It’s too bad Keynes didn’t write in English
from Dean Baker
Keynes explained the dynamics of an economy in a prolonged period of high unemployment more than 70 years ago in The General Theory. Unfortunately, it seems that very few of the people in policymaking positions in the United States or Europe have heard of the book. Otherwise, they would be pushing economic policy in the exact opposite direction that it is currently headed.
Most of the wealthy countries have now made deficit reduction the primary focus of their economic policy. Even though the United States and many euro zone countries are projected to be flirting with double-digit unemployment for years to come, their governments will be focused on cutting deficits rather than boosting the economy and creating jobs.
The outcome of this story is not pretty. Cutting deficits means raising taxes and/or cutting spending. In either case, it means pulling money out of the economy at a time when it is already well below full employment. This can lower deficits, but it also means lower GDP and higher unemployment.
This might be okay if we could show some benefit from lower deficits, but this is a case of pain with no gain. Ostensibly, there will be a lower interest rate burden in future years, but even this is questionable. First, the contractionary policy being pursued by the deficit hawks will slow growth and lead to lower inflation or possibly even deflation. It is entirely possible that the debt to GDP ratio may actually end up higher by following their policies than by pursuing more expansionary policy.
In other words, we may end up with smaller deficits and therefore accumulate less debt, but we may slow GDP growth even more. The burden of the debt depends on the size of the economy and in the scenario where we do more to slow GDP growth than the growth of the debt, then we end up with a higher interest rate burden, not a lower one.
The other reason why we may not end up with a lower interest rate burden is that we need not issue debt to finance the budget deficits. Countries like the United States and the United Kingdom that control their central banks can simply have the central banks buy up the bonds used to finance the deficits. In this story, the interest payments on the bonds are paid to the central bank, which is in turn refunded to the government. This means that there is no interest burden created by these deficits.
If that sounds impossible, then it’s necessary to pick up Keynes again. The economies of Europe and the United States are not suffering from scarcity right now. They are suffering from inadequate demand. This means that if governments run deficits, and thereby expand demand, the economy has the capacity to fill this demand. The decision of central banks to expand the money supply by buying bonds simply leads to an increase in output, not to inflation.
The idea that there is some direct link between the money supply and inflation is absurd on its face. Do any businesses raise their prices because the Fed has put money into circulation? How many businesses even have a clue as to how much money is in circulation? In the real world, prices are set by supply and demand. If any business tried to raise their prices just because the Fed has put more money into circulation they would soon find themselves wiped out by the competition – at least as long as we are in this situation of having enormous excess supply.
This story should be old hat to those who have studied Keynes. In a period of high unemployment, like the present, governments can literally just print money. Not only will this put people back to work, this process can also lay the basis for stronger growth in the future by creating better infrastructure, more energy efficient buildings, supporting research and development of clean energy and improving the education of our children.
Unfortunately, our political leaders don’t give a damn about mundane issues like unemployment and economic growth. It is far easier for them to bandy silly clichés about fiscal responsibility and generational equity, even though the policies they are pushing are 180 degrees at odds with anything that will help our children or grandchildren. Their main concern is push policies that keep the financial industry happy. And 10 million unemployed never bothered anyone at Goldman Sachs, just ask Fabulous Fabio.
Leave a Reply
—— Ugarteche, Puyana and Madi ——
Gerson Lima / Maria Alejandra Madi
Edward Fullbrook and Jamie Morgan
————— Michael Hudson ————–
Maria Alejandra Madi / Jack Reardon
————- Edward Fullbrook ————-
—————— Steve Keen —————–
————— Richard Smith —————
————– Gustavo Marques————
– Victor Beker and Beniamino Moro –
————– Lars Pålsson Syll ————-
—————– Stuart Birks —————-
Edward Fullbrook and Jamie Morgan
———— Armando Ochangco ———-
Shimshon Bichler / Jonathan Nitzan
————— Mauro Gallegati ————–
————— Herman Daly —————-
————— Asad Zaman —————
—————– C. T. Kurien —————
————— Robert Locke —————-
Your interpretation of Keynes work is the very reason for it having fallen into oblivion. Keynes did not strongly advocate deficit spending, which will lead us into far greater troubles if we do not stop it now. Large deficits are needed to avoid spirraling into depression. It is not a way to boost growth, and particularly so when social spending is slowly getting out of hands and is more and more leading to a general paralysis of aging industrial economies and is depriving ever larger Governments of their ability to act. Praise Keynes, forget Domar and other epigones. Keynes did praise the stabilisation effect of social security (mostly but not only unemployment insurance). Maybe a different lesson should be learned depending on which side of the Atlantic you benefit from unemployment insurance. Decades of hubris – not only within financial markets – did not leave us much alternatives to reducing Government spending, which in turn will create a business climate more prone to growth and renewed, more effective Government spending.
