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Fiscal vandals chasing a dream

The Australian government is digging a hole for itself at present. In the May Budget it talked (neo-liberal) tough to demonstrate what it claimed was “Responsible Economic Management” – and this meant it entered a battle with the Opposition about who would deliver the biggest budget surplus. This became one of the comical (in a tragic way) features of the August federal election campaign. The respective treasury boof-heads from the Government and Opposition boasting about the size of their future budget surpluses. They also tried to win the battle of who would get there the quickest. The whole discussion was definitely mindless. Now with the Australian dollar appreciating fairly strongly the Government has realised the reduced economic activity that seems to be occurring is reducing its tax revenue prospects and therefore undermining its surplus projections. So what do they do next? Answer: announce they will cut spending by even more than originally planned. They are going to deliberately undermine employment growth and force even more people to lose their jobs at a time that labour underutilisation sits at the obscene level of 12.5 per cent and inflation is moderating. It is sadly a case of the fiscal vandals chasing a dream. The dream however is a nightmare.

The ABC news today announced that High Aussie dollar threatens budget surplus. The nub of the story is that:

The Federal Government says the high Australian dollar is eating into its revenue and will make it more difficult to keep its pledge to return the budget to surplus in two years.

In the up-coming mid-year economic outlook the government will alter this stance and make it “tougher”. After all the surplus is their golden egg – given they are so entrenched in neo-liberal logic.

The Assistant Treasurer was quoted as saying “If exporters are making less profit they will be in a position of paying less tax.” Unless the government puts the tax rate up!

In the current climate where the RBA is once again hiking interest rates to quell the mining boom to prevent what it thinks will be a big inflationary surge and the government has already indicated it wants to impose a resource rent tax on the Mining industry for equity reasons (to spread the largesse) why wouldn’t a rise in tax rates be appropriate?

The problem with the current approach to the mining boom is that the interest rate rises, if they are effective in stemming aggregate demand, will damage the slow growth areas of the Australian economy – which considering the size of the mining sector (small) – is most of the economy. A fiscal response could be targetted and still allow for nominal demand growth in the sectors and regions which are still struggling post crisis.

But note also that the RBA thinks inflation is going to moderate first – more about which later.

You can read the Government’s stated plan (pre mid-term economic outlook review) for what they call “Responsible Economic Management” in the Economic Statement which is part of the 2010-11 Budget papers published last May and reaffirmed in the recent election campaign.

In that document you read of their boast:

The Government remains committed to delivering on its deficit exit strategy, and returning the Budget to surplus in 2012-13, well before any of the major advanced economies. This would represent the fastest fiscal consolidation in Australia since at least the 1960s and puts Australia at the forefront of global fiscal consolidation efforts.

The Government will continue to focus on its deficit exit strategy by:

* holding real growth in spending to 2 per cent a year until the budget returns to surplus; and

* allowing the level of tax receipts to recover naturally as the economy improves, while maintaining the commitment to keep taxation as a share of GDP below the 2007-08 level on average.

The focus of the fiscal strategy in future years will remain on returning the budget to surplus, including by continuing to reprioritise existing expenditure, consistent with 2 per cent real expenditure growth.

Once the budget returns to surplus, and while the economy is growing at or above trend, the Government will maintain the 2 per cent annual cap on real spending growth, on average, until surpluses are at least 1 per cent of GDP.

So they are going to impose a mindless fiscal rule without reference to the rest of the economy and if the rest of the economy doesn’t behave then they will tighten the rule! That is what I call mindless and reckless fiscal administration.

The changing outlook for tax revenue and spending – as a result of the automatic stabilisers – is a lovely demonstration of the endogeneity of the budget outcome and further why it is a futile economic strategy to budget a particular bottom line two years or whatever in advance.

The appreciation of the Australian dollar is starting to have sectoral impacts – the so-called Dutch disease effects. One of the new neo-liberal agendas that will open up soon is the claim that the solution for the declining competitiveness (as a result of the appreciation) is to cut real wages.

First, when there is an external cost shock (so an imported raw material rises in price), the national economy faces a real loss of income. This has to be shared out in some way among those who stake claims in real output. An equitable sharing arrangement would prorate the losses amongst profit margins and real wages. However, it is this sort of struggle that can provoke a wage-price struggle which may eventually manifest as inflation and depending on how the government manages the distributional struggle – as stagflation.

Second, when a currency is appreciating, you get sectoral effects with the traded-goods sector which is what the term Dutch disease refers to. The Australian problem is typically that mining booms push the dollar up but the same global demand buoyancy that mining enjoys is not shared by agriculture and manufacturing (both who also export). The latter two are then disadvantaged by the higher foreign price for their exports but no change in domestic (AUD) costs.

Productivity boosts will reduce real unit costs in those industries that enjoy it as will real wage cuts. But there are several problems with advocating this. How do you actually engineer real wage cuts in sectors which lose competitiveness? It is unlikely that you can cut nominal wages so you have to rely on inflation outstripping nominal wages growth. Given the mining boom, nominal wages growth in that industry will continue to outstrip average growth. You are then faced with suppressing nominal wages growth in agriculture and manufacturing.

