Monday, January 24, 2011

Our false view of deficits and money « Comments on Global Political Economy

Our false view of deficits and money « Comments on Global Political Economy:

This from self-professed radical small-d democrat Jim O'Reilly at his blog, Comments on Global Political Economy:

"Our false view of deficits and money
by Jim on January 21, 2011

In political debates throughout the developed world, the most prominent divide today is almost certainly that between the needs of society for unemployment safety nets, retirement and pension programs, health care spending, and desired public services versus the demands of the bond market to slash spending in order to reduce budget deficits. The issue is sometimes presented in terms of morality as in “it’s wrong to spend what you don’t have” or “it’s only right that governments, like individuals, manage their finances soundly”. It’s also sometimes presented in a particularly grating parental tone as politicians site a need to have an “adult conversation” with their presumably childlike constituents.

There are two things about this debate that literally scream out for attention. The first is that it’s a completely contrived and false issue having absolutely no bearing on the true nature of money and debt. Individuals can be in debt to others but it’s utter nonsense to think of societies as somehow capable of being in debt to themselves. Societies are not individuals. The second thing is that a very tiny number of elites along with their political and intellectual supporters derive enormous benefits and power from the view that deficits are important. They’re the monied titans that comprise what we call the “bond market” and we’re repeatedly reminded we must change our ways and appease this apparent force of nature. Obama’s former Director of the Office of Management and Budget Peter Orszag, now lucratively sitting as vice-chairman of global banking at Citigroup, instructs us in today’s Financial Times: “it is … difficult to see the political system embracing that reality (of deficit reduction) without being forced to do so by the bond market”. Another article right along side it, entitled “Only tough reforms can save the land of the rising debt”, warns us “… if Japan does not switch course voluntarily (reduce deficits), it may soon find that financial markets will force changes upon it.” We’ve virtually ceded democracy to those with extreme wealth who, motivated only by private greed, claim a right to decide the limits of possible prosperity within societies. Politicians from “center-left” through the right support them and in turn are supported by them.

In this post, I seek to make the argument that there’s no sound justification for this transfer of power and there’s every reason to reject the entire discourse and move to a democratically based monetary regime which permits maximum prosperity for all. It’s not too great an overstatement that the key to overcoming most of our problems is a changed monetary system. For is it not clear the technology exists today for widespread prosperity and the only thing holding it back is a lack of purchasing power (i.e. money)? Monetary policy is not mainly an economic issue, it’s political in the deepest sense of the word. It cannot be left in the hands of economists or those in high finance.

Let’s jump to the central point: we have what is known as a fiat currency. It’s not backed by gold or any other commodity and we, i.e. the government, can issue it without cost by simply crediting a bank account. This immediately should seem strange – is it not the height of lunacy for a government to feel the need to borrow something which it can in fact produce at will? Or to adjust its policies to induce others to lend it back its own fiat currency? The whole thing appears absurd. Is it not equally ludicrous to think we, i.e. the government, must rely on tax receipts in order to obtain this currency? We should pause for a moment and ponder this. If we can create our currency without cost, then clearly we don’t need to rely on taxes or borrowings to generate it. This is counter to all normally accepted intuitions but with only a little thought it must be admitted this is unarguably true.

This being the case, what is the purpose of borrowing and taxes? The reality is they are not means of generating funds for government spending but are, rather, only monetary tools that serve no purpose other than reducing the money supply. Both taxes and borrowing do the same essential thing – they drain money from the economy. The Federal Reserve, in fact, routinely manages interest rates with this understanding of money and adjusts its borrowing levels on a daily basis to meet its monetary targets.

Those who claim government spending should be limited to the sum of tax receipts and a low level of borrowing are in fact favoring a policy of austerity that limits societal spending regardless of need. They base their views on an unfounded conception that any monetary spending must be offset by either of the two monetary tools of contraction, i.e. taxes or borrowing. Why should that be? If the economy is suffering from unemployment and underutilized resources, what possible reason exists to think monetary creation needs to be offset by monetary contraction? Yet that is precisely the standard orthodox view of finance. Monetary creation beyond the limits of the economy is certainly unwise and would be inflationary. But why would monetary creation limited to the productive capacity of the economy be so? All past periods of prosperity involved the “printing of money” through private bank credit. The boom in the late 90’s and the recent mortgage boom involved massive private money creation through debt and yet there was virtually no inflation. Why should economists condemn the government printing of money yet not object to the private? Can anyone seriously believe that expanding purchasing power in today’s environment could possibly be inflationary?

