I am sick of reading or hearing how brilliant such and such economist is and how they should be regarded as oracles because of this “brilliance”. In all these cases, the reality is usually that these characters have left a trail of destruction as a result of applying their brilliant minds. The terminology is always invoked by financial commentators and the like to elicit some authority in the ideas of the person. Apparently, if someone is deemed brilliant we should take heed of their words and judgements. How could we ever question them? In this neo-liberal era, many such “brilliant” minds have been placed in positions of authority and their influence has shaped the lives of millions of people. The financial and then economic crisis has shown categorically that their mainstream macroeconomic insights are not knowledge at all but religious beliefs that bear no relation to real world monetary systems. But still these characters strut the policy stages – shameless – and, in doing so, continue to destroy the prospects for many. It would be good it they were truly brilliant and could see the destructive consequences of their religious zealotry. Oh to be truly brilliant.
There was this article – Inside the crisis – published in the New Yorker (October 12, 2009) which told us that Larry Summers is “one of the most brilliant economists of his generation”. Apparently:
… there are forty brilliant insights scattered around whole bunches of literatures … especially finance, labor, and macroeconomics.
By what criteria would we judge that?
That particular article documented the reasons why the US stimulus was too small despite modelling and advice that it should have been probably twice as large and even then it would have only partially filled the identified output gap that had emerged as private spending collapsed.
The decisions were taken at a meeting on December 16, 2008 and the final memo to the President from Summers outlined why the stimulus should not target the identified output gap. The memo said the stimulus should rather be:
… an insurance package against catastrophic failure.
So what you learn there is that despite the claims by the deficit terrorists that the fiscal stimulus did not work given the appalling unemployment that is evident the real reason that the US economy is still languishing close to recession is that – by design – the US government deliberately failed to introduce a stimulus of sufficient size to address the problem that they had identified.
In other words, Summers advised the President to allow unemployment to sky-rocket but to do just enough to prevent a depression (catastrophic failure). Fiscal policy didn’t fail in the US. It just wasn’t given a chance to work when it should have been. Had the US government introduced a $US1.2 trillion stimulus and relied on multipliers to fill the identified $US2 trillion output gap things would have been very different and the job losses would have been less.
Further, the hysteretic (path dependent) effects that arise when a recession is drawn out would have been stifled. The skill losses, the capital scrapping, etc would have been far less than have actually occurred as a result of the US government’s deliberate strategy to under-stimulate. These effects reduce the potential growth path and make it harder to get back onto the previous trend growth. They ensure that the costs of the recession persist for years after the recovery process is under way.
The costs are not only in the extended losses of income. The accompanying costs manifest in the criminal justice system (rising crime), the health system (rising mental and physical illness), the family court systems (rising marriage and family breakdown) etc. The sum of these costs dwarf all other economic costs. And we should not forget that human lives are destroyed by prolonged recessions – dignity is lost, self-esteem disappears and the children who grow up in jobless households inherit the disadvantage that the system (failure to provide enough jobs) forces on their parents.
In other words, the costs of a recession endure across generations. The longer the recession the greater the costs.
Why would a “brilliant” mind in the face of the worst economic shock in 80 years and knowing that fiscal policy effectiveness would be in trial (given the fact that the neo-liberal dominated economics profession had largely come to the view that only monetary policy was effective) deliberately design a policy response to that ensured the economy would remain in a deeper and longer recession than otherwise?
Why would a “brilliant” mind who knew that the output gap would only be closed by additional spending and clearly knowing that there would be major political fallout regarding the effectiveness of fiscal policy should the recession deepen deliberately advocate a policy response that was going to ensure a prolonged recession?
What perversion of brilliance would suggest that deliberately ensuring that unemployment would sky-rocket and whole communities would be severely damaged was a bright thing to do?
The New Yorker said that Summers:
… believed that filling the output gap through deficit spending was important, but that a package that was too large could potentially shift fears from the current crisis to the long-term budget deficit, which would have an unwelcome effect on the bond market. In the end, Summers made the case for the eight-hundred-and-ninety-billion-dollar option.
