The budget battles

[Winstonm]

This is not a real argument, as wages respond to inflation. Inflation as high as 10% has not been uncommon in developed ecnonomies since WW2, in the UK inflation averaged 13% for the 1970's for example, inflation, but gdp at PPP still rose in the UK through this time.

 

What part of fixed income do you not understand? Wages are not fixed income. Retirement accounts, Social Security, Disability - these are fixed incomes. Inflation crushes those who are on fixed incomes and depletes the value of savings, leading to a buy and spend economy, leading to borrow and spend, leading to a crash...oh, didn't we just do all that?

[Winstonm]

The government can also pay the wages of its employees with this money, for example. Provided the amount printed does not exceed the value of the goods and services that the Government purchases is can buy `real stuff' rather than debt.

 

Buying debt is a strategy for helping the banks, it seems mostly irrelevant to the printing money argument.

 

What exactly do you think wages owed by the government to its employees would be other than a government debt - sure it is short term debt but it is still an obligation (a debt) to pay a certain amount.

 

Besides, I don't think you are right about this. The U.S. Treasury would have to fund the payments, and all the Fed can do is fund the Treasury, so the Fed still has a debt obligation to own by way of the Federal budget which is funded by taxes and bonds.

[y66]

Of poss. interest:

 

The Interest Rate That Did Not Bark in the Night: The Surge in U.S. Treasury Debt and the Non-Reaction of Rates by Brad DeLong. Excerpt:

 

It is in this situation that we want a government deficit--the government to print and issue the safe bonds that private investors really want to hold. As these bonds hit the market, people who otherwise would have socked their money away in cash--thus diminishing monetary velocity and slowing spending--buy the bonds instead. A large and timely government deficit thus short-circuits the adjustment mechanism, and avoids the collapse in monetary velocity that was the source of all the trouble. And as long as output is depressed--as long as monetary velocity is low and there is slack in the economy--printing more and more bonds will have next to no effect increasing interest rates.

 

I will never doubt John Hicks again.

 

But how much longer can this go on?

 

It seems to me that sensible policy should cater more to unemployed dogs who are barking now than to the fat cat dogs who will be barking when their bond portfolios become imperiled by so far non-existent inflation.

 

Clearly, the fat cat dogs and their political pals are winning the barking contest.

[PassedOut]

The Interest Rate That Did Not Bark in the Night: The Surge in U.S. Treasury Debt and the Non-Reaction of Rates by Brad DeLong.

 

It seems to me that sensible policy should cater more to unemployed dogs who are barking now than to the fat cat dogs who will be barking when their bond portfolios become imperiled by so far non-existent inflation.

 

Clearly, the fat cat dogs and their political pals are winning the barking contest.

Good article in that it addresses the crucial importance of the velocity of money (as opposed to the formation of capital, which affects the economy more slowly) in restoring jobs and economic health.

 

And so the speed with which cash turns over in the economy, the velocity of money, falls. And as the velocity of money falls, total spending falls, and workers are fired, and as workers are fired and lose their incomes their saving goes from positive to negative.

Because the velocity of money is so important, a short-term deficit in hard times is most useful when the money goes directly into the hands of those who spend it immediately. Government programs that build infrastructure put money into the hands of otherwise unemployed construction workers, and at the same time provide the conditions for continuing economic growth: a double benefit.

[Winstonm]

Good article in that it addresses the crucial importance of the velocity of money (as opposed to the formation of capital, which affects the economy more slowly) in restoring jobs and economic health.

 

 

Because the velocity of money is so important, a short-term deficit in hard times is most useful when the money goes directly into the hands of those who spend it immediately. Government programs that build infrastructure put money into the hands of otherwise unemployed construction workers, and at the same time provide the conditions for continuing economic growth: a double benefit.

 

There is another school of economic thought that gives no credence to velocity at all, the Austrian school:

 

Contrary to mainstream economics, velocity does not have a "life of its own." It is not an independent entity--it is always value of transactions P(T) divided into money M, i.e., P(T/M). On this Rothbard wrote: "But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation." (Man, Economy, and State, p. 735)

 

Since V is P(T/M), it follows that the equation of exchange is reduced to M(PxT)/M = P(T), which is reduced to P(T) = P(T), and this is not a very interesting truism. It is like stating that $10=$10, and this tautology conveys no new knowledge of economic facts.

