But Can We Afford Big Government?
Paul Krugman has noted that we all seem to be "big government types"--recalling Nixon's statement that "we're all Keynesians now"--but we have not yet addressed whether our nation can afford a big government.
News reports today indicate that some on the Obama team are backing off on the size of the promised stimulus--to something less than $850 billion. I suspect that a big part of the reason can be attributed to Rubinitis (better known as deficit-phobia). Why, in the face of the biggest economic catastrophe this nation has faced since the 1930s, would Obama lose his courage? The three "eyes": Inflation, Investment crowding-out, Insolvency. I will try to calm those fears.
First, inflation. Price pressures can arise from many sources--excess demand, commodity price hikes, bottlenecks, wage or profit pressures, composition of demand (trade surpluses and private investment tend to be inflationary for reasons mentioned in my previous blog), and so on. Most fear that too much government spending will drive demand beyond full capacity, generating wage and price pressures. However, in current circumstances, that is highly unlikely with global demand plummeting, unemployment rising, and commodity prices busting. Still, I have called for faster growth of government even after this crisis passes. So the key is to ensure that government spending grows at a pace just consistent with the required level of fiscal stimulus. Further, it does make a difference where government demand is directed--to avoid bottlenecks, to add to productive capacity, toward underutilized resources, and toward resources whose prices are rising below the average rate of price increase. Right now, it probably doesn't matter too much what the government spends for (the already quoted Keynes statement about digging holes comes to mind); but for the longer run the composition and nature of government spending is critical. This is for two reasons: first, to maintain public support for big government, it has got to spend in a way that has obvious benefits for Americans. Second, government has to avoid spending that fuels accelerating inflation. Both Paul Krugman and Brad DeLong have seemed to accept that moderate and stable inflation is not a bad thing--a position with which I am sympathetic--but rising inflation is not acceptable. Can we have the audacity of hope that government can formulate a policy that ensures just the right amount of non-inflationary spending? Yes we can. In tomorrow's blog, I will outline such a policy.
Second, investment crowding out. There are two main kinds of crowding out--resource and financial. If the government were to hire away all of the competent engineers, investment projects that required engineers could get crowded out for the simple reason that the government has an unlimited checking account and can always win any bidding war. At full employment (as in WWII), additional government hiring crowds out private hiring. The solution to resource crowding out is pretty simple: to avoid it, don't hire away the resources the private sector needs. When the economy is well below full employment, this is easy enough; when it is close to full employment, care is required. Usually, however, economists worry more about financial crowding out--which can occur even with unemployed resources. There are different versions, but the most important ones boil down to the argument that government deficits push up interest rates as its borrowing competes with private borrowing. Again, since the government has a bigger checking account, it will win the competition because its spending is not interest-sensitive. Private spending that is sensitive (supposedly, investment and real estate spending are) is reduced. For a long time, economists of the big government persuasion argued that empirical results are mixed--we find many cases of rising budget deficits and falling interest rates, and falling budget deficits and rising interest rates--so even if the theory is correct, the real world results don't necessarily comply. But it is simpler than that: the theory is just plain wrong. All central bankers everywhere now admit that they target the short-term interest rate; and they hit their targets within a self-determined margin of error. It makes no difference whether the budget deficit reaches a Japan-like 10% of GDP (with zero interest rates), or a US-like 25% of GDP (during WWII, with interest rates at 3/8 of one percent), or a US-like budget surplus of 2% of GDP (under Clinton--accompanied by rising rates!). The Fed determines the short-term interest rate. Period. Yes, it might raise the rate in response to budget deficits--but that is a policy decision. If Congress doesn't like that, it should change the instructions it provides to the Fed.
There are two further points to be made here; and, sorry, they are for the more technically inclined. The central bank operates with an overnight rate target, but it can choose the maturity it likes--indeed, Bernanke's Fed is now experimenting with longer maturity targets under cover of the label "quantitative easing". This seems important because one objection is that the Treasury issues longer-term debt and while it is true that the central bank sets overnight rates, longer rates are "market determined" and crowding-out in the longer maturity markets is still possible. However, the maturity of Treasury debt is a policy variable--and there is no reason in principle why the Treasury could not operate only at the short end (even overnight debt!) to avoid crowding-out. For those who are still skeptical, let me move to the second, more important, point. Government spends by crediting bank accounts (bank deposits go up, and their reserves are credited by the Fed). All else equal, this generates excess reserves that are offered in the overnight interbank lending market (fed funds in the US) putting downward pressure on overnight rates. Let me repeat that: government spending pushes interest rates down. When they fall below the target, the Fed sells bonds to drain the excess reserves--pushing the overnight rate back to the target. Continuous budget deficits lead to continuous open market sales, causing the NY Fed to call on the Treasury to soak up reserves through new issues of bonds. The purpose of bond sales by the Fed or Treasury is to substitute interest-earning bonds for undesired reserves--to allow the Fed to hit its interest rate target. (In the old days, these reserves earned no interest; Bernanke has changed that, effectively eliminating the difference between very short-term Treasuries and bank reserves. It also entirely eliminates the need to issue Treasuries--but that is a topic for another day.) We conclude: government deficits do not exert upward pressure on interest rates--quite the contrary, they put downward pressure that is relieved through bond sales.
