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The Weekend Quiz – October 10-11, 2020 – answers and discussion

Here are the answers with discussion for this Weekend’s Quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of Modern Monetary Theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.

Here are the answers with discussion for yesterday’s quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.

Question 1:

Nation A is running a small current account deficit and its private domestic sector is saving overall. Nation B has a smaller external deficit (relative to its GDP) but its private domestic sector is balancing its spending and income. The governments in both Nations have to be running deficits.

The answer is True.

This question requires an understanding of the sectoral balances that can be derived from the National Accounts. But it also requires some understanding of the behavioural relationships within and between these sectors which generate the outcomes that are captured in the National Accounts and summarised by the sectoral balances.

We know that from an accounting sense, if the external sector overall is in deficit, then it is impossible for both the private domestic sector and government sector to run surpluses. One of those two has to also be in deficit to satisfy the accounting rules.

Further, if the private domestic sector is in balance, then the government deficit will be equal to the external deficit. Hence, both Nations will be enjoying government deficits.

The important point is to understand what behaviour and economic adjustments drive these outcomes.

To refresh your memory the sectoral balances are derived as follows. The basic income-expenditure model in macroeconomics can be viewed in (at least) two ways: (a) from the perspective of the sources of spending; and (b) from the perspective of the uses of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.

From the sources perspective we write:

GDP = C + I + G + (X – M)

which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X – M).

Expression (1) tells us that total income in the economy per period will be exactly equal to total spending from all sources of expenditure.

We also have to acknowledge that financial balances of the sectors are impacted by net government taxes (T) which includes all taxes and transfer and interest payments (the latter are not counted independently in the expenditure Expression (1)).

Further, as noted above the trade account is only one aspect of the financial flows between the domestic economy and the external sector. we have to include net external income flows (FNI).

Adding in the net external income flows (FNI) to Expression (2) for GDP we get the familiar gross national product or gross national income measure (GNP):

(2) GNP = C + I + G + (X – M) + FNI

To render this approach into the sectoral balances form, we subtract total taxes and transfers (T) from both sides of Expression (3) to get:

(3) GNP – T = C + I + G + (X – M) + FNI – T

Now we can collect the terms by arranging them according to the three sectoral balances:

(4) (GNP – C – T) – I = (G – T) + (X – M + FNI)

The the terms in Expression (4) are relatively easy to understand now.

The term (GNP – C – T) represents total income less the amount consumed less the amount paid to government in taxes (taking into account transfers coming the other way). In other words, it represents private domestic saving.

The left-hand side of Equation (4), (GNP – C – T) – I, thus is the overall saving of the private domestic sector, which is distinct from total household saving denoted by the term (GNP – C – T).

In other words, the left-hand side of Equation (4) is the private domestic financial balance and if it is positive then the sector is spending less than its total income and if it is negative the sector is spending more than it total income.

The term (G – T) is the government financial balance and is in deficit if government spending (G) is greater than government tax revenue minus transfers (T), and in surplus if the balance is negative.

Finally, the other right-hand side term (X – M + FNI) is the external financial balance, commonly known as the current account balance (CAD). It is in surplus if positive and deficit if negative.

In English we could say that:

The private financial balance equals the sum of the government financial balance plus the current account balance.

We can re-write Expression (6) in this way to get the sectoral balances equation:

(5) (S – I) = (G – T) + CAB

which is interpreted as meaning that government sector deficits (G – T > 0) and current account surpluses (CAB > 0) generate national income and net financial assets for the private domestic sector.

Conversely, government surpluses (G – T < 0) and current account deficits (CAB < 0) reduce national income and undermine the capacity of the private domestic sector to add financial assets.

Expression (5) can also be written as:

(6) [(S – I) – CAB] = (G – T)

where the term on the left-hand side [(S – I) – CAB] is the non-government sector financial balance and is of equal and opposite sign to the government financial balance.

