{"id":18155,"date":"2012-02-10T17:14:13","date_gmt":"2012-02-10T06:14:13","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=18155"},"modified":"2012-02-10T17:14:13","modified_gmt":"2012-02-10T06:14:13","slug":"stimulus-stimulus-stimulus-a-fact-is-not-an-exaggeration","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=18155","title":{"rendered":"Stimulus, stimulus, stimulus – a fact is not an exaggeration"},"content":{"rendered":"

\t\t\t\tI’ve been travelling for most of today (now back in Newcastle) which has cut the time available to write anything. So this will be a relatively short blog and focuses on the way in which my profession is always trying to reconstruct economic issues when they find some policy proposition uncomfortable. The vehicle to demonstrate this phenomenon is an article published by Bloomberg (February 10, 2012) – Sachs Says Krugman Is ‘Crude Keynesian’<\/a>. It summarised the radio interview<\/a> (mp3 link – running for nearly 15 minutes) with Columbia University’s Jeffrey Sachs. The latter is well-known for providing advice to the old Soviet economies, which led to the massive transfer of public wealth to the private oligarchs via privatisation. Under Sachs’ guidance, the so-called “shock therapy”, hastily imposed deregulation, privatisation and the abandonment of price controls (on rent etc) on the previously planned economies – with disastrous consequences. In the Bloomberg interview, Sachs is highly critical of “macro” interpretations of the current problems – claiming that the major challenges are all micro in origin.
\n
\nAs a prelude, the standout disaster that Sachs was involved in as he sought to impose shock therapy on the world was Poland. In that country, the Sachs-inspired reforms were imposed from early 1990. Once government price controls were abandoned and state enterprises were privatised not only did inflation rise quickly, but unemployment soared and individuals and households lost the savings that they had worked hard the years to build up.<\/p>\n

Sachs claimed at the time that his approach was providing a long-run solution. The problem is that the long-run is just a sequence of short-runs and shock therapy meant that a vast number of older members of the population, who had worked all their lives to achieve a modest, but secure, standard of living now faced poverty in the midst of lost pension schemes, market-based rents and rising unemployment.<\/p>\n

This sort of policy shock was applied in many countries once the Soviet system fell with similar, disastrous, results.<\/p>\n

The Bloomberg Interview started by noting that the “apartness of the Chicago School and the east coast school – the economics of Princeton and Harvard and these generalities we talk about” and then asked Sachs “How far apart are the economists of Chicago from another given academic school?”. He replied:<\/p>\n

\nI think everybody right now in that public brawl is exaggerating. Krugman has staked out a rather crude Keynesian position and unrelentingly so. He knows one thing, which is stimulus, stimulus, stimulus and expand deficit spending and all the rest. It’s a pretty oversimplified view of the economy.<\/p>\n

On the other hand I think the Chicago School did not acquit itself very well in recent years.\n<\/p><\/blockquote>\n

Regular readers will know that I often disagree with propositions put by Paul Krugman in his NYT column. Overall, I consider him to be a deficit-dove who considers fiscal stimulus to the “safe” at present because he thinks there is a liquidity trap operating.<\/p>\n

That is, he doesn’t believe that in the short-run fiscal stimulus will drive up interest rates and “crowd out” private investment spending.<\/p>\n

This is a very conventional mainstream “Keynesian” position, which proponents of Modern Monetary Theory (MMT) reject outright.<\/p>\n

The deficit-dove position reduces to an advocacy of balanced fiscal budgets averaged over the business cycle. <\/p>\n

A deep understanding of national accounting tells us that if a government was successful in achieving this fiscal goal, then the private domestic sector balance (the difference between its spending and income) would be equal, on average over the business cycle, to the external balance (the difference between income flows in and out of of the nation).<\/p>\n

The import of this is that if a nation was running a continuous external deficit, then the private domestic sector will also, on average, be in deficit. Which means it would be continuously accumulating debt – an unsustainable dynamic.<\/p>\n

So while Paul Krugman is at present advocating increased fiscal stimulus to promote economic growth in the US and elsewhere, his position remains highly conditional and flawed.<\/p>\n

