Yummy at first then you get fat!

What do you do when you read strongly worded opinion pieces in national media outlets from people who hold themselves out to the public as experts in the area of interest and which reveal the writers are deliberately choosing to mislead their readers and/or haven’t a clue about the subject matter they are pontificating about? Answer: you write a blog and allow your frustrations to emanate into the ether! That’s what! Usually, mainstream economics commentators and macroeconomic textbooks hold out the analogy that the government budget is just like a household budget. So eventually the government has to pay the piper if they consume beyond its means and that means we all end up paying. Today, we had a new analogy enter the fray – the fiscal stimulus is like a box of chocolates. Yummy at first then you get fat! Lets proceed.

The household-government analogy is for example expressed in Barro’s 1993 textbook (p.367) as:

We can think of the government’s saving and dissaving just as we thought of households’ saving and dissaving.

This analogy is used as a prima facie case to establish that there are financial constraints on national governments who issue their own non-convertible currency. In this context, the mainstream analysis then turns to the macroeconomic implications of how governments “fund” themselves.

The logic according to those who draw the household analogy follows like this. Debt would have to be issued to finance the deficit. Accordingly, bond sales finance government, which will accumulate as debt.

Like a household, the rising debt cannot be sustained indefinitely and so spending must be curbed and brought in line with the financial reality. In this case, the need to repay the debt and service the interest payments arising from its issuance imposes a burden on future tax payers.

Extreme versions of the analogy – so-called Ricardian Equivalence – postulate that the households anticipate the future tax burdens and increase saving now which negates any stimulus effect coming from the budget deficits. Please read my blog – Deficits should be cut in a recession. Not! – to see why this argument is inapplicable.

In the meantime, the demands that the debt issuance places on scarce savings pushes interest rates up and “crowds out” “more efficient” sources of private spending.

Please read my blog – A modern monetary theory lullaby – for more discussion on why this analogy is nonsensical when applied to a sovereign government.

If anyone wants to understand how the monetary system operates and the opportunities it presents the sovereign government then it is absolutely crucial that they understand why this analogy is flawed and inapplicable.

The supposed equivalence between the household budget and the government budget is one of the most damaging analogies in macroeconomics. It is one of the first lines of defence that you have to get through in the struggle against the mainstream ideology.

The analogy is flawed at the most fundamental level. The household must work out its financing before it can spend. Whatever sources are available, the household cannot spend first. Moreover, by definition a household must spend to survive. The sovereign government is totally the opposite. It spends first and does not have to worry about financing.

The important difference is that the government spending is desired by the private sector because it brings with it the resources (fiat money) which the private sector requires to fulfill its legal taxation obligations. The household cannot impose any such obligations.

The government has to spend to provide the money to the private sector to pay its taxes, to allow the private sector to save, and to maintain transaction balances. Taxation is the method by which the government transfers real resources from the private to the public sector. A budget deficit is necessary if people want to save.

The household is the user of the currency that the government issues under monopoly conditions. The single issuer of the fiat currency which is otherwise worthless (that is, is not based on some hard valuable commodity) can never be financially constrained.

The point is clear. When fiat money is used, government spending increases reserves in the banking system. Taxation and borrowing drain the reserves. This gives the clue to the function of borrowing. A deficit generates a net build up in reserves in the banking system.

The spending occurs and the private firms and individuals that sell goods and services to the government deposit the proceeds in the commercial banks, which build up reserves. Unless those reserves are drained from the system, they will earn whatever support rate the central bank pays on excess overnight resercves.

So the only valid (and intrinsic) role that government bond issues play is to ensure the central bank has interest-bearing paper that it can sell to the private sector which can drain the reserves and provide the latter with a competitive return. But as we are seeing in the current crisis, the central bank can just as easily pay a return on the overnight reserves anyway and avoid all the hoopla of open market operations.

To fine-tune this point further, the spending would still have occurred if there were no bond issues. The excess reserves would be held somewhere in the banking system earning zero return (or whatever return).

If the Treasury offers too few or too many bonds relative to the holders of reserve balances at the Central Bank, the Central Banks “offsets” those operations to balance the system. In any case, the “money” is in one account or another at the Central Bank.

We then ask the question – why should government care if the holders of the excess balances chose the one that doesn’t pay interest as opposed to the ones that do (buying bonds)? The answer is simple – they would be indifferent.

Anyway, yesterday (February 22, 2010) I read a Bloomberg article – Stimulus Tab of $41,800 Waits for Wall Streeters – written by one Kevin Hassett who is also the “director of economic-policy studies” at the right-wing American Enterprise Institute.

Once you read the article you will realise that if he is the director of economic-policy studies at the AEI then they must be studying some other planet.

The interesting thing about the article is that we now have a new analogy to contend with. Its sweeter than the household-government analogy but just as ridiculous and non-applicable. It also reveals even more incompetence than the other analogy.

To condition the reader, Hassett opened with:

While President Barack Obama goes on about the success of his economic stimulus, the latest policy developments suggest Democrats are finally backing away from his radical Keynesianism.

Once I read the term “radical Keynesianism” I knew I was in for a torrid time. It just shows how far right the public debate has moved in the last few decades to label what Obama has done as: (a) radical; and (b) Keynesian.

