The following article was written by Post-Keynesian economist Robert Skidelsky over at Project Syndicate. Post-keynesian economists are more thoroughly anchored in reality than mainstream orthodox monetarist economists like Greg Mankiw and Paul Krugman. This is because post-keynesians reject the myths of 1) loanable funds aka fractional reserve lending and 2) rational markets and general equilibrium. However, Skidelsky's article Messed-up Macro repeats a number of mainstream myths that only serve to reinforce the death-grip of ignorance with which the mainstream has clutched the general public since the neo-liberal monetarists started to take over in the late 1970's. This ignorance and mythology that surrounds monetary and fiscal operations are the dual weapons economic conservatives use to force market fundamentalism down the throats of the voting public against our best interests. As it pertains to Skidelsky's article, we'll focus on three parts:
1) Loanable funds. In other words, the concept that deficit spending by the Govt "crowds out" private spending which leads to either A) higher interest rates, B) reductions in private sector spending or C) both.
2) Ricardian equivalence. Which essentially states that deficit spending is ineffective because people believe that taxes andor inflation will be higher due to the need to pay back this so-called Govt "debt". Which means that the fiscal multiplier is effectively zero in the medium term.
3) Bond markets are in charge of Govt interest spending and so we must pay heed to the bond vigilantes.
Now to be sure, Skidelsky brings up each of these three points in the context of posing legitimate questions where there are two sides debating in good faith and the answers to the questions are uncertain and open to interpretation and the opinions of a particular economic school. He does not come out and take a clear stand one way or another, so I'm not trying to invalidly claim he personally believes these three fantasies. While there are many complicated issues in macro-economics that boil down to political points of view and value judgments, none of these three issues is subjective. There is no ambiguity, and to pretend that the mainstream orthodoxy has a legitimate POV wrt these three concepts is an example of false equivalence and only serves to legitimatize economic myths that dont bear any resemblance to reality. And which are hurting the future of human progression in the same way as religious fundamentalism hurts human progress. If I havent lost you yet, follow below the fold for the discussion.
And so we begin:
Crowding Out:
Should governments deliberately expand their deficits to offset the fall in household and investment demand? Or should they try to cut public spending in order to free up money for private spending?
Emphasis mine.
This is the crowding out argument. Which essentially states that because the Govt borrows the money of the private sector, the more the Govt borrows and spends, the less the private sector has for consumption and investment. This seems reasonable as it applies to people's normal lives, the problem is that the Govt does not borrow private sector money. The problem with this description is that all Govt transactions are done using Govt currency (reserves) not private sector money (private bank deposits). And Govt currency (reserves) can only come from one place or its counterfeit and people go to jail, and that place is the Govt itself.
Lets just do some basic accounting to demonstrate this simple concept. Lets say that the Govt is paying Boeing $100M for a plane. Boeing banks at Chase and the Govt (TSY) banks at the Fed (the TSY general account or TGA). Before we do the accounting, lets remember a few things; that Reserves held by the TSY are financial assets of the TSY and Financial liabilities of the Fed, so for the Govt as a whole the effect is they are cancelled out. In the same way that what a husband owes his wife is cancelled out when looking at the couple's household budget. That reserves held by Chase at the Fed are Chase financial assets and Fed liabilities. And that bank deposits that Boeing has at Chase are Boeing financial assets and Chase liabilities. Here we go:
TGA = -$100M reserves
Chase = +$100M in reserves
Chase gets $100M in financial assets (reserves) that it didnt have before and TSY exchanges its reserves for an airplane.
Boeing's checking account @ Chase = +$100M
Chase's customer deposits (Boeing) = +$100M
We've got this entry on here twice because Chase has to increase its financial liabilities (Boeing's deposit account) in exchange for the reserves it received from the TGA, Chase doesnt get those financial assets for free.
So thats it, pretty simple really and the results are that the Non-Govt (Boeing in this case) has $100 million that it didnt have before. So deficit spending by the Govt results in a net increase in financial wealth for the Non-Govt as a whole. Deficits add to the supply of money the private sector has, they dont subtract from it. This isnt opinion, or open to interpretation, all you need is an entry level understanding of accounting and elementary school arithmetic.
But what about issuing TSY securities (going into so-called "debt")? What changes when we include that part of the spending cycle? The answer is.....nothing! So lets say that Boeing doesnt have anything to do with that $100M for the next 6-months and since private bank accounts are only guaranteed up to $250K per account and TSY securities are guaranteed to infinity, Boeing could simply buy $100M in 6-month Govt CDs aka TSY bills.
Boeing's account at Chase = -$100M
Boeing's TSY securities account = +$100M
So Boeing's financial position is completely unchanged by owning TSY securities instead of Chase checking deposits (its actually improved since the whole $100M is guaranteed and 6-month T-bills pay a higher interest rate than Chase checking deposits)
Chase's account at the Fed (reserves) = $-100M
TGA (reserves) = +$100M
Chase's financial position is unchanged because they lose both $100M in liabilities (Boeing's checking deposits) and $100M in assets (their reserves at the Fed). And the TSY gets back the $100M in reserves it originally traded for an airplane. And the Govt has simply traded one type of Govt financial liability (reserves previously owned by Chase in the first accounting) for another financial liability (TSY securities now owned by Boeing). As we can clearly see, the issue of deficit spending crowding out private sector spending is complete hokum, its not an issue for which there can be two sides, it is as black and white as its possible to be. And yet Skidelsky is presenting this paragraph as if both sides have merit, they dont. Believing in "crowding out" effects is no different than believing in creationism or refusing to acknowledge AGW.