Mr. du Plex’s comments are so full of cliche’s I don’t know where to begin. — “social spending is slowly getting out of hand … leading a a general paralysis of aging industrial economies …” The paralysis was caused by a double whammy of bubbles in stocks and real estate creating a short-run compensation for rising inequality — both pre-tax and post transfer — while the social safety net was torn asunder by Reagan/Thatcherism to reduce the roles that social security (Keynes also supported a graduated income tax to increase overall consumption and tax away the sterile savings of the very rich).
The paralysis that the industrial world feels today is based, especially in the United States, in an over 30 year increase in inequality (see the SAEZ data). The reason business does not invest in productive activity is not because of the rising role for government — it’s the other way around. The rising role for government (even under Reagan/Bush/Clinton/Bush) has been BECAUSE of the sluggishness of investment in productive activity. And the reason for the sluggishness of investment in productive activity is because the growing markets for the products of business — markets that depend first and foremost on growing incomes — have been narrowed as a result of the narrowing of the benefits of rising productivity to a smaller and smaller percentage of the world’s population — (this is true in the US but also in China — who has captured the lion’s share of China’s increased productivity in the past 30 years?).
The rise of social democratic capitalism before during and after WW II provided a dramatic increase in the overall demand for products and for a few decades made it possible for business investment to boom, productivity to grow, and profits to grow as well — despite a VERY LARGE role for government in all of the capitalist world.
The neo-liberal model of Reagan and Thatcher helped fuel growth for another 30 years but at a great cost — which we are now seeing most dramatically in the recent financial meltdown.
None of that was caused by TOO MUCH GOVERNMENT (especially “SOCIAL” spending).
Dean,
Nick Kraft sent me to your site. This post is excellent. Aside from your reference to the debt/GDP ratio (It’s a meaningless ratio — See: http://rodgermmitchell.wordpress.com/2009/11/08/federal-debtgdp-a-useless-ratio/ )you are right on target.
Mr. du Plex is the classic debt hawk, filled with personal opinion, but lacking any historical data to support his beliefs. Meanwhile, in the name of “fiscal prudence,” millions of our children and grandchildren will go without jobs adequate health insurance, retirement, good roads and bridges, and R&D, while their financial lives are destroyed by taxes.
Sadly, debt hawks do not work from data or logic. They think the science of economics can be understood on an emotional level. That’s why facts neither enter their minds nor sway them.
But keep trying.
Rodger Malcolm Mitchell
http://rodgermmitchell.wordpress.com
“In the real world, prices are set by supply and demand.” For sure, Mr Dean is not talking about housing market…
I usually like this blog, but I am afraid you’re way of on this one. I don’t wish to discuss the whole entry, but here’s just one paragraph:
“The idea that there is some direct link between the money supply and inflation is absurd on its face. Do any businesses raise their prices because the Fed has put money into circulation? How many businesses even have a clue as to how much money is in circulation? In the real world, prices are set by supply and demand. If any business tried to raise their prices just because the Fed has put more money into circulation they would soon find themselves wiped out by the competition – at least as long as we are in this situation of having enormous excess supply.”
When you increase the money supply, by definition you are giving money to SOMEONE. What do people do when you give them money? They don’t go in their backyard and burn it…they spend all or some of it (even if they save all of it, the banks loan it out). What happens when people spend some of that money and buy things with the money that you gave them? Prices go up. Hence, increasing money supply = inflation.