This is the familiar MMT statement that a government sector deficit (surplus) is equal dollar-for-dollar to the non-government sector surplus (deficit).

The sectoral balances equation says that total private savings (S) minus private investment (I) has to equal the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)) plus net income transfers.

All these relationships (equations) hold as a matter of accounting and not matters of opinion.

So what economic behaviour might lead to the outcome specified in the question?

If the nation is running an external deficit it means that the contribution to aggregate demand from the external sector is negative – that is net drain of spending – dragging output down. The reference to a “small” external deficit was to place doubt in your mind. In fact, it doesn’t matter how large the external deficit is for this question.

Assume, now that the private domestic sector (households and firms) seeks to increase its overall saving (that is, spend less than it earns) and is successful in doing so. Consistent with this aspiration, households may cut back on consumption spending and save more out of disposable income. The immediate impact is that aggregate demand will fall and inventories will start to increase beyond the desired level of the firms.

The firms will soon react to the increased inventory holding costs and will start to cut back production. How quickly this happens depends on a number of factors including the pace and magnitude of the initial demand contraction. But if the households persist in trying to save more and consumption continues to lag, then soon enough the economy starts to contract – output, employment and income all fall.

The initial contraction in consumption multiplies through the expenditure system as workers who are laid off also lose income and their spending declines. This leads to further contractions.

The declining income leads to a number of consequences. Net exports improve as imports fall (less income) but the question clearly assumes that the external sector remains in deficit. Total saving actually starts to decline as income falls as does induced consumption.

So the initial discretionary decline in consumption is supplemented by the induced consumption falls driven by the multiplier process.

The decline in income then stifles firms’ investment plans – they become pessimistic of the chances of realising the output derived from augmented capacity and so aggregate demand plunges further. Both these effects push the private domestic balance further towards and eventually into surplus

With the economy in decline, tax revenue falls and welfare payments rise which push the public fiscal balance towards and eventually into deficit via the automatic stabilisers.

If the private sector persists in trying to net save then the contracting income will clearly push the fiscal position into deficit.

So we would have an external deficit, a private domestic surplus and a fiscal deficit.

There will always be a fiscal deficit at any national income level, if the private domestic sector is successfully spending less than it earns and the external sector is in deficit.

The same logic applies if the private domestic sector is breaking even.

The following blog posts may be of further interest to you:

Question 2:

One consequence (perhaps an advantage) of the government issuing bonds to the non-government sector to match its deficit over the alternative of not issuing any new debt, is that the non-government sector is immediately wealthier as a consequence.

The answer is False.

This answer relies on an understanding the banking operations that occur when governments spend and issue debt within a fiat monetary system. That understanding allows us to appreciate what would happen if a sovereign, currency-issuing government (with a flexible exchange rate) ran a fiscal deficit without issuing debt?

In this situation, like all government spending, the Treasury would credit the reserve accounts held by the commercial bank at the central bank. The commercial bank in question would be where the target of the spending had an account. So the commercial bank’s assets rise and its liabilities also increase because a deposit would be made.

The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made. Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet). Taxation does the opposite and so a deficit (spending greater than taxation) means that reserves increase and private net worth increases.

This means that there are likely to be excess reserves in the “cash system” which then raises issues for the central bank about its liquidity management. The aim of the central bank is to “hit” a target interest rate and so it has to ensure that competitive forces in the interbank market do not compromise that target.

When there are excess reserves there is downward pressure on the overnight interest rate (as banks scurry to seek interest-earning opportunities), the central bank then has to sell government bonds to the banks to soak the excess up and maintain liquidity at a level consistent with the target. Some central banks offer a return on overnight reserves which reduces the need to sell debt as a liquidity management operation.

What would happen if there were bond sales? All that happens is that the banks reserves are reduced by the bond sales but this does not reduce the deposits created by the net spending. So net worth is not altered. What is changed is the composition of the asset portfolio held in the non-government sector.