Ricardian Equivalence:
The Keynesian remedy, the argument went, ignored the effect of fiscal policy on expectations. If public opinion believed that cutting the deficit was the right thing to do, then allowing the deficit to grow would annul any of its hoped-for stimulatory effect. Expecting that taxes would have to rise to “pay for” the extra spending, households and companies would increase their saving
Emphasis Mine
This is just another way of saying that the fiscal multiplier is either zero or negative. Which is to say that if the Govt deficits spends $100M buying an airplane from Boeing, then Boeing will save this $100M in anticipation of higher taxes in the future and thus there wont be any additional increase in GDP (which is simply the sum of all spending in the economy on final goods and services). Even if Boeing never spent a single dollar of the $100M it received from the Govt (something that is impossible), the Non-Govt and Boeing would still be $100M richer (and GDP $100M higher) from receiving that deficit spending. And unless you are arguing that the private sector has too much money and so is already spending more than the economy can handle causing inflation thats too high, the notion that Ricardian equivalence is some serious issue that we need to contend with is laughable. And it gets even more ridiculous when you change the context to social spending. If Joe sixpack receives $1000 from the govt via SS, he is going to spend some of that money eventually if not right now. And to believe otherwise is just as serious as believing in unicorns So here's how this works:
GDP = Govt spending (on real goods and services like the airplane, which excludes Govt transfers like SS spending or unemployment benefits & food stamps) + Non-Govt spending (business + household sectors) - Net Imports.
So in our plane example, GDP increases by the amount of the purchase ($100M) so even if Boeing never spent any of that money (impossible) GDP would still increase by $100M. In our SS example, the only way for GDP to not increase (from the Non-Govt spending component in this case) would be for Joe six-pack to not spend any of the $100 SS payment he received in the observed time period. And how likely is that? And even if Joe sixpack had plenty of money and didnt spend any of the $1000, would he be worse off? No. So again, including Ricardian equivalence in the blog article is not serious by Skidelsky, and the fact that mainstream orthodox economists (including Krugman) give serious consideration to the concept is simply an embarrassment.
Bond Vigilantes:
Fearing sovereign defaults, bond markets would charge governments punitive interest rates on their borrowing.
First of all, what does it mean to default? It means that you cannot make good on your promise(s). In the context of a sovereign Govt like the USA, this refers to the promises it makes when the Govt issues TSY securities. And what promise is that? The promise is to deliver the face value of the TSY security + interest payments if there are any. For the un-initiated, short term TSY bills of $100 would be sold for a discount at auction. So you would pay like $90 on Jan 1 2015 for a 1 yr T-bill and receive $100 when it comes due on Jan 1 2016. So you would receive $10 which is the yield, in other words, the interest you got would be ($10/$100) 10%. And this changes depending where the Fed is setting the base rate aka Federal Funds rate. Or if you are buying a a longer-term TSY security like a 10-yr T-note, you would receive the face value of $100 back at maturity plus an interest payment at regularly scheduled intervals (usually 6-months). So these are the promises the Govt makes, it promises to deliver to TSY securities holders (a type of Govt IOU) US reserves (another type of Govt IOU) which then become your private bank customer deposit as in the Boeing example above. The Govt doesnt promise to deliver you gold or a foreign currency at some set exchange rate. The Govt does all financial transactions with one type of Govt IOU or another. And the Govt is the issuer of its own IOUs, so it cant ever run out of its own promises.
This is fundamentally different than any other participant in the economy. Everyone else must deliver their financial assets when settling their IOUs (promises aka liabilities). When you repay your credit card IOU, Visa doesnt accept more IOUs from you, you have to deliver you assets (checking account deposits mainly). Same thing with a mortgage, you cant pay off your mortgage IOU with your credit card IOUs. Private commercial banks cant pay off their IOUs to you (your checking account) with more IOUs to you (generally). If you bank at Chase and have $10,000 in your checking account and write a check to buy a car from someone who banks at Bank of America, Chase must deliver its financial assets (reserves) to Bank of America in order for BofA and Chase to clear your check and finalize the purchase. One caveat here, if that person selling you their car also banks at Chase, then technically chase is simply shifting its IOUs from your account to the sellers account and they arent delivering any financial assets to a third party at this point. Which is why checks written between customers at the same bank take alot less time to clear, its all in-house for that bank and they dont have to go through the Fedwire reserve settlement system.
The federal Govt is the US dollar monopolist, it and only it can create its own IOUs (aka currency reserves or TSY securities if properly understood). So there is no risk of the sovereign being forced to default on its promises for the USA (unless Congress doesnt raise the "debt" limit which is a completely different issue). And as the only entity that operates in this fashion, the Govt is in the driver seat, not the bond market. In fact, the bond market is nothing but a service that the Govt provides. The Govt does this as a favor to society, not the other way around. There is no economic necessity that says the Govt must offer the people an opportunity to earn a guaranteed, risk-free return on your savings. Last year, the govt spent like $500 billion on interest payments to the mostly already wealthy. Is that a good policy? Maybe, but it certainly doesnt mean that we have to cut down on our public social spending because rich financiers want more risk free interest income.
So there you have it, three ideas that are taken as gospel by the mainstream economic community and which are repeated by the media and politicians but have absolutely zero-bearing on reality. Robert Skidelsky, as a revered member of the post-keynesian community you can do better then to treat these silly notions as if they deserve legitimate thought in our public discourse.