Why NGDP targeting?

These days I keep reading about NGDP targeting, as it keeps being mentioned more and more everywhere. It seems to be another zombie idea taking on more life of its own. It's basically the idea that the current crisis will permanently be solved by the Fed credibly communicating to the people that it will start targeting 4-5% annual growth in nominal GDP level, from here on.

Wow. Imagine, business planners and executives will have no more compunctions about claiming to their investors that they will attain at least 5% nominal revenue growth year in year out.  If they don't achieve it via additional sales volume, the Fed is going to make sure they achieve their targets via inflation. Recessions will be a thing of the past.  Woohoo! There will be NGDP growth year after year, courtesy of the Fed,  regardless of overall business sentiment. Nobody will ever lose again on a business investment, provided everyone invests their money in the most entrenched TBTF companies.

And business investors themselves will have no more worries about their subpar investing prowess. 5% NGDP growth means at least a positive return on their investments, no matter if they put their money in companies run by incompetent managers. If the Fed will work to ensure 5% NGDP growth every year, it wouldn't really mater if the return comes via aggregate demand growth. It can very easily be achieved by asset price appreciation. So fire away, investors. If you don't get the price appreciation via normal market forces, the Fed will come in and goose it up for you.

Now, how again is the Fed supposed to attain this yearly NGDP growth? Via monetary policy? Quantitative easing, Operation twist, swapping Treasuries for reserves? Hasn't this been largely ineffective in reviving demand for the last 2 years? Exactly how is confiscating government treasury assets from the private sector going to make them want to spend more money? And in keeping rates low, or causing more inflation, how is the Fed supposed to convince savers to stop saving, rather than doubling up on saving to make up for the lost yield?

The thing is, monetary policy has overstayed its usefulness as a countercyclical policy. You can only use it so many times to revive an economy from recession. If you don't tighten it back to previous levels, you eventually get to the zero bound, which is where we are.  The Fed can't increase rates, but neither can it decrease them below zero.  So monetarists have been convincing the fed to buy up other types of financial assets, to lower rates on any and all instruments that are NOT YET at the zero bound.  Eventually, where does this take us? They're already proposing the Fed buy up stocks, commodities, and other financial assets.

See, despite all these market distorting moves the Fed has already done, economists are still arguing Bernanke is not doing enough.  They continue to encourage him to communicate to the market - that he will do whatever he can to induce inflation until  the people do it themselves. The thing is, Chuck Norris may continue promising the people he will beat them up unless they do as he wants, but if Chuck has no arms and legs, people are just going to wonder how he's going to make good on his promise.

And if asset substitution, or buying up financial assets, or further monetary loosening still doesn't work in increasing NGDP? Perhaps the fed can just target inflation directly by regular currency depreciation. The US will then be just another currency manipulator.  Will that really get people to start spending their money in the domestic economy, or will it encourage those who can to flee the currency? 

It's the height of futility to insist that the Fed be run on autopilot, based on an automatic rule - "Do we have 5% NGDP level growth already? No, buy more assets, yes, stop, higher than 5% already, sell." The thing is, if we insist policymakers to stop thinking and analyzing the economy, and just follow these policy rules automatically, what we'll have is not a clean, well-functioning economy. We'll have instead the economic equivalent or a runaway car whose speed only varies with the slope of the road it's on. It will still go faster and slower, but it won't care who or what is in its path.  

PS. That time again. No more posts for me till maybe later this year. Don't worry, the zombies will still be there.

Why Nations Fail, a review

"Why Nations Fail" is different from a lot of development books. It neither focuses on specific policy proposals, and neither does it focus on specific micro or macroeconomic theories that lead lead a nation towards economic development.  Quite simply, this book wants to tell you why the same specific sets of policies will work in one nation, and lead nowhere in another. It wants to tell you how you know which nations can run with a specific set of development actions, and end up achieving their objectives.

This book is also different from your regular pseudo-cultural economics books which explain away economic development in successful countries to their specific cultural, anthropological, sociological, or religious makeup. Neither does it barrage you with pseudo-explanations that attribute success to geographical location as the differentiating factor. And neither does it shirk by merely pointing out that successful countries just had the luck of having a really brilliant leader who knew what to do. Yes, these can be big factors that certainly help, but the book in fact explains how each of these common success theories fall short. After all, how many times have we seen countries located strategically next to emerging economies, and led by seemingly smart and charismatic leaders, that still fall short of economic progress, while their neighbours, with seemingly less resources, more run of the mill leaders that come and go, leap into the industrialized world?

No, this is a book that focus on institutions.  It distinguishes between institutions that can be considered extractive from those that are more inclusive.  It then explains how inclusive institutions create the right incentives for local people to invest, to strive, and to take initiative, and how extractive ones discourage them.  If you've been with me on this blog for some time, you know I have a great deal of respect for institutional explanations, and how these institutions create very concrete transmission channels and mechanisms for economic policy. You can have the right policy, but it you do not have the right institutions for it, then no amount of effort will result in successful implementation. To have the right institutions, you need to know how it aligns its objectives with people's incentives and helps them overcome their constraints.

At the macroeconomic level, before you even think of specific goals and policies, you need to ask whether people can see themselves getting more prosperous if they work harder, invest their savings, and take risks with new ways of doing things.  Do they see that rewards go to those who make the effort and investment, or do they risk losing the fruits of their labour to an extractive regime that expropriates and gives everything to someone else more closely connected to the ruling elite? Do they know for a fact that they will have a voice going forward, to ensure that their economic interests are protected and represented, or will they lose out to an elite that's suddenly given a monopoly on their industry?

In my mind these are the questions that must run in the minds of the multitude of people who ultimately make the difference between a nation taking off and a nation not making it.  Steve Waldman posts that depression is a revealed preference, as a polity, and we are choosing continued depression because we prefer it to the alternatives. In the same vein, nations can choose slavery, apartheid, or pluralism, rule by absolute royal decree or rule of law, upward mobility for newcomers or stable representation for incumbents, openness to creative destruction or loyalty to existing regimes. these revealed preferences often also reveal whose interests are most given importance in society. Whether these interests are those of one person, a few elites, or the greater multitude makes all the difference for a nation's rise, and it continued stay up there.