From my understanding of the US policy response, the stimulus has been very muted relative to the collapse of private spending that the US economy has experienced. The fact that the unemployment rate is 10 per cent (and 17 per cent if you count those who have given up looking) tells me that the stimulus has been very inadequate.

A “Keynesian” approach would have expanded the US government deficit as a % of GDP by several more percentage points to really put a dent in the unemployment. They also would have targetted public sector job creation – of which there has been virtually none in the current period. The FDR New Deal was (reluctantly) a Keynesian intervention with major public works programs generating hundreds of thousands of jobs.

So the Obama response has been modest by any “Keynesian” standards.

Anyway, then came the analogy – make sure you are sitting comfortably and in no danger of falling of your chair and hitting you head before you read the next paragaph.

Hassett said:

The truth is, economic stimulus is like a very expensive box of chocolates. You get a sugar high, and a caffeine rush, but when the chocolates are gone, you have nothing but fat to show for it. You are worse off than you were before and still need to find real nutrition.

Where do you go with that “truth”.

First, an expensive box of chocolates is a stock. A nice box full of chocolates has no time dimension – it is a number of chocolates per se.

Now a budget deficit – and I presume this is what he calls the “economic stimulus” is a flow – you measure it as so many $ per day, or month or quarter or year. So a deficit of 5 per cent of GDP is comparing two flows of dollars – net spending and output.

One of the earliest mistakes first-year macroeconomics students make is confusing flows with stocks. It is one of the most basic things you have to learn in macroeconomics.

Modern monetary theory (MMT) is ground out of an understanding of how flows feed into stocks. It is intrinsic to understanding anything about how the monetary system operates and the impacts of government policy.

In trying to push this analogy, it is clear that Hassett hasn’t got a clue.

Second, I guess the “fat” is an allusion to public debt. If I was fat then I would have to sacrifice some non-exercise time for exercise or stop eating. There is no sense that the public debt involves any sacrifice at all on the part of the debtor – the national government.

They do not have to reduce their current spending on other things to service or repay the debt. They can have all of these things. Why? Because as noted above they are not financially constrained.

Now this is not to say they can spending infinitely. They can in a financial sense but only if they want the inflation rate to go to infinity as well. There are real constraints on national government spending which are determined by how much output is available for sale and how much output can respond to further nominal demand expansion.

But that isn’t remotely what Hassett is acknowledging.

Third, all the hard evidence I have seen – from Treasuries, Central Banks, the IMF, the OECD, the World Bank, other credible research since the onset of the crisis tells me that the fiscal interventions saved the World from a depression. The recession was bad enough but a depression would have been more severe and longer-lasting.

So we are definitely better off (overall) because governments did use fiscal policy to stem the collapse of private spending.

But this doesn’t mean that the way they intervened was of a high quality. I have written often arguing that the design of the fiscal interventions reflected a sort of reluctance stemming from grip that neo-liberals still have on policy makers.

First, they tried to rely on monetary policy which just reflected the dominance of the inflation-first school – which holds out that monetary policy is the only effective macroeconomic policy tool available to government. The monetary internventions restored stability to the financial system but did very little – if anything – to bolster aggregate demand.

Second, as noted above, the fiscal interventions were too small. Again this reflects the fact that policy makers didn’t really want to change tack and acknowledge that the mantra they have been rehearsing for a few decades now that fiscal policy is ineffective at best and dangerous at worst was wrong. Please read my blog – We are sorry – for more discussion on this point.

So they were cautiously pushed into using fiscal policy.

Third, the problem then was that the capacity to implement fiscal policy has been damaged by the years of neo-liberal neglect.

The policy process has been so oriented to cutting government back under the neo-liberal ideology and relying on monetary policy, that the machinery of government that supported fiscal activism in the past (the Keynesian years of full employment) had been degraded and abandoned.

In the past, governments had experience in running continuous budget deficits and had to have an “inventory” of effective projects which could deliver returns on the fiscal intervention.

They had planning processes and project design capacities which would support meaningful fiscal interventions.

So it is of little surprise to me that the design of the fiscal interventions was at times less than satisfactory and certainly deficient in terms of the employment dividend.

In this respect, I have some agreement with Hassett but not because of his flawed analogy.

He said:

According to the latest estimate by the Congressional Budget Office, the U.S. stimulus sugar high will cost $862 billion by 2019. The excessively optimistic administration estimate is that the stimulus created 2 million jobs last year. If we take that high number at face value — there are plenty of reasons not to — and given that roughly one-quarter of the stimulus funds have been exhausted, then each job has cost about $100,000.

To put that in perspective, if instead the government had used the stimulus to hire individuals at the going median wage of $37,115, it could have created more than 23 million new jobs.

So much for the supposed Keynesian multiplier effect. From now on, it should be called the Keynesian divisor.

In the Australian context, you might like to read an earlier blog I wrote when our federal government announced its $42 billion stimulus package earlier last year – 90,000 jobs for 42 billion is a bad strategy …

In that blog I pointed out that while the Australian government stimulus package was a step in the right direction, the Government has failed to really target jobs. If the Government had have introduced a Job Guarantee and paid the workers the current national minimum wage (with holiday pay etc) it could have hired 557,000 full-time equivalent workers for around $8.3 billion per year.

