dilution of currency.

    I am sorry, but the more you elaborate your polices, the bigger hole you seem to be digging that even your deficit spending sympathisers can now see through.

    ReplyDelete
  41. Reply to George

    In your new blog, you still do not state a figure for acceptable non-inflationary UK borrowing

    If you bother to read it properly, you will see I point out that ALL deficit spending is potentially inflationary. That inflationary impact is often necessary when powerful deflationary forces are pulling down on CPI prices.

    As I said here:

    George then asks what is the limit of UK money printing before inflation kicks in.

    Most deficit spending is naturally inflationary, so presumably George means what is the limit of UK money printing before serious and very high inflation kicks in.

    In 2009/10 the budget deficit will be about £178 billion or 12.6% of GDP.

    My guess is that if the deficit rises to 15% or even 20% of GDP without austerity but with more stimulus, then this would cause higher inflation, which might be problematic.


    Since UK GDP is about 1.5 trillion pound sterling, a budget deficit of 225 billion pounds to 300 billion, without austerity and with additional stimulus, might well be highly inflationary.

    But then I don’t advocate pushing the deficit that high. If you fixed the banks and introduced effective financial regulation etc, you could get credit flowing again and a return to growth.

    As I said in my post, QE is not inherently inflationary for reasons discussed here:

    http://bilbo.economicoutlook.net/blog/?p=6624

    If you think you can refute Bill Mitchell, go right ahead.

    E.g., the monetary base in the United States went up by 140% in 2009 to over 2 trillion dollars. How many hapless Austrians and monetarists were screaming that hyperinflation was on the way or was 100% certain in 2009? Yet they were, and still are, all wrong.

    If you believe that this was "inherently and inevitably" inflationary, then why did the US get deflation in 2009? Why is core inflation in the US falling now and the CPI clearly showing disinflation?

    Even the alternative Shadowstats.com inflation rate shows massive disinflation in 2009 and disinflation again in 2010:

    http://www.shadowstats.com/

    The above statements just confirm that Keynesian policies are nothing but a Ponzi scheme of debt money creation with the government borrowing from itself via the bailed out banks.

    Modern monetary theory says that government has the power to create and destroy money and use it for deficit spending, if necessary. Advocates of MMT simply don’t agree.

    You also ignore foreign investors who will demand higher interest rates as they see this dilution of currency.

    Higher rates on domestic bonds denominated in UK pounds sterling? But then the government has the power to control the yield curve.
    If foreigners don’t like the coupon rate, then they won’t buy bonds. They might prefer other financial assets with higher returns. So what.
    The “dilution” of the currency only happens under high inflation rates, which I don’t advocate.
    As long as foreigners keep buying private financial assets, then capital account surpluses will still occur.

    ReplyDelete
  42. Another from MattinShanghai, who is unable to post due to Internet problems in China (In 2 Parts):

    Part 1:

    Thanks for your reply. I'm happy that you have elaborated your "positive" views. Btw. I have been following your blog, but am unable to post comments. I especially liked your overview of Austrian monetary theory. Many readers should find that post useful, regardless of their ideological convictions.

    "There is no logical fallacy"

    You are correct, assuming that your goal has been to disprove a universal statement by providing a counter example or examples. But hammering the same point over and over again is not persuasive, especially since many of your earlier comments provided little else besides. The other thing is that it is grossly unfair to label our host as some kind of "hard-line Austrian", and I don't think that he ever claimed that **all** government involvement in the economy is evil. Cynicus' concerns are with **current** developments in UK (and to some extent US) economies, within the real (although unfortunate) constraints under which these economies operate today. The irony is, that as you recently admitted, you actually agree with CE that the BofE policy of using QE to buy govt. bonds is a bad idea, although from a different theoretical stance. I might have missed something, but this was not apparent from reading the discussions at the time.

    I am in general agreement with most of the other things you say. Keynesian-ism is a broad church, and pretty much every successful economy in the world today which has developed with some kind of state-led policy (starting with Nazi Germany even before Keynes wrote his book), can plausibly be described as 'Keynesian'. There are of course exceptions, the US and UK being the notable examples of a 'neoliberal' approach. The fate of economies where the neoliberalism is at its "purest" (e.g. the Baltics and countries which adopted IMF advice) is not exactly a great endorsement of a "hands-off" approach to economic policy and "free markets". I don't know if you are familiar with prof. Michael Hudson (http://michael-hudson.com), but his essays on the current state of the economies of Latvia, Estonia and Iceland are truly horror stories. It seems that "Mr Market" has a similar fate in store for us...

    continued...