The only difference between the Treasury “borrowing from the central bank” and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target. If it debt is not issued to match the deficit then it has to either pay interest on excess reserves (which most central banks are doing now anyway) or let the target rate fall to zero (the Japan solution).

There is no difference to the impact of the deficits on net worth in the non-government sector.

Mainstream economists would say that by draining the reserves, the central bank has reduced the ability of banks to lend which then, via the money multiplier, expands the money supply.

However, the reality is that:

  • Building bank reserves does not increase the ability of the banks to lend.
  • The money multiplier process so loved by the mainstream does not describe the way in which banks make loans.
  • Inflation is caused by aggregate demand growing faster than real output capacity. The reserve position of the banks is not functionally related with that process.

So the banks are able to create as much credit as they can find credit-worthy customers to hold irrespective of the operations that accompany government net spending.

This doesn’t lead to the conclusion that deficits do not carry an inflation risk. All components of aggregate demand carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and productive capacity.

It is totally fallacious to think that private placement of debt reduces the inflation risk.

You may wish to read the following blog posts for more information:

Question 3:

The wage share in national income in Australia fell below 50 per cent in the June-quarter 2020. This means that the real wage fell.

The answer is False.

And while real wages did fall the point of the question was to ensure you understood that the movements in the wage share, while being related to real wage movements are not exclusively dependent on them. The real wage could have risen in the June-quarter and still the wage might have fallen.

The wage share in nominal GDP is expressed as the total wage bill as a percentage of nominal GDP. Economists differentiate between nominal GDP ($GDP), which is total output produced at market prices and real GDP (GDP), which is the actual physical equivalent of the nominal GDP. We will come back to that distinction soon.

To compute the wage share we need to consider total labour costs in production and the flow of production ($GDP) each period.

Employment (L) is a stock and is measured in persons (averaged over some period like a month or a quarter or a year.

The wage bill is a flow and is the product of total employment (L) and the average wage (w) prevailing at any point in time. Stocks (L) become flows if it is multiplied by a flow variable (W). So the wage bill is the total labour costs in production per period.

So the wage bill = W.L

The wage share is just the total labour costs expressed as a proportion of $GDP – (W.L)/$GDP in nominal terms, usually expressed as a percentage. We can actually break this down further.

Labour productivity (LP) is the units of real GDP per person employed per period. Using the symbols already defined this can be written as:

LP = GDP/L

so it tells us what real output (GDP) each labour unit that is added to production produces on average.

We can also define another term that is regularly used in the media – the real wage – which is the purchasing power equivalent on the nominal wage that workers get paid each period. To compute the real wage we need to consider two variables: (a) the nominal wage (W) and the aggregate price level (P).

The nominal wage (W) – that is paid by employers to workers is determined in the labour market – by the contract of employment between the worker and the employer. The price level (P) is determined in the goods market – by the interaction of total supply of output and aggregate demand for that output although there are complex models of firm price setting that use cost-plus mark-up formulas with demand just determining volume sold. We shouldn’t get into those debates here.

The inflation rate is just the continuous growth in the price level (P). A once-off adjustment in the price level is not considered by economists to constitute inflation.

So the real wage (w) tells us what volume of real goods and services the nominal wage (W) will be able to command and is obviously influenced by the level of W and the price level. For a given W, the lower is P the greater the purchasing power of the nominal wage and so the higher is the real wage (w).

We write the real wage (w) as W/P. So if W = 10 and P = 1, then the real wage (w) = 10 meaning that the current wage will buy 10 units of real output. If P rose to 2 then w = 5, meaning the real wage was now cut by one-half.

So the proposition in the question – that nominal wages grow faster than inflation – tells us that the real wage is rising.

Nominal GDP ($GDP) can be written as P.GDP, where the P values the real physical output.