The empirical reality has not accorded with his fears. Bond yields are low and bond markets cannot get enough government debt. Further, the Federal Reserve has shown that it can control rates on any segment of the yield curve.
Summers also believes in the ageing-population myth which I will touch on later and the existence of Ricardian households and firms. On this latter point, please read my blogs – Its simple – more public spending is required and Even the most simple facts contradict the neo-liberal arguments and Pushing the fantasy barrow – for more discussion.
The New Yorker documents a series of not-so brilliant gaffes in Summers career prior to working for Obama. They are well documented and include his famous memo while a senior economist with the World Bank that advocated the advanced world shipping their pollution to poor countries because:The economic logic behind dumping a load of toxic waste in the lowest-wage country is impeccable.
They document is opposition to regulation of derivatives markets, his role in the repealing of the Glass-Steagall act, and his failure to understand what was happening in global financial markets at a time when it was obvious that a crisis was looming.
Please read my blog – Being shamed and disgraced is not enough – for more discussion on these oversights.
In a more recent article in the US Chronicle of Higher Education (October 3, 2010) – Larry Summers and the Subversion of Economics we read again that:
Summers is unquestionably brilliant, as all who have dealt with him, including myself, quickly realize. And yet rarely has one individual embodied so much of what is wrong with economics, with academe, and indeed with the American economy.
I guess that is my problem. How can someone so ignorant of how the monetary system works and who has advocated policy positions that have clearly led to very bad outcomes be labelled brilliant?
Maybe he can play chess well – that might be the answer.
The Chronicle article also documents his failures and lack of foresight. The article particularly reminds us of the 2005 meetings for central bankers at Jackson Hole, Wyoming when the then IMF chief economist Raghuram Rajan presented a paper which warned of a rising “probability of a catastrophic meltdown” as a result of the derivatives markets being unregulated. In a sense, his warnings were too tame and too late when compared to the stronger statements being made by proponents of Modern Monetary Theory (MMT) a decade or so earlier.
The Chronicle says that:
Summers mocked and dismissed those warnings … [and] … When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a “Luddite,” dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector.
You can read the whole transcript HERE.
I speak as a repentant, brief Tobin tax advocate, and someone who has learned a great deal about the subject … from Alan Greenspan, and someone who finds the basic, slightly lead-eyed premise of this paper to be largely misguided … the tendency toward restriction that runs through the tone of the presentation seems to me to be quite problematic. It seems to me to support a wide variety of misguided policy impulses in many countries. I would say as a final example of what has come out of the discussion for the 1987 crisis … argues for the benefits of more open and free financial markets, rather than for the concerns they bring.
That is so-called brilliance – two years later the world’s financial system all but collapsed and only significant government intervention saved it.
Enter US Federal Reserve Chairman – stage very far right
Another one of the economics glitterati – the brilliant ones is the US Federal Reserve Chairman Ben Bernanke. He is said to have a deep understanding of recessions and profound insights into monetary systems. This assessment is another case where the public are severely mislead.
Please read my blogs – Bernanke should quit or be sacked and Oh no … Bernanke is loose and those greenbacks are everywhere – for my earlier assessments of the Federal Reserve Chairman.
He was at it again on October 4, 2010 when he addressed the Annual Meeting of the Rhode Island Public Expenditure Council on Fiscal Sustainability and Fiscal Rules. This speech has been widely commented on in the media in the last few days – usually with journalists choosing to propagate the myths that the brilliant chairman perpetuates.
As an aside, if a treasury spokesperson (unelected official) or even a Treasurer (or the relevant minister) starts making comments about interest rate settings or desirable movements in monetary policy, the mainstream economists and their financial press lackeys start screaming that this is an unacceptable attack on the independence of the (unelected) central bank.
However, when the unelected central bank chairman makes stark remarks about the conduct of fiscal policy which support the neo-liberal agenda and which he knows will influence the policy debate and diminish the prospects for millions of people as a consequence, the mainstream macroeconomists and their lackeys in the press extol the intervention as a timely warning to profligate fiscal authorities.