But in saying that I agree with Paul Krugman that at present the only way out of the crisis in any reasonable time-frame is for the government sector to increase net spending (that is, increase deficits).<\/p>\n

While that view could easily be dismissed as being “oversimplified” its comprehension is based on a sound understanding of the nature of the current crisis and the options available to government to address it.<\/p>\n

There is nothing “oversimplified” about this policy advice.<\/p>\n

At present the global economy is trapped in a “balance sheet recession”, which has special characteristics and leads to the conclusion that the economy requires long-term public deficit support to achieve sustainable recovery. Please read my blog – Balance sheet recessions and democracy<\/a> – for more discussion.<\/p>\n

We are now in a sustained period of private sector deleveraging, which means that private spending growth has returned to more subdued levels relative to those seen during the credit binge.<\/p>\n

That process will extend for at least a decade. Without public deficits supporting aggregate demand growth the economy will languish in stagnation.<\/p>\n

To advocate fiscal stimulus in the current context does not negate a nuanced approach to other pressing matters including migrating supply chains and stagnating industry structures.<\/p>\n

It is also important to understand that many so-called “structural” problems are, in fact, disguised cyclical events. I will come back to that in a moment.<\/p>\n

In relation to Sachs’ quip about the Chicago School not acquitting itself very well in recent years, Bloomberg interjected by saying “With the idea that markets could clear themselves, the markets could discipline?”.<\/p>\n

Sachs replied:<\/p>\n

\nYes we have seen how markets were core destabilising features of the whole global economy. And I don’t think the Chicago School was on top of that beforehand and did us much of a favour.<\/p>\n

But this brawl is really a brawl of extreme positions. It’s not very illuminating, but it is rather entertaining.\n<\/p><\/blockquote>\n

The Chicago School position is certainly extreme. Many of its advocates deny that the crisis negates the view that markets are efficient. As I noted in yesterday’s blog – Yesterday austerity, today growth – but leopards don’t change their spots<\/a> – some of the main advocates claim the crisis was all government-driven.<\/p>\n

There is nothing extreme about the underlying position supporting ongoing and increasing fiscal stimulus.<\/p>\n

It is in fact based upon the most simple, introductory theoretical notion one should learn in macroeconomics.<\/p>\n

To repeat: spending equals income equals output – which drives the demand for labour.<\/p>\n

It is not an extreme position. If the economy fails to record aggregate demand sufficient to generate output commensurate with “full employment” labour demand (that is, the level of employment that provides jobs for those willing to work at the current wage rates), then unemployment occurs.<\/p>\n

Such a shortfall in spending can occur as a result of decisions in the private domestic sector and\/or the external sector. It is the responsibility of government to ensure that its spending will offset any decline in spending of the other two sectors, expressed at their “full employment” levels.<\/p>\n

In this context of decentralised spending decisions all aggregating to determine aggregate demand, it becomes a primary responsibility of government to generate full employment.<\/p>\n

It is an extreme position to argue that unregulated markets will ensure there is enough spending in the private sector to continuously achieve full employment.<\/p>\n

That battle was won by those who support fiscal stimulus as long ago as the Great Depression when the fiscal austerity-approach only made the situation worse.<\/p>\n

So I strongly disagree with Sachs constructing Paul Krugman’s position in this regard as being extreme, and at the other end of the continuum to the free-market view expressed by the Chicago School.<\/p>\n

The Bloomberg interviewer interjected – “Well from John Cochrane … from the .. University of Chicago .. that spending can spur the economy is not part of what anybody has taught graduate students since the 1960s.<\/p>\n

Sachs replied:<\/p>\n

\nThat is also is an exaggeration. Everybody is exaggerating here. But I have been surprised – Paul has a powerful bully pulpit in his New York Times column, and he’s been on one theme for three years and I think he has exaggerated it frankly. He has under-emphasized the risks of growing debt, he’s over-asserted what we really know about the effects of these policies and he has in my view underestimated the long-term needs for public-sector change and reform. On the other hand he is battling ideologues on the other side who have been equally extreme.\n<\/p><\/blockquote>\n

I should note that Sachs has not been shy in self promotion over the years. I considered some of this interview to be reflecting some underlying professional jealousy on the part of Sachs. I can’t prove that but it resonated in that way.<\/p>\n

