Rhetoric Is A Powerful Tool To Advance Moneyed Interests

Money is essential to a successful economy.  But it’s money in circulation that’s useful.  Money that’s locked up in storage in vaults and savings doesn’t help.  The early economists understood this well and often used the analogy of money-is-to-economy as blood-is-to-human-body.  Circulating money, money that is used to buy things is as important to the economy as the blood in your arteries and veins.  The analogy works.  It leads us to realize that money, and more of it, can and usually is a good thing.

The analogy, however, doesn’t work for those economists and policy-makers who want are more interested in enabling the top 1% or so to profit at no risk by earning income on holding money.  Theoretically, the rich, the top 1%, could earn income from their large stores of wealth by investing it in production.  But the profit-by-investment-in-production method requires risk. It’s hard. It requires work to find and exploit good investment opportunities. From the perspective of the really wealthy, it can be more desirable to make money by simply owning money.  To do that, it’s necessary to that there be no inflation. They actually prefer deflation because then their cash wealth gets more valuable without being risked or used productively at all. The other approach to making money without risk by simply owning money is to lend it. Instead of starting, owning, and building a business, investing in equity, you make loans. Ideally you use your wealth and influence to get politicians to guarantee your loans – heads you win and tails somebody else loses. These approaches to making money by simply owning money require that money be scarce and hard to get.  It’s directly counter to the money in circulation paradigm.  A circulatory system deprived of money is good thing those who make money from money instead of labor.

But to persuade the mass of people, the 99%, the ones earning money from labor, it’s necessary to change the metaphor.  That’s been rather effectively in the second half of the 20th century.  It’s been done by extending a different metaphor.  Economists have long used the word liquidity for the idea of how easy it is to convert an asset into cash and therefore spent. For example, real estate (particularly in this market) is very illiquid.  I could own a $1 million house but be unable to buy a Coke from the 7-11 store because I lack any cash.  That’s an extreme example of illiquidity.  In contrast, a liquid asset is one that is either actually cash or easily turned into cash so it can be spent.  There’s a whole range of assets in between with varying degrees of liquidity.

This idea of liquidity and it’s association with cash has been used to push a metaphor that suggests the problem is too much money in the economy.  We’re peppered with phrases like “drowning in debt” or a house mortgage that is “underwater”.  It makes us feel that the liquid stuff is undesirable.  So we get  a central bank that’s reluctant to create and inject money into the economy because critics claim that will create too much liquidity and they falsely claim that it’s inflationary.  When the central bank does increase inject liquidity into the economy, it does it by getting the money to precisely the people who keep it from circulating.  We get a government that refuses to use it’s ability to directly inject money into the economy and get it into circulation.

Government ultimately is the source of all money.  Only government can define and create money.  It has two ways to do it. It can simply create (“print” or “mint” if you will, but it’s not that way anymore) money and spend it.  That puts money immediately into circulation in the circular flow of goods and services.  Or, the government could create money reserves for the banks, a riskier strategy.  The banks then can lend using a fractional reserve logic.  If the banks lend out the reserves, then money is created.  If the borrowers from the banks spend the borrowed money, then it’s in circulation.  If the borrowers use the money to simply buy other financial assets, then it’s not in circulation and is sterile.

In our modern system, the government (in the U.S. and many other nations) has delegated the responsibility for creating money and putting it into circulation to quasi-private central banks such as The Federal Reserve Bank.  In today’s workings of the financial system, these central banks have further delegated the responsibility and decision-making on money-creation to private commercial banks by providing reserves for whatever level of loans they choose.  When those banks choose not to create money or choose not to create and provide money in a way that puts it into circulation, the system suffers. We suffer from too little liquidity.

