Monday, October 11, 2010

Krugman Agonistes: We Are In the "Dark Ages" of Economics

While Paul Krugman has a column today alleging that the Obama administration really has not significantly ramped up domestic spending (which is why he says the economy is mired in the doldrums), I want to go back to something he wrote in January 2009, in which he lays out some opposing lines of economic thought (and stays out of partisan politics, for a change).

Furthermore, I find myself agreeing with Krugman that we are in a "Dark Ages" of economic thinking, but for very different reasons. Krugman is alleging that too many economists are accepting Say's Law as being legitimate, when every good Keynesian knows that J.M. Keynes "discredited" Say's Law in the mid-1930s. I disagree wholeheartedly on many fronts.

The difficulties are legion. First, like Keynes, Krugman really gets Say's Law wrong, creating a caricature of what Say wrote in 1803 and then demolishing the straw man he has created. (One has to keep in mind that Say's Law really is a huge obstacle to Krugmanomics, and, like Keynes, Krugman instinctively understands that point.

Second, the argument really goes to the heart of what constitutes what we call an economy. On one side, we see people like J.B. Say and the Austrians write that an economy consists of real things, real assets, and real relationships between goods. On the other side, we see people like Krugman and Alan Blinder and Ben Bernanke insist that governments can create wealth simply by creating money or borrowing and spending. In their view, an economy is little more than a mechanistic entity in which people robotically create goods with the requirement being that they have enough "purchasing power" so consumers can clear the shelves via spending so that the process can repeat itself.

I would urge people to read Krugman's entire blog post to see the perspective from which he is coming. I will include this quote, which I believe is instructive. Calling the perspectives from Eugene Fama and John Cochrane "pure Say's Law," Krugman writes:
There’s no ambiguity in either case: both Fama and Cochrane are asserting that desired savings are automatically converted into investment spending, and that any government borrowing must come at the expense of investment — period.

What’s so mind-boggling about this is that it commits one of the most basic fallacies in economics — interpreting an accounting identity as a behavioral relationship. Yes, savings have to equal investment, but that’s not something that mystically takes place, it’s because any discrepancy between desired savings and desired investment causes something to happen that brings the two in line.
First, and most important, what we call Say's Law is not about accounting identities or even the infamous S=I. Instead, it is about the fact that consumption and production are intricately related, not by a circular patterns, but rather by the simple fact that one's ability to consume MUST arise from the ability of someone to be able to produce something.

I deal with all of this in a paper I published last year on Say's Law in which I take a telling quote from Benjamin Anderson:
The prevailing view among economists, . . . has long been that purchasing power grows out of production. The great producing countries are the great consuming countries. The twentieth-century world consumes vastly more than the eighteenth-century world because it produces vastly more. . . . Supply and demand in the aggregate are thus not merely equal, but they are identical, since every commodity may be looked upon either as supply of its own kind or as demand for other things. But this doctrine is subject to the great qualification that the proportions must be right; that there must be equilibrium.
This view contrasts with the Keynesian/Marxist views that the real problem with a recessionary economy is that there is the problem of overproduction/underconsumption which can be "solved" by the injection of "purchasing power" into the hands of individuals via government intervention. Call it "pump priming," "giving the economy traction," or "enabling workers to buy back the products they created," but nonetheless all three viewpoints operate on the notion that production and consumption are two unequal and unrelated activities, and that the purpose of consumption (or "spending") is to clear the shelves of the goods that workers made so that the workers can be employed making more of them.

Now, the Keynesian argument -- which Krugman repeats -- is that in the real world, savings are greater than investment, especially when the "animal spirits" of investors are quieted. When that is the case, and investment spending is down, it is up to government to fill in the hole by ratcheting up spending. Now, I don't believe I have mischaracterized Krugman's position here, but, nonetheless, I strongly disagree with it.

First, even if I were to give Krugman his point that S>I, nonetheless (and I have not seen this discussed anywhere) the nature of fractional reserve banking would take the existing savings/deposits and loan them out to where the actual new money created would be substantially greater than the savings base. It is true that banks rarely are going to be fully "loaned up," but Krugman ignores the money multiplier that occurs in lending, something that any student who has taken Money and Banking or even a Macro class would understand.

Second, there is something even more fundamental here, and that is the fact that the Krugman position almost seems to be that the Law of Scarcity is abolished when interest rates approach the "zero bound" (in his words). This also is where Krugman and the Austrians really part company, for in Austrian Economics, the Law of Scarcity is not abandoned at the "zero bound" or the presence of unemployed resources.

Instead, Austrians look to reasons as to why the resources are unemployed, as opposed to the Keynesian argument that people and government simply are not spending enough. Instead, we wish to look beyond to why there no longer is demand for certain things, and to the larger issue of how the proportions involving the factors of production have been disturbed or distorted.

As I have said many times, the Keynesian argument depends upon seeing factors of production as being homogeneous and having no particular special relationships. Everything from mine output to making of cotton candy is just one amorphous and homogeneous set of factors. This is not economic theory; it is a theory of convenience to justify the presence of government spending.

56 comments:

Lord Keynes said...

Enjoyable post, you are an articulate and intelligent defender of the Austrian view whom Keynesians should read and take seriously.

You say:

First, and most important, what we call Say's Law is not about accounting identities or even the infamous S=I. Instead, it is about the fact that consumption and production are intricately related, not by a circular patterns, but rather by the simple fact that one's ability to consume MUST arise from the ability of someone to be able to produce something.

That consumption must have prior production (at home or overseas) is true but I am surprised Austrians make so much out of it. What doesn’t follow is that supply (total factor payments from production) will equal consumption or investment. Failures in aggregate demand do happen. Also, if you go back and look at what J. B. Say actually wrote it’s very easy to refute:

The Myth of Say’s law, http://socialdemocracy21stcentury.blogspot.com/2010/10/myth-of-says-law.html

You will also find a refutation of Say’s law there in the “correct” form formulated by Thomas Sowell (1994), who certainly did a lot of work to see what the Classicals really thought about it.

First, even if I were to give Krugman his point that S>I, nonetheless (and I have not seen this discussed anywhere) the nature of fractional reserve banking would take the existing savings/deposits and loan them out to where the actual new money created would be substantially greater than the savings base.

You ignore the role of subjective expectations in investment. Come on, I thought you Austrians were all over subjectivism! This is the one area where Post Keynesians
can agree with you. If banks and businesses’ expectations became pessimistic, then fractional reserve banking is utterly irrelevant: (1) bank’s willingness to grant loans and (2) demand for loans from business have both collapsed.

Instead, Austrians look to reasons as to why the resources are unemployed …. and to the larger issue of how the proportions involving the factors of production have been disturbed or distorted.

So, basically, anyone who agrees that the arguments against Austrian business cycle theory (ABCT) are compelling has no reason to accept such analysis?

I note that it appears a number of modern academic Austrians have also abandoned ABCT:

http://axiomaticeconomics.com/wreckage_ABCT.php

Anonymous said...

Not sure if serious....

"http://axiomaticeconomics.com/wreckage_ABCT.php"

Bad formatting, bad fonts, bad poetry and tons of people declared as being wrong?

Yup. Looks pretty much the typical crank site.