Further, the import sector will start attracting labour and the disadvantaged export sectors (not including mining) face labour supply shrinkages. The changing terms of trade also promote dynamic efficiencies (productivity growth) in the areas that are facing cost squeezes.

It is not an easy problem to develop effective policy unless you want to propose significant interventions in the market via incomes policy etc.

But you shouldn’t confuse these relative price changes as being tantamount to inflation. Inflation is the continuous rise in the general price level (that is, all prices). So a rise in a particular asset class does not amount to inflation although it does alter relative prices (the prices relativities between individual goods and service). Relative price changes can be very disruptive if they also cause terms of trade changes and sectoral imbalances. The concept of the Dutch Disease is an example of this.

However, all of this is rather moot from the government’s perspective because it desired to put a brake on growth anyway. So at present there is a monetary policy tightening happening (with the commercial banks hiking faster than the RBA) and a significant fiscal contraction occurring.

Now you might want to question why the government would be wanting to curb growth anyway given that inflation is moderating (and low) and we have idle labour to the score of 12.5 per cent (at least) of available labour resources. In addition, many other indicators of growth (and future growth) are pretty flat at present (credit demand, housing, retail sales etc).

But even if you don’t question that, you would wonder about the economic logic of the following government mindset:

1. In May 2010 (Budget night) they announced these fiscal rules and budget surplus targets based on an expectation of growth in revenue at much lower exchange rates (and economic activity).

2. Our terms of trade booms and as is always the case in Australia (and for all primary commodity exporters) the exchange rate sympathetically follows suit. The appreciating dollar is now at the time of writing (late Friday afternoon) well established over the parity line (1.0154) and heading north. This is stifling economic activity in the traded-goods sector.

3. The reduced activity – which was the government’s aim – is reducing their tax revenue take and therefore the automatic stabilisers are delivering forces that will undermine the planned for surplus.

4. Government’s logic – they will have to tighten fiscal policy further than planned to “get the surplus”.

5. Problem: growth will be further stifled and they will chase themselves around in circles and damage the real economy in the shambles.

So you can see how a blind adherence to a fiscal rule is dangerous.

The Finance Minister tried to explain the logic to ABC News:

Obviously it is a matter of logic when you have a higher dollar and the dollar is significantly higher than it was when the forecasts were originally done … It impacts on some of our industries very significantly. Industries like tourism but it also has an impact on government revenue. A higher dollar can mean lower profits for certain companies that are exporting and that can translate to lower revenue to Government.
If the dollar is at parity, obviously you are going to get a different set of figures that flow from that compared to when the dollar was at 85 cents.

Okay that makes sense.

But then she told the ABC that the Government “remains determined” to achieving a budget surplus by 2013.

That doesn’t make sense

But the Opposition Finance spokesman is no better. He claims that the Government also has to cut even harder than they were considering.

If you want to see how more nonsensical an adherence to fiscal rules can be consider that early in October, the Commonwealth Department of Finance warned the government that they would need even tighter spending cuts if they wanted to “protect the surplus” (see article – Finance urges spending cuts to protect surplus).

What was the reasoning here? Answer: Revenue would fall because the world economy is in danger of slowing down. The briefing

… warned the Australian economy is not immune from the downside risks of the global economy … the persistent threat of a double-dip global recession strengthens the case for rapid action … the government needs to build a fiscal buffer to protect against further negative economic shock, singling out retiree benefits, health and defence spending as areas where savings could be found.

The people who wrote this briefing would have at least Bachelor’s degrees from our universities. It shows how our tertiary education system has failed us.

From the perspective of Modern Monetary Theory (MMT) the last thing the government should be doing is cutting its net spending if it fears a serious international slowdown will impact on our own growth fortunes. That is all mindless adherence to fiscal rules that bear no intrinsic relation to what is going around us.

Further, the idea that you need a “fiscal buffer” in case you need to introduce a fiscal stimulus in the future because of another global meltdown has no basis in credible monetary theory or the realities of the fiat monetary system.

There is no “Tin Shed” in Canberra or Washington or anywhere where the national government can put its surpluses away for later use. There is actually no storage because when a surplus is run, the purchasing power is destroyed forever.

A national government in a fiat monetary system has specific capacities relating to the conduct of the sovereign currency. It is the only body that can issue this currency. It is a monopoly issuer, which means that the government can never be revenue-constrained in a technical sense (voluntary constraints ignored). This means exactly this – it can spend whenever it wants to and has no imperative to seeks funds to facilitate the spending.

This is in sharp contradistinction with a household (generalising to any non-government entity) which uses the currency of issue. Households have to fund every dollar they spend either by earning income, running down saving, and/or borrowing.

Clearly, a household cannot spend more than its revenue indefinitely because it would imply total asset liquidation then continuously increasing debt. A household cannot sustain permanently increasing debt. So the budget choices facing a household are limited and prevent permanent deficits.