Even if the comments were correct how does that fit with the concept that the central bank should be strictly independent and stay out of the political fray? It just reinforces what we already know – they are hypocrites.
In fact, there is no real central bank independence. It is one of the mainstream agendas designed to justify the mainstream neo-liberal attack on government macroeconomic policy activism. I have written about the myth of central bank independence in detail in this blog – Central bank independence – another faux agenda.
The neo-liberals invented the concept in an attempt to erode the democratic input into macroeconomic policy making. They claimed that without independence the central bank would be a subject of the political authorities and this would reduce its capacity to fight inflation.
Central bank independence (CBI) refers to the freedom of monetary policy-makers to set policy without direct political or governmental influence. The idea took hold in the mid-1970s as the neo-liberal onslaught began to dominate policy-makers. This dominance was consolidated by the early 1980s. It was time when the OPEC oil price rises had not worked their way out of cost structures around the world and inflation was still an issue.
The central bank independence push was based on the Monetarist claims that it was the politicisation of the central banks that prolonged the inflation (by “accommodating” it). The arguments claimed that central bankers would prioritise attention on real output growth and unemployment rather than inflation and in doing so cause inflation.
The Rational Expectations (RATEX) literature which evolved at that time then reinforced this view by arguing that people (you and me) anticipate everything the central bank is going to do and render it neutral in real terms but lethal in nominal terms. In other words, they cannot increase real output with monetary stimulus but always cause inflation. Barro and Gordon (1983) ‘A Positive Theory of Monetary Policy in a Natural Rate Model’, Journal of Political Economy, 91, 589-610 – was an influential paper in this stream of literature. It is highly flawed but that is another story.
Please read my blog – The myth of rational expectations – for more discussion on this point.
But underlying the notion of CBI was a re-prioritisation of policy targets – towards inflation control and away from broader goals like full employment and real output growth. Indeed, whereas previously unemployment had been a central policy target, it became a policy tool in the fight against inflation under this new approach to monetary policy.
Whether monetary policy is effective or not is another question. But the logic the mainstream believe in as an article of religious faith is that by controlling prices they maximise output over the long-run. In other words they are obsessed with the NAIRU concept. Please read my blog – The dreaded NAIRU is still about! – for more discussion on this point.
This is the reason governments should directly control the central bank to avoid issuing debt. The point is that it is the act of net spending in a fiat monetary system that drives aggregate demand and exposes fiscal policy to the risk of inflation. The monetary operations (the central bank liquidity management) do not increase or reduce this risk.
So if the government just leaves the net spending impact on the cash system as reserves (earning nothing) that doesn’t increase the risk of inflation resulting from the spending in the first place, relative to if they drain those reserves by offering an interest-bearing public bond.
From a conceptual perspective it is important to understand that a budget deficit records a flow of net spending. It is not a stock. So when we see a figure 3 per cent of GDP, that just says that the flow of net public spending in a year (or whatever) was 3 per cent of the flow of all spending.
With the current voluntary obsession with issuing public debt – the flow adds to the stock of public debt at the end of each period. If you didn’t issue debt the stock arising from the flow would manifest as increased bank reserves. Would the treasury care about that? Why would they?
Thus, I would collapse the central bank and treasury functions formally (in an organisational sense) and see it as a pro-democratic development. In practice, the central bank is part of the government sector because its transactions with the non-government sector are vertical. For an explanation of the difference between vertical and horizontal transactions please read the Deficits suite – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3.
For the government sector to work effectively the central bank and the treasury have to coordinate their monetary interventions, the former being passive to the latter, given that the treasury reflects the elected intentions of government. For me, having an unelected and largely unaccountable body able to change policy settings that damage employment is unacceptable in any sophisticated democracy. This trend towards so-called “independent” central banks has been a feature of the neo-liberal erosion of our democratic rights.
On the claim that “monetising” the public debt which is inflationary – I note that this is based on the discredited but still dominant Quantity Theory of Money which says that an increasing money supply translates directly into inflation. The theory is deeply flawed and has no empirical standing. Please read my blogs – Please read the following blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion. – for more discussion on this point.
