\t\t\t\tWhat 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.
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\nThe household-government analogy is for example expressed in Barro’s 1993 textbook (p.367) as:<\/p>\n
\nWe can think of the government’s saving and dissaving just as we thought of households’ saving and dissaving.\n<\/p><\/blockquote>\n
This analogy is used as a prima facie<\/em> 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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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!<\/a> – to see why this argument is inapplicable.<\/p>\n
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.<\/p>\n
Please read my blog – A modern monetary theory lullaby<\/a> – for more discussion on why this analogy is nonsensical when applied to a sovereign government.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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. <\/p>\n
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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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).<\/p>\n
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.<\/p>\n
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.<\/p>\n
Anyway, yesterday (February 22, 2010) I read a Bloomberg article – Stimulus Tab of $41,800 Waits for Wall Streeters<\/a> – written by one Kevin Hassett who is also the “director of economic-policy studies” at the right-wing American Enterprise Institute.<\/p>\n
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.<\/p>\n
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.<\/p>\n
To condition the reader, Hassett opened with:<\/p>\n
\nWhile 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.\n<\/p><\/blockquote>\n
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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
So the Obama response has been modest by any “Keynesian” standards.<\/p>\n
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.<\/p>\n
Hassett said:<\/p>\n
\nThe 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.\n<\/p><\/blockquote>\n
Where do you go with that “truth”.<\/p>\n
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<\/em>.<\/p>\n
Now a budget deficit – and I presume this is what he calls the “economic stimulus” is a flow<\/strong> – 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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
In trying to push this analogy, it is clear that Hassett hasn’t got a clue.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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<\/strong> 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.<\/p>\n
But that isn’t remotely what Hassett is acknowledging.<\/p>\n
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.<\/p>\n
So we are definitely better off (overall) because governments did use fiscal policy to stem the collapse of private spending.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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<\/a> – for more discussion on this point.<\/p>\n
So they were cautiously pushed into using fiscal policy.<\/p>\n
Third, the problem then was that the capacity to implement fiscal policy has been damaged by the years of neo-liberal neglect.<\/p>\n
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.<\/p>\n
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.<\/p>\n
They had planning processes and project design capacities which would support meaningful fiscal interventions.<\/p>\n
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.<\/p>\n
In this respect, I have some agreement with Hassett but not because of his flawed analogy.<\/p>\n
He said:<\/p>\n
\nAccording 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.<\/p>\n
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.<\/p>\n
So much for the supposed Keynesian multiplier effect. From now on, it should be called the Keynesian divisor.\n<\/p><\/blockquote>\n
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 …<\/a><\/p>\n
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<\/a> 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.<\/p>\n
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<\/a> 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. <\/p>\n
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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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!<\/p>\n
In relation to who is going to pay the bill, Hassett says:<\/p>\n
\nUltimately, 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.<\/p>\n
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.\n<\/p><\/blockquote>\n
Where do you start with that? No-where really.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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 <\/a> – for more discussion on this point.<\/p>\n
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.<\/p>\n
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.<\/p>\n
Hassett then says that that new policy discussions in the US are being:<\/p>\n
\n… based on the observation that it is cheaper to create jobs directly.\n<\/p><\/blockquote>\n
I fully agree with this and it should have been the centrepiece of all the stimulus packages. However, the Job Guarantee<\/a> 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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
At least Hassett can see the advantage of getting people into employment via public-sector job creation programs:<\/p>\n
\nGiven 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.\n<\/p><\/blockquote>\n
I totally agree.<\/p>\n
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<\/a>.<\/p>\n
The common feature of these two articles is that they were written by Bloomberg News columnists. Anything going on there?<\/p>\n
So one Matthew Lynn wrote:<\/p>\n
\nThe UK has produced notable economists over the years, but John Maynard Keynes, the guru of government intervention, was one of truly global significance.<\/p>\n
So it may be fitting that the UK will also become the deathbed of Keynesian economics.<\/p>\n
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.<\/p>\n
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.\n<\/p><\/blockquote>\n
So the UK economy is near to communism! <\/p>\n
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.<\/p>\n
The problem is in the policy design not the concept of fiscal intervention.<\/p>\n