On to the final phobia: insolvency. Let me state the conclusion first: a sovereign government that issues its own floating rate currency can never become insolvent in its own currency. (While such a currency is often called "fiat", that is somewhat misleading for reasons I won't discuss here--I prefer the term "sovereign currency".) The US Treasury can always make all payments as they come due--whether it is for spending on goods and services, for social spending, or to meet interest payments on its debt. While analogies to household budgets are often made, these are completely erroneous. I do not know any households that can issue Treasury coins or Federal Reserve Notes (I suppose some try occasionally, but that is a dangerous business). To be sure, government does not really spend by direct issues of coined nickels. Rather, it spends by crediting bank accounts. It taxes by debiting them. When its credits to bank accounts exceeds its debits to them, we call that a budget deficit. The accounting and operating procedures adopted by the Treasury, the Fed, special deposit banks, and regular banks are complex, but they do not change the principle: government spending is accomplished by crediting bank accounts. Government spending can be too big (beyond full employment), it can misdirect resources, and it can be wasteful or undesirable, but it cannot lead to insolvency.
Constraining government spending by imposing budgets is certainly desirable. We want to know in advance what the government is planning to do, and we want to hold it accountable; a budget is one lever of control. At this point, it is impossible to know how much additional government spending will be required to get us out of this deep recession. Whether the Obama team finally settles on $850 billion worth of useful projects, or $1 trillion, voters have the right to expect that the spending is well-planned and that the projects are well-executed. But the budgets ought to be set with regard to results desired and competencies to execute plans--not out of some pre-conceived notion of what is "affordable". Our federal government can afford anything that is for sale in terms of its own currency. The trick is to ensure that it spends enough to produce sustainable growth and other desired outcomes while at the same time ensuring that its spending does not have undesirable outcomes such as fueling inflation or taking away resources that could be put to better use by the private sector.
Next time: a policy proposal.
The Fed determines the short-term interest rate. Period.
Except that the interest rate we all care about (the 10-year note) responds not to the Fed determined short-term interest rate but to the state of the economy and investors/businessmen's confidence in its prospects.
Indeed, deficit spending may produce reduced demand for borrowing and thus, lower long-term rates because people don't trust the government and therefore, don't borrow because they can't project returns with a modicum of confidence.
December 18, 2008 7:36 PM | Reply | Permalink
Doesn't it, in the first instance ,also respond to the FED's purchase of long term notes, driving up demand and lowering the long term rate? Perhaps a secondary effect is , as you might suggest, drying up other demand but if the Fed prints enough dollars shouldn't it win that tug of war?
December 18, 2008 7:43 PM | Reply | Permalink
If you're talking about "quantitative easing," then, you may be correct, but that policy (barely legal) is one used only in the most extreme (a threatened total collapse of the financial system) situation -- not, I think, what Wray's talking about.
December 18, 2008 7:47 PM | Reply | Permalink
That is, government spending "crowds out" private investment projects which fail to be undertaken not because the money/credit isn't available but because a capricious and arbitrary actor (the government) which responds not to the market but to some sort of faith-based policies with demagogic appeal is distorting the market.
December 18, 2008 7:44 PM | Reply | Permalink
Only one small complaint from Ellen! Well done, Professor Wray. Thank you for taking the time to write these posts.
December 18, 2008 7:51 PM | Reply | Permalink
You sorta skipped over that WWII bit, Randall.
The US ran a deficit of 25% of GDP, operated at full employment and kept inflation well in check.
Was monetary policy a factor in this? Emphatically no! Interest rates were set at below 1% and left there for the duration.
Those results were obtained through a combination of highly progresive taxes (top rate of 91%), wage and price controls, rationing and demand control.
So, before you propose a monetary solution, I think it behooves you to provide a like example in which monetary policy had such meritorious results. I double-dare ya!
And one more thing: John Maynard Keynes, summing up what he thought he had learned from his studies, said this in the last chapter of "The General Theory of Employment, Interest and Money": " The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes."
December 18, 2008 8:19 PM | Reply | Permalink
But it is simpler than that: the theory is just plain wrong. All central bankers everywhere now admit that they target the short-term interest rate; and they hit their targets within a self-determined margin of error. It makes no difference whether the budget deficit reaches a Japan-like 10% of GDP (with zero interest rates), or a US-like 25% of GDP (during WWII, with interest rates at 3/8 of one percent), or a US-like budget surplus of 2% of GDP (under Clinton--accompanied by rising rates!). The Fed determines the short-term interest rate. Period.
So what you are essentially saying is that by lowering the interest rate, the Fed can make certain that public sector borrowing does not crowd out private sector borrowing. The only problem is that the Fed deos not create any extra resources for borrowing. Lowering the interst rate simply makes it look like resources have been created, and encourages people to eat their savings. The result is that people make unsustainable investments, because the resources are not there to complete them. The result is recession or depression.