From a MMT perspective, the concept of CBI is anathema to the goal of aggregate policy (monetary and fiscal) to advance public purpose. By obsessing about inflation control, central banking has lost sight of what the purpose of policy is about.
Please read my blogs – The consolidated government – treasury and central bank – for more discussion on this point.
Anyway, back to the “brilliant chairman’s” latest violation of central bank independence.
The recent deep recession and the subsequent slow recovery have created severe budgetary pressures not only for many households and businesses, but for governments as well. Indeed, in the United States, governments at all levels are grappling not only with the near-term effects of economic weakness, but also with the longer-run pressures that will be generated by the need to provide health care and retirement security to an aging population. There is no way around it–meeting these challenges will require policymakers and the public to make some very difficult decisions and to accept some sacrifices. But history makes clear that countries that continually spend beyond their means suffer slower growth in incomes and living standards and are prone to greater economic and financial instability. Conversely, good fiscal management is a cornerstone of sustainable growth and prosperity.
Neo-liberal mythology at its best.
First, the household-government budget conflation myth that drives all mainstream macroeconomic analysis of government policy and always leads it to draw erroneous conclusions. As I have said many times, there is no applicable analogy between the budget of a household and the budget of a sovereign government.
Household spending is always financial constrained as they are users of the currency of issue. Non-government agents in general have to source funds before they can spend – either through earnings, asset sales, prior savings or borrowing.
A sovereign government is never revenue constrained because it is the monopoly issuer of the currency. It neither has to tax or borrow to spend and logically has to spend prior to being able to collect tax revenue or borrow funds.
Second, the levels of government conflation myth that also demonstrates that the mainstream macroeconomic analysis of government policy is inapplicable. A state or local government does not issue the currency it uses and is thus unlike a national sovereign government with respect to its fiscal opportunities and choices. While a state/local government does have access to a tax base its budgetary constraints are akin to those faced by the household in that it has to find funding sources prior to being able to spend.
Third, the ageing population intergenerational budget time bomb myth is exhibited which alleges that the government, which can create net financial assets denominated in the currency of issue (aka money) will run out of money because more people will be demanding hip replacements or pensions in the future than is the case at present. The simple response to that myth is that the national government (US or any sovereign nation) will always be able to “pay for” its pension obligations or provide first-class health care to all as long as there is a political will to do it and there are real resources available to back the spending.
Fourth, the budget surpluses create national savings myth which alleges that governments have to reduce their role in the economy by cutting spending even though there is very high and persistent unemployment and huge spending gaps still present. We are told repeatedly that “very difficult decisions” and “sacrifices” have to be made to allow the government to create budget surpluses so that it will have more resources to spend in the future.
In fact, budget surpluses provide no extra spending capacity in the future. A sovereign government has unlimited spending capacity in its own currency. The constraints are never financial unless they are self imposed.
Fifth, the spend beyond your means myth which equates budget deficits with excessive spending. But in fact the concept of “means” for a national government is totally inapplicable. It has all the “financial means” that it could ever desire – infinity minus 1 cent. A sovereign government can never spend beyond its “means” in the sense that Bernanke is using this. They can spend too much in relation to the real capacity of the economy to absorb that spending via increased output.
With 10 per cent unemployment in the US, the US government faces very little opportunity cost (that is, in real terms) in engaging this labour for productive public sector work. The means are ample.
History only shows that when governments push nominal demand ahead of the growth in the real productive capacity of the economy they push beyond an inflation barrier. Governments have run budget deficits continuously for decades without encountering the types of problems Bernanke claims are inevitable.
So neo-liberal mythology at its best.
Bernanke says in relation to the US:
The budgetary position of the federal government has deteriorated substantially during the past two fiscal years, with the budget deficit averaging 9-1/2 percent of national income during that time.
The terminology “deterioration/improvement” has no meaning in the case of a sovereign government’s budget outcome. A rising budget deficit could be a sign that the real economy is collapsing (via the collapse of revenue as activity drops) or the exact opposite a public-spending supported growth phase. The focus should never be on the “budget outcome” but rather the real activity levels in the economy.