“[…]increasing money supply = inflation.”
Intuitively that may be true, but factually it is not. At least in the past 50 years there has been no historical relationship between money supply and inflation. The relationship has been between oil prices and inflation. See: http://rodgermmitchell.wordpress.com/2009/09/24/is-inflation-too-much-money-chasing-too-few-goods
The myth that money supply = inflation is a classic example of cognitive dissonance. Look around you. The money supply has been zooming and we are worried about deflation.
Rodger Malcolm Mitchell
“…See: http://rodgermmitchell.wordpress.com/2009/09/24/is-inflation-too-much-money-chasing-too-few-goods”
That plot shows on the y-axis the percentage increase in CPI from the previous year. It is almost always positive, which means a constant RATE of inflation and inflation is actually rising this whole time.
“The myth that money supply = inflation is a classic example of cognitive dissonance. Look around you. The money supply has been zooming and we are worried about deflation.”
Businesses are always worried about their prices going down, which they call deflation. But really look around you. Prices have not been falling. It’s true the money supply has been increasing dramatically in the last few years and prices haven’t rising as much. Some say that defeats the “naive monetarists”, but it really doesn’t. No one said prices have to go up right away in response to an increase in money supply. It may take some time but we’ll see its effects sooner or later.
Opinions….Consider logic: it’s fascinating. Sadly economic theory does not offer clearcut answers, particulary if you consider a pluralistic approach. But we can learn from past crises: Indeed our problems today are the consequence of a free financial market bubble economy. My point is that deficits are not the right instrument, which is a lesson from the seventies: you cannot trick expectations. If markets notice that Governments will not pay back debt or inflate it, conditions for incurring debt will become very expensive in the long run. Expectations might be improved with fiscal discipline (there’s plenty of data supporting this). In case of deficits, future generations would bear the cost, not of debt, but of a radically different budget. Government spending should be effective (unlike Europe, the US might consider slashing defence spending in favor of increased social spending). Of course there also is a moral argument that debt must be paid back: you should not plan to default, which might sound strange to an economist… On the other hand a crisis can justify exceptional instruments, but i would rather think of a temporary and moderate increase in inflation.
Who said anything about debt not being paid back? The U.S. never has defaulted on any of its debts. Nor does it ever need to. It has the unlimited ability to service debts of any size.
You said, “Expectations might be improved with fiscal discipline (there’s plenty of data supporting this).”
If by “fiscal discipline” you mean reduced federal debt, I very much would like to see some of that data showing how reduced federal debt has benefited the economy.
GS, you said, “[…]It is almost always positive, which means a constant RATE of inflation and inflation is actually rising this whole time.”
Which has nothing to do with any relationship between money creation and inflation. That post suggested you look at http://rodgermmitchell.wordpress.com/2009/09/09/46/ The data show there is no relationship between deficits and inflation, contrary to popular faith.
You also said, “No one said prices have to go up right away in response to an increase in money supply. It may take some time but we’ll see its effects sooner or later.” Sooner or later? Doesn’t sound very scientific. Again, what is your supporting data?
Rodger Malcolm Mitchell
I heard a lecture once by a previous fed reserve president. He said there are two goals for the fed: stimulating the economy and combating inflation. They often go against each other and the fed has only one tool (although it comes in many forms): controlling the money supply. If the money supply has no effect on inflation then the Fed would stimulate the economy without worry.
On the other half of the world, the European central bank only has one worry: controlling inflation, and only one tool: controlling the money supply.
It seems to me that if the money supply really had no effect on inflation then these institutions wouldn’t have been established in the first place.
Maybe I don’t have data showing an overwhelming positive correlation between money supply and inflation for the past 10 years (because I think the true effects of increasing the money supply haven’t hit yet), but if you look at history you will realize that every increase in the money supply (commonly by devaluing the currency) from the French using less gold to countries leaving the gold standard to countries freeing their currencies from pegs has been accompanied by high inflation.