On to the final phobia: insolvency. Let me state the conclusion first: a sovereign government that issues its own floating rate currency can never become insolvent in its own currency.
Translation: the government can always use the printing press to pay off its nominal debt, essentially repudiating its debt in real terms. Perhaps in some technical sense we cannot be insolvent, but if we tried debt repudiation through inflation, then we would have a difficult time getting any foreign countries to lend to us, and we are way too dependent on foreign countries for us to risk that.
December 18, 2008 8:21 PM | Reply | Permalink
Ellen,
10 year T-bonds follow the short-term and expected short-term rate, mostly. You missed the broader point, though, which is that there is no reason for the Tsy to issue longer-term securities in the first place (as Prof. Wray says, it's a policy variable, and they haven't always issued along the entire term-structure anyway). With a zero rate target, or with a positive target and interest pmt on reserves, no Tsy securities need be issued at all. That's because govt bond sales are just interest rate support--if the Tsy doesn't issue bonds, then the Fed will have to sell them to hit a target above zero and above the rate paid on reserves.
December 18, 2008 8:33 PM | Reply | Permalink
I was using the 10-year note as a marker. What I'm really interested in is a "long-term" interest rate of sufficient stature to stand proxy for a reasonable return on planned (that is, long-term) investments.
In the absence of "quantitative easing" -- which is the usual case -- I think historically, the market (and not the Fed) has set that rate.
December 19, 2008 3:17 AM | Reply | Permalink
Agreed, an interest rate on private sector debt will have various risk premia attached, which will be set by the mkt under normal circumstances.
December 19, 2008 9:40 AM | Reply | Permalink
With all due respect, Glaivester provides the typical mainstream misinterpretation on both counts.
First, the reason there is no financial crowding out is NOT because the Fed sets a low target rate. There is no crowding out because the govt isn't actually borrowing. True, the Fed's operations do not create net financial assets for the non-govt sector. But a deficit DOES, as it is (by definition) the crediting of more balances to bank reserve accounts than are debited. That's why a bond sale by either the Fed or the Tsy is necessary to maintain a positive interest target above the rate paid on reserves.
In fact, in order to buy a Tsy security, one MUST have reserves (or one's clearing bank must have them), because Tsy securities only change hands via the Fed's Fedwire pmt settlement system. But reserves are only in circulation because of previous govt deficits or via borrowing from the Fed (which is now taking many forms). Thus, instead of "crowding out" private sector, the private sector needs a previous deficit or a loan from the Fed to buy a Tsy security in the first place. It's well known, for instance, that (in more normal times) the Fed adds reserves just before Tsy auctions are settled.
Second, federal government spending ALWAYS creates reserves and results in the crediting of bank accounts. There's no such thing as "turning" on the printing press . . . it's "on" every day whenever they spend since that's how they actually spend.
December 18, 2008 9:04 PM | Reply | Permalink
First, the reason there is no financial crowding out is NOT because the Fed sets a low target rate. There is no crowding out because the govt isn't actually borrowing.
But it's still using resources that are therefore not available to be used elsewhere.
When the government spends money, it can do so in three ways: by taxing the money away from private hands, by borrowing from private entities or from governments other than itself, or by printing money (or the electronic equivalent). In all 3 ways, resources are taken from the private sector in order to fund the spending, either through taxes, through a decrease in the available funds to borrow (as savers are saving with the government instead of with private entities), or through inflation.
The idea of financial "crowding out" is based on the assumption that the government is borrowing by selling bonds to private entities (or to other governments) which now have fewer funds to invest in or lend to other projects, thus increasing the rate of interest.
But even if the Fed covers the government's borrowing, the result should be much the same; the actual amount of saved resources left to borrow from is not increased, so demand increases relative to supply. This will result in inflation, and also will eventually result in higher interest rates as lenders charge more interest in order to offset losses due to inflation.
The reason we don't see this - yet - is because the Fed keeps pumping more money into the system to keep the interest rates low (as long as lenders are using new money rather than their old saved money, they can make money on a below-inflation interest rate because they do not have any principal to be devalued).
In any case, STF, the situation you describe (which I think is also the one I described in the prevous paragraph) is actually worse than the "crowding out" effect, because when government borrowing does not crowd out private borrowing, (i.e. when government borrowing increases without an equal decrease in private borrowing), it winds up using our saved resources faster than they are replaced (in other words, private borrowing does not decrease because people assume that there are more resources to borrow than there are). The end result is that we don't have enough resources to fund all of our investments and there is massive collapse.
December 18, 2008 10:09 PM | Reply | Permalink
I don't know whether you subscribe to the maxim that "inflation is always and everywhere a monetary phenomenon," but I do think you owe it to your argument to lay out your theory of why "printing money" is inflationary.
Why is it not the case that debt destruction will cancel out the effects of newly printed money?