Now if you put of these concepts together you get an interesting framework. To help you follow the logic here are the terms developed and be careful not to confuse $GDP (nominal) with GDP (real):

  • Wage share = (W.L)/$GDP
  • Nominal GDP: $GDP = P.GDP
  • Labour productivity: LP = GDP/L
  • Real wage: w = W/P

By substituting the expression for Nominal GDP into the wage share measure we get:

Wage share = (W.L)/P.GDP

In this area of economics, we often look for alternative way to write this expression – it maintains the equivalence (that is, obeys all the rules of algebra) but presents the expression (in this case the wage share) in a different “view”.

So we can write as an equivalent:

Wage share – (W/P).(L/GDP)

Now if you note that (L/GDP) is the inverse (reciprocal) of the labour productivity term (GDP/L). We can use another rule of algebra (reversing the invert and multiply rule) to rewrite this expression again in a more interpretable fashion.

So an equivalent but more convenient measure of the wage share is:

Wage share = (W/P)/(GDP/L) – that is, the real wage (W/P) divided by labour productivity (GDP/L).

I won’t show this but I could also express this in growth terms such that if the growth in the real wage equals labour productivity growth the wage share is constant. The algebra is simple but we have done enough of that already.

That journey might have seemed difficult to non-economists (or those not well-versed in algebra) but it produces a very easy to understand formula for the wage share.

Two other points to note. The wage share is also equivalent to the real unit labour cost (RULC) measures that Treasuries and central banks use to describe trends in costs within the economy. Please read my blog – Saturday Quiz – May 15, 2010 – answers and discussion – for more discussion on this point.

Now it becomes obvious that if the nominal wage (W) grows faster than the price level (P) then the real wage is growing. But that doesn’t automatically lead to a growing wage share. So the blanket proposition stated in the question is false.

If the real wage is growing at the same rate as labour productivity, then both terms in the wage share ratio are equal and so the wage share is constant.

If the real wage is growing but labour productivity is growing faster, then the wage share will fall.

Only if the real wage is growing faster than labour productivity , will the wage share rise.

Further, even if the real wage is falling, the wage share may grow, if productivity is falling more quickly.

The wage share was constant for a long time during the Post Second World period and this constancy was so marked that Kaldor (the Cambridge economist) termed it one of the great “stylised” facts. So real wages grew in line with productivity growth which was the source of increasing living standards for workers.

The productivity growth provided the “room” in the distribution system for workers to enjoy a greater command over real production and thus higher living standards without threatening inflation.

Since the mid-1980s, the neo-liberal assault on workers’ rights (trade union attacks; deregulation; privatisation; persistently high unemployment) has seen this nexus between real wages and labour productivity growth broken. So while real wages have been stagnant or growing modestly, this growth has been dwarfed by labour productivity growth.

That is enough for today!

(c) Copyright 2020 William Mitchell. All Rights Reserved.

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    This Post Has 18 Comments
    1. Question 2:

      I don’t agree with. I’m with Warren on this one and that the mainstream have The whole interest rate management backwards.

      The answer to question 2 doesn’t mention The interest income channels when people save. The larger the debt to GDP ratio The bigger the effect. Pensions for example or NS&I.

      The MMT answer is set the interest rate to zero and let fiscal do the heavy lifting. When critics say how are savers going to get a return on their savings. The MMT answer seems to be, point at Japan and say they just need to save more of their income to get the same returns. Instead of saving a third of their income at a certain interest rate. They now have to save over half of their income to get the same returns.

      For me that is not good enough and spurs the critics on….

      We can do better than that but rarely talk about alternatives and at the same time reign in the FIRE sector. We shouldn’t ignore the interest income channels when it comes to non government sector savings. After all the non government sector savings is what makes the non government sector better off. If it didn’t then why bother saving at all. People save for all kinds of different reasons both long term and short term. Government debt is the main vehicle for that.

      It shouldn’t be but MMT never makes the case that it shouldn’t be. By telling people just to save more to get the same returns after we set the rate to zero just isn’t good enough. Concrete proposals are needed like we can use the ways and means account instead and give everyone an annuity for example. If we are no longer going to issue government debt. Get rid of the private pension sector with a stroke of a pen.

