John B. Taylor summarizes the presentations at a symposium, “Restoring Robust Growth in America”:
George Shultz led off by arguing that diagnosing the problem and thus finding a solution was extraordinarily important now, not only for the future of the United States but also for its leadership around world. Tax reform, entitlement reform, monetary reform, and K-12 education reform were at the top of his pro-growth policy list. Alan Greenspan presented empirical evidence that policy uncertainty caused by government activism was a major problem holding back growth, and that the first priority should be to start reducing the deficit immediately; investment is being crowded out now. He also recommended starting financial reform all over again because of the near impossibility of implementing Dodd Frank. Nick Bloom, Steve Davis and Scott Baker then presented their empirical measures of policy uncertainty and showed that they were negatively correlated with economic growth.
Other presentations proposed tax reform, examined the effects of bailouts in Europe and the United States, and several presentations explaining how and why fiscal policy wasn’t working.
Here’s his conclusion:
In sum there was considerable agreement that (1) policy uncertainty was a major problem in the slow recovery, (2) short run stimulus packages were not the answer going forward, and (3) policy reforms that would normally be considered helpful in the long run would actually be very helpful right now in the short run.
Let the feces-flinging begin!
How is investment being crowded out now compared with four years ago? Tax rates are the same or lower. The debt has grown, but it did that constantly under Greenspan, so how serious can he be?
Anyway, yes on tax reform and entitlemereform, but I am not sure how it helps right now. Also, let me go out on a limb here. If the GOP wins in 2012 and repeals Dodd- Frank, there will be no replacement
Steve
The way to restore robust growth to America’s economy is to fire (or better yet, jail) every single major American corporation’s CEO and replace them with a Chinese CEO.
I’m starting to get the feeling that “policy uncertainty” is just a tagline to use while a Democrat is president. There are very few small “c” conservatives in the U.S. that would give you ACTUAL policy certainty. Even then, there are those pesky elections every two years we can never predict the outcome of.
Is there any empirical evidence that US federal government debt is crowding out investment? The banks are lending at the moment, but that seems to be more a function of uncertainty over future economic prospects than anything else.
But what about the corporations that are making record profits, or are sitting on huge amounts of cash? Why aren’t they investing more? That isn’t because of a lack of readiness on the part of the financial community because they’ve loaned it all out to the federal government – they’re just not investing here regardless. (Although some seem to be investing overseas eagerly enough.)
The truth is that the federal government’s debt problem hasn’t caused a crisis YET. We’re rapidly approaching a point where it must, but we haven’t hit that pot hole yet.
The debt has grown, but it did that constantly under Greenspan, so how serious can he be?
Review your time-lines.
If the GOP wins in 2012 and repeals Dodd- Frank, there will be no replacement.
That would actually count as addition by subtraction. Removing a negative helps, even if you don’t add a positive in turn.
Just to be clear I’m not necessarily endorsing the viewpoints that Dr. Taylor outlines on his blog or those of the symposium presenters. I’m only highlighting those viewpoints to extend the discussion.
At this point I guess I think that there’s so much distortion in the economy that nobody has much of any idea what the results of any policy have been let alone are likely to be.
Oh yeah, empirical evidence schmemperical schmevidence.
Yeah because $400 billion is exactly the same as $1.4 trillion.
The other day I stumbled across a recent empirical study that found that, indeed, uncertainty was a significant factor in the slowness of the recovery. I’ll see if I can dredge it up.
Yeah that would be good.
I was being a bit sarcastic. I think there is something to the policy uncertainty angle. It isn’t the entire story to be sure, but when you talk about making big changes it can frighten people…one of those animal spirit thingies.
The crowding out argument is based on the idea that government spending raises interest rates because reserves are removed from the banking system by borrowing, thereby making loans more expensive. This is entirely incorrect.
Government spending actually drives interest rates DOWN, because our government does not borrow when it goes into deficit. It just credits accounts and creates new currency, which when spent actually increases bank reserves. The additional reserves (inert money, because banks don’t loan their reserves outside the banking system) force banks to compete to rid themselves of the excess, driving down the inter-bank interest rate. Unlike Greenspan I can actually prove this by pointing out that after three years of trillion dollar deficits bank reserves have increased 2,100%, which directly contradicts the basis of “crowding out” theory. In fact Greenspan is so wrong the Fed is now paying banks interest to hang onto those excess reserves in order to prevent the interest rate from falling to zero.