    ReplyDelete
  43. MattinShanghai Part 2:

    I wish I could share the optimism of people like you or Stiglitz, but unfortunately, I don't. I do hope that I'm wrong and you are right (I'm a pessimist, not a masochist). There is no shortage of sensible ideas out there. It is a common conceit among intellectuals, that ideas can change the world. This concept was expressed in its extreme form by Ludwig v. Mises, who wrote that if Adam Smith hadn't written "The Wealth of Nations", then the Industrial Revolution would never have happened. I'm probably in a small minority by believing that it is the other way round. The "world" chooses those ideas which suit dominant power structures within society. These "established ideas" are only replaced with new ones when the balance of power between the various interest groups within the elites or in society changes. Looking at recent events, it should be obvious to any unbiased observer, that the "neoliberal" countries are effectively controlled by finance capital, and the neoliberal ideology perfectly suits and justifies this arrangement. After forcing governments to run up huge deficits in order to bail out the financial sector after its collapse, they have now turned on those same governments and are forcing them to "squeeze" their budgets for the money. This naked extortion is obfuscated by a smoke screen of lies, distortions, and a hefty dose of neoliberal economics bulls**t which passes for informed economic debate in the mainstream media. So this is not a battle of ideas, but a battle of interests, and the best ideas, the most convincing arguments that you or Stiglitz can come up with will not change a thing. Your report of the demise of mainstream economics may prove to be a little premature. The only "hope" is that after the whole thing collapses, which it must, something different will emerge from the rubble.

    "As always it needs popular movements, grass roots civil organisations, educated people in the press and academia to put pressure on political parties and governments to change policy".

    Like 'evgenii', an occasional commentator on this blog, you are a firm believer in the efficacy of democracy. I understand this sentiment, but sadly do not share your optimism. Some time ago I had a lengthy discussion with 'evgenii' on the subject of democracy on Tiberius' blog, where I explained the reasons for my skepticism. You can look it up there if you are interested in my views.

    ReplyDelete
  44. A Real Black PersonJune 23, 2010 at 6:49 PM

    "Since the financial collapse of 2008 has already shown the bankrupcy of mainstream economics and the coming austerity will show its continuing miserable failure, there is reason for optimism."
    How is austerity part of the mainstream economics that lead to the financial crisis? Isn't the whole austerity thing a reaction to the borrowing that lead to the crisis? How can it be a symptom of the 'Free Lunch ' mentality that lead to the crisis? You may not like austerity because of the decline in living standards that will come with it but don't you think a default on government debt would have a less negative impact on living standards? Europe doesn't and that's why it's pursuing austerity. Europe has no feasible alternatives.

    ReplyDelete
  45. A Real Black PersonJune 23, 2010 at 9:52 PM

    Cynicus, every now and then you brush up against the variable of "business culture". It's an important variable , one that needs to be talked about more.

    There still is some confusion as to why post World War II growth occurred. It wasn't because of government spending by itself. Government spending happened in a period
    where there was little to no foreign economic competition. Postwar growth occurred because of the decimation of competition from Europe. Profits were up because innovations went mostly to the U.S. because of a large flight of the best of brightest from a decimated Europe. Not all of the best and brightest fled to America. Some became assets of Soviet Russia. If Russia had switched to an open economy during the 1950s, the competition from Russia would have cut into some of those postwar gains in science and technology sectors, if the space race was any indication.

    ReplyDelete
  46. What do the esteemed readers of this blog think to this?

    http://questioneverything.typepad.com/question_everything/2010/06/peak-energy-peak-economy.html

    I find myself persuaded that the role of fossil fuels in the economy is crucial and that, having built a world on the assumption of perpetual almost-free energy, even gentle increases in the cost can cause the whole system to stall and crash. This doesn't contradict the idea that the rise of China and globalisation in general shocked the economy into instability, just that these factors were natural consequences of the bonanza of cheap fossil fuels, now coming to an end.

    As another blog put it, put a gallon of petrol in your car, drive it until empty, and then hire people to push it back to where you started from, to get a sense of how vital (and cheap) oil is. And yet, even though each of us has this equivalent of an army of slaves working for them, we have still managed to contrive a world where most people are unhappy and trapped in a system where they must work in meaningless, degrading jobs until they drop. There's got to be a better way!

    ReplyDelete
  47. Lord Keynes,

    You state: 'My guess is that if the deficit rises to 15% or even 20% of GDP without austerity but with more stimulus, then this would cause higher inflation, which might be problematic'

    But as Cynicus has previously stated GDP is no longer a measure of productivity, but it is a measure of consumption, most of which is via debt spending in shops and by companies. Hence the more that government borrows to fund spending, and the more that consumers borrow on the back of this borrowed money they (public sector who spend in the private sector) are paid with, GDP is falsely shown to grow with increasing debt. Therfore GDP is a perverse comparative meaure for non inflationary debt and is part of the cause of this financial crisis.

