Monetarism 2

Monetarism 2: Keynesianism and Stagflation

    John Butler's recent post on the Cobden Centre website [1]  cogently argues that "Stagflation is, always and everywhere, a Keynesian phenomenon", but to some extent his piece follows in the vein of Punch-and-Judy argy-bargy between Keynesians and Monetarists that has yanked the truth back and forth across the stage these last 4 or more decades. 

    Of course politicians were happy to blame OPEC for the fourfold rise in the dollar price of oil in 1973 following the OPEC oil-embargo. John Butler calls this a "blatant reversal of cause and effect" because in the same year the USA abandoned the Bretton Woods/Smithsonian price of gold at 38$ per ounce and let the dollar float down by a factor of 2 (albeit to float down further by the end of the decade). In my view there were two causes of the oil-price rise in 1973: OPEC power and dollar weakness. One is no more "blatant" than the other.

    It seems to me that John Butler is largely right that "Stagflation is, always and everywhere, a Keynesian phenomenon", but this misses the point somewhat. Keynesianism is not a method for stabilizing the value of the currency; it is a method of stabilizing the labour market. Of course the injection of money into the system will devalue the currency (unless it is subsequently withdrawn). And of course soaring unemployment of 10, 20 or 50% will bring down labour costs (unless there is a foolproof benefit system).

    It all depends on what sort of country you want to live in.

Reference: [1] http://www.cobdencentre.org/2014/08/

Cawstein (cawstein@gmail.com)

Monetarism 1

Monetarism

The changed brief of the central banks makes monetarism obsolete?

 

In 1923, hyperinflation in Weimar Germany [1] was caused by the central government printing money to pay for its obligations to employees and millions of striking workers in the Ruhr. The absurdity of this was (surely) obvious to all. The so-called Austrian School of economics [2] arose based on the apparently inexorable link between an increase in the quantity of money and the decrease in its value.  At that level it was satisfyingly faultless, irrefragable, unassailable, for it was a priori [3].

But what is money? In the twenties and thirties the definition was relatively simple: it meant notes-and-coin. That is to say, the unlimited production of notes-and-coin soon swamped everything else. Over the subsequent decades innovations in banking have made the definition fuzzy and obscure. But obscure because fuzzy. It has become hard to define what should count as money in the context of the monetarist formula because different assets can have different roles depending on time-scales, and personal psychology. Is the money in my current account mine or the bank's? What about in my deposit account, or my 90-day account? Is an asset like a house to be included? No? But what if I sell the house and spend the proceeds? What if I merely think I could sell the house? What if I can sell the house but think I cannot?  Quantitative Easing in the USA and Europe since 2008 has seen a dramatic increase in the  Monetary Base (which on existing theories should have caused an even more dramatic increase in commercial activity), but there has been no sign of concomitant inflation, and surprisingly little effect on employment.

The Austrian School is in trouble. People now spend days and weeks researching and writing papers to define money in such as way that the Austrian School's formula can be shown to be valid. (This problem is thoroughly aired in reference [4].)  Gone is the certainty of the a priori. A fuzzy definition brings in judgments, and fuzzy answers. If money is in short supply, it is not spent; but the reverse is not equally true; money does not have to be spent simply because it is there. Humans are as much emotional as logical.

The Austrian School is in trouble, but worse is to come. It is the duty of Central Banks to maintain: [a] maximum employment, [b] stable prices (including prevention of either inflation or deflation), and [c] moderate long-term interest rates (insofar as it is possible to reconcile those three different aims) [5]. They are not required to maintain a constant supply of money as such. Many years ago it became clear that it was necessary to release more money in mid-December when it is needed, and withdraw it again in mid-January when it is idle. Money is now created when it is needed. If you want to predict inflation, do not look at the money supply, look at inflation; for that is what the Bank of England is doing (or should be doing***). If money supply (however calculated, M₀, M₂, M₄, M_A, M_Aex, etc), is not a leading but a lagging indicator, there is no point in monitoring it. Nothing will be learned from it that could not be learned earlier by looking at the triple target of the Central Banks, viz employment, prices and interest rates. (The only gain will be for the 'Austrians' themselves if they finally find the right measure of the Money Supply; they will then be able to say they were right all along.)