Daniel Becker at Angry Bear made this point very well in a long post there in June 2011.  He points out that we should really talk about “dehydrating in debt”, not “drowing in debt”.  The dehydration metaphor leads us directly to the solution – more money in circulation.  I from the conclusion to his post:

Got that? Let’s summarize: The share of income to the 99% of people declined from 1976 onward. At the same time the means of making money changed from labor production to money manipulation (producer economy to finanicialized economy) adding to the reduction in share of income. We also changed the ideology to one from relying on the vast population (as represented by the individual and We the People) to relying on a small portion of the population to distribute what money was created. We did this for 33 years. By 1996, people were borrowing as a means to sustain their standard of living (not increase it). If the people are not spending to increase their standard of living, then is the economy really growing? By 2006 people were no longer able to make the payments and consumption was declining.  Then gas hit $4/gal and winter heating was looking like another $4000 to $6000 would be needed.

To date, nothing has been done to address this. Nothing at all. And, by “this” I mean, the income inequality that has resulted in an an economy where a very small group of people (top 1%) are taking money out of the system (that is money that would fuel the engine) faster than the engine can make it which results in an ever faster declining share to the rest of the people. Instead, we have refined new fuel and dumped it right into the top 1%’s hands and wonder why the engine is still sputtering?

One other issue I have with framing and the words used today: Under water.

People are not under water. They are not drowning in debt. On the contrary, people are dehydrating. They are starving for water. Do you know what the symptoms are of dehydration? You get thirsty and then urinate less to conserve water. (debt spending) Then you stop making tears and stop sweating. (can’t borrow) Eventually your muscles cramp, the heart palpitates and you get dizzy. (close to bankruptcy, voting against your interest) Let it go long enough and you get confused, weak and your coping mechanisms fail. (Tea Party, etc) In the end, your systems fail and you die. (recession)

People are dehydrating and Washington is doing nothing about it because they believe it is drowning.  They are throwing out life boats to people in a desert.  That is the chart Ken linked to.

The Fed’s New “Twist” – Not Likely To Help

Late Wednesday The Federal Reserve announced a new program to try to stimulate  the economy so that maybe somebody, somewhere could get a new job, or maybe it’s so that critics would shut-up about employment.  It’s always hard to tell what The Fed’s real objectives are.  I don’t have time to explain now why it’s not likely to do much. But I didn’t want it to go unnoticed, so I’ll give you Stephanie Kelton from neweconomicperpectives, the UM Kansas City MMT people:

Ben Kenobi Launches Operation Twist: Will it Save the Republic?

The Federal Open Market Committee (FOMC) just announced that it’s going to begin another round of asset buying, this time offsetting its purchases of longer-dated securities with sales of shorter term holdings. The goal? Flatten the yield curve. The hope? Engineer a recovery by helping homeowners refinance at lower rates and making broader financial conditions more attractive to would-be-borrowers.

At this point, it looks like Obi-Ben Kenobi realizes that Congress isn’t going to lend a hand with the recovery. Indeed, as a scholar of the Great Depression, he’s probably deeply concerned by the “Go Big” mantra that is now drawing support from people like Alice Rivlin, former Vice Chair of the Federal Reserve.  And so it is Ben, and Ben alone, who must fight to prevent the double-dip. It is as if he’s responding to the public’s desperate cry, “Help me Obi-Ben Kenobi. You’re my only hope.” Will it work?  Not a chance, but that conversation is taking place over at Pragmatic Capitalism, so drop in and find out why.  Below is a description, taken from the full FRB press release, that describes just what the Fed is going to do.  May the force be with us all.

“To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.”

Obama’s So-Called Keynesian Stimulus Efforts Aren’t Very

The simple version of Keynesian economics suggests that if the economy is suffering from too little economic activity and high unemployment there are some policy options.  Specifically Keynes suggests there are three general kinds of policy options:

  1. The central bank (The Fed in the case of the U.S.) could lower interest rates and create money by buying bonds on the open market.  This is called stimulative monetary policy. It is supposed to work by making private sector borrowing more attractive and more profitable so that businesses in particular increase their spending on business investment goods like equipment and factories.
  2. The government could increase it’s budget deficit by borrowing more money and cutting taxes.  This is fiscal policy by tax cuts. It works by putting more cash in the hands of households and firms (increases their after-tax income) who then increase their spending.
  3. The government could increase it’s budget deficit by borrowing more money and directly spending the money itself, either by direct transfer payments to needy individuals, or by buying things like new dams or construction projects, or by hiring the unemployed itself. This is fiscal policy by spending.

