The title of today’s blog comes from a speech given on January 12, 2011 by Richard W. Fisher, boss of the Federal Reserve Bank of Dallas – The Limits of Monetary Policy – which carried the sub-title – Monetary Policy Responsibility Cannot Substitute for Government Irresponsibility. It is a speech littered with ideological assertions parading as sensible public commentary. It will resonate with the deficit terrorists and reinforce the policy agenda that will only make the situation in the US worse not better. The ideas were echoed elsewhere in the world in the last week. Japan is considering hiking tax rates “because they want more private growth and less public net spending”. The (un)truth brigade have thus been out in force in recent days – spreading a litany of lies and falsehoods which only aim to perpetuate their irrational obsession that government economic activity is bad. I only wish they would just speak the truth.
The speech was sponsored by the Manhattan Institute and e21 who Fisher claims are “powerful proponents of the free-market capitalism that made our country the richest and the most successful democracy in the history of humankind”.
One day, I might write a blog about this claim that the US is the “most successful democracy in the history of humankind” which Americans are often heard to say but which evidence might suggest otherwise. I can think of several nations that are more “successful” than the US in terms of things that I consider matter. But that is for another day.
Fisher told his audience that when he first took the job as the boss of the Dallas Federal Reserve Bank he met with the then US Federal Reserve boss (the failed) Alan Greenspan who told him that he “could best serve the System” (of reserve banks) by adopting the following:
Just speak to the truth …
I don’t think Greenspan was a model in that regard. And it seems that Fisher didn’t take his advice if this speech (and previous public utterances are anything to go by.
Fisher claims in his speech that he intended to “speak to the truth as I see it”. Yes, the old “as I see it” from a position of being blind (ideologically blinkered) and ill-informed.
Here are some of these “truths” which as you will appreciate are in fact unmitigated lies.
First, he talks about the need for the new US administration staff “have their work cut out for them” because:
You cannot overstate the gravity of their duty on the economic front. Over the years, their predecessors – Republicans and Democrats together – have dug a fiscal sinkhole so deep and so wide that, left unrepaired, it will swallow up the economic future of our children, our grandchildren and their children. They must now engineer a way out of that frightful predicament without thwarting the nascent economic recovery.
Yes, their work ahead is enormous. There is nearly 10 per cent of the workforce unemployed and look like being that way for some years to come. Long-term unemployment is reaching record proportions in the US. Employment growth is flat and hardly keeping pace with a very slow labour force growth rate. The broader measures of labour underutilisation suggest around 6 or 7 per cent of the available labour is also idle but not counted among the official unemployment statistics.
Meanwhile, income inequality is rising and approaching the proportions we see in poor developing countries.
And further, very little policy development has been evident which addresses the underlying causes of the current crisis that has generated all this real damage. The reforms to the financial sector inasmuch as there have been any are superficial and that sector (courtesy of some very generous government aid early in the crisis) has bounced back as if nothing has happened.
So yes, it is hard to overstate the gravity of the situation the US government is facing at present on the “economic front”.
But I am unaware of any “fiscal sinkhole” deep or shallow. This is an oft-used analogy – water flowing down the drain – public net spending wasted down some hole. Many commentators erroneously talk about the growing hole in the budget bucket. This is presented as some sort of “truth” that we should all be worried about.
I live in a very dry continent and we are very cognisant of water usage because droughts (and government-imposed water restrictions) are common, notwithstanding the record floods that are ravaging the country from north to south at present.
But in a fiscal sense, there is no hole because there is no bucket. To explain this we need to understand what happens when the sovereign government runs a budget surplus.
It is often argued that the surplus represents “public saving”, which can be used to fund future public expenditure. However, public surpluses do not create a cache of money that can be spent later. At all times, national governments spend by crediting a reserve account in the banking system. That spending doesn’t come from anywhere, as, for example, gold coins would have had to come from somewhere.
It is accounted for but that is a different issue. Likewise, tax payments to government reduce reserve balances. Those payments do not go anywhere but are merely accounted for. A budget surplus exists only because private income or wealth is reduced.
In an accounting sense, when there is a budget surplus then base money and/or private wealth is destroyed.
In terms of fiscal policy, there are only real resource restrictions on its capacity to increase spending and hence output and employment. If there are slack resources available to purchase then a fiscal stimulus has the capacity to ensure they are fully employed. While the size of the impact of the financial crisis may be significant, a fiscal injection can be appropriately scaled to meet the challenge. That is, there is no financial crisis so deep that cannot be dealt with by public spending.
Which brings us to understand what a budget deficit constitutes.
As noted above, every day the government is crediting private bank accounts (directly or via cheque issuance) to pursue its socio-economic program and debiting private bank accounts (collecting tax revenue or writing receipts over counters to payees). The tax revenue does not support the spending.