To sum up my argument. The government should create sufficient purchasing power directly through monetary creation in order to provide full employment and utilization of resources. It should only use borrowing and taxes to reduce purchasing power when capacity is being reached and the economy is in need of contraction. Borrowings over an extended term would likely be level as they would decline when the economy was doing poorly and would rise when contraction was needed. Since borrowings are only monetary, interest rates on debt could be maintained at zero percent and so interest on debt would not be an issue. Going further, one can see that borrowings are almost identical to reserves held by banks at the Fed. The government could establish reserve requirements for those with great wealth that would fluctuate depending on monetary policy. This is not the time to expand further on the many options for treating monetary contractionary tools. The critical point is to recognize the monetary nature of it all and the truly democratic opportunities for prosperity that a change in view entails.

There’s a great deal of theoretical support for this line of thinking. Abba Lerner was an early Keynesian economist who coined the term Functional Finance in the early 1940’s. This key article clearly expresses the monetary nature of debt and the need then (as now) to drop the false notions of financial orthodoxy. The guru of right wing monetarism, Milton Friedman, penned this article in 1948. He recognized the same reality and I would think the article should make those who reject this argument take pause. Friedman argues for eliminating the private banking power to create money and supports “as the chief function of the monetary authorities, the creation of money to meet government deficits or the retirement of money when the government has a surplus”. He concludes that “…government expenditures should be financed entirely by either tax revenues or the creation of money”. By today’s standards his proposal is radical but its general thrust is not too different than what is argued here. There are economists who are making the same points today, including Jamie Galbraith and L. Randall Wray (see here and here). But these perceptive scholars are either ignored or even portrayed as near lunatic. The false undemocratic consensus is that strong.

It’s well past time we on the left, those who passionately seek a better and more democratic world, recognize the monetary nature of much of our problems and demand our leaders stop creating artificial barriers to our prosperity.

- Sent using Google Toolbar"

Friday, January 21, 2011

18 Tunisians Visited My Blog?

When did that happen?
Not in the last month, so I can't take any serendipitous influence on overthrowing an authoritarian regime.


Still, I wish they had left comments.
Even if I can't read Arabic. Maybe Google will translate it for me?

Economist's View: When Moralities Collide

Economist's View: When Moralities Collide: "When Moralities Collide

Daniel Little:

Rawls on political liberalism, by Daniel Little:

Long after the transformative impact Rawls brought to social and political philosophy..., Rawls continued to wrestle with ... how a just society ought to encompass major disagreements among its citizens about values and 'conceptions of the good;' and much of his thinking is reflected in his 1993 collection of essays, Political Liberalism. Here is how he formulates the central problem:

A modern democratic society is characterized not simply by a pluralism of comprehensive religious, philosophical, and moral doctrines but by a pluralism of incompatible yet reasonable comprehensive doctrines. No one of these doctrines is affirmed by citizens generally. Nor should one expect that in the foreseeable future one of them, or some other reasonable doctrine, will ever be affirmed by all, or nearly all, citizens. Political liberalism assumes that, for political purposes, a plurality of reasonable yet incompatible comprehensive doctrines is the normal result of the exercise of human reason within the framework of the free institutions of a constitutional democratic regime. Political liberalism also supposes that a reasonable comprehensive doctrine does not reject the essentials of a democratic regime. (xvi)

... How in the context of this pluralism of important value systems, is it possible for a modern society to nonetheless possess the features of civility and stability that we would desire?...

One prior thought we may have had about a liberal society is that the state establishes no more than a neutral system of law... So the liberal state is a neutral state -- one that gives no privilege to one conception of the good over another.

Neutrality is certainly part of the ideal of a liberal state; but it isn't quite enough. The reason is that some conceptions of the good and the right require the intervention of the state for enforcement. If the Alpha group believe that fetal stem cells are nascent human beings and therefore should never be used for the purpose of scientific research, while the Beta group believe that fetal stem cells are no more than useful compounds of organic molecules that can relieve human misery; then both sides of the debate want to prevail through legislation -- either to prohibit stem cell research or to permit stem cell research. Each side sees its position as being driven by a moral imperative -- and therefore not to be compromised without an unacceptable loss of moral integrity...