Bob Roddis said...

Victor Aguilar is no fan of Keynes:

Of Mises, Hayek, Keynes and Kirzner, only Mises is close to this author’s position that the severity and recalcitrance of recessions is explained by the wastage of capital. Hayek describes a rather mechanical shuffling of wealth back and forth between the higher and lower stages of production. Keynes conjures up animal spirits to explain something that he clearly does not understand. And Kirzner is just expressing the blind faith in the market and denials of depression that make the so-called classicals such an easy straw man for Econ. 101 students to slay. But Mises was adamant that his theory was about malinvestment, not overinvestment, and made the quality of loans central to his thesis. The principle difference between Mises and Hayek is that Mises focuses almost entirely on malinvestment and capital consumption (i.e. waste) during the boom period. There is nothing in Hayek’s triangle about the quality of investments, only about the relative quantity allocated to the several different stages. Hayek and his followers focus on the lengthening and shortening of the period of production and on talking around the fact that they do not know how to measure it.22

22 Mises makes only one passing mention of the period of production (1966, p. 556).

Gavin said...

I think the anon above was talking about axiomaticeconomics.com being a crank site. And it is. I don't know why anyone would use it as a reference.

William L. Anderson said...

I think you are right. Sorry about that!! I'll delete the post.

Lord Keynes said...

Can you explain who Victor Aguilar is, just out of curiosity?

AP Lerner said...

Kudos to Prof. Anderson for listing a multitude of neo-liberal myths all in one post

It wasn’t just Keynse that saw Says Law for what it was (gibberish). Robert Clower did as well. What Austrians do not understand is wages are not just a cost – they are always income as well. I’m curious, if Says Law still held, then why are there currently 15M unemployed people chasing 3M jobs right now?

http://calculatedriskimages.blogspot.com/2010/10/job-openings-and-labor-turnover-survey.html

And are you really trying to tell us that crowding is occurring now? Bond yields are closing in on 2% despite all the massive printing and spending you claim is occurring. Where’s the crowding out taking place? Please explain why bond rates keep falling.

And the money multiplier is a myth and by repeating this myth shows you have a fundamental misunderstanding of the monetary system.

http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

Gavin said...

@ Lord Keynes:

Does Victor Aguilar seriously think entrepreneurs didn't make additional investments in higher order production during the boom? Not in construction companies, real estate companies, manufacturing for construction?


All the credit just went to people who couldn't afford houses, no malinvestments in industries related to housing to see here, seems to be what he's saying.

Lord Keynes said...

Gavin,
I do not know the minutiae of his view of the business cycle. I noted merely that "he claims" some Austrians have abandoned ABCT. Maybe you are in a position to correct his claim. Whatever he believes does not affect my argument against Say's law.

Rick said...

AP Lerner:

"And are you really trying to tell us that crowding is occurring now? Bond yields are closing in on 2% despite all the massive printing and spending you claim is occurring. Where’s the crowding out taking place? Please explain why bond rates keep falling."

Perhaps Prof. Anderson has a different answer, but how about the fact that the Fed buys bonds even faster than the US Government issues them? That pushes interest rates down, doesn't it?

Now your turn: If a government can manufacture "money" out of thin air and use it just as if it were output genuinely saved by someone, why is the price of real money, i.e., gold, constantly rising versus the phony stuff?

William L. Anderson said...

Furthermore, Say's Law never says that there is "no impediment to full employment," as Keynes claimed.

AP, are you telling me that production is not important? And that an economy is just a circular mechanism in which the purpose of consumption is to clear goods off the shelves so people can have jobs making more goods to put on the shelves?

In my QJAE article, I point out how Say's Law can hold AND there be a lot of unemployment.

However, since you actually believe that printing money is the source of wealth, I guess that production doesn't matter. If government prints money, then goods magically appear!

Lord Keynes said...

In Say's law in its sophisticated form as developed by the Classical economists(not just by Say), there could not be a downturn caused by an overall deficiency in aggregate demand: slumps were caused by sectoral imbalances/sectoral disequilibrium or by external shocks. There is excess supply in individual commodity markets, but aggregate supply could never exceed aggregate demand.

That is false. Keynes argued that even if all prices and wages were perfectly flexible, there would still be failures in aggregate demand. Any economy where money is used with (1) a medium of exchange role AND (2) a store of value function, under conditions of uncertainty and subjective expectations in real time can have significant idle money balances. The presence of the speculative demand for money for use on financial asset markets also makes things worse. Financial assets are not gross substitutes for commodities.

An Entrepreneur said...

I have been shocked to discover that some economists are so out of touch with the real world they can try to claim that "crowding out" of private investment doesn't exist.

Lets say I am an investor who today might buy a US government bond due to its perceived safety. If the government weren't selling any, then what do they think I would do, stuff the money in a mattress???
No, I would do something else with it, either spend it or most likely invest it in some other fashion. How can this be difficult for economists to understand?

I would presumably be forced into taking more perceived risk and perhaps buy a corporate bond (which might not be marketed in the current environment but would be if all the buyers of government bonds were forced to turn to another investment..). If there are limited options in the bond
market (or too much demand makes them too
pricey) I may decide since I'm already taking some risk I'll consider other types of investments.

I was amazed to see the Delong post the Krugman article links to on the topic is irrelevant nonsense simply noting that money circulates through the economy if its spent. duh. It does so whether its loaned to a private company that spends it or the government which spends it. There is no magic multiplier that makes money somehow remember that it was the government that purchased a hammer with it rather than a private company and magically influence the new owner of the money to spend it faster.

AP Lerner said...

“AP, are you telling me that production is not important? And that an economy is just a circular mechanism in which the purpose of consumption is to clear goods off the shelves so people can have jobs making more goods to put on the shelves?”

The failure of Says Law when dealing with an excess supply of labor is the failure to recognize that wages are not just costs, but also income. So when firms cut wages, they are cutting income, and when done on a systemic basis, well, you get what we are living through today: 15M unemployed chasing 3M jobs. You mean to tell me if the government hires 1M workers to repair crumbling infrastructure or pay teachers to teach at state run schools would be a bad thing if they were willing and capable?

“However, since you actually believe that printing money is the source of wealth, I guess that production doesn't matter. If government prints money, then goods magically appear!”

Of course, I never said this. I know that’s what you want to hear, but you’re not listening. Public deficits support the savings of the private sector. It’s called double entry accounting, and says nothing about wealth creation. It’s up to the private sector to create wealth, but it’s impossible to create wealth if the public sector is destroying financial assets and/or reducing private sector incomes by cutting the deficit in the current environment. It’s not a surprise, and a historical fact, that every depression was preceded by the public sector running surpluses.

“Perhaps Prof. Anderson has a different answer, but how about the fact that the Fed buys bonds even faster than the US Government issues them? That pushes interest rates down, doesn't it?”

But according to Prof. Anderson and the inflationists, the Fed buying bonds is highly inflationary, and if that’s the case, interest rates should be rising. Of course, Prof. Anderson and the inflationist continue to be wrong because the Fed buying bonds does not change net financial assets, and in fact is highly deflationary. The reason why there is no such thing as ‘crowding out’ is because the government does not ‘fund’ itself out of savings of the private sector. The government spends first, creating reserves, then mops up the excess reserves with debt issuance. Private savings are not required, thus, no crowding out.