A deficit arises when the spending exceeds the revenue and the net result is an addition of net financial assets (bank reserves). In achieving this outcome, the government hopes that its spending will boost aggregate demand (“finance” the leakages from the income-expenditure system), and, hence maintain high levels of employment and material prosperity.
The only hole I can see is one that needs to be filled – that is, the spending gap – the leakages from the income-expenditure system – that are created when there is an external deficit and/or a desire by the private sector to save overall.
Budget deficits should aim to fill that hole in and not allow aggregate demand to “fall through it”, which would lead to income and employment collapses. As the fiscal policy “fills” that gap the real problems facing the US economy will be reduced.
Please read my blog – We are in trouble – squirrels are falling down holes – for more discussion on this point.
The related (un)truth (that is, lie) is the intergeneration claim – that the deficits “will swallow up the economic future of our children, our grandchildren and their children”.
The only “frightful predicament” that the youth and future generations face in the US is the real one of having insufficient job opportunities and/or diminished and degraded infrastructure (including health and educational services). These are real problems that might impoverish people in the future economically and/or intellectually.
There are no financial burdens that the future generations will bear as a result of today’s deficits. Please read my blog – Our children never hand real output back in time – for more discussion on this point.
Fisher continued that the expansion of the Federal Reserve’s balance sheet (aka QE2) has meant that the Federal Reserve has:
… run the risk of being viewed as an accomplice to Congress’ fiscal nonfeasance. To avoid that perception, we must vigilantly protect the integrity of our delicate franchise. There are limits to what we can do on the monetary front to provide the bridge financing to fiscal sanity. Last Friday, speaking in Germany, [European Central Bank President] Jean-Claude Trichet said it best: “Monetary policy responsibility cannot substitute for government irresponsibility.”
First, the fiscal nonfeasance that the US government stands accused of is being too conservative and allowing unemployment to rise and remain at 9+ per cent for several years.
The US government has been bullied into running deficits that are clearly insufficient to underwrite real economic activity in the US given the trajectory of private spending. The government should be held culpable for refusing to exercise its fiscal responsibility to ensure everyone who wants to work can find a job whether it be in the private or public sector. When the private sector will not provide enough jobs then there is only one sector left to fill the breach – the public sector.
The Federal Reserve is complicit in this policy failure for holding out that monetary policy was the best tool to counter-stabilise the collapsed demand. The efforts to stimulate private spending by easing monetary policy and buying a mountain of financial assets (and adding to private bank reserves) has failed. Why? Answer: because it was never going to work in the first place – it applied erroneous mainstream economic theory to a situation where that theory was inapplicable.
The inability of the monetary policy initiatives to do anything more than stabilise a very shaky financial system was always clear from the outset if you understood what the problem was. There was not a shortage of credit nor were interest rates punitive with respect to intended borrowing. People didn’t want to borrow because the economy was collapsing and they were carrying too much debt anyway. Please read my blog – Quantitative easing 101 – for more discussion on this point.
The exercise clearly demonstrates the capacity of the central bank to target and control interest rates but it was never going to stimulate demand in any significant way. Please read my blog – Operation twist – then and now – for more discussion on this point.
The mainstream macroeconomics idea of a money multiplier operating has also been categorically exposed as a falsehood. Please read my blogs – Money multiplier and other myths – Money multiplier – missing feared dead – for more discussion on this point.
Trichet, another serial liar actually said this last Friday:
That being said, monetary policy responsibility can not substitute for government irresponsibility. Excessive government borrowing by some Member States led to a seizing-up of the market for government paper. This market plays a central role in our financial system and constitutes a crucial element in the transmission of monetary policy to the real economy. Fire sales of government bonds imply a sharp deterioration in banks’ funding conditions.
This will be the topic of another blog. He interprets what happened as “excessive government borrowing” – I interpret it as economies melting down due to a collapse in private spending and the automatic stabilisers attenuating the subsequent real collapse.
But the point is true that “monetary policy responsibility can not substitute for government irresponsibility” – but, of-course, how we construct the “irresponsibility” of the latter is what it all turns on. Once again that issue can only be considered in relation to the state of the real economy and meagre reliance on some public deficit figure (or rate of change) is meaningless and missing the essential point of what role fiscal policy should play.
The irresponsibility is in fact the reluctance of governments to support aggregate demand at levels that ensure adequate employment growth. In the case of the EMU, it is the imposition of stupid and arbitrary fiscal rules that then promote destructive pro-cyclical fiscal policy changes at a time when the government should be increasing its net spending.
But, of-course, Trichet and Fisher and the rest of them miss this point entirely.
The rest of Fisher’s speech is a rehearsal of many more of these (un)truths and I don’t have enough time today to unpack them all in detail. But they are just more of the same.