The book provides enough stories and anecdotes from history to make this  view of development vivid.  Soviet Russia, ancient Rome, Maya city states, sub-saharan Africa, medieval China and Japan, medieval England, Spain and Europe, even the neolithic age, as are a bunch of other historical places and times make it to this thick book as examples. it's like reading history all over again, but with the end of analyzing why one people or nation makes it, while others don't, and still others fall. Highly recommended for both history and economics buffs.

Written by Daron Acemoglu, MIT professor of Economics; and James Robinson, Harvard professor of Government.

Natural rate brain twisters

Mike Sankowski has a good primer over at MMR on the fallacies about the 'natural rate'. His main points:

1. The NRoI doesn’t exist
2. If the NRoI does exist, it’s not stable
3. Then, even if it does exist and is stable, it’s power is so weak it’s not useful to consider it in policy.
4. Then, even if it does have a powerful impact on our economy, we have such a problem measuring it and observing it and knowing it in real time, we shouldn’t consider using it as any sort of guide for policy.
5. Then, even if we can observe and measure it and consider using it as a policy guide, the NRoI is focusing on the wrong goal and should not be used as a policy guide

I'll just add that it boggles me how economists purport to be able to calculate the ‘natural rate’ or the ‘equilibrium rate of interest’ in the ‘absence of the capital markets’. Since everything is linked to the capital market, how are they able to compute for the natural rate without it, and how do they at all know it is the ‘equilibrium’? Furthermore, what is the conceptual significance of a rate of interest in the absence of a capital market? 

The natural rate means something different for everyone, even for economists, so there can never be one objective measure for it. Personally, I have my own personal ‘natural rate of interest’, but that is personal to me. I’m sure the ‘natural’ rate would be different for you, and different for the next person. Furthermore, the ‘natural’ rate would be different for me tomorrow, and different again next week. It depends on a lot of personal factors that affect how I value whether or not to take out that next loan or make the next investment. Kind of like the risk premium, it’s going to be a different value for everyone, and its value would change as their personal circumstances change. 

There’s no economy-wide risk premium, and there’s no economy-wide natural rate.  Averaging out everyone’s natural rates to get at one overall natural rate to target still ends up with people with higher than average personal natural rates who still end up misallocating funds (and ending up affecting everybody else’s natural rate). I tend to equate the natural rate with risk premium. Having said that, even economists who argue about the merits of calculating a natural rate will calculate the risk premium as exogenous to the interest rate set by the central bank. So how can something calculated exogenously to the natural rate also be endogenous to it?

Are you still with me? Maybe not. That's how convoluted it gets when you start thinking of an economy's so-called natural rate. Mike is right - to calculate it is to focus on the wrong goal and it should not be used as a policy guide.

Some limits to bank printing 'out of thin air'

In this post I want to highlight an interesting discussion I had over at MNE with other commenters about banks and their ability to print money for their acquisitions. An anonymous commented said:

Bank credit money is also created when banks make asset purchases or payments on their own account, not only when they make loans." to which Matt Franko added "imo they must be able to buy the property and construction of their branches by crediting bank accounts of the landowners and contractors.

I was at first resistant to Matt's assertion that banks can print every time they want to make an acquisition. But thinking it through, that's almost about right, but I wanted to add a clarification, based on my own understanding, that not all payments banks make, though they’re paid as credits to accounts, are new money. That credit will result in a debit, and sometimes the debit is to their equity.  For example, if they buy their office supplies, pay their workers, or settle their utility bills, it does not add new money to the economy. If the bank uses its earnings (part of its equity) which is money received from elsewhere, it is not money created at the point of credit. Anonymous commenter says: 

Whenever they spend or lend they do so with their own privately created credit. They only use reserves to settle with each other or with the central bank and treasury (or when they borrow/lend reserves from/to each other,)or cash when people withdraw it. Everything else is done with the 'inside money' they create themselves. ..

When a bank purchases something or pays someone they credit an account, as they do when they make a loan. The credit is typed into existence through a computer keyboard. This adds to the bank's overall liabilities. Banks have to maintain a *ratio* of capital and or reserves. That ratio has to "come from somewhere" in the case of said purchases/payments, but it's only a fraction of the overall credit/deposit money credited by the bank. If the created deposit is then transferred to another bank then of course settlement takes place with reserves, as always.

Not much I really disagree with. I just would add that loans and branch locations are two different animals. When a bank buys a branch property, it has to be funded by a corresponding liability - its own equity, a loan from somewhere else, or via deposits. But when a bank buys a loan, it expects a positive income from the spread between the loan and the cost of the liability that results from it. Then when a bank buys property for a branch, or a computer printer, there's usually no income assumption, as they’re an expense outlay for the bank.  While it is true that purchases or payments are created as an accounting entry by the bank, if they result in net equity outflow, that outflow cannot be compensated by the bank by printing reserves into existence. One has to distinguish whether that payment is for an expense or for funding a loan. Anything that is considered an expense outlay is not new money created by the bank. And any net cost that results from that purchase is not funded with new money, as is the case with equity capital that has to be raised to maintain the ratio. That’s why, as Tom Hickey said, "the bulk of horizontal money creation comes from credit extension, not asset purchases or payments on their own account". Tom also mentions in the discussion. 

When a bank creates bank money to purchase assets other than loans or fund expenses, it is in effect borrowing at the price of reserves, since it is creating deposits that have to clear (after netting). Even if a bak uses its own excess reserves, that's interest it is losing on lending in the interbank market. Banks can create money but not "for nothing." But it is true that banks borrow at a much lower rate than non-banks in the sense that they don't have the spread to deal with.

This is also why, I believe, a bank that has no earnings or no equity cannot continue spending just because it can create money out of thin air by crediting an account. If the spending is going to be funded by liabilities, then the bank incurs greater liquidity and insolvency risk.  As Dan Kervick also adds: 

But the money they create to buy stuff for themselves is just as much a liability as money they create in the process of making a loan. They create an account for the seller of the goods and credit that account. If the seller of the goods then writes a check on that account to someone whose account is at another bank, the first bank will have to make a payment to that other bank that is settled and cleared through the banks' reserve accounts at the central bank. And if the seller comes into the bank and decides to withdraw the total amount in the account, the bank will have to hand him a bunch of vault cash. Clonal also adds: 

I believe the fact that revenue is recognized immediately on making the loan is where all the problems are coming from. More money than the amount of the loan is created at the time of the inception of the loan. The excess money is then capitalized after accounting for things like provisions for loan losses etc.