    I would also argue that increasing the money supply via debt and via Ponzi QE printing does dilute the value of money irrespective of whether inflation lags behind even if you believe government figures where eg CPI is based on substitute products taking the lower increases.

    You also state: 'Modern monetary theory says that government has the power to create and destroy money and use it for deficit spending'

    However it seems that governments are only creating money even during the good years, and this is the cause of the financial debt crisis.

    If you keep blowing the debt money creation balloon, it does not start to deflate, but it suddenly bursts with a BANG, and that is when hyper-inflation suddenly happens when all confidence is lost and people maintain their wealth in goods (and precious metals backed currency) exchanging to these as soon as they get paid with paper money.

    Also if foreigners stop buying our debt, this will increase domestic money creation and interest repayments. Why were governments in the past forced to increase interest rates, if as you say via this Pnzi scheme they can choose to pay zero interest via manipulation? In any case we now have the perverse situation where our bankrupt bailed out UK banks are lending to the USA government, whilst the equally insolvent American banks are lending to the UK government so that it appears that foreigners are funding our deficits.

    Sorry, but even by your statements it appears that 'Keynesian' deficit spending policies is nothing different to 'Ponzian' policies.

    ReplyDelete
  48. But as Cynicus has previously stated GDP is no longer a measure of productivity,

    GDP does not measure productivity.
    GDP measures the value of output, or national income in terms of output as some prefer to say.
    You measure productivity by productivity indices.

    Hence the more that government borrows to fund spending, and the more that consumers borrow on the back of this borrowed money they (public sector who spend in the private sector) are paid with, GDP is falsely shown to grow with increasing debt.

    People don’t “borrow” money from the government. It’s effectively debt free fiat money. It’s the government’s debt. But then public debt is nothing like private debt.

    I would also argue that increasing the money supply via debt and via Ponzi QE printing does dilute the value of money irrespective of whether inflation lags behind even if you believe government figures where eg CPI is based on substitute products taking the lower increases.

    The method by which your money is decreased in value is by rising prices (inflation). Explain how, in the absence of inflation, your money loses value.

    However it seems that governments are only creating money even during the good years, and this is the cause of the financial debt crisis.

    The cause of the financial crisis was a poorly regulated financial system.

    Also if foreigners stop buying our debt, this will increase domestic money creation and interest repayments.
    No, it might mean a balance of payments crisis. Something quite different.

    Why were governments in the past forced to increase interest rates, if as you say via this Pnzi scheme they can choose to pay zero interest via manipulation

    Most interest rate rises are due to central bank inflation targeting.
    Sometimes they need to raise rates to encourage more foreign capital. A country with a current account surplus has no need to do this. An external deficit country might, but then that’s a government choice and allows the current account deficits.

    whilst the equally insolvent American banks are lending to the UK government so that it appears that foreigners are funding our deficits.

    Foreigners do not need to fund domestic budget deficits, they fund current account deficits – two different things

    ReplyDelete
  49. How is austerity part of the mainstream economics that lead to the financial crisis?

    It isn't. I didnt say that.
    I said the coming austerity which the
    neoliberals think will fix the economy will fail.

    Isn't the whole austerity thing a reaction to the borrowing that lead to the crisis?

    Nope.
    It's the result of flawed macroeconomics.
    The private debt is different from public debt,

    but don't you think a default on government debt would have a less negative impact on living standards?

    Less negative impact than what exactly?

    Europe doesn't and that's why it's pursuing austerity. Europe has no feasible alternatives.

    Europe is severely dysfunctional monetary union with NO union-wide federal fiscal policy. Most EU countries have no independent monetray policy any more. The ECB has also been contemptibly incompetent with their monetary policy.

    ReplyDelete
  50. Lord Keynes,

    I notice you fail to address some of my key points. Namely denying that your article comments on bank nationalisation and government manipulation of bond yealds read like a 'Ponzi' scheme of money creation, and that GDP does not represent national income but is more a measure of national debt consumption since it considers borrowed money spent by consumers in shops mostly on imported goods as national income.

    My point is that the income of consumers paid with government borrowed (printed) money enables them to borrow on the basis of their income, and it is precisly my point that private debt spent in shops is much greater than public debt which makes GDP fake if this debt is presented as national income.

    And by the way, the definition of inflation is an increase in money supply which dilutes value, and not as increases in prices which soon follows. I thought you were an academic Kyenesian, but clearly like me you are not academic, but at least I see things in simple terms that you cannot get something from nothing and 'money does not grow on trees' without terminal consequences.

    ReplyDelete
  51. A Real Black PersonJune 25, 2010 at 11:50 AM

    A few clarifications.