Government spending and taxes choke the great entrepreneurial spirit … etc ad nauseum. My only question is what “great entrepreneurial spirit” – it is the same energy that got us all into this mess after its principles hectored governments for years to deregulate and free the space for their so-called self-regulating market-led nirvana?
On the question of these invented “truths” I also read a statement (January 15, 2011) from the new Economy and Fiscal Policy minister in Japan.
Kaoru Yosano claimed that the Japanese government had to cut borrowing because “long-term interest rates will inevitably rise and hurt Japan’s global credibility”. Why is that?
At a time when the Japanese economy is still limping along he is advocating tax rises (5 percent sales tax rate hike) which is exactly the opposite to what is required to ensure the economy doesn’t take a 1997-style nose dive back into recession. There is still above average unemployment and no inflation problem in the economy so austerity is not indicated.
Apparently, a major concern which is being used to justify the tax hike argument and to “cap bond sales and spending” is that it is expected that:
… new bond sales of 44.3 trillion yen ($536 billion) to exceed tax revenue of 41 trillion yen in the fiscal year starting April 1, the second year in a row for issuance to surpass revenue.
This is another one of these (un)truths that now seem to be touted in public debate – that somehow there is a problem if bond-issuance is higher than tax
revenue. These financial statements that have no meaning when considered alone – this one stands alongside rules such as the Rogoff 80 per cent public debt ratio threshold; the Maastricht 3 per of GDP fiscal balance rule; the Maastricht 60 per cent debt ratio rule; the balanced budget over the cycle rule and the rest of them.
These “rules” have no meaning as they stand. They are arbitrary contrivances introduced into the debate to support the conservative position that small government is better than large government. Why is that? Purely because these characters adopt the ideological position that they do not like government activity.
When I read that new bond sales were likely to be 44.3 trillion yen whereas tax revenue would be 41 trillion the only thing that told me was that the former was 1.08 times the latter. Does that mean anything? Answer: nothing of any import.
Where did this concern come from? Answer: it is just an arbitrary concern. What is the basis of it in economic theory? Answer: there is no basis for it at all. It is purely an ideological statement that has zero economic content – like many of these rules.
There is no informational content at all that will help inform the public debate.
Yosano also said:
It’s important to pursue an economic policy that can spur the real strength of Japan’s economy, and not simply depend on the government’s fiscal spending or excessively rely on the BOJ’s monetary policy to overcome deflation …
Yes it is important to stimulate and maintain real economic growth (which is environmentally-sustainable!). But the next point “not simply depend” on public policy to do so is nonsensical in the context of the reality facing Japan at present. If public net spending was cut then the economy will falter. Clearly, stimulating private spending can be a strategy to replace public spending.
But tax hikes aimed at “reducing the deficit” will harm private spending. The logic again is inconsistent.
Progressives also perpetuate these misconceptions.
To see the way in which Modern Monetary Theory (MMT) constructs the argument in a way that is different from the “run-of-the-mill” progressive viewpoint we only have to consider Paul Krugman’s latest Op Ed in the New York Times (January 13, 2011) – A Tale of Two Moralities.
The topic is about the divide in American politics at present which he considers is paralysing sensible policy progress in the fact of the major crisis still confronting that nation. Krugman says:
One side of American politics considers the modern welfare state — a private-enterprise economy, but one in which society’s winners are taxed to pay for a social safety net — morally superior to the capitalism red in tooth and claw we had before the New Deal. It’s only right, this side believes, for the affluent to help the less fortunate.
The other side believes that people have a right to keep what they earn, and that taxing them to support others, no matter how needy, amounts to theft. That’s what lies behind the modern right’s fondness for violent rhetoric: many activists on the right really do see taxes and regulation as tyrannical impositions on their liberty.
On the first position, the reality in a modern monetary economy (such as the US) is that the national government does not tax to raise revenue despite the appearance that it is doing so.
A major role for taxation – other than to create a demand for the fiat currency (which has no intrinsic value) is to serve as a fiscal policy tool via which the national government can regulate nominal aggregate demand growth to keep it in line with the capacity of the real economy. Please read my blog – Functional finance and modern monetary theory – for more discussion on this point.
So it the idea of progressive taxation in MMT is not that “society’s winners are taxed to pay for a social safety net” so that “the affluent to help the less fortunate” but rather that society’s winners (identified in terms of income-earning capacity) take a greater share in maintaining price stability and providing real space for the government to pursue its socio-economic program.
A national government can choose whatever social safety net it thinks is appropriate without recourse to its revenue-raising capacity as long as the real goods and services consumption implied by this safety net (both public and private) are feasible in terms of the available real resources. If the consumption that is implied exceeds what is available in real terms then the government has to make a choice.
