Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
As the Occupy Wall Street movement grows and is spreading to other cities in the US and other cities around the World, my profession is “feverishly” trying to discover the “financial sector” to plug into their New Keynesian models. The global financial crisis caught them out badly. Now they are fixing that “deficiency” up and we will all be better informed again once the boffins do their work. That is what the Bank of International Settlements is trying to tell us anyway. As usual, the BIS is part of the problem rather than being part of the solution. The OWS movement is a recognition of that and anything the mainstream macroeconomists dish up will only inflame the resistance further. It is becoming clear that more people daily are saying “we will not pay for your crisis”.
In a speech to the Occupy Wall Street assemblage, Naomi Klein said the following:
We all know, or at least sense, that the world is upside down: we act as if there is no end to what is actually finite-fossil fuels and the atmospheric space to absorb their emissions. And we act as if there are strict and immovable limits to what is actually bountiful-the financial resources to build the kind of society we need.
The task of our time is to turn this around: to challenge this false scarcity. To insist that we can afford to build a decent, inclusive society-while at the same time, respect the real limits to what the earth can take.
I would only change one word – replacing bountiful with infinite when applied to sovereign governments like the US.
In that vein, the Bank of International Settlements is still perpetuating the myths that the “financial resources” available to government are strictly limited and exhausted. Why we tolerate political statements from the BIS is beyond me. They have a research department that serves as a propaganda machine disguised as independent evidence-based research.
In a recent (September 16, 2011) BIS Working paper – The real effects of debt – which was presented at the Jackson Hole meetings held in the US recently the BIS propaganda machine is in full swing. I am aware that this paper is being used to reinforce the Reinhart-Rogoff claims that there is a distinct government debt threshold beyond which bankruptcy and disaster beckons.
I always mumble Japan when I read papers like this. In the BIS paper they fail to explain how Japan has been in violation of their estimated “thresholds” for two decades or so. All the negative cyclical movements in that economy over this time are fully explained by demand shifts – either collapsing world demand (export declines); subdued private investment as a result of uncertainty about future demand; or contrived government cutbacks to suit the neo-liberals (1997).
All the evidence stands in denial of the excessive debt claim. For a start interest rates have remained around zero and the economy fights deflation rather than inflation. None of the mainstream macroeconomic predictions have borne fruit. But of-course that doesn’t stop them from maintaining the line.
The open gambit in the BIS paper sets the scene:
Debt is a two-edged sword. Used wisely and in moderation, it clearly improves welfare. But, when it is used imprudently and in excess, the result can be disaster. For individual households and firms, overborrowing leads to bankruptcy and financial ruin. For a country, too much debt impairs the government’s ability to deliver essential services to its citizens.
The statement about individual households and firms is accurate. They use the currency that the government provides and must finance all their spending. They can do that by earning income, running down savings (including selling assets) and by borrowing. Clearly, they must be able to service debts from the other sources of spending power. If they fail to do that they go broke.
So there are strict financial limitations on the capacity of the private sector to carry debt.
But the statement about the government is totally false when applied to the majority of governments in the world (that is, excluding those in the EMU; nations that have tied/pegged currencies; and nations that choose to run up public debt denominated in foreign currencies).
From a financial perspective, there are no limitations on such a government to carry debt and “to deliver essential services to its citizens”. It is an outright falsehood to claim otherwise.
There are political constraints surely and they relate to ignorance which is a lack of education mainly.
And – there are economic constraints by which I mean real constraints. Clearly the public debt is a liability to government and has to be serviced and redeemed when the maturity is reached. The servicing of the debt results in income payments to the private sector which may enter the aggregate demand (spending) stream and create an output response from business firms.
So the income payments will have real impacts under these circumstances.
If the economy has idle capacity (like millions of unemployed workers) then there is “real space” available for the economy to absorb that expenditure without encountering any inflationary pressure. In other words, other expenditure (delivering essential public services and/or private consumption and investment) can also flow without any inflationary consequences.
Once the economy hits full employment and there is no real capacity left for the economy to respond to increased nominal spending growth via real output growth then the story changes. At that point, the inflation barrier is reached and decisions have to be taken to bring nominal spending growth into line with the growth in real capacity of the economy.
At that point, the government may have to cut other spending and/or increase taxes to restrict private spending. But that has nothing to do with the level of debt. Any spending growth (government or non-government) at that point threatens inflation. The government could have zero debt and the situation would be the same.