To overcome this contradiction, neutrality is not enough. We need to add a commitment to democratic, constitutional procedures as being the moral trump card when it comes to legislation about areas of conflict based on fundamental disagreements about the right and the good. Essentially this comes down to a second-order commitment that every citizen needs to share: When policy issues arise that lead to profound disagreement among blocs of citizens, the right solution is ... arrived at through legitimate democratic processes. In other words, all citizens need to put their commitment to legitimate democratic procedures ahead of their commitment to a particular conception of the good and the right. Democratic values supersede religious, political, and moral convictions when there is no choice but to legislate an issue. ...

Rawls captures this conundrum with the idea of toleration: the idea that citizens must tolerate and respect the strongly-held convictions of their fellow citizens, even while participating in a political process that leads to legislation that is inconsistent with those convictions. This means that if the Alphas prevail through the political process, the Betas need to accept the outcome as morally legitimate -- even though it contradicts their own firmly held moral convictions. But why would one accept the moral necessity of toleration? Doesn't this mean sacrificing one's own moral convictions to the will of a contrary majority? And doesn't this imply that one's own convictions are tentative and conditional?

The answer seems to go along something like these lines. When one is a member of a society, one recognizes the inevitable fact of ... fundamental pluralism... The citizen is asked to take a ... perspective ... that there is disagreement about these matters, and the only defensible process for resolving the issue is the democratic process in which each person's reasons count as much as every other person's. ...

So -- what is a political liberal, according to Rawls? It seems to boil down to this. It is a moral individual who has his/her own conception of the good...; who recognizes nonetheless that he/she is a member of a polity that is fundamentally plural when it comes to conceptions of the good; who recognizes that there is no basis for insisting on privilege for one's own conception of the good; and who recognizes the moral legitimacy of constitutional democratic procedures when it is necessary to decide among policies that involve conflicting conceptions of the good. It is a person who puts civic commitment to constitutional democratic processes ahead of one's one fundamental convictions when necessary. And it is a person who is fully committed to ensuring the neutrality of the state across fundamental convictions. ...

We can now give a fairly simple explication of illiberal thinking as well. It is moral, religious, or political fundamentalism -- the idea that one's own moral convictions are so compelling that no democratic process could legitimately override them. It is the idea that the individual has a persistent right to oppose the state when the state's actions are inconsistent with one's own moral convictions. It is authoritarian -- it endorses the idea that one's own group or party has the right to override the majority's will when the state contradicts one's fundamental convictions. And it is, of course, a position that is fundamentally disrespectful of democracy and of the equal dignity and worth of one's fellow citizens.

I think the last paragraph captures what has happened to the political process in the last several decades, particularly on the right. There is a group who believe that their moral convictions stand above the democratic process, and hence they do not honor it. This is the point that Krugman has been trying to make. When one side does not believe the democratic process has the moral authority to resolve fundamental issues, the idea that you can negotiate with the other side in a bipartisan manner within the democratic process is foolhardy. The other side simply will not respect the process. Instead, the opposition will do everything it can to subvert it. We've seen this in action on a variety of issues lately, even in Congress where the need to respect the outcome of the democratic process ought to be well understood.

There is no halfway, and there is no resolution once the commitment to the democratic process -- including an agreement to accept and respect the outcome -- has been abandoned. And it isn't just issues like abortion, gay marriage, and religion in the schools where this is happening. The list now includes items such as taxation, health care, and, it seems, the mere election of someone on the other side of the fence.

But to me the real question is why so many people have stopped believing that the state has the authority to be the arbiter of last resort in a pluralistic society. Has the process become so captured by wealth and power that people do not trust it to produce an equitable resolution process? To use the term from above, has neutrality been lost? Is it due to a loss of trust in government that can be traced to Vietnam and then Nixon? Has the right's attack on government, particularly since Reagan, been all too successful? I'm not sure I know the answer to this question, but something does seem to have changed.

- Sent using Google Toolbar"

Life after Capitalism by Robert Skidelsky - Project Syndicate

Life after Capitalism by Robert Skidelsky - Project Syndicate

LONDON – In 1995, I published a book called The World After Communism. Today, I wonder whether there will be a world after capitalism.

That question is not prompted by the worst economic slump since the 1930’s. Capitalism has always had crises, and will go on having them. Rather, it comes from the feeling that Western civilization is increasingly unsatisfying, saddled with a system of incentives that are essential for accumulating wealth, but that undermine our capacity to enjoy it. Capitalism may be close to exhausting its potential to create a better life – at least in the world’s rich countries.