    "but don't you think a default on government debt would have a less negative impact on living standards?"
    Can be better said as:

    "Do you think a potential default on government debt in developed countries due to excessive overseas borrowing would have a less negative impact on living standards than austerity?"

    If there are individuals out there who think that austerity will solve the problems that lead to austerity then they misunderstand what austerity is meant to accomplish. Austerity, ideally, should be a means of slowing debt growth in wake of the downturn. Anyone who thinks tax cuts= job growth is probably only interested in low value job growth.. or they would like the developed world to resemble the developing world because they think low taxes alone would would attract foreign capital. They're a few decades behind the times. Nowadays it's NO taxes that attract foreign capital.

    Lord Keynes : The private debt is different from public debt
    Sure but what happens with the public sector is forced to absorb the private debt of over-leveraged financial institutions? Currently, in many developed countries governments are borrowing money to pay off private debt. Many bondholders are certain that the governments cannot service their debt given the structural and demographic problems in the economies that they oversee. So who is right here? The stockholders who see falling tax revenues or the Keynesian who think that the governments will devalue their debt by rolling it over?

    ReplyDelete
  52. A Real Black PersonJune 25, 2010 at 10:19 PM

    My apologies I meant" Sure, but what happens WHEN the public sector is forced to absorb the private debt of over-leveraged financial institutions?"

    ReplyDelete
  53. "Do you think a potential default on government debt in developed countries due to excessive overseas borrowing would have a less negative impact on living standards than austerity?"

    Nope, because (1) that government debt is nothing like private debt and (2) budget deficits are required to prevent debt deflation and depression.

    Writing off and restructuring PRIVATE debt is certainly necessary, but needs to be done carefully and with government programs and stimulus.

    The private debt is different from public debt Sure but what happens with the public sector is forced to absorb the private debt of over-leveraged financial institutions?

    No public money is needed to allow a central bank to take bad assets off a bank.
    the central bank has the power to create money from nothing.
    You will notice that only a part of the financial interventions are funded with taxpayer money, the rest is just newly created central bank money.

    Currently, in many developed countries governments are borrowing money to pay off private debt.

    No, they are not.
    There are mainly borrowing due to automatic stabilizers and to maintain normal spending in the face of tax receipt collapse, plus some stimulus.

    Many bondholders are certain that the governments cannot service their debt given the structural and demographic problems in the economies that they oversee

    Are these the same investor idiots who bought toxic asset backed securities with gusto?
    I am surprise anyone would take them seriously
    The "markets" are given over to irrationality, herd behaviour, panic and like a good many economists live in a fantasy world when it comes to understanding basic macroeconomics.

    or the Keynesian who think that the governments will devalue their debt by rolling it over?

    Rolling over debt does NOT devalue it.
    Please explain how it does?

    ReplyDelete
  54. Lord Keynes,

    In your latest blog you define 'Ponzi' and state 'The conclusion must clearly be that government debt is not a Ponzi scheme.'

    In that case call government borrowing a 'SCAM' of money creation since when a government borrows money, that money did not previously exist in any bank deposit and is merely created at the time of the loan. Furthermore since the insolvent banks did not have sufficient deposits to even cover the required minimal fractional reserve capital to facilitate these loans, the governments QE printed it via the central bank gilt purchases.

    Effectively we have bankrupt governments requiring loans from banks, and when these bankrupt banks create this money via these loans and gilt/bond purchases, they are allowed to call these capital bank reserves enabling them to lend via fractional reserve banking even more multiple higher loan values to the government.

    Since all central banks and goverments are doing this, they then use their banks to lend overseas to each other and claiming that it is foreign investors who are funding them to disguise this scam.

    If this is not dilution of our money, I don't know what is. We then have your comments that governments can manipulate yields so that they do not pay high interest rates.

    All this confirms that Keynesian deficit spending policies are a 'scam' (if not 'ponzi')that will destroy our civilisation when it collapses via eventual sudden hyper-inflation.

    ReplyDelete
  55. I don't know if this started with the Bush administration in the United States, but over the last eight years there was a concerted effort to weaken the U.S. dollar which commentators suggested was done to boost exports for U.S. multinational corporations.
    Perhaps all this borrowing and printing of money is intentional...EVERY NATION now wants a weak currency and export-led growth because I think some people are starting to figure out that prolonged consumption leads to more poverty down the line.