It is true though that Paul Krugman enjoys a very privileged position as a major contributor to the New York Times, although my profession occupies powerful bully pulpit’s when they impose mainstream macroeconomic theory on their students by way of lectures.<\/p>\n

I would conjecture that the damage done to the world from undergraduate economics programs is far greater than any influence Paul Krugman has as a result of his New York Times column.<\/p>\n

As noted above, I don’t find the reiteration of a basic macroeconomic theory proposition to be an exaggeration.<\/p>\n

It was very interesting in this interview that Sachs chose not to provide any further articulation of his view that in expressing the need for further fiscal stimulus the proponents are under emphasising the risks of growing debt.<\/p>\n

What risks? Sachs doesn’t elaborate but rather leaves the listeners in a state of limbo – presumably because Sachs wants them to then rehearse the basic faux propositions of mainstream macroeconomics.<\/p>\n

These are that rising public debt increases interest rates and ask crowds out private spending. The rising public debt pushes a government closer to insolvency. Rising public debt requires higher future tax rates in order for the government to pay it back.<\/p>\n

Each one of these propositions is inapplicable to a fiat monetary system.<\/p>\n

The historical record does not validate the mainstream predictions concerning a rising public debt, either in absolute terms or, scaled by GDP.<\/p>\n

One can find correlations between rising public debt issuance and bond yields but even that outcome is not unambiguous.<\/p>\n

It will typically signal an improving economy where investors broaden their risk and start purchasing other financial assets. The reduction in demand for the risk-free public asset then drives up yields, under normal circumstances pertaining to the conduct of public debt auctions.<\/p>\n

The central bank can at any time control bond yields should desire to.<\/p>\n

Second, the crowding out story is predicated on a flawed view of the way the banking sector works and how deficits impact on financial markets. I dealt with this in several blogs, but the deficits suite linked below, is a good place to start.<\/p>\n

For a start, governments merely borrow back what they already spent. And then, if you appreciate that bank loans create deposits, and that bank loans are limited by how many credit-worthy customers demand credit (notwithstanding capital constraints), then you will see how stupid the notion that government borrowing reduces the availability of loans to the private sector is.<\/p>\n

Please read this suite of blogs – Deficit spending 101 – Part 1<\/a> – Deficit spending 101 – Part 2<\/a> – Deficit spending 101 – Part 3<\/a>.<\/p>\n

Then please read the following blogs – Building bank reserves will not expand credit<\/a> and Building bank reserves is not inflationary<\/a> – for further discussion.<\/p>\n

Sachs then went on to outline what he thought the main issue facing America (and implicitly the World) was. He said that we don’t “time for nostalgia we have a very changing world economy and a very fast changing American demography and political and social reality … trying find again some inclusive society so we are not leaving half of our country behind.”<\/p>\n

I agree with that viewpoint. But as I noted in this blog – Davos – an exercise in denial not solutions<\/a> – the dramatic shifts in supply chains etc have not undermined the fiscal primacy of a currency-issuing nation state.<\/p>\n

Modern Monetary Theory (MMT) provides us with a way of understanding that currency-issuing monopoly embedded in the national state is still powerful and can be used to advance domestic prosperity independent of the way in which global changes manifest.<\/p>\n

That is not to say that these major changes in supply chains and changes in the pattern of energy demand etc are not major events which are forcing national economies to adapt. That clearly is the case and I have written about it at length.<\/p>\n

But even with the pressure of these changes, the national state remains relevant.<\/p>\n

The reason why mass unemployment occurs hasn’t changed as a result of globalisation. It still remains that if aggregate spending is not sufficient to purchase the total supply of goods and services, there will be an unplanned increase in inventories leading to a rise in unemployment and\/or underemployment.<\/p>\n

To avoid this situation, net government spending (the budget deficit) must fill the spending gap. So mass unemployment always reflects a choice made by government to provide lower net government spending and accept higher unemployment.<\/p>\n

When involuntary unemployment exists, nominal (or real) wage cuts cannot “clear” the labour market unless they somehow eliminate the desire of the private sector to net save, and thereby increase its overall spending in the economy. That is, of-course, unlikely in the extreme. The opposite is highly probably.<\/p>\n