To which I acknowledge, I could be referring to an outmoded banking model. As far as I know, if a bank keeps the loan in its books, revenue is recognized as and when it receives interest income, not when the loan is made. Of course, if a bank securitizes everything or most of the loans it makes, revenue will be recognized when the loan is sold, even if it's at the point the loan is made.

P.S. I add in comment discussion that Basel rules further limit this printing.

Bartering in the Greek Euro odyssey

I want to highlight in this post the flourishing barter system in Greece. It is one that grew out of necessity, due to the lack of circulating income within the country, which is then the result of three years of austerity measures. What do people do when insufficient money is going around, and each has less income to buy his needs, yet still has his demands, as does his neighbour? Last year the New York Times reported on the Greek Volos network:

Part alternative currency, part barter system, part open-air market, the Volos network has grown exponentially in the past year, from 50 to 400 members. It is one of several such groups cropping up around the country, as Greeks squeezed by large wage cuts, tax increases and growing fears about whether they will continue to use the euro have looked for creative ways to cope with a radically changing economic landscape.
“Ever since the crisis there’s been a boom in such networks all over Greece,” said  George Stathakis, a professor of political economy and vice chancellor of the University of Crete. In spite of the large public sector in Greece, which employs one in five workers, the country’s social services often are not up to the task of helping people in need, he added. “There are so many huge gaps that have to be filled by new kinds of networks,” he said. Here in Volos, the group’s founders are adamant that they work in parallel to the regular economy, inspired more by a need for solidarity in rough times than a political push for Greece to leave the euro zone and return to the drachma.

Back in 2008, I mused whether there could be a private sector solution to the aggregate demand problem. Back then, austerity was already being trumpeted by many policymakers and opinion makers as the necessary solution to the economic crisis, while rejecting Keynesian solutions as wasteful and 'crowds out' private sector investment. (Pundits who believed that people stopped spending because of too much government waste rather than because people with the money started hoarding them out of fear, or because of escalated debt calls and investment writedowns). 

Back in 2008, in the similar situation of less transactions, and less income going around, bartering also seemed to me the circuit breaker to this vicious cycle of fear and recession.  "Could the private sector solution involve local companies engaging in quasi-barter trade with each other? Or paying via in-kind currencies? For example, we can have businesses paying employees via credits that can be used by consumers to buy/pay for services of other local producers. So in essence, in an economic downturn where actual cash flow is scarce, demand is created by empowering cash-starved businesses to pay employees and suppliers in some 'credit principle' that other businesses will then consider acceptable form of payment. I don’t really know how this type of arrangement can be made to work, but if it can, it will work only if enough businesses participate. The world is now more globalized than ever before, and this solution would again only be possible if an economy has enough industry diversity to be self-sustaining on its own, otherwise the arrangement will need to be global in scope."

What's happening in Greece shows us that despite the constraints caused by policymakers that are both literally and figuratively distanced from the problems and challenges of regular people, life still has to go on.  I would still expect that this situation (in Greece and in all of the Eurozone) be finally resolved properly, as bartering remains a short-term solution. It gets bogged down by the constant requirement of a double coincidence of wants, and results in far less efficiency and productivity than when commerce is done with a state-backed currency.  Still, for what it's worth, for now this development is a triumph of the human spirit over outsize constraints, of necessity over adversity.

A phenomenon that loanable funds theory can't explain

Mainstream economists believe that since for every buyer there is a seller, they take this logic to the notion of bank lending, and assume that for every borrower, there is a lender, with banks just bringing them together. And they further assume that when a borrower needs to increase his consumption, a lender needs to curtail his, to provide the necessary funds.

Paul Krugman recently asks:  "If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. Yes, in some (many) cases lending is associated with higher demand, because resources are being transferred to people with a higher propensity to spend; but Keen seems to be saying something else, and I’m not sure what. I think it has something to do with the notion that creating money = creating demand, but again that isn’t right in any model I understand."

This image of lending is outdated, and does not explain why banks trip over themselves to provide lines of credit to creditworthy customers. Just imagine, you have all those banks that have issued you credit cards, with varying line amounts, whether you actually asked for the card or not. Why did they do it? Because they have tons of unlent funds that they have to lend out? What good is it to them if you don't use your card, if they've already issued you one? They've given you an open commitment to provide you up to your line limit, but it's your option whether to you use it, not use it, partially use it, or use it then pay it down quickly.  

If you don't use it, the bank doesn't earn interest from you. If they did secure loanable funds prior to you drawing your line, then what happens to the poor schmuck who provided that loanable fund? No interest income for him. Is there really a schmuck standing ready to not consume by the exact amount that you draw your line with, month after month, and stands ready to forego his interest income once you pay it back?  Did the bank promise him something in order to secure his funds? If the loanable funds theory of banking is correct, then credit cards have got to be the most uneconomical bank product ever invented.  Any banker worth his salt will push to sell you an actual loan rather than a miserable line of credit.  As far as the logic of loanable funds theory is concerned,  it's a losing proposition for any bank. So why do banks provide this product, often to people who don't even want it? Does the loanable funds theory have an explanation for this?

Krugman tries to explain why banks do it: "As I (and I think many other economists) see it, banks are a clever but somewhat dangerous form of financial intermediary, one that exploits the law of large numbers to offer a better tradeoff between liquidity and returns, but does so at the cost of taking on very high leverage, with all the risks that entails.The super-high leverage of banks, and the role of bank deposits as a key form of liquid assets, means that banks broadly defined are usually central players in financial crises. But that’s a quantitative thing, not a qualitative thing."

Banks risking insolvency for an uncertain income stream? Does the loanable funds theory have an explanation for this?

Mr Default Buyer and cow inflation

This is a reply to geerussell’s question at MNE. It’s too long to post in the comment section.

To give you a better illustration of my point, let’s use Bill Mitchell’s favorite analogy (with due respect) of the buffer stock of heads of cattle. But in this case, let’s use a recurring income transaction of selling milk, which is what would be more closely similar to a wage income stream. Imagine an economy with 1,000 heads of cattle, owned individually by different farmers, all of whom are each other’s customers for the milk.  Let’s imagine that each cow can only provide for one customer at a time, each of whom buys a long-term milk stream, say for 5 years.