    ReplyDelete
  56. A Real Black PersonJune 27, 2010 at 2:18 PM

    ------------What money supply represents-------
    Lord Keynes, the prevailing theory here is that money is a representation of the value of goods and services currently exchanged within an economy. If money is created without a corresponding increase in goods and services then it naturally devalues what each note can buy. That's inflation. This is not to say all inflation is bad. Inflation rates are higher in developing countries than in developed countries . Inflation in developing countries is a reflection of the value of the goods and services currently being produced within their boundaries. High inflation in developing countries reflects more demand on resources needed for a productive economy that creates wealth. As a consequence, there are less resources available for consumption. Despite all these numbers that claim productivity has doubled over the last twenty year, there's little in wage numbers to support that. The reason why deflation( Deflation might be currently offset by the digital creation of money by central banks. Is that possible?) is spreading throughout the developed world is because there is, outside of healthcare, no new demand for anything that originates in the developed world. Employers and consumers have the whole world now to pick from when looking for labor and products.
    ---------The Size of Various Economies---------
    it me or are the developing economies actually larger than developing economies? When economists quantify the size of an economy aren't they only quantifying the amount of consumption?

    As always, if my understanding is wrong in any area feel free to enlighten me. I'm sure I've gotten some of it wrong.

    ReplyDelete
  57. Reply to George

    I have answered you here on fractional reserve banking:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/fractional-reserve-banking-evil.html

    Perhaps we can move discussion to Cynicus' new post.

    ReplyDelete
  58. the prevailing theory here is that money is a representation of the value of goods and services currently exchanged within an economy.

    But this is a definition of GDP, not money.

    If money is created without a corresponding increase in goods and services then it naturally devalues what each note can buy. That’s inflation.

    This assumes that the quantity theory of money – the idea that there is direct, mechanistic relationship between the money supply and the inflation rate/price level. But the quantity theory makes assumptions that are either (1) fundamentally false or (2) untrue in recessions.

    I have also answered this point in detail here:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/what-is-money-short-analysis.html

    ReplyDelete
  59. Lord Keynes,

    It is not fractional reserve banking that is the problem, it is government use of it by borrowing (creating money) to fund Keynesian deficit spending which has created this financial mess and is making it worse when this debt pyramid scheme finally collapses.

    ReplyDelete
  60. Reply to George

    It is not fractional reserve banking that is the problem

    I am glad you agree.

    it is government use of it by borrowing (creating money) to fund Keynesian deficit spending

    It seems you are effectively objecting to monetizing government deficits.
    Far from being a problem, the government's power to create money and spend it is precisely what is needed to help the private sector deleverage and prevent debt deflation.

    which has created this financial mess

    This is patently absurd.
    Bill Clinton ran budget surpluses in the late 1990s. How could an utterly non-existent Keynesian policy have caused the massive tech bubble of the 1990s?

    Keynesian didn't cause the great financial crisis either, that was poorly regulated financial markets and incompetent free market "regulators" like Greenspan.
    A Keynesian would say that excessive private debt and asset bubbles should by stopped by government regulation. This is the cure for financial crisis, not the cause.

    ReplyDelete
  61. Lord Keynes,

    Fractional reserve banking is a problem (especially when the fractional reserve is not gold but is itself valueless bankrupt government debt/gilts), but governments using it to borrow (creating money) is THE problem which is Keynesian policy.

    You keep harping on about poorly regulated financial 'free' markets causing the crisis negating to mention what they actualy did wrong which was to lend reclessly to now bankrupt governments (the regulators) and to private individuals and companies whose income was derived from government deficit spending.

    ReplyDelete
  62. The problem with many of the social efficiency indicators in that list, like institutions and infrastructure, is that they're circular. They measure subsidized inputs to the dominant business model (Sloanist/Schumpeterian/Galbraithian/Chandlerian mass-production industry, using expensive product-specific capital equipment for large-batch production and supply-push distribution, with high overhead and Taylorist/Weberian work rules), and then increase "productivity" by increasing the prevalence of that business model. A great deal of "productivity" of such individual enterprises, and of GDP on the macro-level, is circular because it simply measures the "productivity" of an input by what it adds to retail price. The more broken windows, the more people digging in holes and filling them back in, the more extra steps in the Rube Goldberg contraption, the more the total level of monetized activity -- and hence the higher the GDP. The goal is full employment of the labor force at 40-hr weeks and full utilization of capacity, even if most of the capacity is superfluous and most of what we consume could be produced quite efficiently with a 20-hr workweek.

    ReplyDelete
  63. A Real Black PersonJune 29, 2010 at 10:05 PM

    The prevailing theory here is that money is a representation of the value of goods and services currently exchanged within an economy.

    But this is a definition of GDP, not money.

    What I mean to say is that currency should be a reflection of the value of the output of an economy. The fact that it isn't is behind most of the problems the global economy is facing.