The Bloomberg interviewer then asked Sachs “How do you fold economics into that analysis?” The response was standard mainstream thinking:<\/p>\n

\nI don’t view the macro perspective as adequate. I view as a core problem that we face that our kids are not geting the education, the skills that they need to compete in the 21 century and that’s why I call for an active role of government at all levels.<\/p>\n

I don’t think that simply pulling back as we;re doing, as one agreement after another in Washington actually is leading to – is going to solve the problems of a hugely unqueal society. But even more than the inequality, is the fact that we’re only putting 1\/3 of our kids through college right now …<\/p>\n

If you look at 25-29 year olds right now its about 33 per cent of 25-29 year old young men who have a bachelors degree. And we aren’t just going to have a middle-class society that we want if that is the case.<\/p>\n

When you track that out you see for minorities, for example, hispanic young men aged 25-29 – its 11 per cent with a bachelors degree. That kind of social inequality, but equally important, lack of education and training needed for competitive middle class jobs is really the core problem that America faces.<\/p>\n

And that’s not going to be solved by stimulus, by QE or whatever those are not macro problems, those are much deeper social and microeconomic problems\n<\/p><\/blockquote>\n

This response is very much in the OECD 1994 Jobs Study mould. It locates the deskilling in modern economies at the level of the individual and denies )or downplays) the existence of systemic failure.<\/p>\n

If you start with the proposition that mass unemployment represents a systemic failure of the economy to generate enough jobs and the labour market then shuffles the queue of unemployed according to “personal” characteristics (such as, education levels, ethnicity, age, gender, etc) then it is likely that the problem of underinvestment in education will be viewed in both macro and micro terms.<\/p>\n

When there are not enough jobs available – and this shortage is chronic and spanning generations – then there is little incentive for disadvantaged workers to invest in their own skill development.<\/p>\n

Further, a systemic lack of employment is driven by inadequate government spending, which often manifests in a failure to invest in first-class education, public housing, public transport and other types of public infrastructure which enhance social mobility.<\/p>\n

While the existence of urban ghettos, full of idle teenagers with vastly adequate levels of formal education, is clearly a micro problem (it affects the local level and individuals), it is crucial to also understand this type of socio-economic problem in macro terms.<\/p>\n

I agree that quantitative easing is not the solution to deficient aggregate spending.<\/p>\n

But if the degree of fiscal stimulus was better calibrated to the current output gaps in all of the mobility benefits of higher employment, lower unemployment, and higher participation rates would significantly reduce the burden that these disadvantaged communities bear.<\/p>\n

Structural adjustments, such as targeted increases in educational and training investment, and made easier when the labour market is strong. Little structural adjustment can occur, without massive economic and individual damages being incurred. When the economy is weak.<\/p>\n

To say, dismissively, that this is “not a macro problem” is to miss the point completely.<\/p>\n

Conclusion<\/strong><\/p>\n

A fiscal stimulus Is not a panacea for all economic ills. Even at full employment they might be significant challenges, including poor productivity growth, stagnant real wages growth, spatial disparities in economic outcomes, etc.<\/p>\n

But an economy labouring with high unemployment and high underemployment will not be able to address these other issues effectively.<\/p>\n

The role of fiscal stimulus is to ensure that spending overall is adequate in proportion to the real capacity to economy to produce goods and services.
\nThere is a primary macroeconomic responsibility of government. What needs to be done after that becomes more easily identified once the burden of mass unemployment is eliminated.<\/p>\n

The mainstream denial of the effectiveness of macro stimulus relates more to their ideological dislike for government intervention at the aggregate level then any sound notion that such intervention is damaging.<\/p>\n

In this regard, I congratulate Paul Krugman on maintaining his consistent voice in this regard. We should chant each day until our political leaders take heed – stimulus, stimulus, stimulus.<\/p>\n

Saturday Quiz<\/strong><\/p>\n

The Saturday Quiz will be back sometime tomorrow – probably easier than last week – in order to stop people posting despairing comments outlining their low scores (-:<\/p>\n

Next week will be very busy – more details later.<\/p>\n

That is enough for today!\t\t<\/p>\n","protected":false},"excerpt":{"rendered":"

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