“Now your turn: If a government can manufacture "money" out of thin air and use it just as if it were output genuinely saved by someone, why is the price of real money, i.e., gold, constantly rising versus the phony stuff?”

Why is gold ‘real money’? Why is the price of ‘real money’ falling? I can buy more house for the dollar than I could 5 years ago. That feels pretty real to me.

An Entrepreneur said...

A major reason "resources are unemployed" at the moment is due to the lack of funding for startups. As the Kaufmann Foundation recently noted, when they looked at data from before this recession on the number jobs created/destroyed vs. the age of a firm.. startups are normally the only group which on net creates jobs.

Part of the difficulty is that even if banks have the cash.. their lending standards have been raised, they are risk averse (and their reserve requirements went up). The real estate entrepreneurs often use as collateral has dropped in price. Its only large corporations that have access to the available cash.

Uncertainty about future tax policy and regulatory factors scare the angel investors that might invest in new technology startups, so investment in startups has declined. The pool of investors in startups is already limited by SEC regulations often requiring investors to be "accredited", ie rich, preventing the larger slightly less well off investors from choosing to take the higher risk (but with higher potential reward) approach of investing in a new company. In general government regulation tends to hurt small startups disproportionately compared to larger companies.

Fiddling with interest rates will do nothing to ease
bank lending standards or calm investor fears. The only hope is that a larger pool of investment dollars available for private investment that some will decide to move up the risk curve. Or for the government to stop creating uncertainty for investors. There is no need to keep focusing on getting cheaper money for big companies who can already borrow.

What do people in the business world do during a recession? (I mean aside from the ones who go whining for a government bailout :-) ). They say "hmm, people are buying less, what do I do?". They come up with new products (e.g. iPads) that inspire people to spend money anyway. The iPad is atypical, usually its new startups (often pulled together from laid off workers) who tend to take advantage of recessions to create new products in past recessions.

An Enterpreneur said...

Sorry for typos,etc. As must be common here I finally felt a need to vent after reading yet another Krugman flight into wonderland and typed too fast in frustration seeing some commenters here off the mark as well :-)

Actually if people don't buy government bonds but instead puts there money in savings accounts it will hopefully lead to enough surplus that lending standards would be lowered (though I'm unsure how much the standards are driven by government intervention vs. choice of the banks themselves).

Lord Keynes said...

Of course, I always am amazed that socialists still want to claim economic superiority. I guess that is why North Korea, which truly is socialist, has such a high standard of living.

The belief that the failure of inefficient Third world communist command economies "disproves" the capitalist mixed economy or Keynesian intervention is about as convincing as the idea that Somalia disproves libertarianism, as argued in this "well researched", "decisive", "irrefutable" argument:

http://www.youtube.com/watch?v=7QDv4sYwjO0
I.e., not at all.

Edward said...

"In Say's law in its sophisticated form as developed by the Classical economists(not just by Say), there could not be a downturn caused by an overall deficiency in aggregate demand: slumps were caused by sectoral imbalances/sectoral disequilibrium or by external shocks. There is excess supply in individual commodity markets, but aggregate supply could never exceed aggregate demand.

That is false. Keynes argued that even if all prices and wages were perfectly flexible, there would still be failures in aggregate demand. Any economy where money is used with (1) a medium of exchange role AND (2) a store of value function, under conditions of uncertainty and subjective expectations in real time can have significant idle money balances. The presence of the speculative demand for money for use on financial asset markets also makes things worse. Financial assets are not gross substitutes for commodities."


Idle money "hoards" are not a obstacle to full employment. Think about it this way, savings come out of profits. (Beautifully and ironically it was Keynes who emphasized that.)In order for you to be adding to or to maintain your hoard, you have to have positive CASH FLOW FIRST, and therefore, be providing some kind of good or service in the real economy. The only way to spend past your income is to borrow or to deplete you assets. I suppose you can argue that a company or a person, stubborn and rich with cash, would refuse to out of sheer stubbornness,, adjust his or her prices, but I think that rich people don't like to lose money do they? So your wrong Lord Keynes. Yes people to have a precautionary demand for cash, and yes this complicates things, But the precautionary demand for money is subordinate to the transactions demand for money. people have to earn money BEFORE THEY CAN SAVE so saving cannot be an obstacle to full employment

The quarrel I would have with Say and the classicals of why aggregate demand fails is price stickiness (they assumed that prices were automatically flexible without checking to see and making sure that they were by indexing) And you're wrong about Keynes, what he said was when nominal interest rates are at zero, price flexibility wont help. of course since interest rate manipulation is IN ITSELF a form of stickiness, Keynes contradicted himself.
And what about debt? its astonishing how many Keynesians and post Keynesians and even monetarists seem to think debt deflation proves the classical story wrong, when all that is wrong is a simple lack of imagination Just index debtors debts to the falling price level of their source of income. For example say someone bought a home at the height of the boom for 400,000 dollars, and the price plunges to 200,000, If contracts are rigid, than yes we ought to fear deflation, But if adjust the loan to the falling price of the asset in question, deflation is NOTHING to fear.

An Entrepreneur said...

btw, more re: the issue of government borrowing to spend vs. private borrowing.

If government weren't needing to borrow as much money then it seems likely that if the current channels spent too long not providing uses for capital.. there would be a larger potential market for creative entrepreneurs to find ways to design alternative investment vehicles/mechanisms to funnel capital to where it may be of use in the economy but isn't available at the moment. (ie, startups and small companies).

The other thing entrepreneurs do during a recession (since they aren't sitting around dumbly doing nothing as some clueless economists implicitly assume) when they think "hey, I'm not selling as much, what can I do to get people to buy?" is drop prices, either temporarily or permanently.

New small companies may not have developed reserves to allow them to drop prices temporarily to maintain their market share during a recession. So they need to borrow to stay afloat.. again needing the capital they can't get now. Instead at the moment they just downsize and lose customers. Many may not even considering the possibility they might have gotten capital to weather the storm (so they don't tell pollsters lack of capital is a problem since they didn't even consider the possibility they could find it). If there were more capital out there needing to find uses then banks would be out marketing to entrepreneurs that they should consider borrowing money temporarily to weather the storm.


For completeness I'll mention the "permanent price drop" choice of an entrepreneur in a recession even though its tangential to the "crowding out" of investment discussion.

Productivity was up 3.9% last year as companies scrambled to do more for less to permanently lower a price and attract new customers. A recession causes price to larger factor in purchase decisions for many that it normally is (including the decision to purchase or not to purchase) which puts downward pressure on some prices. Measures of inflation (and productivity) are of course an oversimplification of changes in a multitude of price levels into a single aggregate measure, but the measurements of the effects of Fed policies on things like inflation are likely even further off during a recession than normal. i.e. it seems likely the "real" rate of inflation is higher than the measures indicate.

Normally in competition for a sale companies are better able to stress other factors than price so "natural" price drops happen slower than during a recession. In general prices drop on many items when there is no government intervention (not all obviously given the cost of natural resources).

Lord Keynes said...

