In yesterday’s blog, I discussed one of the more novel ways that the conservative lobby against government spending is mobilising to present their case. In that paper, it was argued that spending “funded” by taxation is always captive to political lobby groups who ensure the government will waste spending and undermine the productivity of the economy. Alternatively, the author claimed that government spending should be disciplined by financial markets who would reduce the waste that is inherent in public outlays. While there were several flaws in the argument the one that we deal with today focuses on the assumption that financial markets allocated resources optimally.

In a sea of conservative media, two articles stood out this weekend which captures a debate that should be raging but will be quickly buried under the re-emerging neo-liberal hubris unless significant new alliances are formed. In recent weeks, as different economies are showing some signs of recovery, some key players within mainstream economics have been coming out in defence of the profession. They have been accusing critics of misunderstanding what economics is all about and saying that economists have actually saved the world. I covered some of this sort of positioning in Friday’s blog. In this blog I continue that theme but from a different angle. The conclusion is that if we want real change then “one should become more radical as one grows older”. We will see what that means as we go.

Welcome to 2010. Today, in the overcast summer that we are enduring here, in between other things I am finishing off, I was in my office reading about how mainstream economics actually saved us from a major depression over the last 2 years. Far from having to hang their heads in shame, the article indicated we had all embraced Keynes and glory be the day. I also read a counter to that which outlined what further needed to be done. I concluded neither writer really had grasped what has been going on and both would benefit from exposure to modern monetary theory. Not a lot has changed overnight. Happy new year!

Tonight we consider the tale of two countries with some other snippets of good taste included for interest. In the last few days the Japanese government has announced the largest fiscal stimulus in its modern era (since records have been kept) while Ireland announced its 2010 budget which has been characterised as the harshest in the republic’s history. Both countries are mired in recession with only the most modest signs of any recovery. So on the face of it this is one hell of a juxtaposition. What gives?

Many readers have E-mailed me asking me to explain yields on bonds and sovereign credit ratings. There has been press coverage in recent days that following the downgrading of Greece, sovereign debt in the UK, France, and Spain will be downgraded unless severe “fiscal consolidation” is begun. All these places are suffering very depressed domestic conditions with high unemployment, falling per capita incomes and civil unrest looming. The last thing these nations need is for their national governments to be raising taxes and cutting spending. But the financial press are using the threats from these nefarious and undemocratic credit rating agencies to berate governments to do just that. Undermine the welfare of their citizens. Further, judging from the E-mails I have received on this issue there appears to be a lot of uncertainty in the minds of interested people about what all this means. Here is a little introduction which I hope helps.

Last week, the Federal Reserve chairman Ben Bernanke received endorsement for a further term from the US Senate Committee on Banking, Housing and Urban Affairs (popularly known as the US Senate Banking Committee). There is much controversy about this re-nomination along the lines that he was Chairman as the crisis unfolded and he did nothing about it until it was too late. There is also angst about his refusal to provide Congress with specific information about institutions that the Federal Reserve bailed out. These issues are not unimportant. But the strongest reason why he should be dispensed with is that his public statements leads any informed analyst to conclude that he doesn’t really understand the monetary system. From a modern monetary theory (MMT) perspective his comments on the monetary system are as sophisticated as the most flawed mainstream macroeconomics textbook.

Today the Australian Bureau of Statistics released the September quarter National Accounts data which gives us the rear-vision mirror view of how the economy has been travelling while we have all been speculating. The good news is that real GDP continued to grow. The bad news is that the Australian economy is creeping along the bottom. It just managed to keep its head above zero line in the September quarter courtesy of the strong public investment associated with the now, daily-maligned, fiscal expansion. The labour market was clearly spared the worst by declining productivity. As productivity returns to more reasonable rates of growth, unemployment will rise unless GDP growth turns significantly upwards … quickly. Having said all that – there is nothing in today’s data to warm the frozen hearts of the conservative deficit-haters. They should just find a ship to get on and boost our exports.

Over the course of this economic crisis, I have seen a lot of erroneous analysis based on the conflation of things that are not commensurate. It is getting worse as the debt hysteria mounts. These conflations are examples of category errors, which are common in monetary and macroeconomic analysis. Most of the theoretical development in macroeconomics text books used by universities fall foul of this type of error. The one thing that follows is that when you detect this type of error you should be deeply suspicious of the arguments being presented.

Several readers have written to me asking about the Ricardian equivalence theorem, which is increasingly getting mentioned in the media and public policy reports. As I will explain, the theorem is used by anti-government proponents to argue that fiscal deficits are counterproductive and that cutting deficits in the middle of a recession will actually be good for the economy. They never really give up, do they? The theorem is a good example of the general mainstream approach where stark policy conclusions are derived which capture the popular debate but the underlying assumptions that are required to generate those conclusions are rarely widely known or mentioned in the popular press. Of-course, if the public understood these underlying assumptions then they would not take the conclusions seriously.

