Neither Ed Balls nor George Osborne understand deficits.

The above two individuals are engaged in contest to see who can dispose of the deficit the quicker. Here is a simple explanation as to why the contest is pointless (which in turn is a simple exposition of Keynes’s basic ideas which in turn are much the same as Modern Monetary Theory).

If the private sector doesn’t spend at a rate that brings full employment, a solution is to get the public sector to spend more, or “net-spend” to be more to be exact. That is, the extra net spending can take the form of more public spending or reduced tax, or a bit of both. Whichever option is chosen, household incomes and bank balances rise, and (revelation of the century), that causes household spending to rise, which raises demand.

In short, the deficit needs to be whatever brings full employment. Or as Keynes put it: “Look after unemployment, and the budget will look after itself.”

Ergo AIMING FOR ANY SPECIFIC AMOUNT OF SURPLUS OR DEFICIT IN TWO OR THREE OR FIVE YEARS TIME IS FATUOUS. IF THE PRIVATE SECTOR IS IN SUBDUED MOOD IN THREE YEARS TIME, THE DEFICIT WILL NEED TO CONTINUE. IF NOT, IT WON’T, OR AT LEAST THE DEFICIT WON’T NEED TO BE AS LARGE.

As to the alleged problem that a continuous deficit leads to an ever expanding national debt, that’s not true in that the debt is continually being eaten away by inflation. But if the debt DOES RISE relative to GDP, won’t creditors demand an elevated rate of interest? Well if they do, there’s a simple solution: DON’T BORROW!!!!!

That is: print money instead. Indeed Keynes (famous economist who political leaders and their advisors apparently haven’t heard of) said that printing was a perfectly viable alternative to borrowing.

And of course whenever the words “print” and “money” appear in the same sentence, a host of economic illiterates appear from nowhere and start chanting “inflation”. Well the answer that is that if a deficit is needed, that means demand is inadequate, and inflation (demand pull inflation at least) is not going to become excessive when demand is inadequate.

 

 

 

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Benefits Street.

Simon Jenkins’s article in today’s Guardian, “The truth is that we are all living on Benefits Street”, falls for the old myth that public borrowing enables us to pass on the cost of public spending to the next generation.

I have a huge amount of respect for Simon Jenkins: he understands more about economics then 99% of politicians and most professional economists, but he is wrong on the above public debt point.

In the simple case of a closed economy (that’s one that does not engage in trade or any other transactions with other countries), public borrowing simply means that one lot of citizens (the relatively well off or cash rich) sacrifice current consumption so that government CAN CONSUME. That is, GENERATIONS have nothing to do with it.

Indeed, it’s a physical impossibility (never mind the economics) for people in the future to make sacrifices that benefit those living today: for example, the blood sweat and tears needed to make concrete and steel so as build say a bridge and which is produced in say ten years’ time cannot be consumed today. That would involve time travel.

As to OPEN economies (in particular where public debt incurred by country A can be bought by citizens or organisations in countries B, C, D, etc.) they are slightly different. Obviously if country A is loaned money by other countries and pays it back in say 20 years time, then those living today in A will benefit at the expense of those living in 20 years time. However, those sort of cross border debts cancel out, roughly speaking. That is, for every dollar of US public debt held by UK citizens or organisations, there is roughly a dollar of UK public debt held by US citizens and organisations.

 

The economics of immigration.

According to today’s Guardian, the head of the OBR, Robert Chote thinks immigration is desirable because immigrants tend to be people who have recently entered the labour force. That is immigrants tend to be in their 20s or 30s. And people of that age tend to pay taxes rather than be a burden on the state, as are pensioners or those still at school.

There is of course a whapping great flaw in that argument, namely that immigrants grow old! I.e. the “Chote” argument is not one that works in the long term.

Moreover, the Chote argument does not work for the World as a whole. That is, if one country gains someone in their 20s, then another country loses someone in their 20s. Amazing that I need to spell out this blindingly obvious stuff isn’t it? And since Guardian journalists are all good socialists, you’d think they’d mention something about the interests of the world as a whole, rather than referring simply to what benefits one relatively well-off country.

Indeed, on the same day as the above Guardian article, an article appeared in the Financial Times entitled “Romanians despair that wealthy Britain is taking all their doctors”.

The above articles, along with other articles on immigration, lead me to conclude that about 90% of the arguments for and against immigration have been trotted out dozens of times before and demolished dozens of times before. Another conclusion is that an ability to think is not a requirement for anyone applying for a job at the OBR.

 

The drop in Irish per capita GDP proves austerity is a failure?

Paul Krugman  doesn’t make many mistakes, but I think he’s gone wrong here in claiming that the drop in Irish per capita GDP proves that austerity in the Euro periphery is a failure.