These household dynamics and constraints can never apply intrinsically to a sovereign government in a fiat monetary system.

A sovereign government does not need to save to spend – in fact, the concept of the currency issuer saving in the currency that it issues is nonsensical.

A sovereign government can sustain deficits indefinitely without destabilising itself or the economy and without establishing conditions which will ultimately undermine the aspiration to achieve public purpose.

Any financial target for budget surpluses or the public debt to GDP ratio can never be a sensible for all the reasons outlined above. It is highly unlikely that a government could actually hit some previously determined target if it wasn’t consistent with the public purpose aims to create full capacity utilisation.

As long as there is deficiencies in aggregate demand (a positive spending gap) output and income adjustments will be downwards and budget balances and GDP will be in flux.

The aim of fiscal policy should always be to fulfill public purpose and the resulting public debt/GDP ratio will just reflect the accounting flows that are required to achieve this basic aspiration.

Fiscal sustainability cannot be sensibly tied to any accounting entity such as a debt/GDP ratio.

Inflation will only be a concern when aggregate demand growth outstrips the real capacity of the economy to respond in real terms (that is, produce more output).

After that point, growth in net spending is undesirable and I would be joining the throng of those demanding a cut back in the deficits – although I would judge whether the public/private mix of final output was to my liking before I made that call. If there was a need for more public output and less private then I would be calling for tax rises.

This is not to say that inflation only arises when demand is high. Clearly supply-shocks can trigger an inflationary episode before full employment is reached but that is another story again and requires careful demand management and shifts in spending composition as well as other measures

Please read the following blogs – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3 – for more basic conceptual development of these ideas.

All of this discussion was recently considered at Senate Estimates hearings in Canberra. The Treasury secretary Ken Henry was interrogated by the Senate Estimates Economics Committee about this on October 21, 2010. Here is the Full Transcript.

The discussion at the Committee started talking about a supposed trade-off between fiscal and monetary policy. The argument the conservative opposition is now making in Australia is that the fiscal deficits are the reason the RBA is pushing up interest rates because the net spending is fuelling inflation.

So it is crowding out but not in the usual way where the conservatives claim that interest rates rise because government borrowing exhausts allegedly finite savings. In this new version, the government spending drives economic activity too strongly and the impending inflation forces the central bank to push up rates – as the only buttress against inflation.

Note that today, the RBA released its – Statement on Monetary Policy November 2010 – where it concluded that inflation pressures were easing and would do so through to at least mid-2011. After that they claim that the mining investment boom that hasn’t happened yet will push up inflation and hence they need to hike rates now – a year before this alleged happening. Please read my blog – RBA makes the wrong decision – for more discussion on this point.

But the point is that there is considerable fiscal tightening going on at present and this will intensify during the next 6-8 months at a time when the RBA acknowledges that inflation will be moderating. So it is difficult to argue that the fiscal stimulus has had anything much to do with the recent rise in interest rates.

Anyway, back to Senate Estimates – on Page E105 of the transcript you pick up the following conversation. The players are Senator Bushby (a relatively new Liberal – that is, conservative – Senator from Tasmania); Senator Wong, the Minister of Finance and in this context being interrogated rather than asking questions as a Committee Member; and Dr Henry, the Treasury secretary (that is, boss of the Commonwealth Treasury):

Senator BUSHBY – a decision to proceed towards further fiscal consolidation. Applying that rule of thumb, could a decision not to proceed with the planned stimulus spending result in a reduction in interest rates in the order of some per cent?

Senator Wong – ‘Some’ per cent?

Senator BUSHBY – Depending on the accuracy of your rule of thumb and which rule of thumb you apply. But in the order of a per cent or two …

Senator BUSHBY – I would probably be very interested in the Treasury officials’ perspective on that.

Dr Henry – … I would not want to endorse any particular number, obviously. I think it is important to understand that this is not a simple trade-off between fiscal policy and monetary policy. The reason a more rapid fiscal consolidation – a more aggressive consolidation – would to some extent result in lower interest rates is because the economy would be weaker. Growth would be slower, the unemployment rate would be higher and the fact, therefore, that the economy would be further from its full capacity position would call for a more accommodative stance of monetary policy. It is not a simple choice between a particular size budget deficit and a level of the cash interest rate or mortgage interest rates.

So it is quite clear – the fiscal consolidation will make the economy weaker, growth would be slow and the unemployment rate higher. That is coming from the Treasury secretary.

At least he is prepared to say that which is not the case in say the UK at present where the Treasury secretary’s counterpart is claiming that fiscal austerity will increase growth and reduce unemployment. One is lying.

The point is that the direction of policy now is to reduce employment growth at a time when the labour underutilisation rate is persistently around 12.5 per cent and inflation is moderating. That cannot be responsible fiscal management. It is the result of an adherence to a blind neo-liberal ideology which cannot deliver acceptable outcomes.