Edward,

And what about debt? .... If contracts are rigid, than yes we ought to fear deflation, But if adjust the loan to the falling price of the asset in question, deflation is NOTHING to fear.

Debt contracts ARE rigid in the time period in which they made. So: debt deflation is a real problem.

Another Anonymous said...

An Entrepreneur :
Actually if people don't buy government bonds but instead put their money in savings accounts it will hopefully lead to enough surplus that lending standards would be lowered (though I'm unsure how much the standards are driven by government intervention vs. choice of the banks themselves).
If there were more capital out there needing to find uses then banks would be out marketing to entrepreneurs that they should consider borrowing money temporarily to weather the storm.

This is based on the completely & utterly wrong view found in many econ textbooks.
There's zillions of $ in excess reserves sitting in the banks. They've gone up a thousandfold. The surplus there could not be bigger and more useless to the economy.

Bank lending has next to nothing to do with such reserves coming from customer's deposits. Banks lend when they see a profitable loan which they think won't default. After a period of going wild, they are playing it very safe now. They won't start lending until a real recovery. And no real recovery until they start lending, putting scarce money that the economy & ordinary people are dying to have now. A vicious circle, and if the non-government won't break it, well, you can guess who has to.

And as AP points out above, government "borrowing" pays for itself, and does not suck money out of the banking system. On the contrary, deficit spending is the only source that has ever existed of net money in the economy.

R.P. Long said...

Second, there is something even more fundamental here, and that is the fact that the Krugman position almost seems to be that the Law of Scarcity is abolished when interest rates approach the "zero bound" (in his words). This also is where Krugman and the Austrians really part company, for in Austrian Economics, the Law of Scarcity is not abandoned at the "zero bound" or the presence of unemployed resources.

Great blog post, Prof. Anderson. I think you could have fleshed out the above point a little more.

Mises argued that at the "zero bound," the economy grinds to a halt; whereas, at at infinite interest rate, consumption also approaches infinity.

The two views of savings and investment could not possibly be more opposite. I would love to see an economist (Austrian or Keynesian, for all I care) actually address this issue and determine which view of interest rates makes the most sense. Of course, for my money, I agree with Mises.

Inquisitor said...

"This is based on the completely & utterly wrong view found in many econ textbooks."

Asserted, not proven.

"There's zillions of $ in excess reserves sitting in the banks. They've gone up a thousandfold. The surplus there could not be bigger and more useless to the economy."

They are holding on to these reserves to restructure their balance sheets. After the recent crisis it is no surprise they - unlike Keynesian pinheads - are being prudent.

"Bank lending has next to nothing to do with such reserves coming from customer's deposits. Banks lend when they see a profitable loan which they think won't default."

Which does not prove it has "next to nothing" to do with it.

"After a period of going wild, they are playing it very safe now. They won't start lending until a real recovery. And no real recovery until they start lending,"

No, a real recovery would be when malinvestments have been liquidated and any salvageable resources put to their most useful/profitable ends. Not when more funny money enters the system chasing a decreasing amount of goods.

" putting scarce money that the economy & ordinary people are dying to have now. A vicious circle, and if the non-government won't break it, well, you can guess who has to."

No one "has to" do anything.

"And as AP points out above, government "borrowing" pays for itself, and does not suck money out of the banking system. On the contrary, deficit spending is the only source that has ever existed of net money in the economy. "

Pays for itself how? By putting more money in the hands of the government and its beneficiaries? That isn't what people are getting at when they say it is wasteful...

Inquisitor said...

"The failure of Says Law when dealing with an excess supply of labor is the failure to recognize that wages are not just costs, but also income. So when firms cut wages, they are cutting income, and when done on a systemic basis, well, you get what we are living through today: 15M unemployed chasing 3M jobs."


Um, this doesn't even begin to explain why they cut wages. You've not shown that Austrians do not recognise wages are a form of income, probably because you know if you were to try to you'd fail, considering how Mises and Rothbard both recognise them as such. As do they with interest on capital, entrepreneurial profits etc. Wages are not the ONLY source of income.

" You mean to tell me if the government hires 1M workers to repair crumbling infrastructure or pay teachers to teach at state run schools would be a bad thing if they were willing and capable?"

It would be, yes. It is on your shoulders to prove why this would be economically efficient (read: conducive to satisfying consumer wants, NOT putting people to makeshift work.)

"The reason why there is no such thing as ‘crowding out’ is because the government does not ‘fund’ itself out of savings of the private sector. The government spends first, creating reserves, then mops up the excess reserves with debt issuance. Private savings are not required, thus, no crowding out."

Yes, it "prints" the money, i.e. creates it out of nowhere, with all its own attendant problems. Lord Keynes tried this futile argument.

"Why is gold ‘real money’? Why is the price of ‘real money’ falling? I can buy more house for the dollar than I could 5 years ago. That feels pretty real to me. "

Which has nothing to do with any ascent in the dollar's value and everything to do with inflated prices coming down...

Another Anonymous said...

Inquisitor, An Entrepreneur's statements were also based on factually incorrect beliefs - that there is a scarcity of reserves, about which we do not differ. Other things have been explained many times here. See Randall Wray's Understanding Modern Money. Warren Mosler's Soft Currency Economics on the web. That bank reserves have essentially nothing to do with lending is something that even the Fed is now rediscovering and publishing papers about. They discovered it in the 30s - pushing on a string doesn't do anything, but a new breed of nonsense quackonomics in the last 30 or 40 years drove out good economics; I don't think this conflicts with any Austrian theory. This is just how banks work, and the amazing fact that almost all econ textbooks get it completely wrong. If a bank is short reserves, it just borrows on the Fed Funds market, or goes to the Fed discount window if it has to. It just is not going to make a loan at interest below the short term risk-free rate - why would it? To keep banks from making such loans is the main function of government "borrowing".

No one "has to" do anything. Sure, which is why the gubmint, which has the power to greatly strengthen and stabilize capitalist economies and thereby create real wealth for its citizens, should do so, as the overwhelming majority of voters prefer wealth to poverty.

Yes, it "prints" the money, i.e. creates it out of nowhere, with all its own attendant problems. Well, if you have a better idea than a capitalist money economy, let's hear it. All the (net) money that has ever existed has been created by government deficit spending - basically "printing money." See the words of an excellent ancient economist in Mark 12:13-17.

Bob Roddis said...

1. Once again we have seen that the Chartalists and Keynesians haven't the slightest familiarity with basic Austrian concepts. This is a level of ignorance far below a lack of understanding.

2. There are no humans in the mechanical Chartalist world except those unfortunate enough to be forced to pick crops in order to compel the use of the oppressor’s currency.

3. There is no morality in the horrid and oppressive mechanical world of the Chartalists.

Anonymous said...

"They are holding on to these reserves to restructure their balance sheets. After the recent crisis it is no surprise they - unlike Keynesian pinheads - are being prudent."

You are confusing reserves with capital. A common mistake by Austrians. Reserves do nothing to 'restructure' balance sheets.

Anonymous said...

Nice post Bob. I was wondering when the inner racist that most libertarians possess would show its ugly head. You win.

Bob Roddis said...