I referred readers to a major three-year study we had just completed at the time entitled – Creating effective local labour markets: a new framework for regional employment where we estimated that to achieve a full employment level (consistent with 2 per cent official unemployment, no hidden unemployment and no time-related underemployment), an extra 559.2 thousand jobs would have been required in May 2008. Clearly now the figure will be higher.

I would also recommend this Report to all those who are wondering about the effectiveness of public sector job creation programs; the way in which these large-scale interventions can be best organised and implemented – with the primacy of the local communities in determining which jobs should be provided; and the way in which skill development can be embedded in the jobs offered.

But the point is that direct public sector job creation programs would have delivered much higher employment dividends to the recessed economies around the world. The only reason governments didn’t implement them is that the neo-liberals voice – which sees these schemes as the anathema of a free market – is still so strong.

I am amazed that the conservative voice still commands any credibility at all given what caused the crisis. But the sad fact is that they still hold the sway.

Hassett them moves on to analyse the “fat”. All he proves is that he can divide one number by another – probably used a spreadsheet – to come up with a totally meaningless figure which he thinks is important. More the fool him!

In relation to who is going to pay the bill, Hassett says:

Ultimately, American taxpayers are going to have to pay the bill for the stimulus, and it is a steep one. For the average taxpayer, the bill is $7,798.

Of course, the final bill will not be spread evenly across taxpayers, because the rich pay a disproportionate share. Assume the burden is distributed the same as the current income tax. If your income is between $40,000 and $50,000, you will pay about $2,600 for the stimulus. If your income is between $75,000 and $100,000, you will pay $6,500. If you are lucky enough to have an income of between $200,000 and $500,000, your bill will be $41,800.

Where do you start with that? No-where really.

No taxpayer will have to foot the bill for any of the government spending. He is talking about a government that is not financially constrained although he doesn’t realise that.

Taxes are paid and people don’t like paying them – that is clear. But what they don’t like is that the tax payments reduce their disposable income which means that taxation reduces the private command over real goods and services. There has to be “space” for public spending for a given real output capacity. Otherwise inflation becomes the threat.

In this context, taxation functions to create that “space” by reducing the purchasing power of private spenders. Please read my blog – Functional finance and modern monetary theory – for more discussion on this point.

The progression in tax systems merely reflects the fact that you try to deprive those with the most purchasing power more than those with less – so-called equity ambitions. It is a way of more fairly sharing the burden of the price stability.

No private citizen will receive a bill from the government as it pays back the maturing debt (regularly) or credits bank accounts with interest. If anyone out there (from a nation with a sovereign government) can produce an invoice from government telling them that they are being “billed” to help pay back the debt then please send it to me and I will resign my position as a senior professor at the university.

Hassett then says that that new policy discussions in the US are being:

… based on the observation that it is cheaper to create jobs directly.

I fully agree with this and it should have been the centrepiece of all the stimulus packages. However, the Job Guarantee concept isn’t just a recession-fighting response. It should be a permanent capacity for any sovereign economy – and then the buffer stock of jobs would rise and fall – endogenously – with the fluctuations in private spending.

However, while Hassett is supportive of job creation initiatives, he claims “(p)rivate is best.” My view is different. I would create the buffer stock of jobs in areas that address unmet community and environmental needs and where the activities will not substitute (or compete) with private sector job creation. In the Report I cited above we identified hundreds of thousands of such jobs – all adding value to the nation but not undercutting the private sector.

My view is clear – I would never subsidise the private sector. The logic of private capitalism is risk and return. I do not support corporate welfare which leads to the costs of enterprise being socialised but the returns privatised. This is exactly what the financial bailouts have achieved. But it also occurs more generally when employment subsidies are introduced.

There are so many areas of public activity that can be effective in advancing general welfare which require extra labour. Given the unemployed are currently at zero bid in the private market it is a no-brainer that the economy gains if they are employed.

At least Hassett can see the advantage of getting people into employment via public-sector job creation programs:

Given the state of the labor market, it is hard to imagine how any sensible person could oppose such a move. It is a shame that such common sense was absent last year.

I totally agree.

On the Keynesian theme, there was also an article published today (February 23, 2010) in the Sydney Morning Herald in which some other “Bloomberg News columnist” took it on himself to pronounce the The deathbed of Keynesian economics.

The common feature of these two articles is that they were written by Bloomberg News columnists. Anything going on there?

So one Matthew Lynn wrote:

The UK has produced notable economists over the years, but John Maynard Keynes, the guru of government intervention, was one of truly global significance.

So it may be fitting that the UK will also become the deathbed of Keynesian economics.

Britain has been following the mainstream prescriptions of his followers more than any developed nation. It has cut interest rates, pumped up government spending, printed money like crazy, and nationalised almost half the banking industry.

Short of digging Karl Marx out of his London grave, and putting him in charge, it is hard to see how the state could get more involved in the economy.

So the UK economy is near to communism!

First, the British government has not followed the classic Keynesian approach as noted above. It has allowed its economy to wallow in recession for 6 consecutive quarters which tells me it did not spend enough and target it effectively.

The problem is in the policy design not the concept of fiscal intervention.

Second, its quantitative easing emphasis is hardly Keynesian and reflected the obsession of the neo-liberals that monetary policy was likely to be an effective response. It was folly from the start. Please read my blog – Quantitative easing 101 – for more discussion on this point.