I see he hasn’t yet abandoned his theology.
“In sum there was considerable agreement that (1) policy uncertainty was a major problem in the slow recovery, (2) short run stimulus packages were not the answer going forward, and (3) policy reforms that would normally be considered helpful in the long run would actually be very helpful right now in the short run.”
It is astonishing the realities of sectoral balances still have not sunk in to our Wise Men: a spending cut is identical to a tax increase, i.e. the money our government “saves” from lower deficits has to come from somewhere. Our trade balance is negative which leaves only the private sector to strip of assets in the quest for deficit “certainty”.
“The other day I stumbled across a recent empirical study that found that, indeed, uncertainty was a significant factor in the slowness of the recovery. ”
Good. Already looked it over and read critiques on it.
Steve
Ben,
Please explain the problem in Greece, Spain, Ireland, etc? What happened in Germany post WWI, what happened in Zimbabwe?
This notion that governments can create money with virtually no downside strikes me as patently at odds with current and historical events.
This strikes me as…well goofy.
Okay, so the government creates new money by spending money it didn’t previously have…but banks can’t loan this money out even though it is spendable….why? It just has to sit there in the bank as reserves and never go anywhere? Is this the only source of reserves? Please explain if the answer is either yes or no.
I’m not trying to be a dick…well not totally, but you are espousing an idea that is very heterodox, so asking you to explain in more detail strikes me as reasonable.
To be quite honest I have issues with taking accounting identities and turning them into tools to figure out how the economy works. It is a bit like using your car’s gas gauge to monitor your car’s overall maintenance.
Sorry to keep asking these questions Ben, but they pop into my head….
You wrote,
If the banks can’t lend these reserves how do they get rid of them?
“Please explain the problem in Greece, Spain, Ireland, etc? What happened in Germany post WWI, what happened in Zimbabwe?”
Germany suffered from foreign denominated debts (meaning in a currency it did not control), loss of a war and collapse of its productive capacity due to France’s occupation of the Rhine. In desperation it turned to the printing press to buy the gold it owed the victor nations, resulting in rejection of the domestic currency by the German people. Zimbabwe suffered from civil war, foreign denominated debts and collapse of the tax system which led to outright rejection of the nation’s currency. A similar story for Greece, Ireland, etc. though they haven’t experienced hyperinflation: all had debts denominated in a foreign currency, a major no-no in MMT.
“This notion that governments can create money with virtually no downside strikes me as patently at odds with current and historical events.”
The limitation on government spending is inflation. Spend too much into the economy and it runs the risk of pushing demand beyond the country’s productive capacity. That’s genuine crowding out, because it puts government in competition with the private sector for real resources. The basic tenet of functional finance (which I completely accept) is that government exists to benefit the private sector and must never spend or tax in a way which impoverishes it.
I’m not arguing that government can spend as much as it wants with no downside. What I’m arguing is that crediting accounts is actually how our government funds its activities. In fact it’s been doing it for forty years since Nixon closed the gold window. It LOOKS like government funds its deficits through borrowing because we have a gold-standard era law which requires issuing debt in equal proportion to deficits, but this is just an illusion. Believe me, I know it’s a mind-bending concept but this is what actually happens when U.S. bonds are issued. Bank reserves are disbursed from the buyer’s bank to the government’s account at the Fed, and are switched back to the buyer’s bank when the bonds mature.
“It just has to sit there in the bank as reserves and never go anywhere? Is this the only source of reserves? Please explain if the answer is either yes or no.”
Reserves are only used for clearing transactions and payments, and for meeting reserve ratio requirements. The Federal Reserve is the monopoly supplier of bank reserves, which it uses to control interest rates and ensure the system doesn’t come to a halt because banks can’t trust each other’s checks. It works like this:
Let’s say you go to your bank, Wells Fargo, and request a loan for a car. They assess you, find you credit worthy and issue you a check. You go to the car dealer, pick out your new car, then hand him the check and drive off. The dealer takes the check to HIS bank, Bank of America, where he hands it to a teller who immediately enters the amount into the system. The teller doesn’t even question whether the check will clear, he simply makes an entry into the computer and your loan creates a deposit in the car dealer’s bank account.