(*** Of course people make mistakes. House prices in South East England are inflating steeply. So let us build lots more houses, in North East England where there is unemployment and plenty spare land. "Oh! Sorry! Now you tell me that house prices are falling in the North East. Wish you had told me earlier!")

Cawstein, Morpeth, U.K.

References:

[1] http://www.historylearningsite.co.uk/hyperinflation_weimar_germany.htm

[2] http://en.wikipedia.org/wiki/Austrian_School

[3] http://detlevschlichter.com/2014/05/the-a-priori-method-in-economics-in-defence-of-ludwig-von-mises-essay/

[4] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2446812

[5] http://en.wikipedia.org/wiki/Federal_Reserve_System

 

 

Keynes2

Keynes2

Government of the People, by the Rich, for the Rich?

There is, I think, no disagreement that we are currently governed by the rich; and there can be little disagreement that it is for the rich. There may, however, be some division of opinion on the advantages for the bulk of the population of being so governed. I am going to argue that being governed for the rich is disastrous for the country, and that, given the force of natural prejudice, being governed by the rich (so for the rich) is also against the common interest. I should like to see a revival of the Common Wealth Party (q.v.)

The marginal propensity to consume.

JM Keynes, in "The General Theory of Employment, Interest and Money" (1936), discusses (among other things) our 'marginal propensity to consume', which can be visualised thus: If you give £100 to each person in the country, some would spend £99 (and doubtless buy a lottery ticket with the change), some would spend £50 and save the remainder and others would scarcely notice the gift. These would represent 'marginal propensities to consume' of 0.99, 0.5, and 0.001 respectively. Keynes points out that, in general, poor people tend to consume a large part of their income, and the rich tend to save (or invest) a large part.

         In Britain during the last two or three decades we have seen a marked increase in the gap between the very rich and the very poor. Worse still, we are seeing an ever larger fraction of GDP going into the hands of well-off people. This would be galling enough if the well-off spent that money; but at least then it would cascade down the social scale, and the makers of smart cars, their chauffeurs, their petrol-pump attendants and their skivvies would all benefit. But if the rich merely sit on their money (or lend it out at interest, or use it to buy out competitors) it is very damaging to the economy; the country goes into recession; we all sit around waiting for signs of recovery, from someone else. We need the 'multiplier' effect. In the classical phrase "supply creates its own demand"; meaning that, in aggregate, everything that is sold has to be bought; and buyers must sell something if they are to be able to buy.

         I am not crying for astronomical rates of income tax. Nor is this an anti-business agenda. Indeed it is a pro-business agenda, because it is arguing for the importance of markets for enterprises. But it is indeed an anti-rich agenda. The money has to be recirculated somehow. If they are smart, the rich will spend it and enjoy it. Otherwise it has to be taken off them by some means or other; by VAT, by domestic rates on large properties (whether lived in or not); and finally, if any remains, it must be taken off them when they die. (Rich sons are not noted for their enterprise.)

         Unless you are yourself significantly wealthy you should not vote for the party of private wealth. The bulk of the population should not seek to cut taxes, for taxes bring benefits.

Blog1:http://occidentis.blogspot.com/
Blog2:https://ianwest2.wordpress.com/
Blog3:http://cawstein.blogspot.com/

Keynes1

The difficulty of Keynes's Style

    While greatly admiring the clarity and confidence of Keynes's thinking I am very critical of the obscurity of his style and the impediment that raises to a close reading of his important book: John Maynard Keynes* (1936), "The General Theory of Employment, Interest and Money" (readable online). Take (for example) the following from chapter 8.

"Since we are here concerned in determining what sum will be spent on consumption when employment is at a given level, we should, strictly speaking, consider the function which relates the former quantity (C) to the latter (N)."