There’s nothing to stop a country from pursuing all the above options simultaneously if it chose.  But not all of these options are equal in either effectiveness.

NOTE: This is old-style John Maynard Keynes style Keynesianism, not the  “New Keynesian” theories that have dominated some academic circles in the last couple decades. It’s also based on the real thing, not the caricature that it’s opponents paint which is usually without foundation. 

NOTE 2: It’s really not a good idea to try to simplify Keynes.  When you do, you’re likely to over-simplify and really miss powerful insights and nuances.  Nonetheless, I will plunge ahead with full knowledge of the risk.

The real richness of Keynesian theory though lies not just in these prescriptions, but the analysis of when to use which one, whether it is likely to work, and under what conditions.  The first option, monetary policy, is to be preferred in cases of  mild recessions when interest rates are “normal” and the slowdown is largely for mild, temporary factors such as an outside economic shock. Monetary policy is quick and easy to implement. It’s also relatively easy to reverse course when the time comes.

Keynes had two key insights about monetary policy though that are highly relevant to our present situation.  Monetary policy can be become impotent if interest rates drop to near zero and we get into a liquidity trap.  This is when people and firms become fearful of the future and come to expect continued weakness or even GDP declines and deflation.  In a liquidity trap, people just sit on money rather than spend or invest it.  Monetary policy is relatively ineffective in such cases. We have been in a liquidity trap since late 2008 and that’s why the record 3 years of a virtually zero Fed Funds interest rate and The Fed’s QE1 and QE2 programs haven’t worked. Liquidity traps aren’t common, but they do exist and they aren’t extinct.  We were in one in the 1930’s Great Depression and Japan has struggled with one for the last 15+ years.

Keynes also had insights about the two fiscal policy approaches, tax cuts vs. increased spending.   In particular, tax cuts will only be effective to the degree that households and firms actually spend the money.  If they use the money to pay down debts or to save, then it really won’t improve conditions.  Later research in the 1950’s and 1960’s strengthened these insights. Later research showed that it also makes a big difference who gets the tax cuts and whether they think the tax cut is permanent.  Temporary tax cuts are much less effective than permanent ones because people tend to save them more.  Also, high-income individuals tend to save more of the tax cut (proportionally) than more desperate lower-income folks. Finally, later research showed that when a recession comes about because private debt got too high, then tax cuts are least effective.  Notice a pattern here?

The fiscal policy “stimulus” efforts that we have pursued since the Great Recession began have been very, very heavily tax-cut oriented.  Bush’s original stimulus effort in early 2007 in an effort to “nip the recession in the bud” was all tax cuts.  The Feb. 2009 stimulus bill of Obama (the ARRA) was between 40% and 50% tax cuts.  The meager effort passed in Dec 2010 was all tax cuts. And now, the proposal is again very tax cut heavy.  Not only have the fiscal stimulus efforts been heavily tax cut-based, but the cuts have temporary cuts targeted at either high-income folks or only offering a meager amount to low-income folks.  Further, we still have a huge private sector debt overhand that people want to pay down before they spend more. In sum, the dominant response which many have labeled as “Keynesian” really hasn’t been what John Maynard Keynes suggested. Many have asserted that “Keynesian policies don’t work” and cite our weak economy despite several fiscal policy stimulus attempts as proof.  But that’s not really a valid test.  It’s like claiming some physician is a total quack because you took pills like he recommended but you didn’t take the exact same pills as he recommended. You took something else. Now you’re still sick.  It’s not the physician’s prescription that failed, it’s your refusal to follow the prescription and the diagnosis that failed.