      I might have missed it. If so, if someone can point me in the right direction of concrete proposals of how savers can save after we have set the rate to zero. Other than they just need to save more to get the same returns then that would be great. If so what we can do with the FIRE sector at the same time I would like to read it.

    2. I’ve saved like crazy for the last 2 and a half years just about. Slashed My consumption spending by around 2/3’rds.

      My savings are in government debt and I get interest payments paid to me twice a year. I feel better off ?

      When we stop issuing government debt and set the rate to zero. MMT economists have to be able to explain to millions of people like me who have sacrificed their consumption spending and lived like a monk how we can save in the future. Why saving is worthwhile.

      If the only answer MMT economists have is we have to save even more to get the same returns. Then I can’t I have already slashed my consumption spending and will not vote for that at the ballot box.

      There are other alternatives but we rarely mention them. MMT is a lens so we don’t put concrete proposals together. Leaving our critics to roll about in the hat while the sun shines.

    3. For the answer to be false it’s implied that government bonds carry zero interest rate. However, when there is positive interest rate on gbonds private holders are not indifferent between holding cash or bonds and the fact that they rebalance their asset portfolios in favor of bonds is an indication that their net worth rises by the accrued interest income.
      Also, I would like to point to Prof. Mitchell that when the banking sector experiences reserve drainage, mainstream economists argue that there will be a multiple money supply contraction and not increase. Apparently there is a typo in the explanation!

    4. Derek Henry and Demetrios Gizelis – you are both confused. Re-read Bill’s discussion!

      Regardless of the IR/yield offered, the presumption is the CB has an IR target, so if the consolidated government sells bonds to match deficits they will be draining reserves. Conversely, if they choose not to sell bonds then the reserves will increase by exactly the spending deficit, and to maintain their IR target this will force the CB to pay interest on reserves (or some equivalent operation), thus injecting the same cash into the non-government sector as they would have if paying interest on the bonds.

      So in *both* cases the net financial wealth of the non-government sector increases. Thus, as per the question, the bond sales do not make the non-government sector any MORE wealthier than not selling bonds to match the deficit.

      There is only a difference if the CB lets the IR float, e.g., in the no-bonds case by not paying interest on reserves and choosing to miss their IR target, only then will the bond issuance option lead to more net wealth in the non-government sector. But, as usual, implicit in Bill’s question is the presumption that normal monetary policy lurks in the background, and you must assume the CB will not want to miss their target to get the correct answer. If you ignore that hidden assumption it is easy to get this one wrong for the quiz! This is part of the art of the Weekly Quiz. To understand the hidden details Bill often does not disclose (probably because he is mischievous!? and it is more fun this way – forces you to carefully read the discussion).

    5. Derek Henry – you ask: “I might have missed it. If so, if someone can point me in the right direction of concrete proposals of how savers can save after we have set the rate to zero.”

      This is a bit confused. Savers save regardless of the IR, and the CB target rate is not the commercial bank offered rate (which is competitive).

      I think what you mean is how can everyone who has savings DESIRES all net save? And the answer is they probably cannot, again regardless of the commercial bank interest rates. Some will net save. others will be unable to net save. It all hinges on sectoral balances, not the interest rate. For *all people* to have their net savings desires satisfied, someone else has to be running a deficit. That’s the only way. Savings are the accounting records of past investment (someone else’s spending).

      I can point you to a good article on this:
      http://moslereconomics-kg5winhhtut.stackpathdns.com/wp-content/uploads/2019/02/Full-Employment-AND-Price-Stability.pdf

      As for the F.I.R.E sector, they are a huge drain, a huge net savings sector, which thus inhibits all other real productive sectors from realizing their savings desires. How to deal with them? Tax the crap out of them? Regulate them? (Yes, and yes are the answers.) Only the power of a monopoly currency issuer and taxer can control these beasts, but they must want to exercise that control. If you ask me, the only way government will do this and act in the public interest is if mass social movements pressure them to do so. If governments do not feel public pressure, they will just serve their oligarch masters – path of least resistance.