    GDP only really measures the volume of money in an economy. It dislikes savings , likes circulation and doesn't care what the money is being spent on. There is no discretion made as whether twenty million dollars is spent on energy efficiency or on twinkie bars. It's possible in a country for an individuals to be indebted up to 150 percent of their annual income without being very productive, it's possible for the government to be borrowing let's say ten perecent of it's GDP, it's possible to for the country to be a net importer and still have positive GDP growth. If a country like Mexico was supplied with a credit line to the same proportionate amount that was given to the United States over the last ten years, and the peso was perceived as being "safe", it would be one of the fastest growing economies in the Western hemisphere. Another way to put it, if any working person in Mexico could get a credit card, there would be a lot less of them coming over the border for 'a better life.'


    Currency, would be a more concise measure of economic performance if market distortions such as the government bond market currency manipulation didn't exist. A competitive and productive economy would have a strong currency and an economy that got by on low value services wouldn't have such a strong currency. But, alas, that is not how the global economy works at all. Many of the people who do the real work are paid peanuts while the people who push papers, who take more than they give are given status and respect in many instances [in developed economies].

    Both GDP and currency exchange rate are poor measures of the real value created within an economy.

    ReplyDelete
  64. I second your comment on the relation of GDP to real value, Real Black Person.

    There's a strong parallel between the national accounting mechanism entailed in GDP, and the Sloanist management accounting system that prevails in American corporations.

    Under the prevailing American model of management accounting, as described by Waddell and Bodek in The Rebirth of American Industry, only labor is treated as a direct/variable cost, while capital expenditures and management salaries are treated as general overhead. And inventory is treated as a liquid asset. So under the standard practice of "overhead absorption," irrational capital projects and bloated administrative expenses straight out of *Brazil* are simply incorporated via markup into the prices of goods "sold" to inventory. In practical terms, this means that -- despite all the "lean" rhetoric -- "value added" includes the cost of any input that adds to the price of finished goods.

    GDP, likewise, is a measure, not of utility, but of inputs consumed in producing utility.

    ReplyDelete
  65. Lord Keynes,

    Considering that this Cynicus article was written in response to your endless posts of contradictory views, I am surprised that you have not responded to my latest reply to you that Fractional reserve banking enables bankrupt governments to 'create money' as they borrow from badly regulated 'free market' banks, and that this Kyenesian endless deficit spending policy is the cause of the financial crisis. I believe that even Keynes accepted that endless deficit spending would not work, a view that you neo-Keynesians seem to have overlooked or cannot define an end point before total collapse.

    This government created borrowed money has also via public sector wages and 'private sector' contracts on public financed projects created a fake economy of even private sector jobs where these individuals and companies have via fractional reserve banking borrowed and hence created even more money as the bank loans are taken out, hence why private sector debt is even greater than public sector debt.

    Not only this, but when the banks became insolvent with insuficient fractional deposits, the governments printed quantitative easing bank bailout gilt reserves money to inflate the bubble further so as these bankrupt governments can borrow multiples more back than the bailouts. Why else did they need to bailout the banks than for them to borrow from?

    I notice you have also not elaborated on your views that governments can manipulate yields on their debt, and the scam (if not ponzi) that these Keynesian socialist deficit spending government regulators have made of our monetary system in an attempt to bribe the electorate to keep themselves in power.

    You have also failed to dispel my argument that GDP is a fake manipulated measurement of national income, since it measures debt consumption in shops and by companies on imported products as national income, and also includes government borrowed money used in deficit spending as national income. Hence perversly, the greater the borrowing, the higher that GDP growth is shown to be, which makes a mockery of comaparing sustainable national debt versus GDP. Hence you have still not produced a valid figure of how much money creation is sustainble before a total collapse, which was my original question to you.

    ReplyDelete
  66. Reply to George

    responded to my latest reply to you that Fractional reserve banking enables bankrupt governments to 'create money' as they borrow from badly regulated 'free market' banks,

    That’s because I have already dealt with it.
    By the way, governments don’t go “bankrupt”, and do not require private money to “finance” their spending.

    Fractional reserve banking does not
    “enable” governments to create money. The government creates money by means of its central bank.

    and that this Keynesian endless deficit spending policy is the cause of the financial crisis.

    Poor regulated financial regulation was the cause of the crisis.
    I will repeat my question (which you ignore because it shows that your views are wrong):

    Bill Clinton ran budget surpluses in the late 1990s. How could an utterly non-existent Keynesian policy have caused the massive tech bubble of the 1990s?

    I am not sure whether you are an Austrian school sympathizer, but in that case your argument ought to be that fiat money created by a central bank is the problem.

    But it isn’t as I have shown here:
    http://socialdemocracy21stcentury.blogspot.com/2010/06/what-is-money-short-analysis.html

    I believe that even Keynes accepted that endless deficit spending would not work,

    Precisely. I have shown repeatedly how you don’t need to do it endlessly when you have the right macro policies.

    a view that you neo-Keynesians seem to have overlooked or cannot define an end point before total collapse.