Critics will counter with a “yes, but there was still some spending stimulus in the Obama bills and our failure to fully recover is proof the fiscal spending as stimulus prescription is quackery.”  But have we really had an increase in government spending anywhere near large enough to fill the gap?   Let’s look at some trends (courtesy of Brad Delong):

We simply have not expanded government purchases as a share of potential GDP in this downturn:

FRED Graph  St Louis Fed 4

 

The graph shows the relative changes in share of GDP of four key portions of GDP: exports, business equipment investment, government purchases, and residential construction. (everything in the graph is scaled relative to 2005 -that’s why the lines all meet at o in 2005).  The whole Keynesian idea is that if exports, business equipment investment, or residential construction go down then government purchases should go up and vice versa.  That hasn’t happened at all.  Instead, government purchases has consistently declined since 1995!.  In other words, actual changes in government purchases have not only not been a stimulus, but they have been contractionary.  Government spending policy has been contractionary for over 15 years!  We didn’t notice it because strong increases in business equipment investment and housing were doing the stimulating prior to 2006. In the period 1995-2000, it was probably appropriate in a Keynesian sense to have declining government purchases and a contractionary policy – it was countercyclical to the dot-com boom and the housing boom.

But after 2007, residential construction collapsed. For awhile in 2009 both business equipment investment and exports declined sharply.  The only appropriate Keynesian response would have been a very, very large government purchases program.  But we didn’t do that.  Instead, the so-called 2009 stimulus bill was barely enough new spending at the federal level to offset the declines and cuts at the state and local levels. Overall, government spending did not increase. It went neutral for a couple years. But in late 2010, we resumed the march to contractionary policies.  The ARRA wound down.  State and local governments accelerated their budget cuts. And Washington became pre-occupied with imaginary threats of impossible debt crises at some point 10 years from now.

To continue the earlier physician and disease metaphor, we did try a little of the prescription but we took too little.  It’s as if we went to the doctor, the physician diagnosed a very severe infection and prescribed heavy doses of anti-biotics.  We went home took a lot of aspirin instead and only a couple of the anti-biotic tablets.  Now folks want to blame the doctor and his “failed prescriptions” when we didn’t take them.  None of this is what Keynes or 1960’s style Keynesians would have recommended. To conclude that Obama has tried Keynesian policies and they have failed is dead wrong.  The policies have largely failed to stimulate and re-ignite growth, but they weren’t Keynesian.

Washington Post – FAIL on Fiscal vs. Monetary Policy

I have long observed that any students who pass Econ 201 and Econ 202 with good grades and then remember what they learned are far and away more knowledgeable about economics than the majority of Congress.  Now I must add “far more knowledgeable than the nation’s leading(?) newspaper editors.”  Observe the Washington Post in an editorial, November 21:

Yet buying hundreds of billions of dollars worth of federal debt in a deliberate effort to lower long-term interest rates and boost employment looks to many economists, market participants and politicians like fiscal policy by another name. And fiscal policy is an inherently political business.

Buying bonds as The Federal Reserve is doing with it’s QE2 program is monetary policy.  It is most assuredly NOT FISCAL POLICY.  That is by definition.  Fiscal policy is the changing of government spending and taxation (the budget) for purposes of achieving macroeconomic goals.  The Federal Reserve Bank is not the government.  The Federal Reserve bank when it buys bonds and pays for them by increasing bank reserves is engaging monetary policy.  The two are different.  Even a casual investigation of any Principles of Econ text will note the difference.  Heck, skip the text book and look it up in Wikipedia at fiscal policy and monetary policy!  Such ignorance on the part of a major newspaper is appalling. No wonder they’re losing market share.