The BIS paper then claimed:
High and rising debt is a source of justifiable concern. We have seen this recently, as first private and now public debt have been at the centre of the crisis that began four years ago
Again, the excessive private debt buildup precipitated the crisis – I won’t say caused the crisis because I think the root cause was the greed of corporate financial sector illegally exploiting the greed of ignorant households – radix malorum est cupiditas.
They did this in a number of ways which are now obvious: pressuring legislatures to tilt the regulative environment (vastly) in their favour; offering unfathomably financial products which they knew would blow up once beyond their own hands; using fraudulent ratings to sucker people into thinking they were investing in quality assets; lying to clients about the products they were selling; and betting against the products they were selling etc.
There is no doubt that widescale prosecutions of many who remain embedded at the top end of town are warranted and the fact these characters are still walking free and still doing business as usual is a scandal and represents a failure of government legal authority.
But the neo-liberal game has been to deflect all of that and reconstruct the crisis as if it is a public debt crisis. This allows them to then revert to their main theme – controlling governments to serve their own narrow interests without concern for the broader interests of the public. As long as they can divide the public intellectually – so, for example, getting the poorest to get behind movements like the Tea Party – who if they got their way would undermine the basic interests and security of their grass roots members – then the top-end-of-town can forestall public protest.
The Occupy Wall Street movement is crucial – notwithstanding its lack of direction – because it is restoring some sense of citizen action – we will not be cowed by the suits on Wall Street (or wherever). We have the power – we just have to work out how to use it effectively to advance our interests. That is the capacity that such a movement is developing.
I liked Naomi Klein’s interpretation of this:
If there is one thing I know, it is that the 1 percent loves a crisis. When people are panicked and desperate and no one seems to know what to do, that is the ideal time to push through their wish list of pro-corporate policies: privatizing education and social security, slashing public services, getting rid of the last constraints on corporate power. Amidst the economic crisis, this is happening the world over.
And there is only one thing that can block this tactic, and fortunately, it’s a very big thing: the 99 percent. And that 99 percent is taking to the streets from Madison to Madrid to say “No. We will not pay for your crisis.”
There is no public debt crisis outside of the EMU. They have a public debt crisis because the member states surrendered their fiat currency issuing capacity – their basic economic sovereignty – and so are at the behest of the private financial markets and the ECB. Even within that system the ECB could render the private financial markets benign – which for the time being they are by acting as a “quasi” fiscal authority.
In that sense, the ECB could ensure there is no sovereign debt crisis in the Eurozone. The fact that there has been one indicates that the ECB is being dragged into its current role by politics rather than intrinsic desire.
Public bond yields everywhere else are low and stable. There is no shortfall of tenders for each bond auction. Central banks are firmly in control of interest rates. The bond markets queue up every auction for their latest does of corporate welfare (the bond issue) and in the meantime compete on the secondary bond markets for as much government paper that they can get.
From the perspective of the private bond markets there is a shortage of public debt and that shortage will intensify when the new Basel rules for capital adequacy are introduced. Please read my blogs – Bond markets require larger budget deficits and Market participants need public debt – for more discussion on this point.
The BIS paper then sums household, corporate and public debt and makes various comments about this aggregate. The aggregate is meaningless because it conflates two essentially different entities – currency users (household and firms) and the currency issuer (government). The two groups cannot be aggregate in this way.
They also quote as an authority – Reinhart and Rogoff – “This time is different” – but fail to inform their readers of the limited scope of R&Rs work. Their reference is in this context:
But, history teaches us that borrowing can create vulnerabilities. When debt ratios rise beyond a certain level, financial crises become both more likely and more severe (Reinhart and Rogoff (2009)). This strongly suggests that there is a sense in which debt can become excessive.
Quite apart from the other issues that one might have with Reinhart and Rogoff’s analysis (and I have many analytical issues), one has to appreciate what they are talking about.
Most of the commentators do not spell out the definitions of a sovereign default used in the book. In this way they deliberately (or through ignorance – one or the other) blur the terminology and start claiming or leaving the reader to assume that the analysis applies to all governments everywhere.
It does not. On Page 2 of the draft, Reinhart and Rogoff say:
We begin by discussing sovereign default on external debt (i.e., a government default on its own external debt or private sector debts that were publicly guaranteed.)
How clear is that? They are talking about problems that national governments face when they borrow in a foreign currency. So when BIS seek authority in this book you realise immediately that they are in deception mode or just don’t get it.
For a start, the US government has no foreign currency-denominated debt. Remember it has domestic debt owned by foreigners – but that is not remotely like debt that is issued in a foreign currency. Reinhart and Rogoff are only talking about debt that is issued in a foreign jurisdiction typically in that foreign nation’s currency.