Third, it nationalised half the banking industry because the financial system was about to collapse as a result of the failure of the mainstream self-regulation approach. That approach was the policy stance that replaced the Keynesian system of intervention.

After several paragraphs which represent an inflammatory tirade against fiscal policy, Lynn notes that:

The Keynesian consensus is that things would have been far worse without the stimulus provided by government. And if the economy isn’t pumped up with inflated demand, it will collapse back into recession. If it’s not working, that just proves the stimulus should be even larger.

It is the argument quacks always push: if the medicine isn’t working, increase the dosage.

This analogy also fails. If you are sick then you first work out what is wrong before administering any medicine. If any medicine is prescribed then it should be administered in accordance with known causality within the limits that the clinical trials and the general science define.

In the case of a recession, the cause is clearly a collapse of overall aggregate demand. That is indisputable. Then you have to consider the components of aggregate demand that have collapsed. As Keynes demonstrated – and it is still relevant today – if private demand is falling and confidence is low – then the only way in which spending can be supported if for public spending to rise.

That holds in nominal and real terms. The tautologous terminology Lynn uses – “pumped up with inflated demand” – is devoid of meaning. Any additional to spending will increase aggregate demand. Using terms like “inflated” just adds emotion but doesn’t help us understand the way in which spending feeds into the output and income determination process.

But his whole article is full of emotional language designed to steer the reader away from the actual issues.

So if there is a failure of demand then the government can always increase its own net spending. If the private sector responds to this by increasing its own saving ratio (which is happening) it just means that the private balance sheets were precarious before the downturn. The solution? Increase national income which in itself provides the wherewithall for the private sector to increase saving and expand its own spending.

So why is the UK still in an appalling state? The government has not spent enough and has not spent in ways that will increase output or employment. It is obvious that if the government had have introduced direct public sector employment schemes, the unemployed who secured these new jobs would have definitely increased their own spending.

Unemployment is incredibly deflationary. That is why getting the jobless to dig holes and fill them in again (which is after all what the Mining industry does anyway) would help stimulate total aggregate demand. I am not advocating unimaginative job creation like that but the point is obvious.


It is true that some of the fiscal interventions in the recent downturn have made me hide my head in shame.

One of the major criticisms of fiscal policy in the orthodox literature is that it always runs the danger of being pro-cyclical because it takes time to mobilise the resources to engage in economic activity.

That is one reason why the Australian government’s cash handout was so effective (but ephemeral) in December 2008. Purchasing power went straight into the hands of consumers just before the Xmas rush.

But the classic example of what the mainstream claims is also evident in Australia at present – the insulation fiasco. The program aimed to put free insulation into all Australian homes that needed it. In theory it was a sound “green” strategy that would create employment in the private sector.

The program was scrapped last week and has been a disaster. It was poorly planned – the Department involved had zero time or capacity to design and implement the program. There was no coherent regulations or registration processes to ensure the companies that were given the contracts were technically competent.

The private sector shonks came out of the woodwork and we had “incompetent cowboys” in the roofs of our homes installing insulation using dangerous materials and techniques. There have been deaths of 4 workers – electrocuted using faulty materials and some house fires – again wiring defects etc. So a total disaster.

But this disaster does not tell us that fiscal policy is ineffective. It tells us that poorly implemented fiscal policy is ineffective and in this case totally disastrous.

What is required are long-term planning processes – to ensure projects are available that meet satisfactory standards etc. We need projects that can switch on and off – which is why the Job Guarantee (as outlined in the Report I cited) is likely to be an excellent counter-cyclical automatic stabiliser.

The reference to automatic stabiliser is also important. By definition the increase in the Job Guarantee pool tells us that private demand is falling and the last worker who comes into the office seeking a Job Guarantee job signals the limits of the labour market deterioration.

Anyway, I will write more about the insulation example another day.

That is enough for today!

This Post Has 39 Comments

  1. Hi,

    A great post.
    I note that Matthew Lynn claims that the Uk government “nationalised almost half the banking industry.”
    But surely nationialization requires direct management as well as ownership of banks?
    If I am not mistaken, the UK government hasn’t moved to take over management of the banks, have they?
    Or am I wrong?
    Lynn’s statement is inaccurate at best, and hyperbole at worst.
    A better description would be the government bailed them out, but with few strings attached – a type of crony capitalism.


  2. Also one other point – my elderly parents took advantage of the Australian government’s free insulation program last year. They got a decent builder to install it (as far as I am aware), and it has made a big difference to the house, making it much cooler – and really improving their quality of life. Surely it’s a bit over the top to say the program was “a total disaster”? Did no competent builders install insulation sucessfully any where in Australia? I find it a bit hard to believe.
    But, anyway, I thoroughly enjoy your blog and recommend it to my friends!


  3. Hi Andrew.

    I too had the insulation installed and it has made a big difference to my house, temperature-wise.

    I seriously doubt that more than a few percent of installation jobs are shonky or unsafe – any house with exposed wiring in the roof space is already unsafe even without foil insulation.

    But a few percent is all it takes for it to be a POLITICAL disaster and the opposition and the right-wing media will gleefully attempt to link it to pretty much anything and everything remotely related the the government has funded.

  4. Additionally, the banning of the foil-type insulation will put some proper professional installers and firms out of business.