Further, with the external sector still in deficit, the fiscal consolidation will slowly but surely undermine the private sector’s capacity to reduce its own excessive debt levels. That strategy – to further squeeze private sector liquidity and increasingly push it into debt (or else growth plummets) – also cannot be responsible fiscal management.

The Senate Estimates discussion then proceeded to interrogate the Treasury secretary about whether Australia was close to the NAIRU. Please read my blog – The dreaded NAIRU is still about! – for more discussion of this hoax of a concept.

Conclusion

The fact that the Australian economy is not delivering the tax revenue growth to justify the previous budget surplus forecast tells me that growth (even in the so-called booming mining sector) is not as robust as the RBA and other commentators and lobby groups are making out.

It indicates that the Government should continue to provide fiscal support for growth. All the signs are that growth is likely to taper off a bit in the coming months.

The last thing the Government should be doing is “sticking to its fiscal forecast” and attempting to deal with the declining revenue by further cutting spending.

In general, the imposition of fiscal rules places the government in a policy space where it cannot deliver flexible fiscal responses to ensure aggregate demand remains strong. The reason is that the announcement of these rules and the political rhetoric that surrounds the announcements – “surpluses are good” mantras – make it very hard for the government to admit that it needs to expand its discretionary budget deficit.

Saturday Quiz

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    This Post Has 36 Comments
    1. Not a good outlook for Australia,and in more than the ways you outline in this article,Bill.One would wonder where we can find people with slightly more than half a brain who will not drive this nation into the ditch.

    2. @GLH

      It’s a vertical move because it is between the government sector and the non-government sector. But it is two vertical moves. They add some cash and remove an equivalent amount of bonds.

    3. ”Boof-heads”!!! Not sure what it means but it has an interesting ring to it. It sounds pretty negative, in a gentle sort of way.

    4. Hi GLH,

      A horizontal move means you’ve altered both the financial assets and liabilities of the non-govt sector by the same amount. No change to that sector’s net financial assets.

      A vertical move means you’ve altered the net financial assets (financial assets-financial liabilities) of the non-govt sector.

      QE2 does neither. As Neil says, it’s two offsetting moves. An asset swap. (Though, the cb’s purchases can indirectly be vertical moves by creating capital gains for the non-govt sector if its purchases come at an increased price than otherwise would prevail or if some of the assets the cb purchases decline in value after it purchases them as with a default on an MBS for instance.)

      Credit easing, which the Fed did in 2007-8, was a horizontal move, expanding bank reserves and liabilities equally.

    5. Bill “A sovereign government can sustain deficits indefinitely without destabilising itself or the economy and without establishing conditions which will ultimately undermine the aspiration to achieve public purpose.”-

      In the current circumstances much government spending is almost immediately captured as corporate profits and then “leaks to savings”. I realize I’ve been chuntering on about this ad nauseam but I’m still not straight about what the MMT position is about the consequence of that. At some points you seem to imply that corporate profits result in homeowners paying off their mortgages. I’d have thought a more likely result is that billionaires become multi-billionaires. I fail to see how that does not amount to “destabilising itself or the economy and without establishing conditions which will ultimately undermine the aspiration to achieve public purpose”. Billionaires becoming multi-billionaires means that they will consider it mere chicken feed to spend the odd $1M for political lobbying or for employing a 100 PhD’s to manage their assets . That seems to me a gross distortion of government and the economy.

    6. stone:

      I’m pretty sure the MMT position is that, if you desire greater wealth equality, you then need progressive taxation to drain higher incomes. But that’s always a political decision made through the ballot box. The important thing is we need to understand WHY we are doing that.

      People should be disabused of the idea that we need to tax the rich to pay for stuff. They also need to be disabused of the notion that taxing the rich will kill jobs, that only the private sector can create jobs etc. Then you will see the political argument shifting from one where the rich hold the economy hostage, to one where we ask “when do you have enough money?”.

      So, yes, distributional effects matter greatly. But if you don’t even get the basic macro framework correct – what hope do you have of understanding the consequences of anything you do?

      I understand you very much prefer a non-expanding currency. What MMT does is gives you the tools to understand what will happen in such a situation. You can then sit down and say, “Well, in a non-expanding currency, the private sector cannot net save. What are the harmful consequences of that, and what can I do to offset them?”.

    7. Bill said:

      “Inflation will only be a concern when aggregate demand growth outstrips the real capacity of the economy to respond in real terms (that is, produce more output).

      After that point, growth in net spending is undesirable and I would be joining the throng of those demanding a cut back in the deficits – although I would judge whether the public/private mix of final output was to my liking before I made that call. If there was a need for more public output and less private then I would be calling for tax rises.”

      Bill, I’m interested in exactly how you would cut spending or raise taxes in practice, and also how you would measure the inflation constraint.

      For example, take an example from recent history. Around 2002 unemployment was about 6% or 7% and inflation was about 2.5% to 3%. Over the following 6 or 7 years, unemployment gradually moved down to 4% while inflation moved up to 5% just before the GFC hit.

      The RBA responded to this situation by increasing rates from 4.25% to 7.25%.