 

Their take is that currency only facillitates exchanges and it is the underlying work that actually finances the economic exchanges.

 

Say's Law states that supply creates its own demand. IMO, this means that work product (supply) creates its own demand (ability to consume). Unfortunately, it seems many people misunderstood this Law to read that if one overbuilds millions of McMansions that magical pixie fairies will suddenly materialize to buy them with no money down.

 

Reality is that the overbuilding did temporarily create jobs which created demand, but the demand it created was unsustainable because of a misapplication of Say's Law, and the pixie fairies of supply-created demand did not materialize to consume the oversupply.

 

Last quarter U.S. consumption grew at an anemic annualized 0.7% according to Caroline Braun of Bloomberg. With an unemployment rate of 9.1% (no work product) to produce demand (ability to consume), is it any wonder consumption is so low?

[PassedOut]

There is another school of economic thought that gives no credence to velocity at all, the Austrian school:

I understand that, as I understand that some people give no credence to evolution and some no credence to global warming. In reality, many transactions that would occur if folks had money do not occur at all when folks do not have money.

[cherdano]

There seem to be several points here. I think everyone agrees about the benefits of a mildly inflationary economy. However, it does not follow that borrowing is a sensible tool to achieve this. Afterall, a government can inflate the economy easily by "printing" money. It feels like borrowing from the private sector is inflationarily neutral since, in general, the private sector will find a way to put their capital to use anyway. This means that government borrowing is (relatively) inflationary only if the private sector was planning to sit on the money. Further, by printing enough to put inflation at 3-4% the government gets the best of both worlds, since it makes it expensive to sit on capital and therefore forces the private sector to invest even without borrowing money.

I think we agree pretty much. However, unless I misunderstood s.th. very basic, what you describe as "printing money" would be described as the following two things in the US:

1. The federal government runs a deficit.

2. The federal reserve does "quantitative easing", i.e. basically printing money and using it to buy government debt.

 

I am just pointing this out since what you suggest (printing money to keep the inflation at 3%) seems to be the considered an irresponsible lunatic leftist position in the current public debate in the US.

 

(Me, I mostly think that unemployment in the US is currently at 9%.)

[blackshoe]

Say's Law states that supply creates its own demand.

 

You can supply all the mud pies you like. Nobody's going to eat them.

[Winstonm]

I understand that, as I understand that some people give no credence to evolution and some no credence to global warming. In reality, many transactions that would occur if folks had money do not occur at all when folks do not have money.

 

IMO your analogies fail as global warming and evolution are backed by evidence. Velocity is a mathematical expression. Rejecting the former two is not the same as understanding that a mathematical equation cannot be a cause of an event.

 

It seems rather odd to me to attempt to express economics (human activity) in only mathematical terms - when the preponderance of human activity is much more emotionally or psychologically based.

 

Although I do not accept all of Austrian thought, I do think they are much ahead in the area of incorporating some psychological aspects of ecomonic activity.

[y66]

Does Austrian economics understand financial crises better than other schools of thought? posted at Martin Wolf's Exchange. Excerpt:

 

I think we can say that conventional neo-classical equilibrium economics did a poor job in predicting the crisis and in suggesting what should be done in response. We can also say that neo-Keynesians pointed out some important precursors of the crisis, in particular, the destabilising role of huge private sector financial deficits in countries with large external deficits, such as the US, and the Keynesian view certainly played a big part in the post-crisis response, as did that of Milton Friedman.

 

Yet some would argue that economists working in the Austrian tradition were more nearly right than anybody else. In particular, they have argued that: inflation-targeting is inherently destabilising; that fractional reserve banking creates unmanageable credit booms; and that the resulting global “malinvestment” explains the subsequent financial crash. I have sympathy with this point of view. But Austrians also say – as their predecessors said in the 1930s – that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes. I find this unconvincing. Mass bankruptcy is extremely costly. Moreover, it is impossible to separate what is healthy from what is unhealthy during a general economic collapse triggered by an implosion of the financial system.