 Now, imagine 200 farmers want to save, so there is demand for only 800 milk streams. This decreases the price of milk, which was say, $100/one year’s delivery, down to $80/year. But then, imagine that a default buyer arrives, and makes an open offer of $100 /year for each undemanded milk stream, thereby increasing total demand back for all 1,000 heads of cattle, and price back to $100.

This default buyer increases the income stream, and therefore, the ‘animal spirits’ of the cattle owners, and they then start demanding other milk-based products. Milk duds, milkshakes, and chocolate milk start becoming a common craving of the now better-off famers. Let’s say 50 farmers now require more than one cow, because they want to expand into these milk goodies, bringing the farmer end user demand to 850 heads. 

But since the default buyer keeps his open demand of $100 for all undemanded cows, not all cattle owners are willing to provide his cow to the other farmers now willing to buy more than one cow’s milk stream. Some farmers just got accustomed to the default buyer’s arrangement, perhaps because he is more convenient to transact with. So to attract some of the 200 providing their cows in service of Mr. Default Buyer, these 50 farmers up their offer to $110/year.  

30 farmers willingly transfer to the new buyers, leaving 20 more without a cow for their additional demand.  Let’s say and additional 10 were willing to pay for up to $115, which entices more farmers to shift, but still leaves 10 new owners unable to make their expansion. 840 cows are now providing milk for other farmers, 160 remain Mr Default’s suppliers.

Now, the farmer cum customers are getting even more prosperous, and demand even more milk-based products. Milk bonbons, cream pies, and designer ice cream now become the “new cool products” to have.  This entices more producers to come forward, as the profit margins for these can accommodate the now $115 clearing price for one cow’s year of milk, and then some.  Let’ say 80 farmers come forward offering $125.  This entices 50 of the 160 remaining suppliers to Mr Default to shift.

That still leaves 30 new producers unable to find suppliers for their new bonbon business.  Of those already serving other farmers, 20 indicate they’re willing to transfer again at $145.  So 20 of the 30 get their cows, but 20 other farmers that already had cows lose theirs, and the price to get new cows starts at $145. Meanwhile, the 110 that still remain with Mr Default stay with him. 

Now what happens when milk-based pastries, cream cocktails, and milk sauces become the norm? Bidding for the remaining 110 cows, or for any of the others willing to transfer from some other farmer customers, probably starts at $170.  Maybe Mr Default still will 80 cows left afterwards, but cow inflation has now risen 70%. Time to start tightening.

Just because you put a floor on a price for something does not tell you anything about how high its price will go. Not when you only have a finite supply of that thing. And when someone puts an open offer for all of the supply, the bidding starts higher and proceeds more furiously, whenever there's an expansion of general demand, than when the open offer is withdrawn when other offers are coming to the table.

addendum: Geerusell asks a good follow-up question:  “Why are farmers who supply Mr. Default presumed to be so sticky at the $100 level?” - It could be any reason in my mind. He’s easier to deal with, he doesn’t give hell when the cows want to take a cow holiday, is willing to accept a more flexible schedule, work is closer to home…a lot of other reasons. But I can imagine not everyone offered the first higher price will immediate jump on it. A sizeable number won’t jump until.. they’re made an offer they can’t refuse.

A workable JG proposal should be flexible, either on the 100% guarantee, the wage, or duration

Bill Mitchell has a post with a re-exposition of the JG, and this is a repost of some comments I made there trying to clarify the mechanism that ensures workers automatically leave the JG job in an expanding economy.  What is the mechanism that ensures workers leave the JG job in an expanding economy? Will the government force people to leave the JG?

As I understand it, MMT proposes the JG program to permanently guarantee a job at a set wage to anyone looking for a job. While I understand the need for a jobs program now, when the rest of the economy is contracting/ hoarding/ deleveraging/ correcting, my concern is for when the JG gets the economy starting, and companies start hiring again.

The JG is proposed to offer the living wage, and I agree, both on the principle of fair pay for a fair day’s work, and that for it to work in increasing aggregate demand, it should be at this level. JG therefore eliminates bad jobs with crappy wages due to competition from the JG, which to me is an appropriate goal.

MMTers claim that this is a “one-off” price level boost.  So let’s take this ”one-off” price level boost as a given, and think one step ahead. Since the government will continue to put a demand floor to wages under a JG, any heating up in the private sector results in demand shooting above 100% for labour. During a strong expansion, when more businesses are expanding and therefore hiring, the excess demand the JG maintains for workers makes labour scarcer than necessary, and therefore businesses will need to bid up higher to attract people. The only way new firms attract workers is to drive them ever higher above not only what the JG pays, but above what the first few firms to hire are already paying.  The more people a firm needs, the higher the labour clearing price for the firm.  The higher the clearing price, either less firms start, or higher inflation ensues.

Keeping  the JG in such an expansionary environment risks the JG becoming a negotiating ploy for smart workers who know how to use the system, to extract higher wages than they can otherwise. And remember that we’re already talking about a JG program that pays the living wage, so the STARTING POINT for the private sector is to offer higher than this living wage. This means there’s less room for the private sector expansion before it turns into an inflationary environment that would then need to be curtailed by government.

We then get to the mechanism that MMT claims makes the JG program also a price stability program. Paired with tax and interest rate policy, inflation in this scenario can be slain without increasing unemployment, by increasing rates and taxes, so companies scale back operations and lay people off, or businesses close, and more people go back to the lower paying JG job. For a permanent JG to work, the private sector has to stay only up to a certain size, beyond this, the government starts squashing them to ensure price stability.

Hence, if you’re thinking of starting your business once the economy passes this level, you’re going to have to think again, because government will be expected to tighten soon (not by dropping the JG, but by making it more expensive to maintain a small business). Because the government keeps this floor on labour demand even during the boom times, when the economy gets booming, the boom acceleration will be much faster than if the government had withdrawn its additional demand instead. So again, if you’re a businessman, you’ll likely obsess about where this “certain level’ is at.

This is what I meant when I say a permanently fixed JG economy replaces a buffer stock of unemployed with a buffer stock of failed small businesses. Large companies may weather this price stabilization drive by shedding workers, but smaller businesses will close completely. Since a permanently-fixed JG involves a buffer stock of failed small businesses, banking losses will always follow an increase in this buffer stock due to fighting inflation, and there will be great capital wastage due to the closing up of businesses, selling off of inventories, etc. following this increase.  In short, I’m getting that under a JG, both bankers and private entrepreneurs will be reluctant to start or fund new small businesses. Whatever jobs get created going forward will have to come from big business, or the JG itself.