Bernanke at least realises that “premature fiscal tightening could put the recovery at risk” but then invokes the “medium- and long-term” myth:
If current policy settings are maintained, and under reasonable assumptions about economic growth, the federal budget will be on an unsustainable path in coming years, with the ratio of federal debt held by the public to national income rising at an increasing pace. Moreover, as the national debt grows, so will the associated interest payments, which in turn will lead to further increases in projected deficits. Expectations of large and increasing deficits in the future could inhibit current household and business spending–for example, by reducing confidence in the longer-term prospects for the economy or by increasing uncertainty about future tax burdens and government spending–and thus restrain the recovery. Concerns about the government’s long-run fiscal position may also constrain the flexibility of fiscal policy to respond to current economic conditions. Accordingly, steps taken today to improve the country’s longer-term fiscal position would not only help secure longer-term economic and financial stability, they could also improve the near-term economic outlook.
First, lets think about this a bit. The budget deficit rose for two reasons: (a) the sharp movements in the automatic stabilisers as private economic activity collapsed and tax revenue fell; (b) the less than adequate discretionary fiscal stimulus added to the bottom line.
The automatic stabiliser or cyclical effect will reverse once the economy grows again. The fact that the projections suggest that when growth does get back onto trend there will still be a deficit is not a source of concern. It just says that if structural budget balance is correctly computed then if there is a deficit remaining (at so-called full capacity) then it means that the non-government sector is saving overall and this saving (and high level of activity) is being supported by the public spending. That is a good thing!
If the structural deficit measure (correctly computed) rises over time that just means that non-government sector is desiring to save more overall. There is no problem there as long as activity levels are maintained by compensating public net spending.
The fact is that most estimates of structural deficits deliberately bias the budget estimates towards being more expansionary than they really are. Please read my blogs – Structural deficits – the great con job! and Structural deficits and automatic stabilisers – for more discussion on this point.
Second, growing public debt interest payments just tell us that the non-government sector is enjoying increased incomes and returns on their saving. That is a good thing! It doesn’t reduce the capacity of the national government to spend elsewhere. It might be that the combination of increased interest payments and other expenditure is deemed excessive in relation to the impact on nominal demand. There might be equity concerns as to who is getting the benefits of public spending (including the interest payments).
Then the government has a political choice – it could, for example, tax the interest payments away should that be considered desirable or lower interest rates.
Third, any projected long-term budget positions have no constraining impact on what the government can do now or later. The capacity of the government to spend in any period is not conditioned by what they net spend last period. The only constraints are the availability of real resources and the political machinations that are required to engender the spending.
Bernanke then spent some time outlining what he claims are “especially daunting fiscal challenges” which he claims will arise from two “important driving forces” – “the aging of the U.S. population” and “rapidly rising health-care costs”.
I have dealt with the ageing population myth in considerable detail in other blogs so I will only summarise the argument here. Please read my blogs – Democracy, accountability and more intergenerational nonsense and Another intergenerational report – another waste of time – for more discussion on this point.
If population ageing or rising health costs are a problem at all then they are real resource problems – they are never going to be a financial problem for a national government.
The entire logic underpinning the population ageing and health cost debates is flawed. The idea that budget surpluses in some way are equivalent to accumulation funds that a private citizen might enjoy and will help government deal with increased public expenditure demands that may accompany the ageing population lies at the heart of the intergenerational debate misconception. While it is moot that an ageing population will place disproportionate pressures on government expenditure in the future, it is clear that the concept of pressure is inapplicable because it assumes a financial constraint.
A sovereign government in a fiat monetary system is not financially constrained.
There will never be a squeeze on “taxpayers’ funds” because the taxpayers do not fund “anything”. The concept of the taxpayer funding government spending is misleading. Taxes are paid by debiting accounts of the member commercial banks accounts whereas spending occurs by crediting the same. The notion that “debited funds” have some further use is not applicable.