Excerpt from Brad DeLong's comments:

 

Let me give eight propositions that I think of as "Austrian," meaning that they have been maintained by some "Austrian" somewhere and somehow, and assess them:

 

(1) IF THE FEDERAL RESERVE HAD FOLLOWED A "SOUND" MONETARY POLICY--"SOUND" MEANING THAT IT SHRANK THE STOCK OF HIGH-POWERED MONEY AT THE SUM OF THE TREND GROWTH RATES OF THE INSIDE MONEY MULTIPLIER AND OF VELOCITY--THEN WE WOULD NOT HAVE FINANCIAL CRISIS OR BIG RECESSIONS.

 

Status: FALSE. Requiring trend deflation at the rate of labor force and labor productivity growth in order to keep nominal spending without a trend would be more likely to generate waves of universal bankruptcy, deep financial crises, and big recessions than our current system.

Excerpt from Paul Krugman's comments:

 

My view is that the fatal flaw in Austrian economics is that it can’t explain unemployment — or, worse, that it thinks that it can explain unemployment, but is deluding itself. The Austrian view is that unemployment in a slump results from the difficulty of “adaptation of the structure of production” — workers are unemployed as resources are painfully transferred out of an overblown investment-goods sector back into production of consumption goods.

 

But this immediately raises the question, why isn’t there similar unemployment during the boom, as workers are transferred into investment goods production?

 

I’ve asked this question repeatedly over the years, and all I get is one of two things: gobbledygook, or “but during the phase of rising investment, the economy is booming!”, which is of course circular.

[Winstonm]

You can supply all the mud pies you like. Nobody's going to eat them.

 

I agree, which is the reason IMO either Say's Law is misunderstood or it is wrong.

Overbuidling McMansions did not create a sustainable demand for McMansions.

 

That misutilization of resources to overbuild compared to demand is the basis of the Austrian concept of malinvestment, which is quite a good description of what occured during the housing boom and bust, but the Austrian monetay policies are pretty arcane and not nearly so well thought out IMO.

[PassedOut]

IMO your analogies fail as global warming and evolution are backed by evidence. Velocity is a mathematical expression. Rejecting the former two is not the same as understanding that a mathematical equation cannot be a cause of an event.

 

It seems rather odd to me to attempt to express economics (human activity) in only mathematical terms - when the preponderance of human activity is much more emotionally or psychologically based.

I'm not following you here. When I use the term "velocity" I mean a descriptive measurement of how often money is spent over a period of time. Of course the descriptive measurement itself does not cause the spending.

 

But the variations in real-life spending described by changes in velocity do affect the economy: a higher velocity means more goods and services purchased during a specific period than does a lower velocity. Government policies intended to stimulate the economy that produce a higher velocity of circulation do a better job than do policies that produce lower velocities. There is a great deal of evidence to support that position, as there is for evolution and for global warming.

[Winstonm]

Back on the concept of velocity, I do think that the description given by the Austrians makes a lot of sense (or it may be that I simply grasp the written word better than deciphering formulas and equations).

 

Anyway, the Austrian argument goes something like this: Suppose we start with a single $10 bill U.S. Art is an artist, Bill is a baker, and Fred is a farmer, and they are our economic actors.

 

Art creates a painting which he sells for $10.

Bill the baker has made 10 loaves of bread.

Art is hungry so he buys the 10 loaves of bred and gives Bill the $10.

Bill needs to bake more bread, so he buys 10 bushels of wheat from Fred for $10.

 

According to established thought, the initial $10 financed $30 in economic acticity, so the velocity was 3x.

 

The Austrian school argument is that the money simply provided a medium of exchange, it facillitated economic activity, but the financing was the work done by each person. They further point out that the speed at which the money changes hands has no bearing on price - price is always determined by what one actor is willing to pay and another is willing to accept.

 

To me this makes more sense than the mathematical formula - and it explains to me why central bank activity of increasing money supply to offset lowered velocity does not work.

 

But then, what the heck do I know about anything.

[Winstonm]

I'm not following you here. When I use the term "velocity" I mean a descriptive measurement of how often money is spent over a period of time. Of course the descriptive measurement itself does not cause the spending.

 

But the variations in real-life spending described by changes in velocity do affect the economy: a higher velocity means more goods and services purchased during a specific period than does a lower velocity. Government policies intended to stimulate the economy that produce a higher velocity of circulation do a better job than do policies that produce lower velocities. There is a great deal of evidence to support that position, as there is for evolution and for global warming.