    6. “concrete proposals of how savers can save”

      You don’t save, you invest in risk assets if you want to maintain the value of money.

      Otherwise, you are being discouraged from saving deliberately – since that denies somebody else an income.

      There’s no free lunch and there are far more people with mortgages than with net savings assets – who would prefer permanently low mortgage rates. Therefore you top slice the ballot box.

      Remember that saving in a bank still gets you the deposit rate the bank pays. ZIRP is only for banks with reserve accounts. What they pay on deposits is down to what rate they can charge when they create the corresponding loan.

    7. Dear Demetrios Gizelis (at 2020/10/10 at 8:49 pm)

      Thanks for your comment. You are correct. I forgot to add ‘immediately’ to the question (that is, before interest payments start to flow). I have done that now.

      Best wishes
      bill

    8. Dear Bijou Smith,

      Excellent responses from you on the questions raised. However, on a side note, I always have one concern. When our economy is based on fiat currency, which means, it should at least have interest rate equal to the inflation rate or higher, otherwise, everyone loses (the purchasing power in the system grows smaller as time goes on).

      This in a way implies that the FIRE sector is doing OK, or much needed (until we have a better replacement).

      By this I mean, many pensioners through pension funds (FIRE is one such group of funds) rely on this income to survive into the old age.

      If the interest rate is so low, or near zero, the risk-taking will rise to the point that one day another financial crisis will result. Or, if regulations does not allow this higher risk taking, then, this saving industry along with the government’s such fund/schemes will collapse along with the pensioners.

      Any how, my point is that a decent interest rate must be provided by the government for fiat currency system to survive well and into the future.

      On this note, any country that plays with zero interest rate risks losing out compared to the country that does not, because the sectoral balances system must also live in the real resource constraints ecosystem.

      What do we think?

      vorapot

    9. Vorapot, if government provides means-tested above-poverty age pensions, then savers don’t need interest income. (given low inflation). They have their saving to draw on for the nice things in retirement (depending on how much they saved during working life).

      I’m with Islam: charging interest is evil……

    10. Dear Bijou Smith, welcome to the confused gang! Your analysis restricts the nongovernment sector to the banking industry, which is false because gbonds buyers are a variety of other savers/investors as well, including foreigners, and all these are not benefiting when the CB starts paying interest on reserves. In addition, the interest rate on reserves quite often is lower than on gbonds.
      On this account I direct you to Bill’s reply to my comment.

    11. Bijou,

      I didn’t miss it and thanks for the link but read it a decade ago. I”m addressing the ” stop issuing debt and set the rate at zero question ”

      Neil,

      Millions of people don’t want to invest in risk assets. The deposit rates will be rubbish as the risk managers slash interest rates at permanent zero rate. I know it is my job.

      When you get older your appetite for risk vanishes. You want all of your hard earned savings to be safe. I know this as again it is my job as clients swap their portfolio risk models as they start getting near retirement.. No this is not the rich the majority are the working class who have scrimped and sacrificed all their lived to have enough to retire on. The younger ones will be pushed into taking on more and more risk to try and get a return. We know how that ends. You also just push the banks into 2007 territory again.

      Not all government debt is evil. I see the difference it makes to people’s lives every day at work. Those that have worked hard and have never expected a free lunch. The government debt prime purpose is to offset risk that’s why it is in every saving portfolio model. It can’t even do that at the moment hence the rush to gold as risk managers rebalance their portfolio’s to protect the savings of hard working families.