Anonymous:

Look, you jerk, it was the Mosler book that glorified and promoted the "hut tax". I've been hanging around libertarians since 1973 and have NEVER seen a hint of racism from them. NEVER. They cry when they hear about a poor black person caged up forever as part of the drug war.

You have nothing to offer except debasement of the language to disguise your grisly plans of looting and currency debasement. Just go away.

Bob Roddis said...

Since Chartalists have short memories (assuming they process information at all, which is highly suspect), I’ll provide a third link to the book by Chartalist
Warren “hut tax” Mosler here.
Check out page 26. This book was promoted right here in these comments by AP “hut tax” Lerner himself.

The following is not merely a theoretical concept. It’s exactly what happened in Africa in the 1800’s, when the British established colonies there to grow crops. The British offered jobs to the local population, but none of them were interested in earning British
coins. So the British placed a “hut tax” on all of their dwellings, payable only in British coins. Suddenly, the area was “monetized,” as everyone now needed British coins, and the local population started offering things for sale, as well as their labor, to get the
needed coins. The British could then hire them and pay them in British coins to work the fields and grow their crops.


I say it’s a short hop from the “hut tax” to the “hand chop”. In the bizarro Chartalist world, being concerned for oppressed Africans makes one a racist.

jason h said...

Don't sweat it Bob. If they are calling you a racist, you are winning.

Anonymous said...

Nice post Bob. I was wondering when the inner racist that most libertarians possess would show its ugly head. You win.

The cry of Teh Racism! when you can't make a consistent fact based argument, that never gets old.

Another Anonymous said...

Anonymous:Reserves do nothing to 'restructure' balance sheets. I think that now that the Fed pays interest on them, they do, a little. When countries like the US with a positive reserve requirement didn't, and banks had other uses for the dough, it was sometimes called the "reserve tax".

An Entrepreneur said...

Another Anonymous said...

" Banks lend when they see a profitable loan which they think won't default. "

Unfortunately this is too simplistic a view of what happens.


If you actually talk to small business people or read the studies and reports out there you'll discover that the lending standards are up now compared to before the crisis so its only big companies that have access to this capital.
(no time at the moment to dredge up an article for you, even the NY Times was able to discover this :-) in an article last week about big companies getting loans but not small). Its natural that due to both pressure from regulatory agencies and the public banks are currently risk averse while they are still cleaning house or persuading people they've done so.


What matters re: granting a loan are factors like their current risk preferences. e.g. there is no such thing as a black and white "won't default", what matatters is the level of risk of default. What % chance there is of default and what the potential % in exchange is and what the other terms of the loan are, any risk on the value/liquidity of collateral, etc.


The problem with many people who talk about economics is that they don't pay enough attention to those in the business world. In the early days of the recession I'd hear of companies with sterling credit whose credit lines were cut due to regulators pushing the banks to maintain higher reserves. The level of reserves has changed.. but the lending standards haven't loosened.

"Inquisitor, An Entrepreneur's statements were also based on factually incorrect beliefs - that there is a scarcity of reserves, "

I noted that banks weren't lending despite what we perceive as an excess of reserves. The level of reserves helps determine the level of risk banks are comfortable taking on their loans, as does the quantity distribution of potential loans available at different risk levels and the current interest rates and the return on their current portfolio.

My comment re: hoping increased reserves would eventually lead them to loan was in part noting the way things should be but that given we are stuck in
the current situation perhaps despite themselves they would go so far overboard raising reserves they'd eventually do some good. ie trying to "look on the brightside", not entirely seriously I guess.

e.g. If an individual has $1000 in assets they are less likely to loan a friend $500 than if they had $1 million in assets, or $10 million, etc. Even if a bank has decided it can only allow X% of their reserves to be loaned to riskier small businesses, and X% is low, that eventually enough reserves will lead to even X% will be enough to increase the level of loans to small businesses.

An Entrepreneur said...

AP Lerner said...
"The reason why there is no such thing as ‘crowding out’ is because the government does not ‘fund’ itself out of savings of the private sector. "

Don't many people think of government bonds as "savings bonds"? Isn't buying a government bond "saving" or is the purchaser supposedly consuming, finding value in and of itself at say framing a bond certificate? (which I suppose some few do).

Most US debt wasn't purchased by the Fed. If "private savings are not required" then where does the money come from? Is it simply that you are trying to un-productiively define "savings" as only being money placed into a bank account?

Is this really a silly semantic game ivory tower economists get caught up in who can't see the forest of the real economy for the trees of their simplistic models?

Inquisitor said...

"No one "has to" do anything. Sure, which is why the gubmint, which has the power to greatly strengthen and stabilize capitalist economies and thereby create real wealth for its citizens, should do so, as the overwhelming majority of voters prefer wealth to poverty."

Um, this relies on the (utterly unproven) assertion that they can actually accomplish any of the above, as opposed to bring about wealth destruction... in which case most voters should seriously contemplate abolishing states.

"Yes, it "prints" the money, i.e. creates it out of nowhere, with all its own attendant problems. Well, if you have a better idea than a capitalist money economy, let's hear it. "

Unwarranted conflation of FRB systems with capitalist money economy. The alternative is a free market in money, whatever form of currency may prevail, be it 100% backed or FRB...

Inquisitor said...

"You are confusing reserves with capital. A common mistake by Austrians. Reserves do nothing to 'restructure' balance sheets. "

Are you trying to be funny? The confusion of reserves with capital is a neoclassical/Keynesian error, not Austrian. How, pray tell, will these reserves, should they leak out into the system, do anything to foment real economic growth? By your own admission they will not. Yet it does not change the fact that they can sit on them and earn money until they're in a better condition to lend. So try harder.

An Entrepreneur said...

An apparent semantic quibble is over my usage of the word "reserves" rather than the phrase "capital reserves" (vs. cash reserves). e.g.:

Another Anonymous said...
"Inquisitor, An Entrepreneur's statements were also based on factually incorrect beliefs - that there is a scarcity of reserves....
If a bank is short reserves, it just borrows on the Fed Funds market"

People in the business world may use terms in ways different from some specialists. When such terms are used commonly enough in the real world it seems appropriate for the specialists to be aware of the difference when it seems obvious there might be a minor cultural difference (e.g. when someone labels themselves an "entrepreneur"). Actually I remember the word "reserves" being used by an entrepreneur whose credit line had been cut at a local bank which had blamed it on regulators. He was semi-retired after moving away from Wall Street and the respected boutique investment bank he'd built there, so all sorts of folks in the real world use that short cut terminology.

An Entrepreneur said...

AP Lerner said...
"But according to Prof. Anderson and the inflationists, the Fed buying bonds is highly inflationary, and if that’s the case, interest rates should be rising. "

First of all of course the Fed isn't doing QE2 yet.
Also, some economists seem to have difficulty with the notion that the effects of printing more money are complicated and not a simple next day rise in prices at their local store. Your local store doesn't have a "money supply clock" sitting on the wall.
In a global economy inflating the money supply can most directly produce a weak dollar since currency traders are those most inclined to monitor such things. In addition obviously banks cutting back on private lending effects the money supply in the opposite direction. More importantly a recession (or the perception of a bad economy even if not technically in a recession) leads business to be less inclined to raise prices, increased stickiness.
In addition increased productivity, i.e. 3.9% last year, should place downward pressure on prices in a recession even more than a non-recession. i.e. a price increase of 1% during a recession is indicative of more true underlying inflation than a 1% increase at other times.