 

Thank you for letting me clarify.

 

I am questioning the importance of velocity. Certainly velocity describes activity to a degree, but when velocity is placed into a mathematical equation, the equation works but reality fails - and it fails because velocity is not a causation agent.

 

This is why it is important IMO to understand that low velocity cannot be resolved by monetary policy, which is what the mathematical formula says should happen.

 

The reason for this IMO is better answered by the Austrians as velocity is based on each individual's decision on whether to spend or delay spending - supply of money is irrelevant to that decision.

 

So, that is my position - the substitution of velocity into the equation explains what is happening, but the formula does not work as a model that can affect real-world occurences by changes made to the formula, i.e., velocity is descriptive only.

 

I hope this makes more sense.

[PassedOut]

Art creates a painting which he sells for $10.

Art sells fewer paintings (and has a bloated inventory) when people have little money to spend. That also affects Bill and Fred adversely.

 

Changes made to the formula do not affect the economy, I certainly agree, but changes that affect the actual spending patterns measured by velocity do affect the economy.

[kenberg]

I'm impressed, well, sort of. We are in desperate need of people in policy making positions who know what they are doing. But my thinking is that I won't try to explain Semi-Simple Lie Groups to them and they should not feel the need to explain economic theory to me. They need to convince me that they understand it, not make me understand it.

 

Let's look at some simple facts.

 

The economy was in good shape when Bush took office. It was a disaster looking to be a total disaster when he left.

 

There was a budget surplus when Clinton left office. Taxes were higher but I had no trouble paying them and leading a good life. Taxes were lower when Bush left office and the debt was skyrocketing. True, this continues.

 

Why on Earth should we think that Republicans know how to handle the economy? Not raising the debt ceiling is like announcing that we are going to be really responsible about money and to demonstrate our responsibility we are going to stop paying our bills. This is their solution?

 

I am more than willing to listen to arguments about why we should spend less money and especially why we need to get a handle on rising health costs. I would probably agree with many of the proposals. I have lived my life without debt, I avoid debt like the plague, I hate that the nation is in such debt. But a bunch of idiots who ran the economy into the ground and now suggest that we lower taxes further and not pay our bills are not the folks I want to trust with getting us out of this fix.

 

 

As to velocity of money, yeah, it moves away from me way to fast.

[Winstonm]

Art sells fewer paintings (and has a bloated inventory) when people have little money to spend. That also affects Bill and Fred adversely.

 

Changes made to the formula do not affect the economy, I certainly agree, but changes that affect the actual spending patterns measured by velocity do affect the economy.

 

I agree - as a measurement, i.e., a description of what has occured velocity is a valuable tool; however, it is important IMO to keep in mind that velocity is not a "thing" and therefore cannot influence real world behavior as it does the economic mathematical equation when the number representing velocity changes.

 

When velocity slows the mathematical equation is kept in balance by increasing money supply; but increasing money supply does not equate to real-world activities that match the equation; that is where a problem lies IMO.

 

In other words, it appears to me to be a terrific example of the difference between reality and an abstraction that attempts to describe reality - too often I am afraid we confuse the two as equal when they are not, and therefore decisions based on the abstract may not be best in reality.

[hrothgar]

Back in the weird old days, I occasionally had to teach Econ 102 (Macro)

 

I always hated teaching this class (I far preferred teaching Micro or Probability and Statistics)

 

Issues like "Velocity" and the Equation of Exchange are a classic example why I hated dealing with this subject.

 

"Velocity" is almost meaningless.

 

It's an accounting convention to make sure that the equation "MV = PT" balances.

 

People care alot about "T" (the total value of all the transactions in the economy)

People also get excited about "M" - especially the extent to which jiggering "M" will cause "T" to move up or down.

And, of course, people always care about inflation.

 

I never once saw any serious discussion about "velocity".

Unless you're dealing with hyper inflation, its always assumed to be a fixed parameter.

I don't recall ever seeing any serious policy discussion that involved velocity.

 

For that matter, I haven't ever seen serious policy discussion that involved "Austrian Economics" which has long been a marginalized side show, largely isolated to George Mason University.

[Winstonm]

Velocity" is almost meaningless.

It's an accounting convention to make sure that the equation "MV = PT" balances.