December 19, 2008 3:11 AM | Reply | Permalink
I don't know whether you subscribe to the maxim that "inflation is always and everywhere a monetary phenomenon," but I do think you owe it to your argument to lay out your theory of why "printing money" is inflationary.
Why is it not the case that debt destruction will cancel out the effects of newly printed money?
Technically, increasing the money supply is inflation.
As for debt destruction, as I understand it, every time money is created, debt is created. What "printing money" does is convert the debt from a debt the government owes an external entity to a debt one part of the government owes another.
Moreover, every time money is printed, x times as much money is actually created (where 1/x is the reserve ratios for banks). This is because whatever the reserve ratio is (for example, 10% or 0.1), the banks can loan out fractions of the money again and again, expanding the money supply by a multiple of the printed money.
December 20, 2008 7:12 PM | Reply | Permalink
Put another way, the flaw in STF and Mr. Wray's analysis is the assumption that interest rates are just numbers to be played around with (rather than prices that ought to reflect real market conditions, namely the supply and demand for loans), that money has power other than its use as a proxy for real resources, and that depressions are somehow psychologically produced by people who are unwilling to be productive unless we use monetary policy to coax them (or as Paul Krugman would say, that the problem is simply that too many people want to save cash right now, so what we need to do is create more cash so that they can save their cash without destroying the economy).
In a monetary economy, money is essentially a proxy for resources. When I pay someone for a good or service, I am giving him a claim on a certain value of goods and services from anywhere that accepts my money; conversely, I am relinquishing my claim to the same amount of goods and services from the "general store" or society, and claiming the specific good or service for which I am paying.
When the government creates money, which essentially is what happens whenever it spends without either borrowing the money from an external entity (another government or the private sector) or taxing it form someone, it increases the number of claims on the same amount of resources, because creating the money does not create any new resources (unless you believe that some resource is not being used productively but that creating money will make it productive, which essentially suggests that the only reason that the resource was unproductive was psychological - someone was unwilling to work). The result is that in the short term, people use more of the available resources than they would otherwise, because the increased number of claims gives the illusion of a greater quantity of resources. The long-term effect is currency devaluation and the decrease in the number of available saved resources for investment, resulting in investments not being able to be completed, resulting in a market crash.
The difference between Keynesians and Austrians is that the Keynesians believe that the closure of factories and of what "ought to be" productive enterprises is merely due to psychology - someone is unwilling to put forward the cash to make the factory produce (as Krugman would say, "why should perfectly good productive capacity stand idle?"). The Austrians, on the other hand, believe that the idleness of productive capacity is due to the misallocation of resources, so that the factories cannot actually be productive because they lack the proper inputs.
For a whimsical example, let's say that I have a koala farm (for fur and meat). I invest huge amounts into buying all of the inputs, and then I invest huge amounts in buying a large numberof koalas. Then I find out that no one has bothered to make certain that the eucalyptus production is suficient to feed all of the koalas. Until eucalyptus production and the number of koalas grown on farms are brought into balance (either by reducing the size of the koala farm and putting the resources somewhere else, or by increasing eucalyptus production), much of the koala farm will be idle. You can't wish this away and make the koala farms more productive just by subsidizing the production of koala fur.
December 18, 2008 10:38 PM | Reply | Permalink
I must also add, though, that "representing a resource" is itself a resource. So money has a recursive effect. As with fractional banking, the value of the representation is (or should be, otherwise the system explodes) lower than the value of the represented.
(This is a minor point, but it's needed to make the equations work right.)
It's also worth adding that, over time, humans create more resources, so it's appropriate to have an expanding money supply. This is a good reason not to use something like the old gold standard. (There are good reasons to use something like it, of course; it's all a matter of balancing one's options.)
December 19, 2008 4:25 AM | Reply | Permalink
I must also add, though, that "representing a resource" is itself a resource. So money has a recursive effect. As with fractional banking, the value of the representation is (or should be, otherwise the system explodes) lower than the value of the represented.
Yes, it is true that "representing a resource" is itself a resource, in that money facilitates trade and thus is an improvement on a barter economy.
My point, I guess, is that monetary analysis ultimately can be reduced to an analysis of the represented resources, and that any analysis that assumes things that cannot be reduced to this will bring erroneous conclusions.
December 19, 2008 4:44 PM | Reply | Permalink
A govt deficit is a net increase in financial assets of the non-govt sector, as credits to reserve accounts (CREATED out of "thin air," not requiring any "resources") are greater than debits to reserve accounts.
A govt bond sale is an asset trade . . . reserves (essentially overnight liabilities of the govt) for Tsy securities (longer term liabilities of the govt).
The net effect of the two operations (irrespective of whichever order you prefer to put them in) is a net increase in the financial assets held by the non-govt sector. That's how it works . . . always (assuming you're not operating in a gold standard, of course). It doesn't require the Fed to "pump money" or any other sort of intervention (by foreign investors, etc.).
This will, ceteris paribus, be a net addition to aggregate demand, which may, or may not, be inflationary (see Prof. Wray's earlier post for more on inflation). At any rate, more aggregate demand is most definitely what is required at the moment, and it will most definitely not crowd out real or financial resources.