Of course no one wants austerity, but the brute reality in a common currency area is that when a country becomes uncompetitive, it has to cut costs or (much the same thing) effect an internal devaluation. And just as when a country with its own currency devalues, that involves a loss in real living standards and a loss in per capita real output as measured in terms of the relevant common currency: the Euro in the case of Ireland. That is, output as measured in terms of some sort of physical unit (e.g. tons of steel) may stay the same, but the price of that steel has to come down for the country to compete.

So if employment levels in Ireland have risen over the last two years or so, but per capita GDP is still below pre-crises levels, that’s not at all unexpected. Put another way, if Ireland had had its own currency, that decline in per capita GDP would have been much the same, I’d guess.

Putting Warren Mosler’s Debate Club idea into effect.

Warren Mosler recently argued for a permanent near zero interest rate in a recent Debate Club article. That isn’t the first time he argued for that policy. In a Huffington article in 2010 he argued for a system under which the only liability issued by the government / central bank machine would be monetary base. As he put it, “I would cease all issuance of Treasury securities. Instead any deficit spending would accumulate as excess reserve balances at the Fed.” And since monetary base normally pays a zero or near zero rate of interest, Warren’s Huffington suggestion comes to the same as his Debate Club suggestion.

And Warren is not the first to argue for that sort of arrangement: in 1948, Milton Friedman argued for much the same in this American Economic Review paper. As Friedman put it, “Under the proposal, government expenditures would be financed entirely by either tax revenues or the creation of money, that is, the issue of non-interest-bearing securities. Government would not issue interest-bearing securities to the public..”.

However there’s an obvious objection to the above policy which adherents to the conventional wisdom will raise, namely that interest rate adjustments are ruled out. And that in turn implies that aggregate demand is adjusted purely by fiscal policy or by the sort of combination of fiscal and monetary policy favoured by Warren: i.e. having the government / central bank machine create new money and spend it (and/or cut taxes) in a recession.

The objection will be that fiscal adjustments are currently determined politicians. Thus if the sort of stimulus envisaged by Warren were to be implemented quickly, there’d be no time for politicians to argue about where the extra money was allocated to. I.e. the allocation would be done by bureaucrats and that might seem to remove powers from politicians. And politicians would probably object.

However, the loss of power by politicians wouldn’t be all that much and for two basic reasons. First, there is no need for purely POLITICAL decisions to be taken away from the electorate or politicians: that’s decisions like what proportion of GDP is allocated to public spending, and how that is split between education, roads, the military, etc. It’s purely determining the size of the DEFICIT that needs to taken away from politicians and put into the hands of some sort of committee of independent economists.

In other words given a decision by the latter committee to increase aggregate demand by say 1%, the extra money could be split between public and private sectors in the same proportion as the proportion of GDP already taken by those sectors. Plus the various types of public spending (education, law enforcement, etc) could be increased by the same 1%.

But the latter changes would not prevent politicians changing the proportion of GDP taken by public spending, nor would it prevent them deciding at any time to spend more on law enforcement and less on the military, for example.

And a second reason why Warren’s system would not remove all that much power from politicians is that the size of stimulus is ALREADY out of the hands of politicians since any central bank that thinks the amount of stimulus coming from fiscal measures is wrong, can counter that by adjusting interest rates.

However, the above points will be a bit complicated for those simpletons we call “politicians”. So implementing Warren’s ideas will not be plain sailing.

In fact a fair amount of thought has already gone into exactly how a Warren type system would be implemented. See pp. 10-11 here.

Also, Simon Wren-Lewis (economics prof. at Oxford in the UK) dealt with this topic in a recent blog post.

And finally, there’s a neat little argument against interest rate adjustments as follows. Those adjustments effect just borrowing and investment, and there’s no logic in channelling stimulus into an economy JUST VIA extra borrowing and investment. That is, there is no reason on the face of it to think that the average recession is caused by deficient investment spending rather than a decline in consumer spending or exports. Ergo, come a recession, it’s ALL FORMS OF SPENDING that should be expanded (public and private) not just investment spending.

What’s interest rates got to do with economic growth?

An idea appeared on the economics blogosphere at the end of last year which hopefully won’t re-appear. It’s the idea that interest rates on risk free or near risk free investments should be below the rate of economic growth. E.g. see here and here.

In a free market, the rate of interest is determined by the relationship between borrowers and savers. The rate of economic growth is an entirely separate matter: it’s determined by amongst other things the pace of technological improvement.

In a country populated by compulsive savers (and perhaps Japan is an example), the interest rate will tend to be low. In contrast, in a country populated by spendthrifts (and perhaps Anglo-Saxons are an example) the interest rate will tend to be high. But that “spendthrift/compulsive saver” matter has little to do with the pace of technological improvement.

As distinct from the above mentioned free market, there is the real world where there are various interferences in the interest rate: first and foremost there are central banks which deliberately try to influence interest rates. Also it can be argued that commercial banks interfere with interest rates in that they create money out of thin air and lend it out.

But given a genuine free market, I don’t see why the interest rate is necessarily above or below the rate of economic growth.

Hope that’s the last I hear on that subject.