Monetary Policy: The Wrong Tool for the Job

Generally, there are two broad policy approaches to having the government (or it’s appointed representative, the central bank)  manage the macro economy.  One, fiscal policy involves deliberate management of the government budget (spending and tax policy) with a view to stimulating or slowing the economy.  The other is monetary policy where the central bank (or government if it has retained control over currency) moves interest rates up or down, and buys or sells bonds in order to stimulate or slow the economy.  Fiscal policy acts directly on the economy: government spending adds directly to demand for goods and causes those goods to be produced and thus raise employment (assuming there are unemployed people to hire).  Taxes directly take money away from households and prevent them from buying goods (assuming they were going to spend anyway – which they may not if very high income or wealth).

Monetary policy however, is very indirect. It’s almost a Rube Goldberg machine in design.   The central bank has to buy/sell bonds on the public market and to/from banks in an effort to increase/decrease interest rates by affecting the supply/demand for such bonds.  Then, if the central bank is trying to stimulate, it has to hope that the lower interest rates cause busineses and consumers to decide that lower financing costs (lower interest rates) now make some purchases more attractive than before. Then the businesses and consumers have to borrow and then go buy things (typically consumer durables, houses, or business investment).  There’s a lot of steps there where the policy could be defeated by folks not cooperating.  For example, today lots of businesses are deciding that since they have excess capacity already and not enough people are buying the goods they make now, there’s no sense in borrowing to expand.  Likewise, consumers who are scared they may not have a job next year are taking a pass on buying a house or car even though the interest rate is low.

Joe Stiglitz explains the problems we face today with monetary policy in a post at Project Syndicate.  Keynes pointed out a long time ago (before the dark ages of macro), that in times of high unemployment, unused capacity, and low interest rates (what is sometimes called a liquidity trap), monetary policy isn’t going to be very effective.

With interest rates near zero, the US Federal Reserve and other central banks are struggling to remain relevant. The last arrow in their quiver is called quantitative easing (QE), and it is likely to be almost as ineffective in reviving the US economy as anything else the Fed has tried in recent years. Worse, QE is likely to cost taxpayers a bundle, while impairing the Fed’s effectiveness for years to come.

John Maynard Keynes argued that monetary policy was ineffective during the Great Depression. Central banks are better at restraining markets’ irrational exuberance in a bubble – restricting the availability of credit or raising interest rates to rein in the economy – than at promoting investment in a recession. That is why good monetary policy aims to prevent bubbles from arising.

But the Fed, captured for more than two decades by market fundamentalists and Wall Street interests, not only failed to impose restraints, but acted as cheerleaders. And, having played a central role in creating the current mess, it is now trying to regain face.

In 2001, lowering interest rates seemed to work, but not the way it was supposed to. Rather than spurring investment in plant and equipment, low interest rates inflated a real-estate bubble. This enabled a consumption binge, which meant that debt was created without a corresponding asset, and encouraged excessive investment in real estate, resulting in excess capacity that will take years to eliminate.

The best that can be said for monetary policy over the last few years is that it prevented the direst outcomes that could have followed Lehman Brothers’ collapse. But no one would claim that lowering short-term interest rates spurred investment. Indeed, business lending – particularly to small businesses – in both the US and Europe remains markedly below pre-crisis levels. The Fed and the European Central Bank have done nothing about this.

They still seem enamored of the standard monetary-policy models, in which all central banks have to do to get the economy going is reduce interest rates. The standard models failed to predict the crisis, but bad ideas die a slow death. So, while bringing down short-term T-bill rates to near zero has failed, the hope is that bringing down longer-term interest rates will spur the economy. The chances of success are near zero.

Large firms are awash with cash, and lowering interest rates slightly won’t make much difference to them. And lowering the rates that government pays has not translated into correspondingly lower interest rates for the many small firms struggling for financing.

More relevant is the availability of loans. With so many banks in the US fragile, lending is likely to remain constrained. Moreover, most small-business loans are collateral-based, but the value of the most common form of collateral, real estate, has plummeted……

…Copyright. Project Syndicate, 2010.
http://www.project-syndicate.org
For a podcast of this commentary in English, please use this link:
http://media.blubrry.com/ps/media.libsyn.com/media/ps/stiglitz130.mp3