Gene Callahan said...

This Aguilar seems a nitwit:

"Of Mises, Hayek, Keynes and Kirzner, only Mises is close to this author’s position that the severity and recalcitrance of recessions is explained by the wastage of capital. Hayek describes a rather mechanical shuffling of wealth back and forth between the higher and lower stages of production. Keynes conjures up animal spirits to explain something that he clearly does not understand. And Kirzner is just expressing the blind faith in the market and denials of depression that make the so-called classicals such an easy straw man for Econ. 101 students to slay."

Hayek's theory is very much a malinvestment theory as well. And where in the world does Kirzner deny depressions, or even talk about the business cycle at all?!

AP Lerner said...

@ An Entreprenuer

"If "private savings are not required" then where does the money come from?"

From government spending. The government is not a household and has the ability to spend first, creating the reserves to buy government secrurities to should the private sector chose to do so. And the private sector always will since its better to earn interest on reserves. Thus, private sectors savings are not required, and crowding out does not occur. When a government like the US issues bonds, it is strictly a monetary operation, not a fiscal one, and are not neccessary. Crowding out is a myth.

Also, QE is not money printing. It's an asset swap, and has zero impact on money supply.

There also appears to be confusion by many on this thread between capital and reserves. Reserves are not capital, and only change the composition of bank balance sheets, and say nothing about the solvency of a bank. Banks are never reserve constrained, only capital constrained.

Ned Netterville said...

Lord Keynes, On another forum, I dared you to refute Say's law in your own words. You failed the test. Didn't even try. Now I see you have put together your own refutation of Say's law on your blog. And there you came up with a hodgepodge of pseudo-economic goggledegook??? You gotta be kidding. Keynes claimed to have refuted Say's law with essentially the same kind of ridiculous nonsense. And because Keynes' entire General Theory depended upon rebutting Say's law, Keynes' entire General Theory flopped.

So, let me make it simple for you, and give you another chance here to refute Say's ;aw in your own words without reference to any of your other equally ridiculous blogs, nor to any other authority. If you can't do that, just say so.

JB SAY; In order for people to consume, they must produce, because without production there can be nothing to consume, and without production, people would have nothing (no money) to use (spend on) with which to procure other goods (consume)."

JM KEYNES: No, government can create and spend money, which will allow people to consume without producing.

SAY: Um, what will they consume?

KEYNES: They will consume bread, because the State, by its ability to print money, can turn stones into bread. (Reference omitted, but we both know Keynes said it.)

SAY: Huh???

K: Ah, see my General Theory.

An Entrepreneur said...

AP Lerner said...
"Also, QE is not money printing. It's an asset swap, and has zero impact on money supply."

Someone had referred to bond buying causing inflation so I assumed they must be referring to QE2 which hasn't happened even though my initial take on it agreed with your statement. Initially I assumed QE2 was not going to be about printing money but was simply asset swap as you say.. but I've seen many references to it giving the (perhaps faulty) impression it would involve simply printing new money. Its unclear at the moment what exactly the Fed will do (and how much in the short run the distinction will matter (which may differ from the long run effect of the Fed's balance sheet and its actions based on it))

Anonymous said...

There's two way in which Quantitative Easing is done. The first way is when the fed just prints money (electronically) to buy assets in the open market. This expands the FED's balance sheet and injects money into the economy, but it mostly ends up as excess bank reserves. The main effect is that it lowers interest rates.

The second way in which Qualitative Easing works is when the Fed keeps its balance sheet the same size, but changes the composition of the assets it's holding. For example, the Fed might swap its treasure bonds for riskier assets from the private sector without increasing its balance sheet. This means that the fed absorbs risk away from the private sector; thus it further lowers interest rates by minimizing the risk premium. I've heard this referred to as Qualitative (instead of Quantitative) Easing.

I suspect this second method is what AP lerner means by asset swap, although I don't know for sure.

An Entrepreneur said...

Odd, a post I made continuing to ask about the mythical source of funds for government borrowing other than private savings doesn't seem to have posted. I'll redo it later. For now I just happened to run into links to a couple of articles on the topic I mentioned before of low interest rates not helping get capital to small businesses:

Oct 3rd New York Times:
Cheap Debt for Corporations Fails to Spur Economy
Notes:
"Smaller companies continue to have trouble borrowing, and most of the new financing is limited to bigger corporations." and that "The Fed’s low rates have in fact hurt many Americans, especially retirees whose incomes from savings have fallen substantially."


From the Aug 17th, 2010 Wall Street Journal:

Big Banks Loosen Lending Standards - WSJ.com
"Big banks in recent months eased standards on small-business lending for the first time since late 2006" though: "The results, however, reflected only a gradual return toward conditions before the financial crisis, when banks tightened standards sharply."

The lending standards need to be eased further though to get more money to startups to create jobs.

AP Lerner said...

"the mythical source of funds for government borrowing other than private savings doesn't"

It's not mythical. Pretty simple, actually, The government spends first creating new reserves in the banking system. Government securities (bonds)are issued to then mop up those reserves to maintain a positive funds rate. Government bond issuance is a monetary operation, not a fiscal one. Ask yourself this: how come rates have not been rising due to all the government spending and printing that is suppose to be crowding out private investment? Why have they been accelerating lower when the theory of crowding out says the should be rising? Because there is no crowding out. The mistake most folks (and, unfortunately, policy makers) make is you view the government balance sheet like a household or corporation, which is false. The government is never revenue constrained and can spend first, issue securities second. A household does not have this luxury.

I know, it's a very non mainstream view of monetary and fiscal operations, but clearly the mainstream views have been complete and utter garbage for decades. And while we are at it, the idea that savings are required to fund investment is not correct as well. Investment creates savings. Loans create deposits. Throw away your Mankiw textbook away: its garbage. See this for a lot more detail.

http://bilbo.economicoutlook.net/blog/?p=5762

""The Fed’s low rates have in fact hurt many Americans, especially retirees whose incomes from savings have fallen substantially.""

This is exactly correct, which is why quantitative easing is a useless AND deflationary policy.

"The lending standards need to be eased further though to get more money to startups to create jobs."

True, but lending standards are a function of a banks capital position and their outlook for profitable loan growth. Capital positions are weak from all the bad loans of the last decades. The bad loans exist because of the brilliant idea by our brillian policy makers to prop up the banks with nonsense policies like QE. Instead of letting them fail or forcing them to repcapitalize, we are in a situation where savers are robbed to support zombie bank bail outs. It's the worse of all worlds, and a very deflationary policy.