I mentioned in yesterday’s blog that there is a growing number of deficit-terrorists out there who are trying to appear reasonable to separate themselves from the more loony Austrian-school fringe. They are appearing reasonable by saying that “now we should have deficits” but soon (unspecified) “we will need surpluses” to “pay back the excesses”. That sort of spurious reasoning. Even some self-styled progressives who want us to think they are both reasonable people and knowledgeable commentators are starting to emerge within this broad camp. But in general their arguments reflect, at best, an ignorance of how the monetary system operates. This unholy gathering will prove to be very damaging to the need for a broader understanding of how these operations and how government fiscal interventions impact.

Late this afternoon I appeared on ABC Radio National Saturday Extra at a public forum on the future of coal that was held at Fort Scratchley which is near my favourite surf beach in Newcastle (Nobby’s). The site is near the mouth to the Newcastle Port which is the World’s largest coal export port. The program will be broadcast this coming Saturday (see link) but there was a public audience (to heckle the Minister!) present. They filmed the forum and it will be available via podcast sometime later. But that is not the topic of today’s blog. It is about another Nobel Prize winner.

At present, Australia is embroiled in yet another outbreak of boat people hysteria such that 72 poor souls who took the extraordinary risk to travel across the Indian Ocean to improve their circumstances and perhaps escape political intolerance are cast as being threats to our national sovereignty. The current debate continues years of shameful hysteria which has seen our government imprison children indefinitely because their parents wanted something better. More people come in daily by air and remain illegally than will ever come by boat. Apart from my moral repugnance for the scaremongering, it appears to be hypocritical that the free market lobby always calls for the free flow of capital but rarely for the free flow of people while the left seem to adopt the opposite view. I was thinking about that today when I read that the British PM Gordon Brown has renewed his call for a Tobin Tax. How does that square with modern monetary theory (MMT)? Not very well.

Today, I have read a number of different reports from various organisations (IMF, Bank of England, US mortgage brokers, etc.) keeping up to date with what it going on. It all adds up to a bleak way to spend the day although that is the lot I bear (violins out!) as an economist. Imagine being a dentist though (apologies Martin!). Then you would be really working in confined spaces. My confined spaces are the claustrophobic world of mainstream economics. The economic crisis has really demonstrated how stupid (and evil) this body of theory (and policy) is. Anyway, today’s blog reports on what I have been reading and writing about today – all from a modern monetary theory (MMT) perspective – which is the free-range and sunny world that all economists should migrate too!

Today I have been working on a new book and have been deeply emeshed in paradigmic debates. The practical relevance, other than the work gives me another day’s pay to maintain my part in keeping aggregate demand growth moving, is that two Nobel prize winners (Phelps and Krugman) have had a recent paradigmic dispute about similar themes. One attack was implicit (Phelps on Keynesians), the other very direct and personal (Krugman on Phelps). Neither understand modern monetary theory (MMT) although Krugman is closer than Phelps. Phelps’s work, in my view, has been used by neo-liberals for years to undermine the employment prospects of millions of workers. It is also a primary IMF tool for keep less developing countries poor. Sounds like a topic to be discussed.

Today we consider the current debate about whether we need to return to fixed exchange rates and create a new reserve currency for the World – which might even be a supra-national currency. In general terms the calls for these sort of reforms reflect a misunderstanding of how a modern currency operates and also the opportunities the fiat monetary system presents to a national government which desires to advance public purpose (full employment and price stability). The claims for this type of currency reform also reflect serious misunderstandings about trade and the financial flows which accompany trade. More worrying is that the fixed exchange rate call is becoming a cause celebre for progressive economists who see flexible exchange rates as somehow a cornerstone of a neo-liberal free market plot against prosperity. Talk about being misguided. So this blog introduces these issues – and will probably be the first of several on the topic.

I was going to write about manufacturing today in the light the Campaign for America’s Future staging of Building the New Economy conference in Washington DC today. I started investigating what it was about. It raises a lot of issues what a progressive position should constitute. However, I got way laid by other things which were also interesting and will leave my blog about the demise of manufacturing for another day. But what this conference demonstrates to me is that we have a long way to go before we get a united progressive understanding of the way the modern monetary system works. And until we have that understanding, no real progress will be made reforming the economy. We will always be trading off tax cuts for spending increases and all that sort of mainstream mumbleconomics and feeling defensive any time a deficit arises. And then today, I started reading the latest report from the IMF …

Australia is already heading the charge back into the neo-liberal macroeconomic policy orthodoxy, which caused the financial crisis that has seen millions of jobs shed and poverty rates sky-rocket around the world. Next Tuesday, the central bank will surely increase its target rate of interest again because it is worried about the inflation genie escaping again. When actually did we last have an inflation problem anyway? The problem with this strategy is two-fold. First, it is highly unlikely that monetary policy does effectively operate as a counter-stabilising force. It has distributional effects clearly which punish low income earners but they not the cohort driving the housing prices, for example. Second, it forces fiscal policy to play a passive role so there will be even greater pressure on the government to start winding back the fiscal stimulus. More pain ahead on both fronts.