  5. Hi Lefty,

    Yes, good points. It was a good idea but poorly implemented. Perhaps the result of 30 years of neoliberal attacks on government fiscal policy and the government planning agencies necessary to do things rapidly and effectively?


  6. Dear Lefty and Andrew

    It was a great idea but needed planning and capacity development within government. Around 130,000 houses need to be checked so not a small issue.

    But overall it doesn’t make a case against fiscal policy. The spending on all programs has helped aggregate demand. There just would have been better ways to do it.

    best wishes

  7. We spend a lot of money on military exercises, cyber-attack exercises, etc. Why not a fiscal spending readiness exercise? And just as we pay agents to try to sneak into airports with bombs, why not pay agents to apply for social services or get support, to see how ready and responsive the government is? Announce that a large plant is closing down and give the local government 24 hours to swing into action. Compare that to the announcement of a terrorist cell in the area — which threat is more likely?

  8. The absurdity of the response to the insulation scheme is that the shonks are going to be paid – again – to ‘inspect’ the shonky jobs they did in the first place!

    That Lynn article is wharrgarbl in the extreme but the comic linked in the comments sums it up well.

  9. Hey all — I was wondering if someone might help me clear some things up, as sometimes the more I think about things the more confused I get. Although not discussed in this post, one of the central arguments of MMT is that loans create deposits and that banks don’t need reserves to lend — the reason being that the Fed must accommodate reserve demand if it wishes to target an overnight interest rate.

    My question is why then are banks competing for depositor’s money? Why are banks, especially today, offering any yield at all on CDs, savings accounts, etc.? The fact that they are offering yields on deposits implies that they intend to do something with that money. And why is it so that problem banks tend to offer higher yields to depositors than more solid/creditworthy banks?

    thanks a lot for the help.

  10. Government policy – fiscal and (de-)regulatory are very effective at redistributing income (neoliberals would agree with that). U.S. policy – fiscal and (de-)regulatory – have effectively redirected income upwards to top income households and corporations. The battle or war is over the direction of U.S. policy – that is the true ‘class war’. What we see now is that deficits only matter when a Democrat is in the WH – in part because of the ‘fear’ by neoliberals/conservatives of the change in policy and redirection back downward. Democrats, specifically Clinton and Obama, not understanding this, or lack the courage to change the policies, have caved to neoliberal/conservative pressures.

    Change will only come from a mass movement started from ‘bottom’ – the community level. But we are a long way from that and huge hurdles to overcome. The biggest hurdle is the traditional media which keeps spewing this crap quoted above and other stuff. IMO, we have to educate/inform people about what we should be fighting to change – economic policy.

  11. Bill,
    Great blog as usual. Just a point of fact to put the Hassett piece in context — this is the same guy who will go down in history as having helped pen “Dow 36,000.” Simply. Not. Credible.

  12. The only problem I see in all this MMT stuff is that if the government increases the public’s income through spending – the banks would be less able to call loans and thereby fail to increase their real wealth through foreclosure. The FIRE sector spent a lot of time and effort building these instruments of financial mass destruction – they have finally succeeded in setting a fire and you want to put it out!

  13. ds, the answer is simple: cost and reliability. Retail deposits are extremely cheap, very stable and predictable. However it does not mean that they are required. Many banks do not have retail operations and yet feel (or rather used to feel until this crisis) fine. It is a question of business model rather than the need to attract despots

  14. Bill: Taxation is the method by which the government transfers real resources from the private to the public sector.

    It seems that it is currency issuance through disbursements that creates the financial assets that are used to pay taxes, and the portion currency issuance used to purchase goods and services in the private sector that transfers real resource to the public sector, while disbursement for other purposes, like transfer payments, do not. Taxes simply remove some of those financial assets so that the NFA in a budgetary period do not adversely impact NAD relative to real output capacity.

    In a hypothetical situation were the government might suspend all taxation and spend profusely on goods and services to increase NAD, say in a severe depression, private sector real resources (not otherwise being used at the time) would be transferred to the public sector, e.g., through public works programs.

    So why is it that taxation is the way that government transfers real resources to the public sector? I thought that taxes didn’t fund anything, but rather than taxation is simply a fiscal operation to adjust NFA to NAD relative to capacity utilization. I’m confused on this one.

  15. Tom,

    It is because the tax system is what creates the demand for the governments otherwise useless monopolist supplied money in the first place.

    The taxes force the private sector to engage in trade / business with the government and hence transfer goods and services from the private to the public sphere / sector as a means to gain the monopolist supplied fiat so they can meet their tax obligations.


  16. ds, at the marketing level banks know that customers produce revenue for them by using their services. So they compete for customers by advertising loan rates, etc. But the fundamental rule of marketing is that a solid, large and loyal customer-base is a firm’s most important resource. So banks offer good deals on opening deposit and savings accounts to increase their customer-base. You know, the free toaster.

  17. Tom: Re your 3.24 comment, I think you attach too much importance to MMT phraseology, e.g. to the phrase “taxes don’t fund anything”. I can see the truth in the latter phrase, but at the same time I’m perfectly happy with the phrase “taxes fund government spending”, or “taxes transfer real resources from the private to the public sector” as long as those using the latter phrase are aware that net government spending funds the private sector’s desire to increase net financial assets (and Bill Mitchell, of all people clearly is aware of the latter point).