I’ve shown you the data, in the U.S., for the past 50 years. There is no relationship between federal deficits and inflation, which is caused by oil prices.
Your intuition tells you the data simply must be wrong, somehow. Could your intuition be wrong and the data correct?
Rodger Malcolm Mitchell
Thank you for the plots. They are interesting. However, I would like to point out a few things:
1. Increasing the money supply isn’t exactly the same thing as accumulating more deficit. My claim was that increasing the money supply pushes prices up, at least in the long run.
3. Even if you are totally correct about the past 50 years. The past 50-60 years have seen more technological advances than the last 2000 years put together. I do believe that technological advances can absorb increases in money supply without causing inflation, so even if there’s a period of history where we see an increase in money supply and no increase in inflation it does not mean it will persist in the future. There have been many more episodes in history where increases in money supply directly caused inflation (i.e. France in the 1800’s is a classic example).
1. This post was referring to deficits. What is the “long run” and what is your data?
2. “I do believe that technological advances can absorb increases in money supply without causing inflation […]” “Do not believe?” What is your data?
[…]”even if there’s a period of history where we see an increase in money supply and no increase in inflation it does not mean it will persist in the future.” What is your data?
“There have been many more episodes in history where increases in money supply directly caused inflation (i.e. France in the 1800′s is a classic example).”
France is a terrible example. It was on a gold/silver standard, paying for war, dealing with internal, political struggles, food riots and other economic upsets.
In 1971, the U.S. and most of the world, went off the gold standard, which changed economics dramatically. Sadly, most economists and the public still do not understand the vast implications of this change. The world of economics post-1971 is unlike the world before then.
I keep asking you for data, not to be rude, but to make the point that in science, intuition can be misleading. The public believes large federal debt is harmful, simply because large personal debt can be harmful, without understanding the difference.
Rodger Malcolm Mitchell
Thanks for your replies. Here’s some data of more or less the same quality you provided:
Looks like the money supply has some effect on CPI doesn’t it? I am not saying nothing else affects prices (i.e. an oil shock does), but to say that there is no direct link between money supply and prices (as in the original article) is not right.
I think with the Transfinancial Economics we would be able to know the economy en direct, and via electronic monitoring of transactions/accounting data we would be in a position to know what is causing real inflation…..
This post (and I) referred to federal deficits. Your data talks about M2, not deficits. As you yourself said, “Increasing the money supply isn’t exactly the same thing as accumulating more deficit.”
M2 and M3 (no longer published) are arbitrary definitions based on liquidity, and comprise only a small fraction of the real money supply. The government once published a definition called “L,” which included M3 + T-bills, banker’s acceptances, savings bonds and commercial paper. And even “L” didn’t include T-bonds, T-notes and corporate bonds, all of which are less liquid forms of money.
Although your data have little to do with federal deficits, especially deficits after 1971, the subject of this post, they are interesting in their own right, and give pause for thought. Can you tell me what “+ lies” means in your graphs?
Rodger Malcolm Mitchell
Since you now have moved the subject from deficits to M2 and M3, I thought I’d look at those figures on the St. Louis Federal Bank site. Sorry for the length of this address (below), but if you cut and paste it into your address bar, you will see no relationship between M2 and M3 and inflation. I’d have to study the data to understand why your graphs show otherwise. Perhaps its the 10 year smoothing your graphs use.
Rodger Malcolm Mitchell
http://research.stlouisfed.org/fred2/graph/fredgraph.png?&chart_type=line&graph_id=0&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23B3CDE7&graph_bgcolor=%23FFFFFF&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=CPIAUCNS,M2,M3&transformation=pc1,pc1,pc1&scale=Left,Left,Left&range=Custom,Max,Max&cosd=1970-01-01,1980-11-03,1981-01-05&coed=2010-04-01,2010-05-10,2006-03-13&line_color=%23FF0000,%23006600,%230000FF&link_values=,,&mark_type=NONE,NONE,NONE&mw=4,4,4&line_style=Solid,Solid,Solid&lw=1,1,1&vintage_date=2010-05-22,2010-05-22,2010-05-22&revision_date=2010-05-22,2010-05-22,2010-05-22&mma=0,0,0&nd=,,&ost=,,&oet=,,&fml=a,a,a
THE OTHER ROAD TO SERFDOM – Chapter 10 The Betrayal of Keynes.