Japan has no foreign currency-denominated debt. Many other advanced nations have no foreign currency-denominated debt.
It turns out that many developing nations do have such debt courtesy of the multilateral institutions like the IMF and the World Bank who have made it their job to load poor nations up with debt that is always poised to explode on them. Then they lend them some more.
But it is very clear that there is never a solvency issue on domestic debt whether it is held by foreigners or domestic investors.
Please read the blog – Watch out for spam! – for more discussion on why RR should be largely ignored.
So the BIS conclusion that there is some authority for “strongly suggesting” their is an 80 per cent safety threshold for public debt is without foundation and any reasonable editor would have forced the authors to delete those claims.
The BIS paper is essentially an econometric study. The data for the paper is HERE. I will comment a little more on the underlying econometric techniques used later but the validity of any econometric study rests on the underlying theoretical framework being employed. That is where the BIS research fails badly.
In their theoretical section, the BIS authors acknowledge that:
As modern macroeconomics developed over the last half-century, most people either ignored or finessed the issue of debt. With few exceptions, the focus was on a real economic system in which nominal variables – prices or wages, and sometimes both – were costly to adjust. The result, brought together brilliantly by Michael Woodford in his 2003 book, is a logical framework where economic welfare depends on the ability of a central bank to stabilise inflation using its short-term nominal interest rate tool. Money, both in the form of the monetary base controlled by the central bank and as the liabilities of the banking system, is a passive by-product. With no active role for money, integrating credit in the mainstream framework has proven to be difficult.
Yet, as the mainstream was building and embracing the New Keynesian orthodoxy, there was a nagging concern that something had been missing from the models … The latest crisis has revealed the deficiencies of the mainstream approach and the value of joining those once seen as inhabiting the margin.
In response to the challenge, macroeconomists are now working feverishly to put financial stability policy on the same theoretical footing that exists for conventional monetary policy.
Which is an extraordinary admission that the mainstream macroeconomics fails to deal with the economy that we live in. There is no recognition of the centrality of money in the economic system in New Keynesian economics.
What was missing is a fundamental recognition of how the monetary system operates and how the real economy is influenced by the way in which the monetary system is structured and the way government interact with the non-government. These are central perspectives that are offered by Modern Monetary Theory (MMT).
New Keynesian economics denied there was a business cycle – MMT predicted that there would be a major financial crash.
Where New Keynesians talk about government they claim rising public deficits crowd out private spending by pushing up interest rates. MMT shows that central banks control interest rates and deficits add to private wealth and income and bring forth their own private savings.
The so-called “brilliant logical framework” (Woodford) is the exemplar of the high New Keynesian farce. Please read my blog – Mainstream macroeconomic fads – just a waste of time – for a more detailed critique of New Keynesian economics.
It amuses (and saddens) me that my profession is now “feverishly” trying to “add” a financial sector after the fact and in a way that doesn’t reflect the way it integrates with the monetary system. So it is sort of like – “well guys (economics being dominated by males) … we seem to have a financial crisis on our hands – what do our models say about that?” –
“nothing we don’t actually have a financial sector in our models” – “we better fix that – so – assume there is a financial sector – and it works optimally through self-regulation – etc”
Seriously, mainstream economics is a moribund activity and is rotten at the core. Various ad hoc attempts to resurrect it will not fix the core.
The BIS paper then says:
Like a cancer victim who cannot wait for scientists to find a cure, policymakers cannot wait for academics to deliver the synthesis that will ultimately come. Instead, authorities must do the best they can with the knowledge they have.
As if the economists are going to “deliver the synthesis”. The work that he is referring to is all designed to make the case the self-regulation is better than regulation. That the government deficits should be eliminated and that unemployment is essentially a short-run problem that will go away if inflation is stable.
Further, policy makers have all the knowledge need to fix the problem. They just do not have the political will having ceded their independence to their paymasters – the financial and corporate elites.
The problem is clear – deficient aggregate spending. I acknowledge that Naomi Klein’s concern for the environment etc are constraints on what we should be doing with the real economy. But there is no sense that these environmental constraints dictate that millions of people should be without work to keep real output within environmental limits.
Indeed, increased public sector employment aimed at advancing quality of life issues are more likely to be “green” than a scatter-gun stimulus to private employment. I will write a separate blog about that question one day.
But right now with millions of people not working the problem is not that their is a shortage of work – I can conceive of millions of productive jobs that should be done. The problem is that there is no funding for the work that is out there. In that regard, the private sector is reluctant to fund it and to some extent should be curtailing its spending anyway to ensure its debt levels are reduced.