    The phrase “taxes transfer real resources…..” is strictly speaking not right, but it’s obvious to me what is meant. A more accurate phrase might be, “taxes transfer the right to purchase real resources”.

  18. One last word on the insulation – and then I will leave it at that as it is beginning to deviate from the subject of economic stimuli – is that we be should finding out if the number of incidents is actually out of proportion.

    130 000? homes had the foil fitted in under 12 months. Were there less incidents with the previous 130 000 foil fitting jobs before that? My bet is that the previous 130 000 took rather more months and years to install than 12. Even if there had been more incidents with the previous lot, it is unlikely the public would have noticed since it probably occurred over a span of years and there was no reason for it to be continuously in the public spotlight.

    Could be largely hysteria. All that occurred was that the government was seen to have paid for the bulk installation of a product that has been used for many years.

    However, it does bring to the fore the obvious conclusion that standards across the industry were simply not good enough. Foil insulation should only be fitted by qualified professionals.

  19. Alan, that’s what I surmised Bill must mean. But “Taxation is the method by which the government transfers real resources from the private to the public sector,” is exactly the way the “small government, low taxes” Grover Norquist crowd puts it in arguing against taxes, as well as deficit spending, which they claim must be financed by debt that has to be paid by future taxation, canceling any stimulative effect according to Barro’s Ricardian equivalence hypothesis.

  20. “Although not discussed in this post, one of the central arguments of MMT is that loans create deposits and that banks don’t need reserves to lend – the reason being that the Fed must accommodate reserve demand if it wishes to target an overnight interest rate.

    My question is why then are banks competing for depositor’s money?”

    ds, it’s a good question. People have correctly observed that reserves play a relatively unimportant role in regulating the amount of bank lending, but this does not mean there are no regulations. It seems to be a misconception that banks do not have to source funding at all – this is incorrect.

    Banks cannot or would not just continue making loans without bothering to raise funds through deposits or capital markets, and just rely on borrowing from the central bank. Regulators and central banks do not want this.

  21. Dear Tom and Bill,
    No need to complicate things. The private sector needs money balances (horizontally) because they represent the legal tender neccessary, although not sufficient, to complete and clear (in bank accounts or cash) transactions. Taxes is ony one of these transactions. Actually, it is more efficient if productive activities that generates income are not charged any taxes. The sovereign with non convertible issue authority can donate public services (public domain) with fiscal policy strictly for the grace of its citizens and purchase private resources (private domain), by issuing money balances as long as it does not crowd out private spending (full employment). Why then pay taxes? Assuming that all systems lead to excessive behavior, speculation over capital gains in capitalism, taxation flows can be a penalty to confiscate excessive returns (collateral damage on productive resources) and control capital inflation (bubbles), restraining speculators! The tax factor can be set to capture these returns compounded with a penalty spread factor corresponding to the extra risk imposed upon the system (spread on the speculators for a change!).
    Proposition: Taxation equivalent to adjusted capital gains controls capital inflation and restores fiscal policy to its role for acheiving approximate (sorry Bill) full employment.

  22. Gamma,

    Most banks could not care less about deposits. They are more concerned with off-balance sheet activities where they can implement fees to derive their incomes.

    Check the numbers out. Banks make most of their incomes through fees not investment returns.

    Finding depositors is merely a way of signing up more imbeciles for the banks to charge fees to and hence profit from it.

    As for loans not creating deposits you need to step out of your Say’s Law world.

  23. Panayotis, these are lines along which I’ve been thinking, too. According to functional finance, government disbursement is properly used to create net financial assets for non-government at no cost to the government and the government can create as much as it wishes consistent balancing NAD and real output capacity. Taxes are simply a fiscal tool for withdrawing NFA when there is inflationary pressure building. It may be true that some taxation is needed to give a fiat currency value, but there will always be a need for some taxes to adjust distribution in order to maintain balance and reduce inefficiencies, e.g., due to speculative excess that cannot be addressed through regulation.

    There is still a problem because of bank money creation, which history shows can become excessive relative to risk, especially at the tail end of a long financial cycle. Therefore, bank money has to be controlled to some degree by government, since private banks are public/private partnerships in the monetary system, for which the government is responsible. This means not only regulation, such as capital requirements to limit leverage, but also the imposition of taxes to deflate imbalances arising from speculation, for example.

    However, there are a lot of moving parts in a national economy, and national economies are relative to other national economies in a global economy, and the whole system is unstable due to shock. So it is not simple task to get right, especially with the complication of the politics of interest.

  24. “Taxes are simply a fiscal tool for withdrawing NFA when there is inflationary pressure building.”

    Tom, in practice, how would this work? For example if over the next year inflation starts to pick up, how would the government increase taxes to dampen it? Through income tax, company tax or otherwise?

  25. Gamma. some of this would be accomplished through the automatic stabilizers, specifically progressive taxation. As incomes increase, people find themselves in a higher tax bracket, for example, and unemployment transfer payments decrease as more people are hired.

    But for functional finance to work, a lot of people would need to be reeducated and the system retooled. Right now, the paradigm is to use monetary policy instead of fiscal policy. Monetary policy has the advance of being administered by the Fed, which is purportedly “independent” (ROFL), but it has the disadvantage of not working very well. It’s a very blunt instrument. At the moment, economic policy is not aligned with operational reality. A new approach is needed, and a crisis present the opportunity to fix what’s clearly broken.