      What alternative policies would you have pursued during this time? Specifically, do you consider a 5% inflation rate evidence that aggregate demand is exceeding “the real capacity of the economy to respond in real terms”.

      If yes, what sort of fiscal changes would you have made? Cut spending or increase taxes? What spending would you have cut or what taxes would you have raised, in this particular instance.

      If no, what level of inflation do you consider a problem?

      Sorry for the barrage of questions, I am very interested to hear how this sort of policy might be implemented in practice, if you have the time.

      Cheers.

    8. Gamma:

      Someone posted up a great link on the previous blog (that for some reason generated massive amounts of comments):
      http://rodgermmitchell.wordpress.com/2010/04/06/more-thoughts-on-inflation/?preview=true&preview_id=1015&preview_nonce=72b4e94651

      It talks about how it seems that deficits etc have pretty much no impact on inflation, but oil prices have a huge one. Essentially suggesting that the only real inflation targeting policy you should have, that will have any impact, is to use as little oil as possible. What do you think?

    9. Grigory:the only real inflation targeting policy you should have, that will have any impact, is to use as little oil as possible. Having a strategeristic petroleum reserve that sells rather than buys when the prices go up, as well as jumping at a longterm deal for $50/barrel from the nation with the world’s largest reserves would help too, but US politicians are far too brilliant for such things.

      Gamma: The JG would be one, as it would be disinflationary by automatically cutting spending in the situation you describe.

    10. “At least he is prepared to say that which is not the case in say the UK at present where the Treasury secretary’s counterpart is claiming that fiscal austerity will increase growth and reduce unemployment. One is lying.”

      I’m not sure which is worse. Knowingly running the economy down or running it down through ignorance.

      It’s interesting Grigory brought up the topic of oil. There is so much talk of the economic relationship between the US and China. Everyone seems to have forgotten the relationship between oil importers and exporters which in my mind is a bigger macro economic and political issue. The oil shocks of the 70’s went a long way to shaping the political outlook of the world today. Speculation on oil up to $200 per barrel was the precursor to the GFC.

      I’m interested how the oil exporting countries in the Gulf impact the US economy from an MMT perspective. Gulf royalty must have the biggest ultra wealthy game in the US economy. They extract an enormous economic rent from the American people and accumulate huge reserves of cash. US military action tells us how important the Gulf is.

    11. Grigory Graborenko “People should be disabused of the idea that we need to tax the rich to pay for stuff.”

      I suppose my struggle with MMT is that I can’t help think that we need to keep a lid on the amount of money simply inorder to retain the economic function of money. When ever a genetic engineer has a demanding design job to do, they fall back on setting up an artificial evolutionary proccess rather than actually trying to design the construct themselves. In order to operate, an evolutionary process needs to be constrained. An evolutionary proccess is a bunch of agents with potential to expand exponentialy but with the only room for expansion being at the expense of their competitors. To my mind the economy is also an evolutionary process. When MMTers (or neoliberals) allow for “ability to net save” they try and sidestep the constraint that expansion must be at the expense of one’s competitors. Not only is the expanding approach doomed to fall apart, it also results in a dysfunctional system in the meantime. It is like the genetic engineer deciding that instead of having the selection occur in a 1ml volume, more reagents will be added so as to not constrain the sellection. Such a misguided genetic engineer would add first an extra 1ml then 2ml then 4ml then by the next day 1000ml or whatever. The selection would not have been working whilst they were adding the extra reagents and in the end they would run out anyway and by then the population would have become so skewed that the selected material would be no use.

    12. Thanks Grigory for the link. When gamma told about the inflation I wondered what the cause was. It seemed as if the employment might have been at fault, but since I read the post at rodgermmitchell, I recall that at about the time gamma was talking about oil was running close to $150 a barrel.

    13. I would second Gamma’s request at 10:00. I would also be interested in knowing what position the MMT folk take in regard to Abba Lerner and David Colander’s “Market Anti-Inflation Plan (MAP).” MAP functions similarly to the U.S. carbon cap and trade program in that it sets an explicit price target and then auctions off permits allowing firms to increase prices beyond that point at some fraction of the value their products add to the economy. These permits would then be tradable in secondary markets. This approach to inflation control seems more effective to me than the simple raise taxes or decrease spending measures Professor Mitchell usually refers to as MMT’s preferred method of inflation control because: 1) it avoids the political process, which as everyone knows can be time consuming and is subject to corruption and other abuses, 2) is market based, and 3) presents an explicit price targets businesses can plan around. I see the MAP as an interesting supplement to the job guarantee, which is primarily geared toward dealing with inflation in the labor market. The job guarantee proposal deals with inflation in the job market and the MAP deals with inflation in the goods and services product market. I’d be interested to know what the MMTers think of this..

