{"id":45378,"date":"2020-07-11T16:00:37","date_gmt":"2020-07-11T06:00:37","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=45378"},"modified":"2020-07-11T16:00:37","modified_gmt":"2020-07-11T06:00:37","slug":"the-weekend-quiz-july-11-12-2020-answers-and-discussion","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=45378","title":{"rendered":"The Weekend Quiz – July 11-12, 2020 – answers and discussion"},"content":{"rendered":"

\t\t\t\tHere are the answers with discussion for this Weekend’s Quiz<\/strong>. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of Modern Monetary Theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.
\n<\/p>\n

Here are the answers with discussion for yesterday’s quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.
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\nQuestion 1:<\/strong><\/p>\n

\nLarger fiscal deficits as a percentage of GDP reduce the local productive resources that are available to the private sector.\n<\/p><\/blockquote>\n

The answer is True<\/strong>.<\/p>\n

It is clear that at any point in time, there are finite real resources available for production. New resources can be discovered, produced and the old stock spread better via education and productivity growth. The aim of production is to use these real resources to produce goods and services that people want either via private or public provision.<\/p>\n

So by definition any sectoral claim (via spending) on the real resources reduces the availability for other users. There is always an opportunity cost involved in real terms when one component of spending increases relative to another.<\/p>\n

Unless you subscribe to the extreme end of mainstream economics which espouses concepts such as 100 per cent crowding out via financial markets and\/or Ricardian equivalence consumption effects, you will conclude that rising net public spending as percentage of GDP will add to aggregate demand and as long as the economy can produce more real goods and services in response, this increase in public demand will be met with increased public access to real goods and services.<\/p>\n

You might also wonder whether it matters if the economy is already at full capacity. Under these conditions a rising public share of GDP must squeeze real usage by the non-government sector which might also drive inflation as the economy tries to siphon of the incompatible nominal demands on final real output.<\/p>\n

You might say that the deficits might rise as a percentage of GDP as a result of a decline in private spending triggering the automatic stabilisers which would suggest many idle resources. That is clearly possible but doesn’t alter the fact that the public claims on the total resources available have risen.<\/p>\n

Under these circumstances the opportunity costs involved are very low because of the excess capacity. The question really seeks to detect whether you have been able to distinguish between the financial crowding out myth that is found in all the mainstream macroeconomics textbooks and concepts of real crowding out.<\/p>\n

The normal presentation of the crowding out hypothesis which is a central plank in the mainstream economics attack on government fiscal intervention is more accurately called “financial crowding out”.<\/p>\n

At the heart of this conception is the theory of loanable funds, which is a aggregate construction of the way financial markets are meant to work in mainstream macroeconomic thinking. The original conception was designed to explain how aggregate demand could never fall short of aggregate supply because interest rate adjustments would always bring investment and saving into equality.<\/p>\n

At the heart of this erroneous hypothesis is a flawed viewed of financial markets. The so-called loanable funds market is constructed by the mainstream economists as serving to mediate saving and investment via interest rate variations.<\/p>\n

This is pre-Keynesian thinking and was a central part of the so-called classical model where perfectly flexible prices delivered self-adjusting, market-clearing aggregate markets at all times. If consumption fell, then saving would rise and this would not lead to an oversupply of goods because investment (capital goods production) would rise in proportion with saving. So while the composition of output might change (workers would be shifted between the consumption goods sector to the capital goods sector), a full employment equilibrium was always maintained as long as price flexibility was not impeded. The interest rate became the vehicle to mediate saving and investment to ensure that there was never any gluts.<\/p>\n

So saving (supply of funds) is conceived of as a positive function of the real interest rate because rising rates increase the opportunity cost of current consumption and thus encourage saving. Investment (demand for funds) declines with the interest rate because the costs of funds to invest in (houses, factories, equipment etc) rises.<\/p>\n

Changes in the interest rate thus create continuous equilibrium such that aggregate demand always equals aggregate supply and the composition of final demand (between consumption and investment) changes as interest rates adjust.<\/p>\n

According to this theory, if there is a rising fiscal deficit then there is increased demand is placed on the scarce savings (via the alleged need to borrow by the government) and this pushes interest rates to “clear” the loanable funds market. This chokes off investment spending.<\/p>\n

So allegedly, when the government borrows to “finance” its fiscal deficit, it crowds out private borrowers who are trying to finance investment. The mainstream economists conceive of this as the government reducing national saving (by running a fiscal deficit) and pushing up interest rates which damage private investment.<\/p>\n

The analysis relies on layers of myths which have permeated the public space to become almost self-evident truths. <\/p>\n

This trilogy of blog posts will help you understand this if you are new to my blog<\/p>\n

1. Deficit spending 101 – Part 1<\/a> (February 21, 2009).<\/p>\n

2. Deficit spending 101 – Part 2<\/a> (February 23, 2009)<\/p>\n

3. Deficit spending 101 – Part 3<\/a> (March 2, 2009).<\/p>\n

The basic flaws in the mainstream story are that governments just borrow back the net financial assets that they create when they spend. Its a wash! It is true that the private sector might wish to spread these financial assets across different portfolios. But then the implication is that the private spending component of total demand will rise and there will be a reduced need for net public spending.<\/p>\n

Further, they assume that savings are finite and the government spending is financially constrained which means it has to seek “funding” in order to progress their fiscal plans. But government spending by stimulating income also stimulates saving.<\/p>\n

The flawed notion of financial crowding out has to be distinguished from other forms of crowding out which are possible. In particular, MMT recognises the need to avoid or manage real crowding out which arises from there being insufficient real resources being available to satisfy all the nominal demands for such resources at any point in time.<\/p>\n

In these situation, the competing demands will drive inflation pressures and ultimately demand contraction is required to resolve the conflict and to bring the nominal demand growth into line with the growth in real output capacity.<\/p>\n

The idea of real crowding out also invokes and emphasis on political issues. If there is full capacity utilisation and the government wants to increase its share of full employment output then it has to crowd the private sector out in real terms to accomplish that. It can achieve this aim via tax policy (as an example). But ultimately this trade-off would be a political choice – rather than financial.<\/p>\n

The following blog posts may be of further interest to you:<\/p>\n