Further, the so-called government budget constraint is not a “bridge” that spans the generations in some restrictive manner. Each generation is free to select the tax burden it endures. Taxing and spending transfers real resources from the private to the public domain. Each generation is free to select how much they want to transfer via political decisions mediated through political processes.
When MMT argues that there is no financial constraint on federal government spending they are not, as if often erroneously claimed, saying that government should therefore not be concerned with the size of its deficit. We are not advocating unlimited deficits. Rather, the size of the deficit (surplus) will be market determined by the desired net saving of the non-government sector at desirable levels of real activity and employment growth.
To achieve and sustain full employment the government has the responsibility to ensure that its taxation/spending are at the right level. Accordingly, if the goals of the economy are full employment with price level stability then the task is to make sure that government spending is exactly at the level that is neither inflationary or deflationary.
This insight puts the idea of sustainability of government finances into a different light. The emphasis on forward planning that has been at the heart of the ageing population debate is sound. We do need to meet the real challenges that will be posed by these demographic shifts.
However, all of these remedies which focus on “fiscal consolidation” miss the point overall. It is not a financial crisis that beckons but a real one. Are we really saying that there will not be enough real resources available to provide aged-care at an increasing level? That is never the statement made. The worry is always that public outlays will rise because more real resources will be required “in the public sector” than previously.
As long as these real resources are available there will be no problem. In this context, the type of policy strategy that is being driven by these myths will probably undermine the future productivity and provision of real goods and services in the future.
It is clear that the goal should be to maintain efficient and effective medical care systems. Clearly the real health care system matters by which I mean the resources that are employed to deliver the health care services and the research that is done by universities and elsewhere to improve our future health prospects. So real facilities and real know how define the essence of an effective health care system.
Further, productivity growth comes from research and development and in Australia the private sector has an abysmal track record in this area. Typically they are parasites on the public research system which is concentrated in the universities and public research centres.
For all practical purposes there is no real investment that can be made today that will remain useful 50 years from now apart from education. Unfortunately, tackling the problems of the distant future in terms of current “monetary” considerations which have led to the conclusion that fiscal austerity is needed today to prepare us for the future will actually undermine our future.
The irony is that the pursuit of budget austerity leads governments to target public education almost universally as one of the first expenditures that are reduced.
Most importantly, maximising employment and output in each period is a necessary condition for long-term growth. The emphasis in mainstream integenerational debate that we have to lift labour force participation by older workers is sound but contrary to current government policies which reduces job opportunities for older male workers by refusing to deal with the rising unemployment.
Anything that has a positive impact on the dependency ratio is desirable and the best thing for that is ensuring that there is a job available for all those who desire to work.
Further encouraging increased casualisation and allowing underemployment to rise is not a sensible strategy for the future. The incentive to invest in one’s human capital is reduced if people expect to have part-time work opportunities increasingly made available to them.
But all these issues are really about political choices rather than government finances. The ability of government to provide necessary goods and services to the non-government sector, in particular, those goods that the private sector may under-provide is independent of government finance.
Any attempt to link the two via fiscal policy “discipline:, will not increase per capita GDP growth in the longer term. The reality is that fiscal drag that accompanies such “discipline” reduces growth in aggregate demand and private disposable incomes, which can be measured by the foregone output that results.
Bernanke then advocated for the use of more strict fiscal rules and rehearsed all the standard myths that accompany that debate and supporting literature. I have dealt with those myths in this blog – Fiscal rules going mad ….
Overall, a major neo-liberal intervention by the boss of the Federal Reserve. My assessment: not a very brilliant exposition of the way in which the monetary system operates but a very influential intervention nonetheless. Which just tells you that the level of understanding that the deficit terrorists have is pretty low (or non-existent).
Today I am giving a lecture on monetary systems at Maastricht University. The class has been exposed only to mainstream thinking and as such are totally without an understanding of how the system works. They probably think Summers and Bernanke are brilliant too.
Anyway, that is where I am heading now.
Tomorrow, the Australian Bureau of Statistics releases the latest labour force data and I am sure to be commenting on that.
That is enough for today!