I’m not against the JG as a countercyclical policy, but using it as a price stability mechanism means that 1) it seeks to keep private sector only up to a certain level, and 2) with onset of inflation, its price stability mandate kills a lot of new private sector growth just when it’s gaining momentum, more than if the JG was downscaled instead.

The comparisons of permanent JG and no permanent JG in my mind remain: In a JG-less economy in recession, labour demand can be at 80%, while in a booming economy, it will be at 100%.  In a permanently-fixed JG economy, labour demand during recession will be at 100%, while during a boom, it will be at 130%. Inflation-fighting taxation will be a lot harsher in the JG economy with 130% labour demand than in an economy with only 100% labour demand. Government will have to kill more private sector companies when it is trying to get that 30% excess demand back to 100% than when it’s trying to get 100% down to 96%. It seems the need to kill more businesses will be much lower if the JG was instead preemptively scaled down by government when the economy starts growing.

I believe that the JG, contra to many MMTers, will not automatically disappear, without distorting the economy, simply by virtue of JG workers leaving for the private sector. That kind of magical thinking is no different than monetarists believing that increasing money supply automatically increases its velocity. No, the JG ends only with the private sector bidding up wages so as to attract workers away from the JG. If this happens by more than a sufficient level, there would be higher inflation than is acceptable. The JG program, which will also have a price stability mechanism, will not stand idly by. The government under a JG policy will try to get prices back to the government’s stated level by getting people back into the lower wage JG, and away from the private sector. It will do so by all means that make it less profitable for business to thrive – taxation, interest rate policy, whatever, anytime the private sector expands by more than a certain level.

As far as I know, there has been no testing of JG on a significant scale, and perhaps only in certain areas where there really is no interest from private sector to invest. In which case, we really need a JG of some sort in that area. In a previous discussion I had with Tom Hickey, he mentions of places like Iowa, where small business have been permanently wiped out by large businesses. I agree with Tom that in these places a permanent JG could be helpful. These are places where the private sector would normally not invest in because it wouldn't be profitable. But there are other places where a permanent JG could eventually become counter-productive. It cannot be enacted on a similar scale, and permanently, in urban centers where private sector already tends to congregate. It will only end up squashing the grassroots initiative there, and the JG will eventually become an alternative economy unto itself, not a bridge for when private sector is weak. That's why when you propose the JG, it's important to make nuances, and signify how it rolls out by sector and geographic location. It's can't be a one size fits all for the entire country.

Advocating that government stand ready to hire “all ready and willing to work” without regard to the state of the economy is advocating for the monopoly currency issuer to tilt the playing field and compete with the currency-constrained private sector for - if there is an open job offer to everyone - scarce labour resource.  In the same way iron is good for an anemic but bad for someone with hemochromatosis, a permanently fixed JG would be good or bad depending on the state of the economy. I’m merely suggesting this program needs to be localized rather than enforced in aggregate, and be flexible depending on what is going on in the economy.

Tom Hickey asks what macro policy solution I would suggest instead and what buffer and price anchor. The stock I could think of using as buffer, as is evident from my position, is the JG itself. A working JG proposal should be flexible either on the 100% employment guarantee, on the JG wage, or on the duration of the program, depending on the overall economy.  In times of higher inflation, the JG is what adjusts, either in price (wage) or quantity of its workers.  With JG flexibility, during a private sector expansion over-all wages don’t rise as fast, and hence, the boom can probably stay for longer, and the fiscal tightening needed to contain it not as harsh. I don’t have suggestions on price anchor, why change what we use now? Call me neoliberal if that’s what this makes me, but the permanently fixed JG has a tradeoff, as Tom acknowledges, and the tradeoff can just be as damaging economically as a buffer stock of unemployed. Less people may venture into private business creation and may end up relying more on government for many things.  If there’s a JG during a recession, then everyone who can hold a job should be able to get a job. But when the private sector is expanding, then the JG should be wound down as a matter of policy, not merely as a passive result of people leaving for higher private sector wages.

Canada and Iceland

Iceland wants to adopt the Canadian currency, eh? What's that aboot?

Iceland, which had to bail out its banking system in 2008, and therefore now has massive sovereign borrowings and diminished currency stability, has recently been looking to adopt a more stable currency from a strong economy, to regain its standing and respectability to the world. The big winner for most of its inhabitants, it seems, is the Canadian loonie. Iceland, which has about 300,000 population, is easily buffeted by currency headwinds, most especially after the 2008 crisis.  And since they already have 59 billion euros foreign denominated debt stemming from the crisis, adopting another foreign currency as their default currency is a problem that's probably moot to most Icelanders.

In general, by adopting the Canadian currency, Iceland imports the Canadian monetary condition (highly stable compared to other countries as of the moment). However, only the Canadian government and Canadian-chartered banks can issue this money. How will local Icelanders get hold of this money, for it to be widely-held enough to be their default currency? In all likelihood, Iceland as a whole will have to incur lots of trade and capital surpluses vis-a-vis Canada.  That's the only way the Canadian currency will make its way into Icelandic economy in large amounts. With sufficient amount circulating in their economy, it will then be the currency that Icelanders use to buy daily necessities and pay for their obligations, including borrowings, which will now be Canadian-denominated, and borrowed from Canadian banks.  Canada will begin to enjoy the exorbitant privilege the U.S. has had globally, at least with regards to Iceland. For this to work, Canadians will have to massively spend into the Icelandic economy.

I don't think this will be detrimental to Canadians monetary-wise, since as people who've read into MMT know, a monetarily sovereign nation that issues its own currency can issue as much as is necessary to clear all transactions. If it spends more than it earns vis-a-vis a foreign trading partner, what it gets are real goods and services that people will sell in exchange for their fiat currency.  There could be a glut of Icelandic products and services into the Canadian economy. Salmon? Fisheries? Aluminum? Spa tourism?

By having the same currency, it makes it easier for Iceland to do business with Canada.  It will spur Canadian business investment into Iceland, since there will be no more forex risk.  More Canadian-owned factories and shops will sweep into their economy. I can imagine Weston, Metro and Shoppers Drugmart setting up shops all over, without worries of losing on foreign exchange whenever they replenish inventory and repatriate profits. Canadian banks will race to set up the first branch in every desirable corner of Reykjavik, and their corporate parent will have stronger, wider funding base than local Icelandic banks.  Ditto for consumer investment to the Iceland economy.  If Canadians ever tire of the escalating house prices in Canada's metropolitan cities, they can instead buy a cottage overlooking Mt. Eyjafjallajökull? (I kid) And with the convenience of having the same currency, there would be more Canadian tourism to Iceland, which is 3,700 kms away.