ISBN 978-81-8274-394-6
In his – The General Theory – Keynes distilled the thinking that went into this great work in the following statement –
‘I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the means of securing an approximation to full employment. But beyond this no obvious case is made out for a system of State-Socialism which would embrace most of the economic life of the community’.
Anyone really conversant with Keynes thinking in the General Theory knows that it is the above factor which is ignored by economists when they discuss the causes of inflation and unemployment. He insisted throughout the whole of his work of the important part that interest rates play in the operation of the economy and concluded that near-zero interest rates were crucial for the survival of producer-capitalism. In order to avoid “Deficiencies of Effective Demand” arising Keynes, also called for ALL money to be created by treasury departments and spent not lent into circulation – but that as a consequence:
‘It would mean the euthanasia of the rentier, and consequently, the euthanasia of the cumulative oppressive power of the capitalist (Goldman-Sachs et al) to exploit the scarcity-value of capital.’
We see, therefore, that Keynes brought himself to separate the money-capitalist from the industrial-capitalist and in his advocacy of ‘socialisation of investment’ was asking for that which David Ricardo called for in his plan for the establishment of a National Bank of England in 1823, parts of which were implemented later by Abraham Lincoln in his issue of his Debt and Interest Free Greenback dollars..”
Arthur Swan – Cheltenham – England 1993
PS
1865. ABRAHAM LINCOLN’S 17. POINT MONETARY DECLARATION
1. Money is the creature of law and the creation of the original issue of money should be maintained as the exclusive monopoly of national Government.
2. Money possesses no value to the State other than that given to it by circulation.
3. Capital has its proper place and is entitled to every protection. The wages of men (however) should be recognised in the structure of and in the social order as more important than the wages of money.
4. No duty is more imperative for the Government than the duty it owes the People to furnish them with a sound and uniform currency, and of regulating the circulation of the medium of exchange so that labour will be protected from a vicious currency, and commerce will be facilitated by cheap and safe exchanges.
5. The available supply of Gold and Silver being wholly inadequate to permit the issuance of coins of intrinsic value or paper currency convertible into coin in the volume required to serve the needs of the People, some other basis for the issue of currency must be developed, and some means other than that of convertibility into coin must be developed to prevent undue fluctuation in the value of paper currency or any other substitute for money of intrinsic value that may come into use.
6. The monetary needs of increasing numbers of People advancing towards higher standards of living can and should be met by the Government. Such needs can be served by the issue of National Currency and Credit through the operation of a National Banking system.
7. The circulation of a medium of exchange issued and backed by the Government can be properly regulated and redundancy of issue avoided by withdrawing from circulation such amounts as may be necessary by Taxation, Redeposit, and otherwise.
8. Government has the power to regulate the currency and credit of the Nation.
9. Government should stand behind its currency and credit and the Bank deposits of the Nation. No individual should suffer a loss of money through depreciation or inflated currency or Bank bankruptcy.
10. Government possessing the power to create and issue currency and credit as money and enjoying the right to withdraw both currency and credit from circulation by Taxation and otherwise need not and should not borrow capital at interest as a means of financing Governmental work and public enterprise.
11. The Government should create, issue, and circulate all the currency and credit needed to satisfy the spending power of the Government and the buying power of the consumers.
12. By the adoption of these principles the long felt want for a uniform medium will be satisfied.
13. The taxpayers will be saved immense sums of interest, discounts, and exchanges.
14. The financing of all public enterprise, the maintenance of stable Government and ordered progress, and the conduct of the Treasury will become matters of practical administration.
15. The people can and will be furnished with a currency as safe as their own Government.
16. Money will cease to be master and become the servant of humanity.
17. Democracy will rise superior to the money power.
Regardless of who actually composed it – I believe that it encapsulates the thinking of Lincoln, Jefferson and Ricardo.