That leaves the public sector – which has no financial constraints (that is, could fund millions of jobs without issue). With the non-government sector unable/unwilling/unwhatever to provide sufficient work to match the preferences of the labour force in each country then it becomes the responsibility of the public sector to take up the slack. The government thus chooses the unemployment rate once the private spending decisions have been taken.
That should be at the forefront of the Occupy Wall Street awareness – the GOVERNMENT CHOOSES THE UNEMPLOYMENT RATE.
If that rate is objectionable then BLAME government for that. Do not blame them for having a monopoly on the issuance of fiat currency. Do not blame them for having a central bank. Force them to use the currency issuing monopoly and its central bank to advance public purpose – in this case, by creating enough jobs for all.
For the unskilled who have nothing. For the graduating students lumbered with huge debts from their studies. For anyone else who wants to work but cannot find work in the non-government sector.
The BIS paper thinks government debt is a problem:
When a crisis strikes, the ability of the government to intervene depends on the amount of debt that it has already accumulated as well as what its creditors perceive to be its fiscal capacity? that is, the capacity to raise tax revenues to service and repay the debt. Fiscal authorities may become constrained both in their attempt to engage in traditional countercyclical stabilisation policies and in their role as lender of last resort during a financial crisis. That is, high levels of public debt can limit essential government functions.15
Once again, EMU nations aside, this statement is false.
The capacity of a government to intervene during a crisis is not contingent or limited by past fiscal policy decisions. Each fiscal year, the government has the capacity to purchase whatever is for sale in the currency it issues should it wish to do so. It can certainly purchase the labour services of any unemployed worker – whenever.
Budget deficits are flows and are not stock contingent. Government spending and taxation occur each period as flows of spending and negative spending (taxes). On the spending side, the government has no capacity constraints. It can electronically credit bank accounts whenever it chooses which is different to saying that it can spend in unlimited volumes whenever it wants.
Financially it can do that but from a responsible policy perspective it has to recognise real constraints. The inflationary ceiling I noted above. But during a crisis, the non-inflationary space for spending increases because idle capacity increases.
Further, the notion that the government has “creditors” is extremely misleading. Households seek credit to supplement their spending capacity. The creditor then sets the terms including whether to advance the loan in the first place.
Public borrowing is not akin to private credit seeking. First, governments just borrow back what they have previously spent. There is a wash in the monetary system. Government spending creates new financial assets which then create the capacity for the government to issue bonds to the non-government sector. When the government runs a budget surplus it destroys non-government wealth.
Second, the consolidate government sector (treasury and central bank) is always in the dominant position vis-a-vis private bond markets. The former doesn’t need the latter whereas the latter certainly need the former. Please read my blog – Who is in charge?– for more discussion on this point.
Third, governments only rarely pay back debt – in the overall sense of the word. They redeem specific bonds on maturity but hardly ever reduce the overall level of outstanding liabilities which grow – more or less (in a cyclical fashion) with the scale of the economy.
It is highly misleading to say that governments raise taxes in the future to pay back debt. That is not the way the system functions. Government may raise taxes to stifle private spending to avoid inflation or to achieve equity principles. But they don’t raise taxes to increase revenue to permit higher spending.
Fourth, it is an absolute lie to say that central banks lose their ability to function as a lender of last resort. Even the ECB has unlimited capacity to bail out all European banks, all government debt, and then some if they choose. Even at the height of the great recession, governments (treasury and central banks) had unlimited to transfer currency into the non-government sector. There are no financial constraints on that capacity. All the constraints are political at that point in the business cycle.
So the summary point is that the BIS paper while correctly analysing private debt adopts a flawed model for public solvency which leads to a series of spurious conclusions. These conclusions should never be allowed to influence the public debate about government deficits etc. The paper has no credibility in that area of discussion.
Another section of the paper looks at why the debt levels escalated so much in the last 30 years. They note “how extraordinary the developments over the last 30 years have been” but don’t associate that observation with the way in which the neo-liberal paradigm has assumed dominance in the policy setting and academic domains. That association is intrinsic to understanding the nature of the crisis and its solutions. The BIS, however, is silent.
They do acknowledge that regulation has been relaxed since the late 1970s but lauds the “improvements in financial theory and information technology” that led to the “intensification of financial innovation” – as if all this has been a good thing. The improves in financial theory – like the “brilliant analysis” above – centre on “efficient markets” theory and the asset pricing theory – all of which have failed to predict the crisis and which were used as levers to pressure government to relax the regulative environment in the first place.