    The term “neo-Keynesians” refers to the post WWII neoclassical synthesis Keynesians. I advocate Post Keynesianism. Different macro theory.
    I have answered you on the limits of government spending in the UK here:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/uk-deficit-spending-qe-and-inflation.html


    Why else did they need to bailout the banks than for them to borrow from?

    They bailed out banks because depositors were going to lose their money. Perhaps this has slipped your mind.

    I notice you have also not elaborated on your views that governments can manipulate yields on their debt,

    There is no need for me to “elaborate.” I have already provided you with a link to Bill Mitchell’s blog here:

    http://bilbo.economicoutlook.net/blog/?p=8986

    My views are in line with his. He gives the details.

    You have also failed to dispel my argument that GDP is a fake manipulated measurement of national income, since it measures debt consumption in shops and by companies on imported products as national income, and also includes government borrowed money used in deficit spending as national income.

    There is nothing “fake” about it. Debt has ALWAYS been a fundamental part of funding virtually ALL important economic activity. It was fundamental in the 19th century as well. When excessive private debt builds up, the consumption part of it becomes larger of course. But then the government can just substitute badly-needed other parts of GDP that were neglected during the neo-liberal bubble years like investment (think R&D and education and public works) to prevent debt deflation and unemployment.

    There is no reason why government spending should not be included in GDP. Government provides fundamental things like basic R&D for science, education, health care, and public infrastructure – all things of use to the community.

    Only your anti-government bias causes you to reject government spending as a legitimate part of GDP. No one who disagrees with you will have any reason to accept your view.

    Hence you have still not produced a valid figure of how much money creation is sustainble before a total collapse, which was my original question to you.

    Yes I have here:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/uk-deficit-spending-qe-and-inflation.html

    Cheers

    ReplyDelete
  67. Lord Keynes,

    Countries do go bankrupt when they cannot repay their creditors, and when they resort to printing money to pay for deficit spending, which by the way is a form of diluting the wealth of its citizens if not bankrupting them also when its currency subsequently devalues.

    In a fractional reserve banking system, money is created by debt when the loan is taken out, since 90% that money did not previously exist (you should go and do your homework on this). Therefore when bankrupt governments borrow from banks to fund deficit spending (Keynesian policies), money IS created out of thin air.

    What you are referring to is when these bankrupt insolvent banks do not even have sufficient fractional reserve in deposit accounts, that the central banks then buy back their existing government debt/gilts to further create money via quantitative easing. It is all a scam (if not ponzi) fraudulent system that any individual would be jailed for doing, but is legal for governments to defraud its citizens via this money dilution.

    Please specify what these poorly regulated (by the government regulators) 'free market' banks did wrong, and if it is that they lent recklessly, then you admit that the governments allowed this so that they could benefit from this reckless high lending.

    Clinton may have repaid say 14 billion dollars over 3 years, however the USA has over more years increased its debts to a hugely higher 14 trillion dollars of money that did not previously exist prior to them taking out loans from the banks. Whenever fake money is created this way, asset bubbles occur whether in stock markets or house prices and it doesn't have to correspond to the same year money is created or marginally repaid.

    For as long as national debts increase in actual terms you Post Keynesians cannot specify ever there having been an end to endless deficit spending, or when such an end can occur without then claiming that austerity of reducing deficits will sacrifice growth and recovery.

    It is a fact that in addition to the majority of retail investors having their savings protected up to the 50,000 pounds per separate banks, it would have cost less if these government bailouts were given to guarantee depositors to their full deposits values than the current bank bailout situation where the banks have still not written off the full value of their losses. Of course the reason that the governments bailed out the banks was so that the governments could continue borrowing from the banks in multiples to the bailouts via this fractional reserve banking system which allows valueless bankrupt government debt/gilts to be considered as a capital bank reserves. Even the then (prior to bank bailouts) Labour government minister Yvette Cooper was reported as saying 'but if the banks go bust, then who will we borrow from?'

    Perhaps government spending in R&D for science, education, health care, and public infrastructure should be included in GDP figures, but NOT if this money was derived from government borrowing and debt and deficit spending. This has been the perverse fantasy island economics of GDP growth that is now crashing around us. Of course measuring sustainable national debt and borrowing against this measure of GDP growth is meaningless, and you fail to acknowledge that consumer debt spending on imported goods is also measured in GDP of national income when clearly it is not.

    Hence your attempt to give a figure of sustainable money printing and deficit spending as a percentage of GDP is not a valid answer.

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  68. you admit that the governments allowed this so that they could benefit from this reckless high lending.