Either cut back the real standard of living defined by the safety net or reduce the purchasing power capacity of other groups in the society to ensure that the real resource demands are compatible with the capacity of the economy to produce (in real terms). That is the role of taxation in this context and progressives should always argue that the high-income earners should bear proportionally more of the brunt of such taxation than low-income earners.
Sadly, progressives typically do not understand this point and continue to justify progressive taxation in the erroneous way that Krugman does above.
Secondly, the conservative position that taxation amounts to theft really defaults to a position that everything private is good and everything public is bad. At least, until the elites who mostly propagate this position are in need of public assistance and then with mouths closed and hands out they quietly take the cash, wait until the dust settles and resume their anti-public sector role.
Many of the same also are among the most martially-oriented of Americans and do not blink when the government outlays billions of dollars on equipment whose only purpose is to kill and maim. Their concept of liberty is highly skewed in other words and is not defensible.
The whole concept of “free choice” which is embedded in the conservative rhetoric is nonsensical when you step back and think about it for a moment. The capitalist system they extol relies on continuously growing consumption and without it the economy grinds to a halt with damaging losses of income arising from the resultant unemployment.
We are thus coerced into being in the first place – consumption units. Our sense of welfare that the capitalist advertising industry pushes down our throat every day becomes dependent on us continually spending. That is coercion. Then more disadvantaged citizens are made to feel bad because they cannot have as much as the better-off members of society – a second stage of the same sort of coercion.
Capitalism offers only the chimera of freedom.
In relation to the political differences, Krugman correctly notes that:
… what we’re talking about here is a fundamental disagreement about the proper role of government.
As noted above the right say that small government (focusing on law and order and national security) is only barely tolerable until it is their turn to benefit. Then it is all hush-hush, hands-out sort of territory.
Those who see a broader role for government usually do not make the essential points regarding the nature of the government transaction with the non-government sector.
In a modern monetary system there are consequences for the non-government sector in choosing a particular government policy stance (here I am talking about fiscal policy). The “cut budget deficits” gang may think that they are supporting the freedom of the people to spend what they earn but in many situations are actually undermining that aim.
It is common for conservatives and progressives alike to advocate positions that do not make any economic sense – which means they advocate policy and other aspirations without understanding the macroeconomic constraints and behaviours that will follow.
For example, a classic error of logic is to argue that the US government and the US private sector should be reducing their debt levels which is impossible when the country is also enjoying an external deficit. Note the use of the descriptive term “enjoying” in relation to the external sector which is also counter to what most of the commentators think. A current account deficit is beneficial to domestic residents.
But more broadly, if the government does seek to “cut” its deficit when the private sector is seeking to save overall (and the external sector is in deficit) all that will happen is that economy will contract and national savings will fall thwarting the private sectors capacity to not only reduce debt levels but also to “spend what they earn”. The unemployment that results from this sort of policy advice is a tyranny in itself.
Given that unemployment falls disproportionately on certain demographic groups, what the conservatives are really advocating is a “freedom” for some (the privileged) at the expense of a “tyranny” and denial of liberty for others (the unemployed).
When I hear people (and some appear as commentators here) say that we have to cut government net spending to reign in the external deficit because otherwise the exchange rate will fall, I immediately relate to those statements in terms of imposing unemployment in return for cheap foreign ski holidays and cheaper imported cars. That is, assuming that the exchange rate might be lower when the economy is expanding faster (due to the impact of the higher income levels on imports).
If that is the case then I find the argument that you have to have unemployment to keep the exchange rate higher to be an immoral one. Moreover, the extra outlays required for the trip to St Moritz or the BMW car are usually very small (in the normal ranges that exchange rates fluctuate in advanced countries) whereas the losses arising from unemployment (to the economy overall and the individuals in particular) are enormous. There is no comparison between the two “costs”.
Further, that outcome is not always evident – that is, there is very no discernible relationship between currency movements in foreign exchange markets and budget balance outcomes. While we read regularly among the comments on this blog that the foreign sector is a constraint on fiscal policy, the evidence does not support that notion. Exchange rates do not follow a systematic inverse relationship with budget deficits.
Meanwhile … vote him out
The ABC News reported today that the Irish PM calls confidence motion on leadership. Apparently, he will see a “motion of confidence” from his party at “next Tuesday’s parliamentary party meeting”.
My advice – dump him and elect someone that is committed to restoring national sovereignty and will start by targetting domestic employment creation. What does that require? Answer: an immediate exit from the Eurozone and the re-establishment of the Irish currency.
I will be back tomorrow on the topic of inequality I think. I have been reading some interesting material in recent days on this topic.
For now – when a conservative says “lets speak the truth” in relation to macroeconomics – we should make sure we are in a position to understand that they are usually lying! I hope my blog helps advance that purpose.
That is enough for today!