As for the comments and misunderstandings of QE, the mainstream view is this is just money printing, or monetizing the debt, and it will cause a spike in the money supply and inflation will result and the US will turn into Zimbabwe. Anyone paying attention for the last few decades should at least agree the mainstream view is all wrong. Mankiw should retire and his intro to economics books confiscated and destroyed for all the nonsense he has spread that is now taken as truth. All QE is an asset swap. Swapping a zero interest rate security for an interest bearing security. No new financial assets are created, thus it has no impact on inflation. Yes, the Feds balance sheet expands due to the increase in reserves, but it has no direct impact on the money supply. Even the Fed is starting to figure that out. The money multiplier is a total myth. Anyone that wants to claim the money multiplier exists should read this and please cite where it is incorrect.

http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

In fact, you can argue QE is deflationary policy since interest income is being removed from the private sector. Bernanke should be jailed for continually repeating this failed policy. The constant push to get the consumer to lever up as asset prices rise because they feel wealthier caused this mess, and now Bernanke is just continuing the Greenspan playbook.

Another Anonymous said...

An Entrepreneur: a post I made continuing to ask about the mythical source of funds for government borrowing other than private saving doesn't seem to have posted. Bob Roddis & I have had the same problem. It's a conspiracy!!!

Seriously, AP answered the question above at his October 12, 2010 7:29 PM, and again, just as I was about to post this, at October 13, 2010 10:17 AM.

Here's my try: The answer is that the funds come from the government spending that the bonds are supposedly there to finance. It's really simple. (1) The government spends money, as if it created it out of nowhere (2) It goes through the economy and ends up in bank reserves, the bank account that the banks have at the Fed. (3)The banks use this new extra money to buy the bonds that the government issues, supposedly to "finance" the debt, in reality to raise interest rates which the government spending and excess reserves would lower.

Net result, private sector has some nice new bonds, and didn't pay any of its money for them. As Michael Kalecki pointed out in this 1943 article http://gesd.free.fr/kalecki43.pdf, it is as if the government paid the private sector with bonds it just printed up. - see http://bilbo.economicoutlook.net/blog/?p=11127 for discussion. These were very helpful to me to understand MMT. Governments always spend by "printing money" out of nowhere - usually nowadays the money it prints is called "bonds". An important thing is to realize that government bonds and dollar bills are basically the same type of things - they are both IOUs from the government to you.

Another Anonymous said...

Inquisitor: Um, this relies on the (utterly unproven) assertion that they can actually accomplish any of the above, as opposed to bring about wealth destruction. Well, my main proof is the history of the USA from 1933-1980 and of the rest of the world from 1945-1980. During these years, Keynesian (Lernerian) full employment policies and interventionist government spending (to help the economy and ordinary people rather than the superrich) were riding high, and there was an unprecedented period of growth and stability. Since then monetarist/neoliberal/neoclassical free-market laissez-faire cultism BS has ruled the roost, with comparatively pathetic results.

An Entrepreneur said...

I wrote: "If "private savings are not required" then where does the money come from?"

AP Lerner said...
"From government spending. The government is not a household and has the ability to spend first, creating the reserves to buy government secrurities to should the private sector chose to do so."

The difficulty seems to be that you folks are getting caught up in the issue of the circulation of money prematurely and avoiding focusing on real individual actions in the marketplace.

Households and businesses have the ability to "spend first" in a sense when they borrow money from credit lines. The government is merely doing the same thing. If the claim is that it simply prints the money first and borrows the money soon after.. then that is something households can't do. However any temporary "float" is utterly irrelevant to the issue at hand which is the borrowing that occurs.

A government bond is purchased by a non-government entity. Over $9 trillion are owned now. Who purchased them? Investors (private, foreign, corporate, individual, whoever). To avoid semantic quibbles ignore purchases by any government entity.

An investor chose to pay $X to buy a government bond. If there were no government bonds on the market, what would they have done with the money?
Most would have likely bought a non-government investment (or alternatively spent it or stuffed it in a mattress). How is that *not* crowding out private investments? If you buy stock in Apple that money isn't available to buy stock in Microsoft. Is the government somehow supposed to be magically different, that if you buy its bonds you can also buy a private investment??

Don't get caught up in irrelevant tangents related to the circulation of money (privately spent money circulates as well).

If you have a retirement account and you chose to buy government bonds, didn't you forgo private investments? In times of crisis people look for the safety of government bonds.. but would look elsewhere if that weren't an option. The limited supply of lower risk private investments would force more capital to go up the risk curve and eventually be available to the small companies that need it and aren't getting it.

Of course the other factors limiting investment in small companies need to be addressed such as whatever influence the government has on keeping lending standards artificially high for them, the uncertainty about taxes and regulations that cause investors to delay investments, etc. (as again you'll hear from people actually out there searching for private investments, as well as the research).

An Entrepreneur said...

There are likely more recent articles, but for those who avoid paying attention to the real world of what banks actually do here were some articles from Aug 16th when there were the first signs lending standards might start to lower.

This one:

Bank Holdings Of Government Debt Continues Rocket Ride, While Industrial Lending Slides Again

is "Just a couple of charts from the St. Louis Fed to indicate what US banks are doing." which show that despite the mythical fantasy world some choose to believe in..(unless they can explain the mysterious source of public debt purchases other than the capital of private entities) .. in the real world purchases of government debt displace private debt.

While a Fed survey showed they'd backed off of tightening standards:
It's A Miracle! Bank Loan Officers Say They're Starting To Lend Again
noting "By the looks of things, banks are still being uber-skittish with regard to lending, while plowing their money into government securities.
But at least according to those Senior Loan Officers surveyed by the Federal reserve, these banks are slowly kinda getting ready to lend again."

with more detail here:
Did Mediocre Q2 Bank Earnings FINALLY Light The Spark For Increased Lending In The US?

Noting: "Could this actually be the start of a real thawing that actually translates into meaningful economic traction?
It's possible.
Mike O'Rourke of BTIG theorizes as to what's going on: basically it's a response to mediocre earnings and the rapidly compressing yield curve (which makes the lend-to-the-government play less and less profitable)."

Noting that: "What we believe is happening here is that banks are begrudgingly being forced back into banking by the market and investors."

Though its only been the last month that the total amount of loans has increased according to an Oct. 7 article:


You Won't Believe It, But Banks Are Actually Starting To Lend Again


Noting "In the past three weeks, the total amount of loans and leases made by banks (as opposed to securities) has started to grow."

So of course the rationale for QE2 is fading but they are talking about it anyway perhaps so they can try to take credit for the loosening up of lending and journalists (and naive ivory tower economists) will buy it even though the loosening has begun.

Another Anonymous said...

A E: Yes, you have some good points. But you are asking different questions. The irrelevant tangent was relevant to your first question: where does the money come from? The kind of crowding out you refer to is a major goal of issuing government bonds. Without bonds the effect of government spending would be to push interest rates to zero. Bond sales push up interest rates. This does prevent very marginal, speculative, often dangerously so, activity, and can restrain inflation. But you should reverse the first question - where did the money the private sector uses to buy bonds or anything else come from? Answer: government deficit spending, the only source of base money in the economy.

Uncertainty about taxes and regulation, government lending restraints, etc are a microscopic factor in business decisions now - what matters is that business is bad because demand is low. And reserves have expanded enormously with very little effect on lending. Monetary policy like QE is a weak tool, while fiscal policy is a powerful one. This was the mainstream view until 1970-1980, but crazy quackonomics with no relation to reality purported to "prove" the reverse was true. I don't Austrians would disagree.