By “better,” I mean better ethically, not materially. Material gains may continue, though evidence shows that they no longer make people happier. My discontent is with the quality of a civilization in which the production and consumption of unnecessary goods has become most people’s main occupation.

This is not to denigrate capitalism. It was, and is, a superb system for overcoming scarcity. By organising production efficiently, and directing it to the pursuit of welfare rather than power, it has lifted a large part of the world out of poverty.

Yet what happens to such a system when scarcity has been turned to plenty? Does it just go on producing more of the same, stimulating jaded appetites with new gadgets, thrills, and excitements? How much longer can this continue? Do we spend the next century wallowing in triviality?

For most of the last century, the alternative to capitalism was socialism. But socialism, in its classical form, failed – as it had to. Public production is inferior to private production for any number of reasons, not least because it destroys choice and variety. And, since the collapse of communism, there has been no coherent alternative to capitalism. Beyond capitalism, it seems, stretches a vista of…capitalism.

There have always been huge moral questions about capitalism, which could be put to one side because capitalism was so successful at generating wealth. Now, when we already have all the wealth we need, we are right to wonder whether the costs of capitalism are worth incurring.

Adam Smith, for example, recognized that the division of labor would make people dumber by robbing them of non-specialized skills. Yet he thought that this was a price – possibly compensated by education – worth paying, since the widening of the market increased the growth of wealth. This made him a fervent free trader.
Today’s apostles of free trade argue the case in much the same way as Adam Smith, ignoring the fact that wealth has expanded enormously since Smith’s day. They typically admit that free trade costs jobs, but claim that re-training programs will fit workers into new, “higher value” jobs. This amounts to saying that even though rich countries (or regions) no longer need the benefits of free trade, they must continue to suffer its costs.

Defenders of the current system reply: we leave such choices to individuals to make for themselves. If people want to step off the conveyor belt, they are free to do so. And increasing numbers do, in fact, “drop out.” Democracy, too, means the freedom to vote capitalism out of office.

This answer is powerful but naïve. People do not form their preferences in isolation. Their choices are framed by their societies’ dominant culture. Is it really supposed that constant pressure to consume has no effect on preferences? We ban pornography and restrict violence on TV, believing that they affect people negatively, yet we should believe that unrestricted advertising of consumer goods affects only the distribution of demand, but not the total?

Capitalism’s defenders sometimes argue that the spirit of acquisitiveness is so deeply ingrained in human nature that nothing can dislodge it. But human nature is a bundle of conflicting passions and possibilities. It has always been the function of culture (including religion) to encourage some and limit the expression of others.

Indeed, the “spirit of capitalism” entered human affairs rather late in history. Before then, markets for buying and selling were hedged with legal and moral restrictions. A person who devoted his life to making money was not regarded as a good role model. Greed, avarice, and envy were among the deadly sins. Usury (making money from money) was an offense against God.

It was only in the eighteenth century that greed became morally respectable. It was now considered healthily Promethean to turn wealth into money and put it to work to make more money, because by doing this one was benefiting humanity.

This inspired the American way of life, where money always talks. The end of capitalism means simply the end of the urge to listen to it. People would start to enjoy what they have, instead of always wanting more. One can imagine a society of private wealth holders, whose main objective is to lead good lives, not to turn their wealth into “capital.”

Financial services would shrink, because the rich would not always want to become richer. As more and more people find themselves with enough, one might expect the spirit of gain to lose its social approbation. Capitalism would have done its work, and the profit motive would resume its place in the rogues’ gallery.
The dishonoring of greed is likely only in those countries whose citizens already have more than they need. And even there, many people still have less than they need. The evidence suggests that economies would be more stable and citizens happier if wealth and income were more evenly distributed. The economic justification for large income inequalities – the need to stimulate people to be more productive – collapses when growth ceases to be so important.

Perhaps socialism was not an alternative to capitalism, but its heir. It will inherit the earth not by dispossessing the rich of their property, but by providing motives and incentives for behavior that are unconnected with the further accumulation of wealth.