December 18, 2008 10:41 PM | Reply | Permalink
The difference with Austrians is that Austrians have no understanding of the monetary system and are essentially analyzing a barter economy.
December 18, 2008 10:43 PM | Reply | Permalink
The differenceis that Austrians understand that money is simply an indirect form of barter and do not give it any magical properties.
December 18, 2008 10:57 PM | Reply | Permalink
Right . . . another way of saying they don't understand the monetary system.
December 18, 2008 11:15 PM | Reply | Permalink
No, I think that we are the ones who truly do understand the monetary system - all of the complications that come from treating a monetary economy as something other than indirect barter are, I believe, a form of flim-flam to obscure what is actually going on. The idea that money issues have an existence independent of its use as a proxy for goods and services is used to make the essential aspects of the economy seem more complicated and further removed from real life and common sense than they are, and is essentially promoted by two classes of people: those who wish to flim-flam others, and those who have been flim-flammed.
I think that you are in the second category; I think that your belief is honest, but also incorrect.
December 18, 2008 11:32 PM | Reply | Permalink
By the way, the reason why World War II succeeded better at ending the Depression than the New Deal did was because of the massive savings imposed upon us to pay for the industrial upgrades and investments needed to win the war.
If we hadn't had rationing, and the constant campaign to get us to put our savings into war bonds and stamps to fund all of the investments, we would not have been able to have funded the industrial growth and the depression would have continued.
Ask yourself this question: why didn't the U.S. forego rationing, shut up about buying liberty bonds and stamps, an simply fund the war by printing money to pay for all of the factories, mines, planes, bombs, and tanks?
Then ask yourself, why do they think they can produce prosperity by borrowing without an increase in savings to back it up when we are not at war?
December 18, 2008 10:43 PM | Reply | Permalink
.
Well . . .
We didn't have the Chinese, the Japanese and the House of Saud buying our long-terms and putting the nation in debt up to our collective ears to foreign investors?
Just a thought . . .
~OGD~
December 19, 2008 4:18 AM | Reply | Permalink
Glaivester . . . we went off the gold standard in 1933. Again with all due respect, your analysis assumes we were on it during WWII and are still on it today. (Correction from previous post . . . Austrians analyze as if we're on gold standard, not barter--at least not always.)
WWII saving was to hold inflation down. Who had enough income to save before the govt starting running big deficits? Unemployment was above 14% until 1940. Interest rates stayed low because the Fed targeted very low interest rates on Tsy securities during WWII.
December 18, 2008 10:57 PM | Reply | Permalink
WWII saving was to hold inflation down.
WWII saving was to prevent people from consuming resources that were needed for the war effort. Holding inflation down is essentially just the monetary manifestation of that fact.
A govt deficit is a net increase in financial assets of the non-govt sector, as credits to reserve accounts (CREATED out of "thin air," not requiring any "resources") are greater than debits to reserve accounts.
Without an increase in resources, an "increase in assets" doesn't represent an increase in wealth. All it does is to redistribute the wealth - anyone whose "net assets" increased by a greater percentage than the "net assets" of the economy as a whole is wealthier, anyone whose "net assets" increased by less is poorer.
A govt bond sale is an asset trade . . . reserves (essentially overnight liabilities of the govt) for Tsy securities (longer term liabilities of the govt).
When entities other than the government issuing a bond buys the bond, they give up purchasing power that could have been used for something else. Essentially they forego purchasing power which is transferred to the government, resulting in no net increase of demand, just a shift from one entity to another. If the government buys its own bonds, it is essentially creating new money, and no one is deliberately giving up purchasing power, so the effect is a net increase in demand.
It doesn't require the Fed to "pump money" or any other sort of intervention (by foreign investors, etc.).
The government buying its own bonds is "pumping money."
Again with all due respect, your analysis assumes we were on it during WWII and are still on it today.
No, it doesn't. Americans forewent the consumption of resources in order that they could be used for the war effort. Buying liberty stamps and bonds was essentially U.S. citizens giving up their purchasing power (in the short term) to the government to fund the building of war materials, and more importantly from the standpoint of economic recovery, to fund the building of the means of production for the war materials. Rationing furthermore was a way not only to reduce American consumption, but to specifically reduce the consumption of the specific goods and services that were needed for the war effort.
The fact that only so many resources were available at any point in time is true irrespective of what monetary system we use, or whether we use money at all. In order to use those resources for investment, we need to refrain from consuming them. Money of any sort is simply a bookkeeping tool.
The effects of saving and rationing on inflation is ultimately simply a manifestation of this underlying reality.
Do you actually think that when we are off the gold standard that we can conjure resources for production up out of thin air, or that the variations machinations involving financial assets mean anything in the absence of resources for actual production? Can you eat assets, or drive assets? Can assets keep you warm or cure your sicknesses, in the absence of actual resources for those assets to represent?