      Since July I’ve been dealing with maturing direct shares, ISA’s and index linked bonds. Hard working families,not the rich invested in these as they are virtually “risk free”. The time range varied between 5-6 years. Due to the virus the minimum return 0.5% is what they are getting. Over 30,000 have matured so far another 15,000 in November and 20,000 in December. I’m working round the clock. 0.5% gross after 6 years with income tax and capital gains tax on the index linked bonds and direct shares. So nothing after 6 years basically.

      Most have decided not to reinvest as they see it as a waste of time. So savings are now sitting in deposit accounts earning 0.01%. Our plan is to take away the only thing that mitigates the risk government debt and set the rate to zero. Without offering an alternative.

      Without an alternative yeah sure push hard working people into more risk assets and banks into ever more riskier assets. See how that plays out. Government debt is not just a free lunch for the rich.

      Regarding mortgages – build more social housing millions of it.

      I wonder if that is why the old saying is true the older you get you end up voting Tory. As you try and hold onto your hard earned cash you’ve saved over your lifetime. Why so many pensioners run to them.

      I do not want riskier assets and there is a free lunch for “every” saver it’s called government debt.

      So won’t get my vote at the ballot box without a real alternative that helps with risk.

    12. I see the reality not theory every day at work.

      Why I can play the part of Devils advocate.

      Once you realise government debt is the “corner stone” of risk management for hard working families and you take away that corner stone without providing an alternative. Then it is a vote loser.

      Those who decided to choose more risk the younger savers that……

      a) had no government debt in their portfolios

      b) Very little

      Have done very badly disastrous in fact. We want to take govt debt out of all the risk portfolios.Think about that.

      Those who are bailing out and want a return with less risk. Guess where they are being advised to go by their savings advisors ?

      Into property pushing house prices up. So the ballot box probably hasn’t been sliced up at all even with a lower mortgage rate. It just allows them to buy more property. Pushing prices up which ends up a zero sum game.

      Those that did get 0.5% gross return after 6 years at least knew their savings was ” safe”. As you get older that’s all that matters. People are living longer remember the votes in that.

      So in short if we are going to take away the ” corner stone ” of risk management for hard working families or set the ” corner stone ” of risk management at a very low rate. Remember fund managers are already running into the volatility of the gold price in order to rebalance the portfolios of hard working families due to the virus.

      Then we better have a good alternative. Even taking banking out of the private sector the alternative has to be good. Otherwise it ends up being like the basic income story. Hard working families who save for the future will simply not vote for it.

      Millions of workers don’t want to be stuck in risk assets they want to feel safe. Especially after not just the financial crash, but what savers have experienced with the virus. With promises of more viruses to come in the coming years.

      Taking away the ” corner stone ” or setting it low would be political suicide without a real alternative.

      “Save more to get the same rate “or “there is no free lunch “are not vote winners I’m afraid. I prefer the ways and means account and give everyone an annuity idea.

      An article on where the hard working Japanese voters go to get a return on their savings would shed some light on the issue. I would take a guess they are staying well clear of risk assets. As the Japanese stock market did not go up in tandem with their huge deficits and debt to GDP ratio. Are they saving more to get the same returns ? Or globetrotting to find the best returns in the best government debt ?

    13. For those that have not seen the ways and means and give everyone an annuity idea that Neil came up with years ago… Then here it is….

      We need an alternative a vote winner if we remove the corner stone of risk management.

      ” The Ways and Means Account is just an infinite overdraft with the Central Bank, and it grows over time to balance the net-savings of the non-government sector just as the Gilt stock does now.

      HM Treasury simply doesn’t issue any Gilts any more. Any funding of private pensions in payment should be done by offering annuities at National Savings, which would also have the neat side effect of ‘confiscating’ net savings and making the deficit go down.

      It’s irrelevant what interest BoE charges on the ‘Ways and Means’ account since any profit the BoE makes from it goes back to HM treasury anyway. So it can 50% if that gives the necessary level of satisfaction to mainstream economists.