Robert Skidelsky, a member of the British House of Lords, is Professor Emeritus of Political Economy at Warwick University, author of a prize-winning biography of the economist John Maynard Keynes, and a board member of the Moscow School of Political Studies.
Copyright: Project Syndicate,

Thursday, January 20, 2011

Rajiv Sethi: The Original Mandate of the Federal Reserve

This from Rajiv Sethi:

Rajiv Sethi: The Original Mandate of the Federal Reserve: "Writing on his recently launched blog, my colleague Perry Mehrling traces the evolving mandate of the Federal Reserve from its founding to the present day:

From a longer historical perspective, populist targeting of the Fed, both from the right and from the left, is nothing new. Big Finance and Big Government are perennial bogeymen in American political discourse. Coupling the two in the institution of a central bank is at the heart of current debate about the role of the Fed during the crisis.

In 1913, at the founding of the Fed, legislators directly confronted both bogeymen. The whole idea of the Federal Reserve System, so the language of the Act made clear, was to channel credit preferentially to productive uses. Section 13(2) makes clear who was supposed to get the credit: “Discount of Commercial, Agricultural and Industrial Paper”, not speculative financial paper and not Treasury paper. The new Fed was about reversing the upper hand enjoyed by Big Finance, and without replacing it with the hand of Big Government.

Exigencies of war finance soon shifted the focus of the newborn Fed, and the Act was accordingly amended. During both World War I and World War II, the Fed pegged the price of Treasury debt, and expanded its balance sheet as necessary to absorb any excess supply that was not taken up by private buyers.

Does that kind of emergency intervention sound familiar? It should.

So-called QE1, back in early 2009, involved the Fed pegging the price of mortgage-backed securities by taking $1.25 trillion worth onto its own balance sheet. This is war finance. Actually it started even earlier, back in September 2008, with the collapse of Lehman and AIG. The initial balance sheet expansion occurred as, in addition to its domestic lending, the Fed lent $600 billion to foreign central banks, as well as other billions directly to foreign private banks, financing the loans simply by expanding its own monetary liabilities. This again is war finance, but without the war.

What troubles critics of the Fed is the use of the powerful tools of war finance to support private capital markets, and to support foreign bankers. For some, a similar unease arises from the latest QE2 twist, which has the Fed buying $600 billion of Treasury debt. There is no doubt in my mind that the Fed’s actions were legal under the “unusual and exigent circumstances” provision of the Act. But what everyone wants to know is whether the Fed did the right thing, and what the transformation of the Fed over the last few years portends for the future.

As it happens, one of the many responses of the Fed to the financial crisis was a return to its original mandate as an active participant in the commercial paper market: 'funding purchases of commercial paper... to improve liquidity in short-term funding markets and thereby increase the availability of credit for businesses and households.' But this was done in late October 2008, after a massive expansion of its balance sheet in support of failing financial intermediaries, and after TARP had been signed into law.

The main justification for these extraordinary measures in support of the financial sector was that perfectly solvent firms in the non-financial sector would have been crippled by the freezing of the commercial paper market. But as Dean Baker has consistently argued, had the Fed's intervention in the commercial paper market been more timely and vigorous, it might been unnecessary to provide unconditional transfers to insolvent financial intermediaries. While I do not subscribe to Baker's view that Ben Bernanke 'deliberately misled' Congress in order to gain approval for TARP, his main point still stands: if the Fed can increase credit availability to non-financial businesses and households by direct purchases of commercial paper, than why is any financial institution too big to fail?

It's a question that the most ardent defenders of the bailouts would do well to address. The impressive numerical estimates of the effects of these policies on output and employment rely on a comparison with a 'scenario based on no financial policy responses.' But this is obviously not the proper benchmark. If output and employment could have been stabilized by direct support of the non-financial sector, then we would currently be faced with a different distribution of claims to this output, as well as a different distribution of financial practices.

Among supporters of the government's financial market policies, Bill Dudley has been especially forthright in acknowledging their flaws:

[It] is deeply offensive to Americans, including me, and runs counter to basic notions of justice and fairness, that some of the very same individuals and financial firms that precipitated this crisis have also benefited so directly from the response to the crisis. This has occurred at the same time that many Americans have lost their jobs and hard-earned savings. The public outrage this situation has produced is understandable. In the context of actions taken to support the financial system, the Federal Reserve and other government agencies have provided considerable support to banking organizations and other large systemically important financial institutions. The employees and executives of those institutions have benefited from our intervention. In a perfect world we would be able to prevent those individuals and institutions from benefiting; we would have a better way to penalize those who acted recklessly. But once the crisis was underway, one goal took precedence: keeping the financial system from collapsing in order to protect the nation from an even deeper and more protracted downturn that would have been more damaging to everyone.

