{"id":6645,"date":"2009-12-15T16:31:59","date_gmt":"2009-12-15T06:31:59","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=6645"},"modified":"2009-12-15T16:31:59","modified_gmt":"2009-12-15T06:31:59","slug":"lost-in-a-macroeconomics-textbook-again","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=6645","title":{"rendered":"Lost in a macroeconomics textbook again"},"content":{"rendered":"

\t\t\t\tToday’s Australian newspaper, sadly our national daily carries a story – Stimulating our way into trouble<\/a> – by Griffith University professor (and ex-federal treasury official) Tony Makin. I pity the students who have to study with him. The article continues the News Limited campaign against the government stimulus package and demonstrates the extent that is prepared to use the services of so-called experts (that is, titled mainstream economists) who seem prepared to grossly mislead the readership to advance their ideological strategy. Whatever it takes seems to be the strategy. Anyway, once again the mainstream macroeconomics textbook is called upon to make policy statements.
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\nTony Makin is already in the running for the billy blog worst Op-Ed column of 2009 award which I will announce at the end of the year. I think this article reinforces his hold on that award. Possibly the worst article of all time.<\/p>\n

For a professional economist such as myself the Makin article is very funny – because it is so bad – sort of like those old movies – such as Santa Claus conquers the Martians<\/a>, which is a particular favourite. But the message it provides is potent to those who are wavering on the issue and do not understand the technical framework that Makin is using as an authority for his parlous argument.<\/p>\n

In short, this sort of spurious reasoning sounds reasonable, is highly dangerous but also spurious to the core.<\/p>\n

Makin begins by noting that:<\/p>\n

\nSINCE late last year numerous contributors to this page, me included, have argued that the Keynesian spend and borrow response to the economic downturn embraced by the federal and state governments has been seriously flawed in theory and practice.\n<\/p><\/blockquote>\n

Yes a veritable cacophony of shrill conservatives who haunt the pages of The Australia and who are wheeled out on a daily basis to scare the readership who, unfortunately, do not know better. This is not a newspaper that tolerates broad perspective.<\/p>\n

Anyway, Makin decides to approach this from a theoretical basis saying that:<\/p>\n

\nThe 23 per cent increase in the current account deficit in the September quarter arising from a fall in exports and rise in imports provides direct evidence of this.<\/p>\n

To understand why, we need only invoke undergraduate textbook theory of how fiscal policy operates in an open economy with a floating exchange rate.<\/p>\n

This theory tells us that a growing budget deficit due to increased government spending of the kind we have seen puts upward pressure on domestic interest rates, all other things being equal.\n<\/p><\/blockquote>\n

First, lets be clear on what happened to the external accounts in the September quarter. It is true that the Current Account balance went from a deficit of -13,133 million AUD to -16,183 million in the September quarter a reduction of 23 per cent.<\/p>\n

Almost all of the change was driven by the balance on goods and services. The decline in net exports “This is expected to detract 1.8 percentage points from growth in the September quarter 2009 volume measure of GDP” (Source<\/a>).<\/p>\n

The ABS data tells us that “the net goods deficit rose $3,847m to $4,767m” and the “net services deficit rose $377m to $641m”. Exports fell by 6 per cent while imports rose by 2 per cent.<\/p>\n

In terms of the rising imports, capital goods rose by 6 per cent and accounted for more than 66 per cent of the rise in imports. A 3 per cent rise in intermediate and other merchandise goods accounted for a smaller proportion. Capital goods and intermediate gods reflect the growing investment that is now appearing in the Australian economy.<\/p>\n

The change in consumption imports accounted for only 5 per cent of the total rise in imports in the September quarter.<\/p>\n

So that looks like an economy that is dependent on imported capital equipment which is in the early stages of an investment boom. The declining exports reflect soft conditions in world markets which are of-course exogenous to Australia.<\/p>\n

Then consider Makin’s call to authority – the “undergraduate textbook theory of how fiscal policy operates in an open economy with a floating exchange rate”. The theory he is alluding to tells you very little about the way the real world actually operates.<\/p>\n

To see this it is best to first rehearse his argument that fiscal policy expansion drives up interest rates.<\/p>\n

Need I say it but using the same textbook theory a rise in private investment spending or net exports will have exactly<\/strong> the same impact on interest rates. That is, any spending growth would deliver the same outcome.<\/p>\n

Anyway, in attempting to establish his proposition, Makin says that interest rates rise:<\/p>\n

\n… because increased government spending increases the overall demand for money in the economy which, for a given supply of money as determined by the Reserve Bank of Australia, tends to raise domestic interest rates above foreign interest rates.\n<\/p><\/blockquote>\n

This is an extraordinary piece of cheek.<\/p>\n

The mainstream theory of money and monetary policy that Makin is appealing to asserts that the money supply (volume) is determined exogenously by the central bank. That is, they have the capacity to set this volume independent of the market. The monetarist portfolio approach claims that the money supply will reflect the central bank injection of high-powered (base) money and the preferences of private agents to hold that money. This is the so-called money multiplier.<\/p>\n

So the central bank is alleged to exploit this multiplier (based on private portfolio preferences for cash and the reserve ratio of banks) and manipulate its control over base money to control the money supply.<\/p>\n

To some extent these ideas were a residual of the commodity money systems where the central bank could clearly control the stock of gold, for example. But in a credit money system, this ability to control the stock of “money” is undermined by the demand for credit.<\/p>\n

The theory of endogenous money is central to the horizontal analysis in MMT. When we talk about endogenous money we are referring to the outcomes that are arrived at after market participants respond to their own market prospects and central bank policy settings and make decisions about the liquid assets they will hold (deposits) and new liquid assets they will seek (loans).<\/p>\n

While there have been many contributors to the literature on endogenous money, my favourite work is the evolving writing of Marc Lavoie<\/a>, who is at the University of Ottawa and who I have a lot of time for. The core articles are:<\/p>\n