Later that night Well Fargo has to ensure that the check it issued clears because the Fed requires it to do so. It will check its bank reserves to determine whether the levels are sufficient to cover the check. If they aren’t it can either go to the inter-bank market to borrow reserves from another bank, or it will go to the Fed’s discount window and borrow from the Fed, but there’s a penalty attached to the loan so borrowing from the inter-bank market is preferred.
This is the only use banks are permitted for their reserves, and because of this the Fed can pump up the monetary base all it wants and it won’t do any good; the reserves have no channel to enter the real economy. The reason government spending increases those reserves is because when government transfers money into the real economy, it does so by transferring new reserves to the recipients’ banks to clear payments.
The more our government spends, the faster reserves accumulate. The banks obviously wouldn’t want excess reserves just sitting around, so they compete to loan their reserves to banks which are short by bidding down the interest rate. The only way the Fed can intervene to prevent this from driving down to zero is to pay the banks interest on reserves, giving them a reason to hang on to the excess rather than bidding down the inter-bank interest rate, and since 2008 this is exactly what the Fed has been doing.
The problem I see Ben, is that the reserves did have an impact on the real economy…I got a car.
I think that’s incomplete, at least in the real world. If the government just produced more money and spread it evenly throughout the economy, you might be right but it doesn’t. It spends in some places and doesn’t spend in others. This creates relative price differences, distortions, in the market.
The additional money available for particular goods and services attracts individuals and companies to provide those goods and services. That creates more distortion. The deadweight loss reduces the level of economic activity below what it would otherwise be. IMO the distortion is probably harder to wring out of the economy than inflation.
That’s the reasoning behind my view: even if the government is not reserve-constrained it should, in general, behave as though it were. The consequences of not doing so are beyond its ability to predict or control.
Also, I’m reading up on this MMT, found some stuff by Wray. One thing he posits is that for there to be net private sector financial assets the government has to engage in deficit spending. The reasoning follows as such.
If I borrow from Ben, my liabilities are his assets. The sum of these two is zero. This is true of all private sector financial transactions. Now if the government engages in deficit spending its liabilities are my assets.
Problem is I see this as being incomplete….
Eventually, the government will redeem that bond and it will do so via taxes. In a world that is distortion free (don’t laugh this is just a thought experiment) the total tax bill will equal the value of the assets. However, we don’t live in a distortion free world. Deadweight loss will ensure that there is a loss associated with that deficit spending (unless that spending entails further economic activity that offsets this loss, a positive multiplier effect).
So even still everything nets out to zero…or less. Note, I don’t think the deadweight loss issue crops up in private financial transactions because one party does not have the power to distort prices, well ideally (i.e. neither party has price setting power).
And to say that the reserves have no impact on the real economy is misleading to some extent because it leads to increased demand and thus inflation. However, this supposedly isn’t like inflation that we think of. These are legitimately higher prices due to higher demand. We see that here,
Productive capacity is not set in stone. In the immediate run it is pretty much fixed, but with higher prices and higher demand for more goods and services (i.e. this isn’t a money illusion problem) there is a strong incentive to provide those goods and services. So this in turn will lead to an increase in the productive capacity.
I’m sorry Ben, but your views strike me as being insufficiently grounded in micro economic theory. That was a painful lesson macro/monetary economists learned in the late 1960s and into the 1970s.
Just out of curiosity how does MMT explain stagflation?
@Ben Wolf
The reason the Fed is paying interest on bank reserves is to get the banks to increase their reserves. When the banks balance sheets begin to blowup, they will have the money to cover the losses. The Euro crisis has been on the radar for a while, and it ain’t getting any better.
——————————
I think I can see what you saying about the banking system, reserves, and government debt. I am still trying to digest it, but my impression is that it is tautological. The banking system is based upon asset/debt columns balancing. It seems that your argument is that money is just moving between the columns. I realize this is probably a vast oversimplification.
You may have addressed this, but how do you account for the Fed’s balance sheet? It seems to me that if it is included, the entire system would be out of balance. I suspect this the reason the Fed is not audited.
“For the Snark was a Boojum, you see.”
“The problem I see Ben, is that the reserves did have an impact on the real economy…I got a car.”