Most importantly, people from outside of both Iceland and Canada, who would shy away from investing in Icelandic krona right now, but would gladly put money in Canadian-denominated investments, would be more open to putting money in the local Icelandic banking system, thereby helping to diminish the still-large risk of bank run similar to what happened in 2008. (However, in the event that investor aversion shifts towards Canadian-denominated assets, Iceland-based banks will suffer as much as those in Canada).

The biggest risk to Iceland adopting the loonie is the loss of currency sovereignty and monetary policy control. By adopting a foreign currency, it's putting itself in the same position Greece put itself in when it decided to adopt a currency its government does not issue. Since it will no longer be issuing its own currency, Iceland will lose its ability to enact large countercyclical programs during recessions. Whenever its government has to deficit spend, it will have to borrow in this foreign-issued currency. 

Also, the currency's value will be affected by events happening in economies much larger  than its own and in places thousand of miles away. Right now, the strong Canadian currency is buoyed by its most productive and successful province, oil-rich Alberta. Just ask the manufacturers in Ontario, or the fishing industries in the Atlantic provinces, how that's going for them. A stronger currency due to oil exports also makes their own exports more expensive. Unfortunately, unlike oil, what they do export are also sold from places with cheaper currency. But if enough economic integration happens, who's to say that there won't be further integration later on, since economic integration leads to greater need for labour mobility, to make up for the economic dislocation integration creates. Looking at history, Newfoundland adopted the loonie first before it eventually became a Canadian province. 

I don't know whether this currency adoption plan will go much further than the talk made so far. The Canadian government has discouraged its ambassador to Iceland from making the speech that was supposed to acknowledge this Icelandic plan. After all, publicly talking about another country adopting your currency seems  a bit like gloating, and Canadians think it's not polite. But in any case, should this adoption ever happen, perhaps there comes a day when Icelanders also adopt the Canadian obsession of going shopping in the US whenever the loonie gets stronger.

Why a local manufacturing base is important

This post builds from a comment I made here.  It's a reaction against the point that it's okay for a country to lose manufacturing if you have a thriving services economy.

Unless people can live on consuming services alone, buying/importing all hard goods from outside is a form of slow suicide. Imagine you, me and Mike are all the inhabitants of Consumer Republic. You cut my and Mike’s hair, I cook for you and him, he entertains the two of us. Yes, we all have a means to earn a living, and money circulates our economy. But when it comes time to buy our car, our furniture, our basic hard item necessities, we have to buy it outside, from Producer Republic.

Now imagine that Producer Republic doesn’t need to buy anything from us, they have their own domestic service providers, and they’re pretty self-sufficient when it comes to producing all their hard goods basic necessities. Meanwhile, all they get from us in return for their goods are tokens (fiat currency) that enable them to buy our services - all of which, however, they can provide themselves. What happens if they start hoarding their hard goods and stop accepting our tokens? Where and how do we get our hard goods?

This is even more worrisome if Producer Republic prefers to accept someone else’s tokens (fiat), not our own. How do we get those tokens unless we sell something besides domestic services? (And yes, markets for most services have a tendency to be domestic-focused, and hence, most countries will prefer to get their services from locals.) 

For example, if Producer Republic prefers Privilege Republic's tokens, Consumer Republic will need to sell its services to Privilege at whatever price Privilege is willing to pay for. Consumer Republic is therefore fucked, and this results in a status quo lower over-all price level of services in its country. Its inhabitants will therefore be able to buy even less hard goods imported from outside. And every time it does buy from outside, it results in an outflow of money from the economy, an outflow that, if its government compensates for by printing more money, only results in an even lower real price level. This vicious spiral will slowly eat away the economy. The only other solution would probably be to sell its patrimony to outsiders, in return for the needed token. (Just ask Greece how this feels like, since it's in the same situation of having to sell its soul to get enough of the "outside" currency, the Euro.)

This constant need to scramble for the token accepted by hard goods producing countries is probably lost on much of the population of the country that that has the "exorbitant privilege" of having the reserve currency, the unit that everyone accepts payment in. However, if this country of privilege chooses to lose all its hard goods producing capacity, because of the confidence that it can always print whatever it needs to fund all its consumption, whether of goods and services sourced from within or outside its economy, what's to prevent producer countries from eventually deciding to start hoarding their hard goods and stop accepting its tokens? Where and how will it get its hard goods, unless it starts making them itself again?

Four years ago, I advocated/predicted that both the developed and developing worlds will probably each have to become more equally divided into being both consumer and producer economies. This seems now to be actually happening. Everyone needs to have a producer economy. You can't live on consuming services alone, while buying/importing all hard goods from outside. It's a form of slow suicide. Ditto for  agriculture sector.


more in comments

Prospects for retail deposits

We're now on year 4 of ZIRP, and it looks like things are going to be like this for awhile to come.  I'm not on the funding desk of a bank, I'm just wondering out loud.  But how could this environment be affecting the medium and long-term plans of commercial banks with regards their deposit base?

This is an environment engineered by the Fed to discourage saving and to encourage borrowing/lending. But the people's persistence to save and delever continues unabated. So banks have been ending up with a lot of deposits, which  are a cost base for them (both in terms of service and in interest) while good lending opportunities continue to be outnumbered by the amount of funds available to them.  Ordinary savers continue to leave their savings in cash deposits rather than invest them in businesses or other productive endeavours (Many are still afraid of lagging demand). Meanwhile, the Fed further exacerbates the situation by swapping their treasury holdings into even more idle cash.

The yield curve has been flattening over a longer maturity period, and hence, banks have no problem securing funds whenever they need them for loan settlements.  And for shorter periods, they could borrow them for zero or close to zero cost. So what the hell do they still need retail depositors for?

Retail depositors are costly to maintain. You need to have branches, costing money to rent and maintain. You need to have staff ready to serve their needs,  and many of these depositors could be very needy.   Rising deposits cost more to insure with the FDIC.  To the extent deposits are made in physical currency, there are further costs to safeguard, keep, and transport this deposit base. 