    The “neoliberal” governments over the past 30 years have pursued this policy of excessive private debt, which in fact I do criticise.

    Clinton may have repaid say 14 billion dollars over 3 years

    Yes, so “Keynesian deficits” didn’t cause the 2000s bubble.

    however the USA has over more years increased its debts to a hugely higher 14 trillion dollars of money that did not previously exist prior to them taking out loans from the banks.

    You are clearly confused about who buys US treasuries. Most of them are held by Japan and China through trade surpluses. Pension funds and moey market funds buy alot of the rest of them. FRB is not going on here.

    Whenever fake money is created this way, asset bubbles occur whether in stock markets or house prices and it doesn't have to correspond to the same year money is created or marginally repaid.

    This is false, under the system of financial regulation before 1980, asset bubbles were virtually non-existent. US house prices were very stable from 1950 down to 1980.
    Also, assets bubbles occurred long before fiat money and fractional reserve banking. Ever heard of the Amsterdam tulip bubble?

    For as long as national debts increase in actual terms you Post Keynesians cannot specify ever there having been an end to endless deficit spending

    You confuse absolute numbers with debt to GDP ratios. If your economy has very strong real GDP growth (say like the US from 1945-1980) then debt as a percentage of GDP falls rapidly and is no problem.

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  69. Reply to George

    Countries do go bankrupt when they cannot repay their creditors, and when they resort to printing money to pay for deficit spending

    A country suffering severe output/supply shocks might. A modern country like the US with huge internal resources won’t. It can create a return to growth through right macro policies and reducing private debt.

    which by the way is a form of diluting the wealth of its citizens if not bankrupting them also when its currency subsequently devalues.

    Money creation per se does not decrease money’s purchasing power.
    That happens by inflation. Most conservatives don’t understand inflation.
    Incidentally, if you are an Austrian, you are committed to the view that changes in the level of prices depend very much on both real factors and monetary ones. In reality, whether inflation happens or not could be determined by real factors. Such real factors that can overwhelm monetary factors and keep inflation low include:

    1. the falling prices of specific goods through increasing productivity or output;
    2. low capacity utilization rates;
    3. a rise in cheaper imports into a country;
    4. falls in the prices of imported basic commodities that are factor inputs;
    5. changes in the velocity of circulation of money, and
    6. level of employment (= level of demand for goods and services).

    Whether you get inflation or not depends on the particular state of the economy at that time.

    In a fractional reserve banking system, money is created by debt when the loan is taken out, since 90% that money did not previously exist

    If a modern bank is buys government bonds if will do so through excess reserves. The central bank has created excess reserves. Different process, I am afraid.

    Therefore when bankrupt governments borrow from banks to fund deficit spending (Keynesian policies), money IS created out of thin air.

    Credit money is “created” by banks all the time in private loans.
    Fiduciary media in the 19th century gold standard did the same thing. New money unbacked by gold.
    Central banks have been creating since the 1930s by open market operations.
    Creating “money out of thin air” is necessarily a problem at all.

    Please specify what these poorly regulated (by the government regulators) 'free market' banks did wrong, and if it is that they lent recklessly

    It was a poorly regulated neoliberal system that allowed banks to cause excess debt and asset bubbles:

    http://socialdemocracy21stcentury.blogspot.com/2009/11/financial-deregulation-and-origin-of.html

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  70. Reply to George

    I note your false statement above:

    You have also failed to dispel my argument that GDP is a fake manipulated measurement of national income, since it measures debt consumption in shops and by companies on imported products as national income

    By definition, all imported goods are subtracted from GDP whether they were bought in consumption, investment or by government spending, and the resulting measure of GDP leaves us with the value of all domestic goods and services. Thus GDP is national income minus imports.

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  71. Lord Keynes,

    I am glad that you could not find fault with the rest of my facts on government money creation via their regulated banking system.

    Regarding GDP, it does consider retail company sales to be national income, and considering we now hardly manufacture anything including clothes, it cannot avoid including imports that our purchased by shops and companies through say UK middlemen distributors. My main point however is that GDP does not differentiate consumption paid by income and consumption paid by debt, and considering even you specify that private debt dwarfs government debt, you can only guess how distorted a figure that GDP is of national income.

    Also, considering that £160 billion pounds deficit per year of government spending is via borrowed (debt created) money, plus the £200 billion of quantitative easing (printed) money that the government benefited from in just one year was included for GDP growth activity (something you have stated to agree with), you can see an even greater distortion of GDP for it to be considered as a measure 'national income'.

    Therefore please indicate a sustainable level of government borrowing 'created money' plus quantitative easing 'printed money' versus another measure instead of this fake GDP, to avoid inflation and worse financial collapse.

    ReplyDelete

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