Do you really think that we could have funded all of the production for World War II without saving the resources needed for said production simply because we used non-commodity money? Do you think that the resources available was an irrelevant concern? Could we have fought the war with "assets?"
The idea that money represents something real in the absence of actual goods, services, and resources for it to represent is the fallacy that caused so many people to go into debt during the housing bubble, assuming that the appreciation in value of their homes somehow represented an actual increase in wealth that could be tapped with which to buy things.
December 18, 2008 11:19 PM | Reply | Permalink
"WWII saving was to prevent people from consuming resources that were needed for the war effort." Agreed.
Beyond that, though, you need to read Minsky and Wray.
December 18, 2008 11:38 PM | Reply | Permalink
Actually, WWII savings programs were intended to support Galbraith's project and counter/undermine the deleterious, psychological effects of black markets which in the absence of programs designed to drain money out of consumers' wallets threatened to go hyperbolic.
December 19, 2008 3:35 AM | Reply | Permalink
Another point about WWII that is relevant to today: approximately 43% of total wartime expenditures was covered by taxes, mostly on income.
So it is possible to have a strong stimulus program while also increasing taxes - as long as most of the tax comes from those who wouldn't spend it anyway.
December 18, 2008 11:39 PM | Reply | Permalink
So it is possible to have a strong stimulus program while also increasing taxes - as long as most of the tax comes from those who wouldn't spend it anyway.
No, you're wrong in your assertion that the important thing is to make certain that taxes come from money that would not be spent (i.e. if you are saying that we need more spending and less savings to simulate the economy).
Again, the stimulus from World War II came largely from increased savings used to cover capital investment (i.e., in industrial productivity), not from the money spent on blowing stuff up.
December 20, 2008 11:41 AM | Reply | Permalink
There's another viewpoint to consider: What's the most useful investment for a guy with a few million and no "stuff" he wants to buy? I think the stock market bounced up when interest rates went to zero because there isn't a socially responsible place to put money these days. Real estate isn't cheap enough yet. The trouble with the stock market is that even if you invest in progressive(ish) businesses, your money mostly goes to your broker and other investors, not directly to the business (except in the IPO). In WWII, the rich guy could buy war bonds to help his country. No real equivalent today. I'd like to see a lot of green tech and mass transit muni instruments of some sort out there.
December 19, 2008 3:21 AM | Reply | Permalink
December 19, 2008 4:34 AM | Reply | Permalink
The obvious threat here is for oil to be priced in something other than dollars. Should the floating rate value of the dollar drop sufficiently far and fast, oil could be re-priced in euros for example, after which we would be in trouble, since we do not produce enough domestically.
As long as you are not proposing to hyperinflate, this particular objection vanishes. (Of course, hyperinflation is bad for other internal reasons anyway. In particular people lose faith in the currency, so that it stops having value.)
December 19, 2008 4:29 AM | Reply | Permalink
Yes, better to have policy promote substitutes in that case, which obviously the Europeans (for instance) have done better than us over the last few decades. It also doesn't necessarily require oil to be priced in something other than $ . . . it's plenty bad already when oil is $150 a barrel (or more).
December 19, 2008 9:44 AM | Reply | Permalink
Interesting comments. A couple of responses:
1. Looks like an infinite regress in arguing over the Austrian view of saving and money. I agree with the STF position on all of that.
2. In WWII, we needed to ration to avoid inflation that would occur beyond full emp. Govt could always have won any bidding war, but at the cost of accelerating inflation. War bonds and taxes sucked income away (temporarily in the case of bonds), helping that process, and as Ellen said (interesting point) it also probably reduced black mkt activity.
3. All of the hand wringing about demise of the dollar sure was misplaced! It has come back like a lion. Euroland right now is trying to depreciate its way to recovery--really the only thing it can do since it is just a bundle of nonsovereign countries with no domestic policy space.
4. but yes we need to reduce dependence on oil, and also on coal.
December 20, 2008 3:32 PM | Reply | Permalink
Randall Wray and STF:
The problem that I have with your views is that, as I see it, you believe that having fiat money (or "sovereign money," if that is the term you use) allows you get something for nothing.
Maybe you don't exactly believe that increasing the amount of money in the economy is equivalent to increasing the amount of wealth, but I think that what you do believe ultimately boils down to a qualified version of that once you cut through all of the jargon and get to the fundamentals.
STF: The difference with Austrians is that Austrians have no understanding of the monetary system and are essentially analyzing a barter economy.
Me:The difference is that Austrians understand that money is simply an indirect form of barter and do not give it any magical properties.
STF:Right . . . another way of saying they don't understand the monetary system.
Essentially, I would argue that STF, by denying that money is ultimately an indirect form of barter, is saying that it has magical properties, and that the issuance of money allows the economy to get something for nothing. However, in the end, all that money does is facilitate transactions and allow for the calculation of wealth by providing a single standard to measure wealth and transactions by. While this definitely gives money a function that in a sense increases wealth in a society (compared to one without money), it does not mean that the amount of money in a society affects its wealth (provide that the money can be denominated in such a way as to make small transactions feasible - if we could not divide money into increments smaller than $100, for example, we would need enough money that everything could be easily sold in $100 increments, but if we could, if we desire, divide money into units smaller than any reasonable transaction, then the amount of money is irrelevant).