Households and businesses have the ability to "spend first" in a sense when they borrow money from credit lines. The government is merely doing the same thing. Not really. A point here is that government "borrowing" is not borrowing. Both bonds and currency are government liabilities, debts or IOUs owed to you. In real borrowing, two IOUs in different directions are exchanged - you give the bank your IOU, it gives you bank money, their IOU to you. Government bond sales are asset swaps, an exchange of zero-interest bonds (=currency) for positive interest bonds, not borrowing.

An Entrepreneur said...

Here is a quick useful reference from Nobel laureate James Buchanan talking about the issue of "crowding out". From 8.5.29 in this chapter from the book
Democracy in Deficit, starting with "Utilization of savings by government to finance its deficit will crowd out utilization of savings for private investment."

btw, at one point 40% of the country worked in agriculture and some made horse-drawn carriages. These days less than 2% of the country is needed to produce food and few carriages are made. Where did the jobs come from that employed the people who are no longer working in those niches? From new products and services mostly created by the"speculative" activity of entrepreneurs (and less so innovators in existing companies, some of which aren't large and still need outside financing).

When there is a downturn in business.. business people don't sit around and do nothing. They find ways to get more sales by dropping prices or creating new products which will inspire people to buy. The iPad was introduced during a poor economy. That was done by a large company that had the cash.. entrepreneurs and small companies are starved for it.

An Entrepreneur said...

Another post didn't show up, I'll rewrite part of it:

Another Anonymous said...
"The kind of crowding out you refer to is a major goal of issuing government bonds. "

Hopefully not since that is draining the lifeblood from small businesses and startups that create
the jobs.

"This does prevent very marginal, speculative, often dangerously so, activity"

Such as the creation of new companies, products and jobs unfortunately. Protecting big business
from smaller more innovative, nimble ones who switch directions during a recession.

" A point here is that government "borrowing" is not borrowing."

A government isn't magic. Its only difference from a private entity
in terms of money is its ability to print it. Thats not relevant in regards to borrowing, so
for the moment pretend it didn't have that ability and was simply another entity in the private economy.
The only difference is rather than selling a product for revenue it gets its revenue through force via taxation
(like one of the revenue streams mob has). Or if you wish pretend taxes are given freely and its like a private
charity.

Borrowing is borrowing. A bond is merely one form of loan. To an investor there is no magic difference
between loaning money to the government vis a bond or to a private entity. (Except in terms of the perceived
risk).

If you then go back to the power of the government to merely print money.. that is something which effects the economy
separately from the issuance of bonds. If it inflates the money supply that affects both private and public bonds.

re: "uncertainty about taxes and regulation.. are a microscopic factor in business decisions now". er, have you bothered
reading the business literature and surveys and talking to investors and small businesses? (big businesses aren't the issue, they can
get cash). Angel investment crashed quickly during the start of the crisis and hasn't recovered (I know, I was dealing with high
profile national angel groups at the time and talking to others who were and the folks that run the groups) due to uncertainty.
Investing in a startup ties the money up for an indeterminate length of time, it wasn't liquid enough for people uncertain about
upcoming changes in the economy and then upcoming regulatory changes and taxes. During the Dodd bill they initially tried to raise
the level of capital required to be an angel investor and make startups raising funds deal with the SEC for months. The deck tends
to be stacked against the smaller companies needing capital.

Another Anonymous said...

AE: ..cash.. entrepreneurs and small companies are starved for it.
Yes, exactly. That is why the government should deficit –spend to put money in the economy. Deficit spending – printing money (in a wide sense) - is the ONLY ultimate source of money in the economy. The only way to get coins with the King’s picture on them is if he spends them, more of them than he taxes away.

AA:"The kind of crowding out you refer to is a major goal of issuing government bonds. "

AE: Hopefully not since that is draining the lifeblood from small businesses and startups that create the jobs.

AA:"This does prevent very marginal, speculative, often dangerously so, activity"

AE: Such as the creation of new companies, products and jobs unfortunately. Protecting big business from smaller more innovative, nimble ones who switch directions during a recession.


No, not at all. That is not what I am talking about as a function of positive interest rates.
MMT/Chartalism/Functional Finance tends to want low rates, and to put more money into people’s and businesses hands, just as you do. William Mitchell suggests 0 short term rate– no bond sales. Wray has proposed 0.25% - forever. The USA held it at 0.375% for 3 month bills during WWII.. This function of interest rates is used when the economy is at full employment during a boom, when the government does well to restrain “animal spirits” a bit. The speculative activity meant to be restrained is low return, speculative / Ponzi activity like buying derivatives on margin, like asset bubbles fueled with borrowed money. During WWII, the government sold war bonds to cool down the economy a little, to restrain spending and thus inflation, because big deficits and full employment put money in people’s and businesses’ pockets. It is not meaningful now, with a very low risk-free rate, and is hardly ever a constraint on real businesses. The constraint is getting the loan in the first place, not the interest rate. This is just like the discussion on bank reserves. If the Fed were run by 1980s Volcker, with superhigh interest rates, yes you have a point. High rates would stifle business.

Another Anonymous said...

A government isn't magic. Its only difference from a private entity in terms of money is its ability to print it. That is an ENORMOUS difference. (And the other difference, which gives money value, is the power of taxation.)
it gets its revenue through force via taxation The government does not get its revenue from taxation. Money is just a score-keeping system. The government creates money when it spends, and destroys it when it taxes. The function of taxation is to drive demand for money. Bonds and interest rates are a sideshow with much less importance; the government has no need to sell bonds to get money from the private sector – an absurd idea.

To an investor there is no magic difference between loaning money to the government vis a bond or to a private entity. (Except in terms of the perceived risk).
Agreed, although the risk of US government bonds is zero for all intents and purposes.

Concerning Buchanan: The mainstream macroeconomics of the last 30 years is incoherent, insane raving with a pseudomathematical veneer that has nothing to do with reality: reverse everything it says and you will get things right.. As that guy in Wonderland aptly calls it, it's been the dark age of macroeconomics - which unfortunately affects him too.

Buchanan talks about things like the "loanable funds market" - which does not exist. He thinks bond sales finance deficit spending. No. Contrary to what he says, deficit spending pushes down interest rates, bond sales are necessary to make them positive. Government spending doesn’t take money away from the economy, it puts it in! It is all much clearer if you forget about bonds, (and private bank credit) and just think of governments spending by printing money. Then think of bonds as just another kind of money, like very big denomination bills. To make it basically accurate, think of bonds as post-dated checks that the government eccentrically uses to pay its bills. Then you can see that the present system of printing bonds – (spend, print a bond, take the money you spent back and give back a bond) is little different from just printing money. Neither suck money out of the economy.

Then you can see that very little that Buchanan says makes sense, or has anything to do with the real world.

Here is a link which could be helpful: http://bilbo.economicoutlook.net/blog/?p=11022 analyzing Mankiw's similar arguments. As Mitchell says: "The analysis relies on layers of myths which have permeated the public space to become almost “self-evident truths”. Sometimes, this makes is hard to know where to start in debunking it."

Lionel from France said...

Very good presentation of what JB Say (and his commentators as Mill and Ricardo) actually said that is very different from what Keynes said about it. Unfortunately, the economic knowledge of some people start from Keynes.