      What you have is a standard intra-group loan account between a principal entity (HM Treasury) and its wholly-owned subsidiary. Normally those sort of loans are interest free for the fairly obvious reason that interest charging is utterly pointless, and they are perpetual for the same reason. Rolling over is totally pointless.

      Any term money can then be issued to the commercial banks directly by the Bank of England – up to three month Sterling bills.

      If you are a member of a pension scheme then the savings of the current generation, plus the interest on Gilts and any income from the other assets owed pay the pensions of the current generation of pensioners. They are all, in effect, private taxation schemes that circulate money around the system.

      You’ll note that when there was a threat of people failing to save in pensions, the government introduced compulsory retirement saving – which is of course a privatised hypothecated tax.

      So in essence rather than the assets of a pension scheme being used to purchase Gilts, the assets would be used to purchase an annuity from the government dedicated to an individual. The result is that rather than the private pension receiving Gilt income from the state, to then pass onto the pensioner, the state would cut out the middleman (and their cut) and pay the pensioner directly as an addition to the state pension. There’s a whole private pension industry out there literally doing absolutely nothing of any real value. They can’t provide a guaranteed income in retirement without state backing in the form of Gilts. So what is exactly the point of having them? “

    14. Think about it in real terms. Pensions are always a current production issue. The introduction of compulsory pension payments was to prop up the payments to people who currently have pension annuities. There is no “saving” in aggregate. Just the changing of the labels on supposed assets.

      What funds the elderly is the young working more hours than they strictly need to and who then transfer that output to the elderly.

      The problem we have at the moment is that the young are being stitched up like kippers by the older generation, and therefore they are not minded to be more generous to the elderly.

      Private pension schemes have always been a bit of a lie, whether backstopped by private corporations, or “invested assets”. They don’t work – because they don’t tax the young sufficiently. Only government can do that.

      Which means that either the lie has to be dispensed with – and the state pension beefed up accordingly. Or there has to be an issue of “Granny Bonds” at National Savings that people can “save” in voluntarily. Whichever one we need depends upon how we think the future distribution ought to be allocated. To every person who gets old, or just those who were capable of depressing the economy throughout their lives by saving too much.

      Which is more virtuous? Those who spend and ensure others have a job, or those who do not based upon the traditional view that somehow they are laying things down for the future.

    15. Got this from an NK fan

      Bonds yield the exact same amount as money. IOER is the same as the 1 month T-bill rate. In mainstream economics, short-term bonds and money are basically the same security. It shouldn’t matter which security the government issues, they have identical payoffs.

      Long-term debt ends up being different because it can trade below par allowing policy to smooth inflationary fiscal policy shocks. This effect will only matter if you assume a Non-Ricardian fiscal policy regime though. If fiscal policy is Ricardian (as is assumed in typical New-Keynesian models), then it never matters what liability they issue as inflationary fiscal policy shocks are ruled out by assumption.

      It’s worth remembering that when people swap money for bonds they pay the discounted price of the bond at the expected interest rate to maturity (as they can see the future perfectly in the model world).

    16. Wow, so many interesting discussions and offers from all sides. I so am impressed by the amount of knowledge and Insights you all possess. Keep sharing on Bill blog; they are worth waking up to in the morning to read, not to mention that they make my cheap instant morning coffee tastes like one from the best black gold mine.

    17. In as much as retirement savings contribute to actual unemployment, it would seem obvious that they are counterproductive (very literally).
      In as much as they discourage working age people from outbidding retired people for labour, they are valuable (see the literature on financing WWII).
      The trick would seem to be to keep retirement savings finely balanced in the power band, diverting resources to retirement services, without stalling the economy.
      One thing I would like to see is more effort to divert retirement savings to productivity improving investment.

    18. “One thing I would like to see is more effort to divert retirement savings to productivity improving investment.”

      That requires risk, and the one thing you don’t want to do with “retirement savings” is risk.

      You don’t need to divert savings. What you do is accommodate them using the monetary system and enable risk investing elsewhere.

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