    14. For a brief synopsis of why Dr. Lerner felt the MAP approach developed after the inflation outbreak of the 1970’s was superior to his earlier work developing his theories of Functional Finance see here (specifically the section of the PDF entitled “Seller’s Inflation):

      http://academic.cengage.com/resource_uploads/downloads/0324321457_65785.pdf

      If you have the time and money, I would also recommend purchasing the book Drs. Lerner and Colander wrote about MAP, which is currently out of print, but can be found here:

      http://community.middlebury.edu/~colander/books/map.html

    15. NKlein1553 – On the face of it, the MAP sounds like a dysfunctional bonanza for the industry that would spring up to opperate it. There would be endless litigation as to whether the latest car or TV or yogurt was some novel product that required a novel price.

    16. stone:

      If you keep a lid on money supply, people will still attempt to net save, and if you have net imports, it’s foreigners that are doing the net saving. This will create a consumption gap, and unsold inventory will pile up. People then get fired. So you have to then figure out what to do about that.

      If you mixed a job guarantee with a fixed money supply, you would have to have a way of ensuring taxes match spending. It would have to be some kind of variable tax rate. On top of that, how would you prevent net imports? Money supply will leak away and instead you will have a shrinking money supply domestically. This was one of the main reasons the gold standard failed so badly. Under your scheme how will you deal with this?

      Once again, I’d like to make the point that *IF* you wanted to set up a fixed money supply system, the only framework in which you can understand the consequences is MMT. If you tried it while reading mainstream economic textbooks, the system would blow up in your face because other economic paradigms don’t describe how the real world works in any way.

      I totally agree with you though on the MAP thing. Sounds very fiddly and impractical. Still, I shouldn’t close my mind to alternative ideas. I’ll have a read when my hangover goes away.

    17. Grigory,

      I read that post on inflation that you referred to. The author makes the point that there is a reasonable correlation between oil price inflation and general CPI inflation. I think it’s a fair point, but not a very novel or controversial one. Petrol and energy prices make up a significant portion of most consumer price baskets used around the world.

      Just off hand I think that petrol prices account for about 6% weighting of the entire index in Australia. So it naturally follows that an increase in oil prices feeds directly in an increase in the calculated price index.

      Personally I think there are 2 questions that are more important to consider wrt oil prices and CPI inflation.

      1) What are the second order effects of higher oil prices? Do higher energy prices cause other prices to rise?
      2) Is there any systematic / underlying cause of oil price inflation? For example, do monetary factors play a role? Does money creation (quantitative easing) cause commodity price inflation, which might ultimately feed into consumer price inflation?

    18. Gamma “Does money creation (quantitative easing) cause commodity price inflation, which might ultimately feed into consumer price inflation?”

      -Isn’t it fairly uncontroversial that quantitative easing pushes up the price of “investment commodities” such as gold and silver? Whether quantitative easing pushes up prices of “real commodities” such as oil and wheat depends on whether they are being traded as “investment commodities” or simply to supply consumption. In 2008 oil and wheat were bought up as “investment commodities” causing a sharp short term price spike. Presumably quantitative easing will result in occasional price spikes and crashes in individual commodity prices whenever that commodity comes into fashion as an “investment commodity”. Without money creation, asset prices for things such as stocks and real estate would be lower and so yields would be higher and so commodities would not be attractive as “investments” in comparison.
      Isn’t long term oil price inflation (rather than short term speculative price spikes) more a function of rising demand and the cheap to extract oil fields running dry? In China there are still only 70 cars per 1000 people so there is plenty of scope for demand to increase much further. It costs far more to extract oil from Canadian tar sands than from gushing wells in Saudi Arabia.

    19. Grigory “If you keep a lid on money supply, people will still attempt to net save, and if you have net imports, it’s foreigners that are doing the net saving. This will create a consumption gap, and unsold inventory will pile up. People then get fired. So you have to then figure out what to do about that.”

      -My impression was that the reason why things failed so badly in the gold standard days was because there wasn’t enough of an asset tax to ensure that the money was kept circulating. I think it would be neccessary to have all of the tax burden in the form of an asset tax (on cash, stocks, real estate etc) and in order to legally own anything you had to demonstrate that the tax was up to date. There would also need to be a way to get money dispersed out to potential consumers. The JG would be one way but I’m more of a fan of a citizens’ dividend system. Simply having tax as an asset tax rather than as income and consumption taxes would in itself increase aggregate demand. Aggregate demand never need fall below ideal levels. All the “pain” would be born by asset prices BUT as asset prices dropped, the yields delivered for those owning the assets would increase. So stocks and real estate would be cheap but P/E ratios would be much more favourable.
      The other problem with the Bretton Woods system was that currencies were not free floating. I think it would be neccessary to have free floating currencies and for international trade to use a SDR type system with the basket of currencies in the SDR being weighted by the population of each country. It would probably need to be a set up where all the trading partners signed up to the system. Much of the advantage of such a system would be to eliminate the injustice of indefinate trade deficits.

    20. “Isn’t it fairly uncontroversial that quantitative easing pushes up the price of “investment commodities” such as gold and silver?”

      Is that what happened when Japan did QE at about 3x as much a percent of GDP as the US?