Every retail client is valuable to a bank to the extent that he churns his deposits in various transactions, where the bank earns its fees.  Savers who simply leave money with the bank unused and unturned are a cost to the bank. Some banks have actually started charging fees to large deposits last year, both in an effort to make back what it costs them to take the deposits, and get this….to drive away the depositors!  As some bankers in the article have said, this has never happened before. 

Now as I said, retail branches can be profit centres, to the extent that they churn depositors' money, by encouraging more fee-based transactions, or encouraging savers to put them in bank-sponsored asset management vehicles. Branches that are able to do this in economical numbers can continue to justify their existence. What about those that simply have more deposits than they have transactions, and are unable to change the course of things? Many of them will probably close, pretty soon or in the coming months, if either: rates continue at ZIRP, or bank lending doesn't pick up to pay for the cost of the deposits.

If neither of those happen soon enough, is your neighbourhood bank branch at risk of closure?

Welcome back home, 'stateless' corporation

Three years ago, I wrote, tongue-in-cheek,  that we may be seeing the beginning of the end of the nation-state.  Because of four decades of relentless globalization, capital was now free to go anywhere in the world, anytime it wanted, instantaneously. One day capital could be rushing towards Brazil, while the next, it's rushing out to speed on to India.  The next obvious goal for the world 'surely' was the global mobility of labour, which would be the final step in dismantling all national borders, and the entire concept of the nation-state.

I wrote: Everything else in the world is mobile – capital, technology, products, entire businesses. But one crucial aspect of enterprise isn’t, and that’s people. This has resulted in a severely lopsided globalization process….people cannot mitigate the effects of a relatively-more benign policy in one region by migrating to it, or mute the harsh consequences of a neighbour country’s (competing or trading partner) actions, by piling on to that country.  Countries currently compete to attract capital and technology, but not a lot also compete to attract labour.

But of course, the world is not yet ready for this step, and all its ramifications. So, the next most logical cure for the large imbalances caused by globalization is its retreat.  We should see a gradual acceptance once again of capital controls and trade controls - capital controls to both keep existing capital in, and to keep new capital out. Too much fleeing capital could collapse a currency, too much flowing in could make it too expensive.   

Obama's most recent state of the union speech is an indication that protectionism and trade restrictions will become more prevalent in the coming years. He's already given the first warning signs to those who continue to choose to outsource American jobs abroad. In a world where the conspicuous consumer has retreated, where everybody is trying to save, or pay down debts, and where jobs are disappearing as a result, barricading jobs  and keeping them from being off-shored has become priority one.  

So what do we expect of this going forward? We'll probably see much of the "stateless" corporations to become once again home-focused businesses. We'll see them retreating from countries where they have no significant consumer toehold, and bring their processes back to where their end consumers live.

We'll see globalization stop dead on its tracks, and both private and public sectors start focusing on their own domestic economies.  Which is probably just as well. With less global linkages, all economies will start decoupling from each other.  Everyone will start focusing their economic development efforts on their own domestic economies, and on where they're supposed to have from day one: not merely on creating jobs, regardless of where its place in the value chain was, but on building prosperous domestic business clusters of their own, ready to hire locals as much as to sell to them.


Added in comments: On a generalized view, I think companies that find they have a stronger demand for their goods and services abroad than locally will start transferring head offices abroad. Those with equally strong local and foreign demand for their offerings will probably have a local presence everywhere. Even if their operations costs will cost more in the US, if the new offshoring tax equalizes overall cost, penalizes not having local presence, they would probably choose to move back a lot of their jobs. Those that only serve locals will probably move everything back.

For example, if Apple, Dell, or JP Morgan find that their main growth would be in Asia, they'll probably move head offices there, and export to the US, or serve the US market from there. They won't be affected by the tax if they are no longer US companies. If they feel that their offerings will be equally as strong both in the US and abroad, they'll probably have local manufacturing/operations both in Asia, and in the US (to avoid any offshoring penalty and taxes). But if they only serve the US public, like your local telecom or cable company, they'll probably begin to rethink having their customer service operations abroad, and bring them all back.

Some suggestions to improve MMT and the JG proposal

Cullen Roche, along with TC and Beowulf, have a new initiative, to flesh out a quasi-MMT economic paradigm, and will likely start website dedicated to it. This paradigm  seeks to incorporate all, if not most, MMT insights on monetary and banking operations into its thinking while doing away with the controversial JG component of MMT. They call this new MMT offshoot Monetary Realism, or MR. This sounds like a promising initiative, one that could only be good for both those who want to preserve market-based adjustments in the functioning of the macroeconomy, while seeking to spread the insights of sectoral balances approach in both private and public decision-making and policy-making;  and for the main proponents of MMT. After all, If MMT proponents are correct, that better understanding and functioning according to the real world monetary reality will eventually lead us to accept the JG, then this is also helpful to MMT. 

Cullen starts off some of their basic principles, at least as to how it would distinguish itself with mainstream MMT:

1. We side with Godley on the current account issue.
2. We view the state theory and the “taxes drive money” idea as incomplete.
3. We will focus more on productivity as a compliment to consumption as opposed to mainly looking at ways to increase aggregate demand.
4. We reject the JG as a central component of understanding the modern monetary system.

MR will focus on monetary and banking realities and operations, and focus less on the macroeconomy, to be clean in its analysis. For the mainstream MMT, meanwhile, I suggest it approach economic analysis with a clearer view of how specific policy proposals would affect grassroots-based businesses.  It needs to start looking at the economy as comprised not just of large private sector institutions, but also of many small mom-and-pop size businesses. Consideration for small businesses and their concerns is something that is currently still weak in the current evolution of MMT(as I see it). For example how does government tweak its tax policy and deficit spending in a way that does not kill off a significant part of what makes a dynamic economy. To wit:

1. If inflation starts heating up, mainstream MMT with a 100% JG proposes to manage it by increasing taxes and decreasing spending. The goal would be to decrease private employment and bring a segment of workers back to the public JG. What types of taxes would be increased? Taxes of whom? For doing what activities?  Will the higher tax burden be rolled out the same across the board, or segmented and differentiated, depending on size of business? I ask because, while increased taxes could affect large businesses the way MMT economists intend - by decreasing their employee rolls, it will entirely kill off the smallest businesses whose profits are now below the higher income threshold caused by higher taxes, and whose sales may now fall below break-even with the decreased government spending. 