Ultimately, all that money creation does is shift wealth to those who receive the money early from those who receive it late. The only way that this can be economically beneficial is if you think that this indirect form of taxation, this form of wealth redistribution, takes wealth away from those who misuse it to those who will use it better. Any explanation for how manipulating the money supply will improve the economy that does not ultimately reduce to this is nonsense.
December 21, 2008 12:18 PM | Reply | Permalink
In WWII, we needed to ration to avoid inflation that would occur beyond full emp.
The problem with this argument is that you are arguing the symptoms, not the root issue. "Rationing to avoid inflation" - why? Because if you did not ration, people's demand for goods would go up, thus raising prices. Why would demand for goods raise prices? Because it would reduce the amount of goods available for the same amount of money, thus causing the relative value of the goods compared to the money to go up.
So ultimately, rationing was done to conserve resources, so that those resources could be directed to other uses.
Govt could always have won any bidding war, but at the cost of accelerating inflation.
But this would have also amounted to rationing, just price rationing rather than the form that rationing actually took.
War bonds and taxes sucked income away (temporarily in the case of bonds), helping that process, and as Ellen said (interesting point) it also probably reduced black mkt activity.
Yes, but part of the reason to reduce such activity, again, was to make certain that resources went to the war effort rather than to those who participated on the black market.
The point I am trying to make is that the economic recovery of World War II was accomplished largley by conserving resources to be used for investment in capital goods (factories, mines, etc.). The idea that the economy recovered because of the massive consumption or because of massive spending on goods (e.g. military hardware) that were quickly consumed simply doesn't make sense.
If increasing consumption were the way to help the economy, there should have been no rationing during World War II, because people consuming more goods would stimulate the production of more goods and thus helpo the war effort. That saving resources was encouraged indicates that at some level this basic fact was understood in World War II.
If you want an effective economic stimulus package, you need to fund it by savings. If you want to create massive infrastructure or other capital goods as a way to try to create jobs, you need (a) to make certain that this infrastructure will be economically beneficial, and (b) encourage people to curb their consumption in other areas in order to fund it (basically, you need a "buy government bonds" campaign). Otherwise, you will soon run out of resources, and some capital projects will have to shut down.
I'm not saying that this is the most effective way to get economic recovery (I'm more of an Austrian free-market guy), but it certainly beats massive unfunded debt (i.e. printing money) or getting more in hoc to China et al. (unless of course your plan is to borrow a lot from foreigners and then screw them out of it by repudiating some the debt or by devaluing the currency to repudiate some of the value of the debt).
December 21, 2008 12:33 PM | Reply | Permalink
Ok, I'll bite.
First, nobody said that the economy recovered during WWII because of "massive consumption," but rather because the govt credited bank accounts to move otherwise idle (at least to begin) resources into military production. To continue doing this on such a massive scale without creating inflation, it's necessary to constrain consumption and thereby ensure finite productive capacity is sufficiently supporting the war effort. Nobody suggested that the capacity was "consumed," though it certainly depreciates if not maintained.
Second, if the US govt were to, say, purchase cars from Chrysler right now (not saying they should, necessarily) instead of having Chrysler shut down factories, and if it were to do it by simply crediting Chrysler's bank account (no bond sale, no taxes), how does that look within your framework?
December 21, 2008 7:04 PM | Reply | Permalink
First, nobody said that the economy recovered during WWII because of "massive consumption," but rather because the govt credited bank accounts to move otherwise idle (at least to begin) resources into military production.
My point was that I do not see how producing things that are to be destroyed without adding the the standard of living of anyone can help the economy compared to where it would have been had such production not been necessary (obviously one could argue that military production helped us in that we avoided an economically catastrophic victory by Hitler).
What caused the recovery were the massive capital improvements that were built (factories, mines, technological development) in the process of creating the military production.
To continue doing this on such a massive scale without creating inflation, it's necessary to constrain consumption and thereby ensure finite productive capacity is sufficiently supporting the war effort.
Yes. That's my point. At any given point in time, we have a particular finite capacity (over time, that capacity can grow). In order to do more of one thing, we have to do less of another. In order to invest in capital goods, we must reduce our consumption of resources by the same amount that we wish to invest.
My point is that the massive inflation that would result if we had not constrained consumption reflects the deeper economic reality that no amount of crediting to bank accounts increases the actual resources available to use at a given time.
The Americans war effort was ultimately funded by the resources that Americans forewent consuming in order to contribute them to the war effort. Rationing, buying war bonds and stamps, all of these things represented U.S. citizens (and other residents) giving up purchasing power (and therefore consuming power) so that the resources they consumed could be used for the war effort. Rationing and war bonds prevented inflation because they prevented consuming scarce resources beyond what was available.
Nobody suggested that the capacity was "consumed," though it certainly depreciates if not maintained.