    21. Scott Fullwiler “Is that what happened when Japan did QE at about 3x as much a percent of GDP as the US?”-

      You are correct that QE will only push up the price of whatever asset (or “investment commodity”) happens to have the momentum in the global economy at the time. Previously the Japanese QE fed the housing bubbles in the USA and europe because at that time that was where the momentum was. Once the build up of global money is great enough, then all assets will become so overpriced that yields are very poor and then “investment commodities” (that never have any yield) become a more likely site for bubbles.

    22. So our government makes the right call to save us from a nasty recession when the GFC struck, by throwing spending at nearly every part of the economy and it was by and large successful.

      But now they feel political compulsion to reverse that decision when it is clear to they themselves that they will achieve little more than slow growth, push up unemployment, further lower tax revenue thereby meaning that a surplus will be no closer and people will suffer.

      Sad day for this country.

    23. stone:

      The asset tax concept is interesting. It would essentially discourage saving – if that’s what you wanted to do. Personally I like to be able to save money – lets me sleep better at night knowing I have something squirreled away in case I lose my job, crash my car or need emergency root canal work. I’d hate to wind up in debt – the longest I’ve ever been in the red was about a week and I loathed it.

      That’s the problem – you would have to make the tax 100% for it to prevent a consumption gap. Any saving, no matter how small, even if it’s in cash, gets withdrawn from the spending stream. It’s almost as if the money you get paid would have to have an expiry date, like prepaid mobile credit. Spend it within a week or lose it! Doesn’t sound good to me.

      The other problem you haven’t addressed is import leakage. Once a foreigner gets a hold of your unit of currency, you can’t do anything about it. You can’t tax foreigners if they hold your cash. That money is gone from the spending stream. Sure, you can get it back by exporting – that being the ideal situation. But what if they want to hold on to your currency (maybe because it’s so non-expanding?). That’s what China is doing to America. It’s shrinking their money supply by net accumulating US dollars and there is nothing the US can do apart from banning imports.

      How would your non-expanding money supply deal with these issues?

    24. Grigory Graborenko “you would have to make the tax 100% for it to prevent a consumption gap. Any saving, no matter how small, even if it’s in cash, gets withdrawn from the spending stream”

      -I think the distinction between “saving” and “net saving” is critical. I totally agree that saving is very important. We all need to save when we can so as to provide for ourselves and dependents when we later have the need. On a population wide basis there will be people who are at a stage of life when they can save and also other people who are at a stage of life when drawing down savings is appropriate. Such a situation does not amount to the population “net saving” and results in no “leakage to savings” in a macroeconomic sense. There would be a steady amount of money in the global pool of savings that could remain the same decade after decade. There are plenty of problems for small scale savers in the current system. Cash savings have below inflation interest rates. Asset prices are volatile and asset yields are very low. If you are a billionaire with the best of the best hedge fund managers at your service, then volatile asset prices work in your favor. The current system does not aid someone saving for emergency root canal work :).

      “The other problem you haven’t addressed is import leakage. Once a foreigner gets a hold of your unit of currency, you can’t do anything about it.”

      – I tried to address that issue with the suggestion: ” it would be neccessary to have free floating currencies and for international trade to use a SDR type system with the basket of currencies in the SDR being weighted by the population of each country. It would probably need to be a set up where all the trading partners signed up to the system.” If the current USA/China trade imbalance was occurring (under a system where such an SDR was used for the trade and both currencies were non-expanding), then Chinese exporters would accumulate SDR and USA importers would have to pay more and more USD to obtain SDR. That would weaken the USD to the point where it was no longer sensible to buy manufactured goods from China rather than making them in the USA.

    25. Grigory Graborenko :”Once a foreigner gets a hold of your unit of currency, you can’t do anything about it. You can’t tax foreigners if they hold your cash.”-

      Further to my above comment, is it actually true that you can’t tax foreigners if they hold your cash? Interest is paid to foreigners holding say USD isn’t it? Couldn’t the asset tax just be like negative interest? The non-expanding currency presumably would not suffer from inflation so the taxed non-inflating currency would be no less attractive than the current currency paying below inflation interest.

    26. @stone,

      You can tax foreigners, because largely the currency never leaves the central bank reserve accounts. So 100% taxation of foreign held accounts is perfectly possible technically, if not politically.

    27. Neil Wilson “You can tax foreigners, because largely the currency never leaves the central bank reserve accounts. So 100% taxation of foreign held accounts is perfectly possible technically, if not politically.”-

      Thanks for clarifying that. That was what I suspected. I think it is curious though that it is politically impossible to have say a 3% asset tax and 1% deflation but perfectly fine to have 0% interest and 3% inflation.

    28. The issue isn’t draining assets, but incomes. Incomes are what matter, the excessive assets are indicators of excessive incomes. If you were to drain the assets but the income inequality remained, you would remain demand constrained. So asset taxes are indirect, as well as being difficult to enforce.

      I don’t think an asset tax would be a good idea, purely from a feasibility and operational perspective, but I agree with the larger goal of suppressing excess savings.