They claim that:
The Great Moderation brought lower unemployment rates, lower inflation rates and less uncertainty. Believing the world to be a safer place, borrowers borrowed more, lenders lent more – and inflation remained low. There was also a likely feedback here: as financial innovation improved the stability of credit supply and allowed risk to flow to those best able to bear it, it improved general economic stability.
Please read my blog – The Great Moderation myth – for more discussion on this point.
The borrowers were continually told the world was a safer place by my profession who claimed the business cycle was dead. The financial sector combined with my profession to invent a fantasy world that the products they were spewing out to hapless (greedy) investors were safe and would continue to generate wealth. Even though they knew the products were not safe and would generate guaranteed wealth to only the top-end-of-town.
It was a fool’s paradise and we were the fools.
The “economic stability” was ephemeral and illusory. It was a growth strategy that had a time bomb ticking and the continual denial of that fact allayed our fears and our investigative instinct. Compliant – we “invested” into bankruptcy and poverty.
Finally, I didn’t want to dwell on the econometric aspects of the paper because not many readers will be interested. Suffice to say that the paper has several major flaws. I won’t go into detail – their principle finding is that “indebtedness can turn from good to bad – from initially growth-enhancing (or neutral) to eventually growth- reducing” and they “estimate that public debt starts to be harmful to growth … [at] … 92% of GDP… [up to] … 99%” although when they “control for crises” this threshold drops to “84 per cent”.
But the modelling is heavily dependent on an assumption that all governments are of the same quality in decision-making etc. A government that ran up public debt to 100 per cent and squandered the money on statues of the President and siphoned the rest of the public spending off onto purchases of financial assets abroad (Swiss bank accounts etc) will not have the same impact on economic growth as a government that uses the same scale of spending to create local jobs and build public infrastructure.
The BIS paper says that “(u)nfortunately, we have found no straightforward way of controlling for bad government”. Which means the results as they apply to public sector debt cannot be taken seriously at all.
Bouyed with confidence, the BIS authors then fill up the rest of the paper with doomsday scenarios based on rising dependency ratios. I haven’t the time today to deal with them. You will find the same arguments and my critique in this blog – Another intergenerational report – another waste of time.
Once we get beyond the myth that there are scarce financial resources available to governments to deal with the crisis then we can have a more realistic debate about the options.
In commenting on the Occupy Walls Street development, Paul Krugman said in his recent New York Times (October, 6, 2011) – Confronting the Malefactors – that:
A better critique of the protests is the absence of specific policy demands. But we shouldn’t make too much of the lack of specifics. It’s clear what kinds of things the Occupy Wall Street demonstrators want and it’s really the job of policy intellectuals and politicians to fill in the details.
I agree that is the role of the academy and others. Millions of dollars get spent each year on our salaries and then the economics academy has taken additional sinecures from the financial sector to produce “economic theory and research” that promotes the agenda of the investment banks rather than advance public welfare. That is an overwhelming conclusion one can draw from the crisis and the behaviour of my profession before and during the crisis. I was nearly going to add “the aftermath” of the crisis but it is clear we are still in the crisis period.
Paul Krugman says that “debt relief for working Americans become a central plank of the protests” because “in addition to serving economic justice … [it] … could do a lot to help the economy recover”. I agree with that although I would perhaps provide that relief in an indirect way – by creating jobs. Much of the debt became toxic as a result of unemployment. The “debt crisis” would have been attenuated significantly if national governments had have maintained high levels of employment.
Krugman also wants protesters to “demand infrastructure investment – not more tax cuts – to help create jobs”. I agree.
But I would go further and demand that the American government (and all national governments) use their fiscal capacity to CHOOSE a lower unemployment rate. They could easily employ all the unemployed to advance community development, personal care services, environmental care services, urban renewal and all the rest of the unmet needs that exist in the world.
The “unemployed” are already in the public sector – variously receiving some dollops of public relief. So why not use this idle labour force productively. If there was full employment many of the additional problems that we get fixated on would appear to be very much smaller.
I also agree with Paul Krugman that “(t)he Obama administration squandered a lot of potential goodwill early on by adopting banker-friendly policies that failed to deliver economic recovery” and that the Democrats have “a chance for a do-over”.
If the national political debate changes and rallies against all the lies and misinformation that is perpetuated in the BIS paper I looked at today then I agree that “Occupy Wall Street will have been a smashing success”.
I am rushing to the airport now.
That is enough for today!