In a perfect world, according to Dudley, we could have done much better. But even in our very imperfect world, might we not have been able to stabilize output and employment by returning quickly and forcefully to the original mandate of the Federal Reserve, to channel credit preferentially to productive uses?

- Sent using Google Toolbar"

Why did it take three years to figure this out?

Alas, even if we had, the lunatic free market fundamentalist right would have gone howling mad, screaming Illuminati conspiracies that would have blocked any form of stabilization effort at all. The Hooverites believe government neither can nor should ever do anything about business cycles, debt deflation or anything else in the face of economic meltdown. Depressions are, in their view, meant to be endured, no matter the impact on the bottom 90%.

Wednesday, January 19, 2011

Debt, deleveraging, and the liquidity trap: A new model | vox - Research-based policy analysis and commentary from leading economists

Debt, deleveraging, and the liquidity trap: A new model
vox - Research-based policy analysis and commentary from leading economists

Debt, deleveraging, and the liquidity trap
Paul Krugman18 November 2010
Print EmailComment Republish

Debt is the crux of advanced economies’ current policy debates. Some argue for fiscal expansion to avoid recession and deflation. Others claim that you can’t solve a debt-created problem with more debt. This column explains the core logic of a new model by Eggertsson and Krugman in which debt shocks and policy reactions can be examined.
Relying on heterogeneous agents, the model naturally produces the paradox of thrift but also finds new supply-side paradoxes, those of toil and flexibility. The model suggests that most economists have been misthinking the issues and that actual policy in the US and EU is misguided.

If there is a single word that appears most frequently in discussions of the economic problems now afflicting both the US and Europe, that word is surely “debt.” Between 2000 and 2008, household debt rose from 96% of US personal income to 128%; meanwhile, in Britain it rose from 105% to 160%, and in Spain from 69% to 130%. Sharply rising debt, it’s widely argued, set the stage for the crisis, and the overhang of debt continues to act as a drag on recovery.

The lack of formal theory
The current preoccupation with debt harks back to a long tradition in economic analysis, from Fisher’s (1933) theory of debt deflation to Minsky’s (1986) back-in-vogue work on financial instability to Koo’s (2008) concept of balance-sheet recessions. Yet despite the prominence of debt in popular discussion of our current economic difficulties and the long
tradition of invoking debt as a key factor in major economic contractions, there is a surprising lack of models – especially models of monetary and fiscal policy – of economic policy that correspond at all closely to the concerns about debt that dominate practical discourse. Even now, much analysis (including my own) is done in terms of representative-agent models, which by definition can’t deal with the consequences of the fact that some people are debtors while others are creditors.

New work that I’ve done with Gauti Eggertsson (Eggertsson and Krugman 2010) seeks to provide a simple framework that remedies this failing. Minimal as the framework is, I believe that it yields important insights into the problems the world economy faces right now – and it suggests that much of the conventional wisdom governing actual policy is wrong-headed under current conditions.

The model’s economic logic
We envision an economy very much along the lines of standard New Keynesian models – but instead of thinking in terms of a representative agent, we imagine that there are two kinds of people, “patient” and “impatient”; the impatient borrow from the patient. There is, however, a limit on any individual’s debt, implicitly set by views about how much leverage is safe.
We can then model a crisis like the one we now face as the result of a “deleveraging shock.” For whatever reason, there is a sudden downward revision of acceptable debt levels – a “Minsky moment.” This forces debtors to sharply reduce their spending. If the economy is to avoid a slump, other agents must be induced to spend more, say by a fall in interest rates. But if the deleveraging shock is severe enough, even a zero interest rate may not be low enough. So a large deleveraging shock can easily push the economy into a liquidity trap.
Fisher’s (1933) notion of debt deflation emerges immediately and naturally from this analysis. If debts are specified in nominal terms and a deleveraging shock leads to falling prices, the real burden of debt rises – and so does the forced decline in debtors’ spending, reinforcing the original shock.
One implication of the Fisher debt effect is that in the aftermath of a deleveraging shock the aggregate demand curve is likely to be upward, not downward-sloping. That is, a lower price level will actually reduce demand for goods and services.
More broadly, large deleveraging shocks land the economy in a world of topsy-turvy, where many of the usual rules no longer apply. The traditional but long-neglected paradox of thrift – in which attempts to save more end up reducing aggregate savings – is joined by the “paradox of toil” – in which increased potential output reduces actual output, and the “paradox of flexibility” – in which a greater willingness of workers to accept wage cuts
actually increases unemployment.
Where our approach really seems to offer clarification, however, is in the analysis of fiscal policy.