I never suggested that capacity was consumed (which I assume to mean capital goods being dismantled to create lower order goods) or that the consumption of capacity was what brought us out of the Depression.
What I am saying is that people suggest that the consumption of resources to produce military hardware is what got us out of hte Depression. What I meant by "consumption" was the production of first-order goods, that is, goods that are not used for the production of other goods, such as war machines and consumer products.
My point was that what got us out of the recovery was a shift in the use of resources from producing lower-order goods to producing higher-order, or capital goods. In other words, consumption and building productive capacity are two competing uses of resources. During World War II we used rationing and the purchase of bonds and stamps to shift our use of resources from the lower-order to higher-order goods. Yes, we stil produced first-order goods such as planes, tanks, and bombs, but we also produced second- and higher-order goods, such as factories, mines, technological improvements, and this was largely funded by restricting the use of resources for consumption.
Second, if the US govt were to, say, purchase cars from Chrysler right now (not saying they should, necessarily) instead of having Chrysler shut down factories, and if it were to do it by simply crediting Chrysler's bank account (no bond sale, no taxes), how does that look within your framework?
Well, what it would do would be to redirect resources toward Chrysler. By crediting Chrysler's bank account, you would give Chrysler a greater ability to purchase resources. Because adding such credits does not make new resources come into being, this would result in Chrysler's competitors having a smaller ability to purchase resources. If it resulted in an overall increase in the number of cars produced, it would also mean that competing uses for car-making resources would be deprived (e.g. we would be using metal to produce cars that would have otherwise been used to produce some other thing that people would have chosen to buy instead in the absence of government intervention).
If the government destroyed these cars, it would simply be wasting the resources used to produce them. If the government gave them away, it would essentially be imposing the cost of those cars on Chrysler's competitors, who would have to pay more for the resources for car buying and who would also face reduced demand for their vehicles. It would also be imposing costs on anyone who wanted to use the resources Chrysler used to build the cars for some other use (because raw materials would be scarcer and cost more). It could also discourage Chrysler from innovation, if it knew that it had a guaranteed market for its cars. This could also make it easier for Chrysler to produce cars more affordably than the competition, which would result in a lot of people who prefer some other style of car winding up getting the less satisfactory Chrysler because of the subsidy (and the implicit tax on Chrysler's competitors).
What it would not do is suddenly make resources more available or increase overall productivity. Yes, you might save Chrysler from going under, but it would not be costless, even though the costs would be dispersed and much harder to quantify than the cost of Chrysler shutting down.
December 21, 2008 8:22 PM | Reply | Permalink
Does your framework allow for, in the absence of crediting Chrysler's bank account, resources simply sitting idle, not being used at all, deteriorating, layoffs and so forth at parts suppliers, reduced income for employees of Chrysler and its suppliers? Or do all of these find some other, more productive use rather quickly via the market or some other mechanism?
December 21, 2008 8:32 PM | Reply | Permalink
Yes, resources can sit idle. However, I believe that resources that can be put to a useful purpose generally will be.
I think that this is the difference between the Austrian theory of recessions and the Keynesian theories (I don't know enough about the Friedmanite theories). Keynesians believe more or less that resources siting idle during a recession is due, more or less, to a psychological unwillingness to use them. The resources are there, but the will isn't. So government intervention and manipulation gets them working again.
Austrians tend to believe that when resources sit idle, it is because their development has been miscoordinated with complementary resources. (For example, you've built the automobile plant, but do have a great enough supply of chromium to make all of the bumpers you need. Or there is not enough rubber to make all the tires that are needed for your cars to be useful). To "de-idle-ize" them with government intervention will deplete those resources for other uses, and impoverish other areas of the economy.
The only long-term solution is to allow the different resources to equilibrate so that they are coordinated. The market is, in my opinion, the best way to do this. However, if the government is going to intervene, the best intervention would be to try to get an overall increase in capital investment without trying specifically to get the increase to any one item (i.e. let the market handle the details). The best way to do this is to have some sort of savings program to get people to save money that is then available for capital investment.
Yes, increased savings in the short term might cost retailers. But it would rebuildd the economy on a stronger footing. (And note that the purpose of savings is always investment, not just that people reduce consumption to hoard resources, but that they do so to increase the proportion of spending that is done on capital goods).
December 22, 2008 10:40 AM | Reply | Permalink
Ok . . . thanks.
Chrylser's stated reason for shutting down factories (at least temporarily) was that their customers couldn't get credit. Also, Toyota is reporting a loss for the first time in 70 years. In your view, is this due to "miscoordination"? Will more saving by consumers help the auto industry eventually come out on a "stronger footing," in your view?
Lastly, in regard to "The best way to do this is to have some sort of savings program to get people to save money that is then available for capital investment," since loans create deposits, is it the case in your view that money isn't the issue here, but whether there are real resources available if the money is created? (Deposits precede loans--whether fractionally or not--only in a gold standard monetary system.)
December 22, 2008 9:35 PM | Reply | Permalink