 

Again you say elegantly in a handful of words what it took me volumes to say and I did not explain it nearly so well.

[y66]

Quote from Andrew Leonard via Krugman's blog:

 

The best deficit-reducing strategy is a growing economy that generates increased tax revenues.

Surely, no one disagrees with this.

[Winstonm]

Quote from Andrew Leonard via Krugman's blog:

 

 

Surely, no one disagrees with this.

 

I don't think anyone would disagree, but at the same time there are caveats that apply. For example, the current U.S. debt is so great that it is folly to hope that economic growth alone could eliminate it.

[y66]

I don't think anyone would disagree, but at the same time there are caveats that apply. For example, the current U.S. debt is so great that it is folly to hope that economic growth alone could eliminate it.

Nobody thinks economic growth alone will eliminate the budget deficit anytime soon.

[y66]

Is U.S. business abandoning the middle class? Good story by Chrystia Freeland.

[Winstonm]

Nobody thinks economic growth alone will eliminate the budget deficit anytime soon.

 

My contention has always been that there is a distinct difference between the tautological balancing of the equation MV=PT and real world economic activity.

 

The same holds true for the Laffer Curve - when we are talking about 95% taxation rates being lowered to 30% there is benefit, but when rates are lowered from 35% to 30%, the same benefit not only does not hold but reverses.

 

In both instances, what I think has happened is that a kernal of truth has been extrapolated into a bumper-sticker ideology that is more dogma than doggone right.

[phil_20686]

I think we agree pretty much. However, unless I misunderstood s.th. very basic, what you describe as "printing money" would be described as the following two things in the US:

1. The federal government runs a deficit.

2. The federal reserve does "quantitative easing", i.e. basically printing money and using it to buy government debt.

 

I am just pointing this out since what you suggest (printing money to keep the inflation at 3%) seems to be the considered an irresponsible lunatic leftist position in the current public debate in the US.

 

 

There are two distinct phases to this. A government can run a deficit, which converts idle private savings into current investments. This is because in order to run a deficit there must be someone who is prepared to buy your bonds. If the economy was booming people would have many profitable investment opportunities and there would not be as great a demand for bonds. You could probably get around this via higher interest rates, but then you would in a sense be robbing peter to pay Paul, as you would necessarily be dampening investment somewhere. (One can see this in the Japenese economy, where the public's desire to buy "safe" Japanese bonds keeps their bond yields low despite a decade of ballooning public debt). At a time like this, with private companies unsure whether to invest there is probably a gain to running a moderate-large deficit. Thus, a deficit is essentially funded by lowering private investment.

 

Anyway, I got sidetracked, my point is that a deficit does not inherently affect the money supply at all. QE may or may not be funded by government debt, or may be funded by creating money. In the former case it is not inflationary, in the latter is is inflationary, but has some interesting caveats. Say the asset purchased is a mortgage, then as it gets paid off the bank accumulates money, which is is a slow deflationary pressure, as it is slowly decreasing the supply of "narrow money" as people are paying cash to the fed. Its not at all clear what the Fed plans to do with this money. Originally QE was seen as short term solution with the fed planing to sell the assets back to the market at some point. Its now looking like it might have to hold on to the m for a while. It could use the savings to purchase more assets, but normally the activities of a central bank are constrained in this regards. Moreover, if it sells them at a profit the entire escapade will be deflationary as it will be taking back more money than it originally injected. If it sells them at a loss the tax payer will take a hit.

 

Of course, by printing money it is taking this money from savers, on the grounds that good have value, and that value is only denominated in dollars, so changing the value of a dollar has an inherent effect on the value of goods. Saved dollars do not have inherent value so get degraded by inflation. The total value of this devaluation of savings is the value of the newly printed dollars in the Feds account.

 

It seems like one of the major problems in the US economy is a failure to invest. One could attempt to see to this shortfall via ever larger deficits to transfer money from private investors into public investments, but it seems like not only is this not really working, but it is also storing up trouble for the future, in the sense that as the debt gets paid back it will put pressure on companies to invest during the boom, which will lead to a real danger of overheating in the economy. Alternatively, by raising inflation one can attempt to force private companies to invest on their own, as holding on to capital becomes ever more expensive.

 

Inflation will also reduce the indebtedness of private consumers, which might to a little to alleviate suppressed consumer spending.