2. Will this tax be rolled out by sector, by geographic location, by nature of business activity? Would it take into consideration a business' place in the value chain? Or how many JG-skill level employees it has? 

3. How would this economy-wide aggregate demand management account for small business who occasionally need to borrow funds? This type of system will likely discourage banks from extending any medium or long term loans to the smallest businesses who could easily be killed by a ramping up of JG and increase of taxes. Does MMT propose to take the banks' place, or do these smallest businesses become casualties in the name of greater employment and price stability?

4. Also, those businesses most highly affected by those occasions when government increases the JG sector would likely lose all their revolving credit lines precisely when government announces a ramping up of the JG. Is this a natural aim of the JG program, or is there a proposed mechanism whereby those businesses with existing obligations towards employees, suppliers, and customers will be provided a bridge loan by the government, at least to enable them to attend to their open client accounts until they can cleanly liquidate their business and everybody can go back to join the JG?

5. How does JG address greater than normal inventory and capital equipment liquidation every time a ramping of JG and private sector taxes kills off the businesses now below the marginal profitability? Will the government buy these excess, or will it let the market clean up the mess?

6. How does the JG account for the current long and interconnected supply chain processes among businesses? Ex. if the smallest car components makers are to close to accommodate the JG ramp up, does the government intend to turn those business operations into JG positions owned by the government so as to keep the supply lines from disrupting the entire auto industry? How about with large food conglomerates that source a lot of their raw inputs from small growers, who in turn source their own inputs from further small businesses? Do these processes become government-owned JG businesses during times of inflation? And paying the lower JG wage level?

7. How does this JG-led system account for JG people who wish to save up capital, so they can leave the JG to start their own business? So let's say a prospective entrepreneur saves up enough for startup capital, but when he tries to hire people, he can't hire them unless he promises to pay them more than he himself used to earn from the JG? Would the JG have incentive programs to encourage entrepreneurship, to make up for the higher startup costs effected by a permanent JG? Further, if a JG can give workers employable skills, what makes these same workers to still willingly leave that skill-enhancing JG job for a job in the private sector at all? Does the JG coerce these workers to leave the JG?

8. How will MMT address the possibility that JG entrenches big companies even more? If small businesses were to start up, the guaranteed JG wage could be used as a negotiating ploy by workers, and could lead to escalating wages, and the more people a startup needs, the higher its labour clearing price.  Less startups would probably result. The Walmarts of the world, in the meantime, would probably start trying to justify that they are a JG supporting company that creates a lot of jobs for the JG, so the government better start paying their line workers.

9. The JG as proposed likely will encourage the mass expectation among workers that though they might work for JG now, tomorrow they'll work for private business, but maybe next month, economic changes will cause the government make them go back to the JG. How does the JG still encourage long-term planning among both workers and small business owners?

For as long as the program as proposed goes against people’s EXISTING risk-return mindset, and discourages free initiative, it's not ready to be at the forefront for reform.

discussions below and at MNE, where my position and Tom Hickey's eventually converge, more also at NEP.

Increasing NGDP to increase income

Scott Sumner today writes:

Of course wages are not flexible, but if NGDP was raised sharply then aggregate nominal wages would not rise as fast, allowing more jobs for Murdock making pick-up trucks, and more income to buy those pick-up trucks.  This is what “Say’s Law” is really trying to “say.”  If we can produce more stuff, society will be rich enough to buy that extra stuff.  No matter how much we produce, there is always some price level where we are rich enough to buy all the stuff.

I have questions about this assertion:

You're advocating ↑NGDP, and you believe this ↑income to buy trucks. But how does  ↑income without ↑wages?

If ↑NGDP, thus ↑cost of living, why won't people demand ↑wages?

If ↑NGDP , how does this actually lead to ↑income? Does ↑NGDP entail government sending checks to everyone? QE, does not cut it as a mechanism that ↑income, as it just exchanges income earning assets with non-income earning cash.

If you believe in neutrality of money, why would you believe that - if you ↑NGDP,  which ↑costs, and thus ↑wages - it leads to ↑sellers and ↑income?  Income for whom? And sellers do not automatically become buyers of same nominal amount.

And if money were indeed neutral, what is the point of ↑NGDP?  Money neutrality just means everything will ↑pari passu.  (Of course, we know that money is not neutral, ↑NGDP via QE actually ↑price of financial assets, making savers strive to save more.)

Why do we believe that S=I ?

The latest endless, debate, among, mainstream, economists is on S=I.  This equation is so controversial right now, it's already comedic.  Anyway, why do we have this equation anyway, S=I?  

Savings in an economy can comprise of actual investments, and unspent income. Any unspent income does not contribute towards the GDP, so it can't be part of C+I+G+X-M. Any unspent income will actually lead to lower GDP in the next time period.

If I means income spent on capital investment, and savings includes unspent income, why will S=I?  Savings a.k.a unspent income doesn't lead to more capital investment because, even if deposited in banks, it doesn't lead to more lending for investment. After all, banks don't need deposits prior to lending. It's lending that creates deposits. Also, savers don't normally save to put to investments later on. Many just want to have a cash buffer for consumption, if they foresee not having enough coming from income in the coming time periods.

So why keep S=I? Investment may include inventory, which may have remained unsold by businesses during the current time period. But unsold inventory usually isn't a result of businesses wanting to spend more of their income on more unsold inventory. They're usually a consequence of buyers deciding not to buy. So an increase in household savings does not necessarily mean an increase in business savings. It may actually mean a decrease in savings by businesses because businesses may now have to liquidate those unsold inventory at a huge loss, and not necessarily by selling to households at discounted prices. i.e., increased savings for households. Some unsold inventory may simply go to waste, the scrap heap, meaning, decreased savings for business (they'd used previous income to purchase the inventory) and decreased business income for the current time period. 

So why keep S=I? It assumes the economy is in equilibrium, where all savings goes towards investment, which it never is and never does. Nowadays, I can constitute not just of S, but increasingly, of B (Borrowing). This B doesn't come from S because again,  banks don't need deposits prior to lending. It's lending that creates deposits. 

Any unspent income, not put into actual capital investment, for all intents and purposes, has now exited the economy (unless it's used to pay off their B, which doesn't really contribute to GDP, but can be considered as decreasing banks' I).