    The basic principle is to add when the economy contracts where it will be the most effective and efficient, following the management principle, “Efficiency is doing the right thing, and effectiveness is doing the right thing” (Peter F. Drucker). Similarly, when inflation threatens, taxes should be targeted to where excess is most likely to build first, usually in asset markets in which leveraged speculation is rife and through which wealth is redistributed to the top.

    The government should incentivize productive investment and discourage speculation, especially when it threaten to become destabilizing. Taxation can do this in a tightly targeted fashion, whereas regulation doesn’t work very effectively. Wages at the bottom are the last to rise in an inflationary cycle, so they should not be targeted with taxes. My view is that it is more productive to tax consumption than corporate income, since the problem of inflation is rising prices. This would involve increasing taxes on discretionary spending, but not maintenance expenditures. I think also that there would have to much tighter controls on hiding personal disbursements as company expenses.

    This may sound complicated, but the present tax structure is hugely complicated and doesn’t work very well either. Most people agree it needs to be revised. I would say it needs to be revised operationally IAW functional finance.

  26. Ralph: I think you attach too much importance to MMT phraseology, e.g. to the phrase “taxes don’t fund anything”. I can see the truth in the latter phrase, but at the same time I’m perfectly happy with the phrase “taxes fund government spending”, or “taxes transfer real resources from the private to the public sector” as long as those using the latter phrase are aware that net government spending funds the private sector’s desire to increase net financial assets (and Bill Mitchell, of all people clearly is aware of the latter point).

    Ralph, I am a political activist, not an economist. Phraseology is very important politically. The GOP gets this, the Democrats don’t. The essence of political communication is messaging, and this is accomplished through memes, e.g., TV sound bites. For example, the GOP mantra is “Taxes fund spending, so cut spending to cut taxes.” It’s a nonsense and a non-sequitur, but it works politically to motivate voters to vote against their interests by cutting spending programs that benefit them, when the tax cuts will chiefly benefit the wealthy and not them.

  27. Gamma,

    Thanks for the reference. I was looking at term deposits just this week so that link will come in very handy.

    Again it’s just a way to get people in the door so they can hit em up with the fees and make the big bucks.

    You seem to imply that the banks require these deposits to fund lending which is not the case at all.

    I have had first hand experience with Keynesians, and believe it or not The Austrians (Rothbardians) and though it pains me to say it – Bill Mitchell and co are so far ahead of the pack on this stuff it’s not funny.

  28. Re ds’s question

    I always assumed it was simply a relatively low cost way to obtain reserves – not because they are needed in order to lend, but just from a settlement perspective. You want to have a reliable reserve inflow so that you don’t have to seek out higher cost avenues to obtain reserves.

    Banks don’t really compete for deposits (after all, they can create them themselves if they really want, at a cost to equity), they compete for the reserves that come attached with new deposits.

  29. Dear fellows,
    In aprevious comment I had posed a concern that was not answered. For approximate full employment to be achieved using fiscal policy in MMT reality, the price of capital assets (productive capacity) must remain constant.As by accounting definition, total nominal capital assets (private financial assets/liabilities cancel out) are identically equal to total public liabilities (money balances or reserves and public debt) held internally. Assume that investment production has a rising cost, given technical requirements, due to private financing terms, transaction and organization costs. In this case the price of capital assets is higher and the share of prices to nomimal value of accumulated capital is higher than the share of the quantity of accumulated investment goods (employng workers) to nominal value of capital than if prices were constant. Given the total public liabilities available from fiscal policy, the level of accumulated investment would be less than the level required to achieve approximate full employment. if fiscal policy raises the level of public liabilities and the cost of investment goods rises more, the share of prices will rise further reducing even more the level of effective employment. Notice that there is also a debt leverage spiral effect. At rising capital asset prices (capital gains) internal private fund financing will drop out eventually of the investment financing pool, which pool will first be dominated by speculative financing and with leverage rising it will eventually be converted ito a pool dominated by Ponzi financing. Notice that even even with the private asset/liability cancel out, RISK is not neutralized but is rising! At some point thr bubble bursts and we have a Minsky moment! Of course the proposed solution is for fiscal policy to promote investment that is embedded with technology and innovation sufficient so the rate of investment costs equals the rate of investment, in order for capital asset prices to remain constant and the level of fiscal policy and the corresponding level of public liabilities neccessary for approximate full employment to assure this result.

  30. Gamma,

    Interesting point about the term deposits – they seem high!

    If you ask a banker, the answer you will get is “A/L Management” but that doesn’t help right ?

    Banks do care about deposits. They set interest rates depending on their “liquidity preferences” and also that of the household sector. When banks want to have higher yielding assets on their balance sheets, they increase the term deposit rates. This makes some households move into the term deposits and the banks buy some securities from households. The person who is moving into term deposits from transaction deposits, is not selling any bond to the bank but at the macro level it holds. A simpler way to look at it is to consider the household sector as one – the household sector and the banking sector swap assets.

  31. Further to 23:31 . . .

    I should add that “swap assets” was not good terminology. The banks’ balance sheet expanded when it bought an asset from the household. The household swapped an asset.