It’s not that reserves don’t have an effect on the economy, it’s that the liability and loan together net to zero. This is the weird part: the bank doesn’t actually lend money. It just offers to clear a large payment through the banking system in exchange for a series of smaller payments in the future. As the loan is repaid the money you send to your bank is “destroyed”, and loan and liability disappeared. The loan financed a productive activity (you pay your bills and you needed a car more than you needed the money) and thereby increased the private sector’s wealth. What did not happen is that net financial assets (in this case money) were not added to the private sector. Money goes in, money comes out.
“I think that’s incomplete, at least in the real world. If the government just produced more money and spread it evenly throughout the economy, you might be right but it doesn’t. It spends in some places and doesn’t spend in others. This creates relative price differences, distortions, in the market.”
I agree, and probably should have worded it better. There is no hard constraint on how much government has the capacity to spend. But there are real constraints if we agree we don’t want government trashing our economy. One way it can do that is through inflation. The other as you point out is malinvestment triggered by WASTEFUL forms of government spending. Pretty much any MMT advocate is going to argue that the appropriate discussion on policy is not, “can we afford it?” but rather, “should we do it?”
“Eventually, the government will redeem that bond and it will do so via taxes. In a world that is distortion free (don’t laugh this is just a thought experiment) the total tax bill will equal the value of the assets.”
This is true, if the government is actually engaged in borrowing to fund spending. But one of the primay observations of MMT is that the government is only simulating borrowing. It keeps going through the motions but actually just prints what it spends and then uses the bond issuance to drain the reserves it creates through that spending. If the government only spent what it could gain via taxation and borrowing, there could never be an increase in the money supply because what government takes in and what it spends out would always net to zero. Yet we know the money supply does increase because we have all kinds of metrics tracking its growth.
Think about this thought experiment:
A country on the gold standard and using gold coins has run out, its mines depleted. This prevents growth in the supply of money and limits economic growth. So its leaders decide to switch to an entirely fiat currency (we’ll assume they were freely and fairly elected) of which the government is the monopoly supplier. The main problem is how to get the people to accept a currency which has no intrinsic value. It’s just a slip of paper not based on anything, so why would anyone want it? The solution their leaders arrive at is to declare a tax in the new currency, which will require citizens to go out and get their hands on sufficient currency to extinguish their tax liabilities. For anyone who tries to pay with the old gold coins, the government has men with guns and prisons to provide additional incentives for compliance.
But now an additional problem becomes apparent: how can people pay their taxes with the new currency when they don’t have it yet? Somehow government has to put sufficient currency in the private sector to pay its taxes, and it does so by SPENDING the currency into the economy. In the case of this country government buys all the gold coins in circulation with the new currency, and spends extra to give people the chance to save, invest and engage in other transactions.
Printing and spending more than savers can horde means spenders don’t have to watch their income drop. It can’t be any other way because in our current system government is THE monopoly supplier of the dollar.
“The reason the Fed is paying interest on bank reserves is to get the banks to increase their reserves. When the banks balance sheets begin to blowup, they will have the money to cover the losses.”
This conflates reserves with capital. Reserves can’t be used to cover losses because the Fed won’t allow it. Capital, however is required to cover losses in the event that loans don’t perform. The confusion stems from the Fed having reserve requirements for banks, which is also an anachronism left over from the gold standard. Banks aren’t reserve constrained because they can always obtain the reserves the need from the inter-bank market or the Fed. Canada doesn’t even have reserve requirements because their central bank recognizes this fact.
Banks are on their own for capital though. They can get it from selling bonds or issuing shares and must have enough on hand to satisfy the Basil requirements.
Please keep in mind that what I’m writing is not my policy proposal. I’m simply saying that this is what we see when we study the operational details and coordination between the Fed and Treasury. You can confirm for yourselves that U.S. bonds are bought with bank reserves, and that reserves are supplied by the Fed. You can look at the Fed reports on bond auctions and see that the primary dealers ALWAYS offer more in reserves than there are bonds to buy, typically two to three times more. The Fed and Treasury ensure those auctions do not fail because they ensure sufficient reserves are available to the primary dealers to take down the entire auction. These are not the actions of an entity borrowing because it doesn’t have enough money, they’re the actions of a government which is now, at this minute creating whatever amount of currency it needs.
@Ben Wolf
When the assets go bust, the books are no longer balanced. The additional reserves are to prevent insolvency. By having more money in their Fed account than needed, the books will stay balanced. In order for the bank to borrow, they need a fraction in reserve. The FDIC has been working to strengthen the banks books for the present and coming crisis.