      It would essentially discourage saving – if that’s what you wanted to do.

      Meg Whitman, who recently ran for governor of California, saved about 1.3 billion. Since she’s 51, and assuming she started saving when she was 20, that amounts to saving over 60 million dollars per year, which is an extreme form of frugality. I try to pack my own lunches and don’t go out that often, but still can’t manage to save even one million a year, let alone 60 million.

      Christy Walton saved about 25 Billion, or about a billion a year during her working life, that is, if she would have worked. That is much more thrifty than the average American, who has negative financial net worth (but they have positive total net-worth from their house). Of course Christy adds a lot of value to the economy, being the daughter of Sam Walton, founder of Walmart. Walmart’s slogan is “Saving people money so they can live better lives”, so it is no wonder that the founder was such a successful saver. But something tells me that if more people tried to save by shopping at Walmart, the balance sheets of the average household would not improve, but Christy’s balance sheet would.

      We need different words to describe what is happening, in order to see that there is a problem.

    29. RSJ: “I don’t think an asset tax would be a good idea, purely from a feasibility and operational perspective”.

      -I naively thought that a major advantage of an asset tax is that it would be the most inescapable tax that was also applicable to wealthy people. If to legally own something, one had to demonstrate that the asset tax was up to date, then wouldn’t that ensure that the tax was up to date. With cash and bonds, the tax could just be harvested as a negative interest rate. With stocks it could be harvested as a negative dividend. Real estate is quite hard to hide from the tax man.
      -The examples you give of prodigous “savers” seem to me to be examples of people benefiting from asset price inflation being so much higher than consumer price inflation. To my mind, the way to address that is to move tax away from income tax and purchase taxes (our VAT in the UK) and to an asset tax. Presumably Meg Whitman , Christy Walton and their ilk own large asset holdings and asset price inflation is how they build wealth. If they sell any of the assets then they will pay capital gains tax but until they do so they will escape tax. In terms of income tax, they are slipping under the radar because the very real increases in their financial power are not viewed as “income” .
      -I have to stress that I, like you, never saw it as a problem that people were saving in order to have savings to draw down when they later needed them.
      -Excessively high asset prices cause problems in themselves. If asset price to yield ratios are low then investment allocations are more likely to be those that serve the real economy. If asset prices are inflated then asset price volatility becomes the way that money is harvested- buying low and selling high relative to the other people in the market. That scenario just acts to transfer wealth from the “dumb money” to those who have the best wealth management (ie the ultra rich).

    30. stone:

      You make a good point that foreigners holding cash reserves would still be reachable. The government even prevents actual physical cash from leaving the country by forcing you to declare over X amount. Of course, this might have the disadvantage of severely discouraging people exporting to your country. If they can’t hold on to your currency as reserves long term they might be so eager to swap goods for it. They would have to offload their US dollars to an importer quickly I guess.

      I’m still trying to figure out how you ensure that savings are distributed equally. Do you allow people to accumulate savings until they die and then hit them with a 100% inheritance tax? If so, then consumption will still fall for the first half century, until I suppose it reaches some kind of equilibrium. Perhaps it can be temporarily supported by private debt? Seems like the first generation might have to suffer a bit before things start running smoothly.

      The other alternative might be to limit savings – a progressive tax on the total amount. So maybe 10k is tax free but anything above that is reduced by x% per y% time unit?

      Seems like a fairly heavy handed system either way. Might be a hard sell to a lot of people. I would prefer it to the current one I suppose, as long as it had these equity controls. Otherwise it would quickly become an excuse to hose the poor by cutting services in the name of budget balancing – just like now!

    31. Grigory Graborenko: “Do you allow people to accumulate savings until they die”

      -I was thinking that simplicity is key for making tax inescapable. I was thinking of a flat % tax on all assets applicable to everyone. Simply moving the tax burden to asset values in itself would make the system massively more progressive without any need for varying rates etc that end up being a bonanza for the tax avoidance industry. Inheritance tax is tricky because the very richest manage to wriggle out of it- the wealth gets passed on as “ill advised” speculative trades (from the point of view of the old generation) with the other side of the trade being the young generation :). I think better than an inheritance tax would be an inheritance cap such that legally one couldn’t inherit more than a certain amount. Personally I’d vote for a very low inheritance cap but even if the inheritance cap was high (say £1B) the system would be sustainable. The inescapable constant asset tax would be the key.

    32. Min, cheers for the link. I guess what I was hoping an asset tax (applicable for cash etc) would do would be to ensure that money was made best use of so as to raise the yield necessary for paying off the asset tax. If someone made unwise investments or just hoarded the money then it would be eroded in value just as inflation erodes its value now. Under the current system the currency expands creating asset price inflation that is greater than consumer price inflation. The current system allows people who can afford wealth management services to build wealth just by riding asset price inflation -jumping from asset bubble to asset bubble. Under a non-expanding currency with an asset tax, earnings from the investments would be needed and earnings tend to reflect genuine usefulness.

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