  32. Panayotis, I think that probably pretty well describes why we are where we are now. A lot of people don’t think that the current system can be reformed. Some, e.g., Stephen Zarlenga, propose fixing it by folding the CB into Treasury, ending the creation of bank money, and making government the monopoly provider. There is already a state bank functioning in the US, the Bank of North Dakota, for example. That is proposed as a model. However, I think it would take a complete meltdown to able to do something like this. But I don’t think that a complete global meltdown is out of the question, either.

  33. I have 5 propositions (pictures) for debate.

    1. Fiscal policy is a reaction to production shortfall(underemployment of resources), capital devaluation and exclussion behavior, conditioned by the degree of policy corruption, speculation and market power of private interests.

    2. Net taxation policy,( after tax procceds of regular income are spent and cancelled out), is a reaction to speculative activity and excessive returns, conditioned by cheating behavior and market power of private interests.

    3. Fiscal policy can assure approximate full employment if it is accomodated by technology against convention(tradition) and liquidity (uncertainty), if a non convertible issue authority exists, in order to maintain capital prices constant.

    4. Conditionality upon the system is imposed by the regime(political) situation (phenomena,presentations) and the complexity induced entropies of reduction of regular behavior, inertia of recovery, illusion of impression and subject to the relative intensity of private orientation of the reaction by economic units.

    5. Economic reality is not invariant and is nothing more than the reaction by units to economic occurences which reaction is non- monotonic and therefore leads to surprise.

    Now let the video roll and enjoy the discovery!

  34. Panayotis,

    1. I assume by “fiscal policy” you mean deficit expenditure. MMT simply says that operationally when NAD is insufficient relative to real output capacity due to shortfall of one of more the private sectors (C, I or NX), then government must fill the gap. The contributory conditions you mention are sufficient. The question is, are they necessary?

    2. According to MMT, when NAD is in excess of real output capacity, then inflationary pressure increases. Either disbursement must be reduced or taxes increases, or a combination of both. Again, the contributory conditions are sufficient. Are they necessary?

    3. I assume that by “technology” you mean operationalism, and by “convention (tradition)” you mean ideology, or theory rather than operations, which is based on assumptions that are not empirically grounded in reality. By “liquidity (uncertainty),” I assume you mean risk-taking in the face of uncertainty, i.e., where the degree of risk is indeterminable.

    4. By four you mean to introduce wild-cards that are essentially operational limitations involving knowledge and behavior.

    5. Illustrated by the failure of neoliberalism to foresee the looming crisis until it broke in full force. “Who could have seen it coming?” Refers back to #3.

  35. Dear Tom,
    Conditionality means that these factors if present, they tend to limit policy.
    1. Fiscal policy is public spending behavior that attempts to adjust for the shortfall and capital devaluation. The conditions I mention are both sufficient and neccessary because of system contradictions. Only their degree differs. I believe Marx, Keynes, Minsky and Kalecki and the Greek philosophers will agree with my position. What systems you know do not have the tendencies for excess,corruption, exclusive behavior and power in their marketplace!
    2. The point I make here is different. The system attempts to adjust for excessive behavior and unless checked it leads to crisis. The defensive mechanism is not regulation as the neoclassical economists propose but a tax penalty that confiscates these returns as the system tries to preserve itself. However, there is a contadiction that partly defeats this policy consisting of cheating and market power that private interests attempt to achieve limiting competition. These are also neccessary conditions being endogenous to the system!
    3. The point I make is different. The cost of investment is a rising function and the price of capital assets tend to rise also. This is related with pure uncertainty of decision and convention of praxis, unless liquidity becomes available and technology gets embedded in investment. This is required to keep the price of capital constant, otherwise the accounting equality between nominal value of capital assets and public liabilities cannot be achieved at full employment of resources. Of course in the case of a sovereign with non convertible currency the liquidity condition is achieved but not the technology condition unless you allow innovation to cover for the convention/tradition problem. This is dealt in my manuscript with the appropriate Bernoulli math.
    4. This gives the reasoning behind the conditionalities which are endogenous to the system and neccessary.
    5. Reality is not something objective that we seek to find. The reality is our reaction! Thus it can be different depending on how we react to an occurence (actually we are the occurence). The only gap that remains is our surprise that impacts upon us causing us to react and if we are capable to attempt to discover the enigma behind our surprise, we are living beings. Socrates said “All I know is that I do not know” and used the dialectic method to show that. It is not that I exist because I think (Kant) but I discover because I live (vioma).

  36. Bill, Tom and whoever is reading my comments. Again, I want to thank you for giving me the opportunity to present my views. I like my seclusion and although my friends prompt me to publisize more I avoid it. You are one of the very few blogs that I offer comments because I know (reading what you write) you care about people and their well being. Keep up the good work!



  37. Hi Bill,

    Thanks for another great post. Just one point – Scott Steel over at Pollytics has just done an interesting analysis of the whole “insulation gate” incident and concluded that the level of workplace deaths and house fires actually DECREASED significantly since the start of the government’s program:


    He also provides an interesting overview of the MSM’s typically irresponsible “reporting” on the issue. As so many of your posts deal with debunking just such reporting on financial matters, it is worth checking to make sure you are not inadvertently falling for the MSM’s spin on this story.

    It’ll be interesting to see if you end up agreeing with the Pollytics article (or not).



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