You have written before that the Fed cannot print money, but you just wrote that the government can create currency. Is this a technical argument?I may not be using the technically correct terms, but I would still contend that the Fed does create money. Until the Fed opens its books, we have no idea of whether the two columns balance, and I suspect they do not.
Personally, I think it is similar to money laundering, but what do I know?
“For the Snark was a Boojum, you see.”
“The way to restore robust growth to America’s economy is to fire (or better yet, jail) every single major American corporation’s CEO and replace them with a Chinese CEO.”
And they said years of acid and psilocybin wasn’t hard on the brain……
Steve V.- I told you, MMT will make your head hurt. The Interfluidity blog has a number of discussions about MMT thought and he does a nice job of interpreting and questioning the ideas.
Steve
“When the assets go bust, the books are no longer balanced. The additional reserves are to prevent insolvency.”
The reserves are to ensure liquidity, the flow of short-term funds doesn’t freeze up like it did after Lehman Brothers died. Insolvency is related to capital and the long-term capacity of the banks to pay off their debts. Our banking system is drowning in liquidity thanks to the Fed; what they’ve tried to keep secret is that the banking system is at the same time almost completely insolvent, hence the massive loans it made to “recapitalize” after the financial system went bust.
“You have written before that the Fed cannot print money, but you just wrote that the government can create currency. Is this a technical argument?I may not be using the technically correct terms, but I would still contend that the Fed does create money.”
Congress is the only body empowered to print and it does so by spending. When it does so the Fed transfers reserves to the banks of those organizations receiving the funds Congress authorized. So the Fed is effectively printing money, but is only empowered to do so when Congressional tells it to. On its own the Fed can only swap assets; bonds for reserves, cash for bonds etc. It has in fact more than tripled the size of the monetary base, but that base has no (lawful) channel to the real economy and cannot spark demand related inflation.
The monetary base consists of bank reserves which are not part of the money supply and cash which is too small to have a significant impact. This is why Bernanke testified last year before Congress that he didn’t know why the Fed’s efforts to stimulate had been ineffective: his neo-liberal and monetarist training said that increasing the monetary base would create new lending via the money multiplier, yet this didn’t happen.
The only way the Fed on its own can print money into the money supply, the “flow” of financial assets which powers economic activity, is to make loans and deliberately take losses. This would be a gross violation of the Fed’s charter. So for example if the Fed were to make a $100 billion loan to the ECB in exchange for euros, then were the euro to become defunct, the Fed has effectively dumped $100 billion into the private sector. A number of bank watchers have expressed concern that this is exactly the risk the Fed is running with the unsecured swap lines we heard about last week. If no hard assets are pledged to the Fed as collateral in the event of euro collapse then there’s no even swap and the Fed’s efforts will result in expansion of the money supply. One of the Fed governor’s voted against the swap lines for this very reason.
By the way, thanks to everyone for putting up with my typos from last night, the unfortunate results of writing about MMT an hour after tequila shots at Nacho Hippo.
But I still got a car…for more than the manufacturer produced it. There is a real gain, so for the economy it is not a zero sum game.
And this is where people who either haven’t heard of MMT or don’t agree with it say, “This is a strong implication that deficits simply don’t matter.” The government can just keep this perpetual motion machine going forever. Social Security’s actuarial short fall is just blinkered accounting, the government will just do its thing to create more reserves. I’m not kidding this is a view expressed here,
In other words, there really is such a thing as a free lunch! All we have to do is issue debt and just keep rolling it over. So long as the government sets an interest rate lower than the growth rate of GDP the government can run a stable ponzi scheme.
And this paragraph,
First it is the government that creates reserves, then the Fed, then the government again. But we are told the Fed can’t do anything to the economy, but the government can by creating reserves…but can’t the Fed create reserves?
Tastybits,
That is because it is. Taking an accounting identity and working of that gives you pretty much a tautology. Where the rubber really meets the pavement is when you start to deal with human behavior…those are not derivable from accounting identities are are contestable.
This is another thing that annoys me. Sure the U.S. government is the monopoly supplier of the dollar…but the dollar is not the only currency in game…so it is more akin to monopolistic competition than monopoly.
Again, lack of appreciation for micro foundations.