Implications for fiscal policy
In the current policy debate, debt is often invoked as a reason to dismiss calls for expansionary fiscal policy as a response to unemployment; you can’t solve a problem created by debt by running up even more debt, say the critics. Households borrowed too much, say many people; now you want the government to borrow even more?
What's wrong with that argument? It assumes, implicitly, that debt is debt – that it doesn't matter who owes the money.
Yet that can't be right; if it were, debt wouldn't be a problem in the first place. After all, to a first approximation debt is money we owe to ourselves – yes, the US has debt to China etc., but that's not at the heart of the problem. Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth – one person's liability is another person's asset.
It follows that the level of debt matters only because the distribution of that debt matters, because highly indebted players face different constraints from players with low debt. And this means that all debt isn't created equal – which is why borrowing by some actors
now can help cure problems created by excess borrowing by other actors in the past. This becomes very clear in our analysis. In the model, deficit-financed government spending can, at least in principle, allow the economy to avoid unemployment and deflation while highly indebted private-sector agents repair their balance sheets, and the government can pay down its debts once the deleveraging crisis is past.
In short, one gains a much clearer view of the problems now facing the world, and their potential solutions, if one takes the role of debt and the constraints faced by debtors seriously. And yes, this analysis does suggest that the current conventional wisdom about what policymakers should be doing is almost completely wrong.

Eggertsson, Gauti and Krugman, Paul (2010), “Debt, Deleveraging, and the Liquidity Trap”, mimeo
Fisher, Irving, (1933), “The Debt-Deflation Theory of Great Depressions,” Econometrica, Vol. 1, no. 4.
Koo, Richard (2008), The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession, Wiley.
Minsky, Hyman (1986), Stabilizing an Unstable Economy, New Haven: Yale University Press.

Monday, January 17, 2011

Tax Progressivity as Justice... or Dessert

just-deserts.pdf (application/pdf Object): "- Sent using Google Toolbar"

An interesting article that, among other things, supports my intuition that top marginal tax brackets of 50% (possibly a bit higher) are entirely fair.

And which supports my intuition that ordinarily earned wages ought to be taxed at [steeply?] lower rates.

An overall progressive tax system is not only fair, but is MORE fair than so-called flat tax proposals.

Actually Existing Capitalism | CEPR Blog

Actually Existing Capitalism CEPR Blog

Key findings:

1. Virtually everyone underestimates the degree to which wealth is unequally distributed, and by a large degree. On average, most Americans believe the distribution of wealth is more equally distributed than it actually is: whereas the top 20% wealthiest in society actually own some 80% of all wealth, Americans believe the top 20% only own [a bit less than] 60% of wealth.

2. Even Bush voters - Republicans, conservatives and fearful independents/moderates - believe that the ideal distribution of wealth is far "flatter: in their ideal, fair distribution, the top 20% would own only 35% of the wealth. [Kerry voters - presumably Democrats, progressives, liberals, and fearless independents/moderates - estimated the top 20% should only own 30% of the wealth.]

These give rise to a key question:
To what extent does ignorance of the actual inequality of wealth contribute to voter unwillingness to address the issue? If voters believe that wealth is more equally distributed than is true, does that not imply that the issue must have lower priority/significance than it otherwise would/should?

... and highlight a key implication:
The difference between a howling American socialist and a fevered American free market fundamentalist is apparently only 5% difference [for the top 20%] in their preferred wealth distribution scheme. Not much. So why all the acrimony?

Thursday, January 13, 2011

The Limits of Minsky’s Financial Instability Hypothesis as an Explanation of the Crisis - Monthly Review

An interesting article - which I have not fully digested yet, and so am not ready to provide a complete, fully-commented blog entry about... yet.
But it seemes important enough to share ahead of time...

The teaser here is how it speaks about icome and wealth inequality as driving factors of economic instability/stagnation... topics that I have had gnawing, gut-level concerns about, but for which I have as yet been unable to find a convincing explanatory theory. Do the New Marxists (Foster and McChesney), SSA theorists (Kotz) and "Structural" Keynesians have it right? [shudder] I don't know, and my unfiltered immediate reaction is to shy away from anything called "New Marxist"... but maybe I've got to open my eyes wider?

The Limits of Minsky’s Financial Instability Hypothesis as an Explanation of the Crisis - Monthly Review