The 'here' is mere pedantry. And the definitions of C and N are unnecessarily delayed. Given that, in English grammar, 'which' describes while 'that' defines, I conclude that JMK has a tendency to confuse the two. So try:

Since we are occupied in determining what sum will be spent on consumption (C) when employment (N) is at a given level, we should consider the function that relates the two.

    Another example of the that/which problem (from chapter 2):

"....; whereas they do not resist reductions of real wages, which [I suggest 'that'] are associated with increases in aggregate employment and leave relative money-wages unchanged, unless the reduction proceeds so far as to threaten a reduction of the real wage below the marginal disutility of the existing volume of employment."

    I submit that not all reductions of real wages are of the sort described, so the 2^nd clause is a 'definition', a necessary limitation, and not a 'description'. (But I do not claim to underatand "the marginal disutility of the existing volume of employment.")

    Take that obscure but important definitions in Chapter 2 — that of "involuntary unemployment". Unless you understand this you do not understand Keynes:

"Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. "

    Keynes's "would be" throws me, as it flouts the Humpty-Dumpty rule on conditionals ('If the number were greater the men would be unemployed'). Which men? No-one has been sacked, so are we talking about men currently idle by choice, who wish to become employed because of a rise in real prices, but who cannot find a job (except at a wage below the current)? (I do not see the force of this. Will not the classical school say that there is nothing to stop these men taking a lower wage (unless it be collective bargaining)?) 

    What is the 'aggregate demand for labour'? Does Keynes mean that the entrepreneurs are seeking workers? So, why does not the 'existing volume of employment' increase if there is both rising demand and supply? Are we merely talking about a time lag; the supply and demand for labour go up, but the jobs do not appear immediately? However, we all know that there are people seeking work during a 'depression', and we suspect it is because the entrepreneurs do not see a market for further product.

    I find (to my amusement) that people write books [ref. 2] about this important concept of the 'involuntarily unemployed', and the obscurity of Keynes's writing.

References:

1.  John Maynard Keynes (1936), "The General Theory of Employment, Interest and Money" (0nline at eth, Zurich.)

2.  G. L. S. Shackle (1983) The Years of High Theory: Invention and Tradition in Economic Thought 1926-1939.

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Interest Rates

I have been trying to follow the argument of Gerardo Coco in his interesting, but confusing, piece posted on the Cobden Centre website. I wonder if I have got the gist of his argument in the two short paragraphs below. 

Interest rates have to play several different roles.

(1) The first role that springs to mind is that of indicating the price of credit; interest being a regular (e.g. annual) fee paid to the lender for the temporary use of his capital. This capital may be invested in a productive investment, to buy tools, or a mill, or an extra field. A rational investor will pay no more in interest than he can gain (per annum) from his investment. Good times will allow interest rates to rise, and conversely bad times will hold interest rates down.

(2) For some people liquidity is the problem; they want cash in hand, not to invest, but to pay the bills. Their desperation will determine the upper limit of the interest rate they will pay. Let us call this process of turning credit into cash 'discounting'.

(3) People have grown to expect money to breed, to yield an annual income. The relationship between capital and income is of course the interest rate. There is a backwards way of thinking which says "My assets yield £100 a year; interest rate is 1%; so my assets are worth £10,000."  If interest rates were 5% I would value my assets at a mere £2,000. A form of this argument may be driving up current house prices; "My house is worth £300,000 and I can afford a mortgage (at 6%) costing £18,000 per annum. If mortgage rates drop to 3% I can sell my house for twice as much."

(4)  Central banks use their 'base rate' as a means (essentially their only means) of controlling the money supply, and with it the 'growth of the economy', 'unemployment', and 'inflation'.

It is hard for a single 'Interest Rate' to fulfill all the roles required of it. It is true that Bank Base Rate does not impinge directly on the high street borrower, for the normal citizen cannot borrow money at the present comically low rate of 0.5%. But it remains a problem that a lender does not always know to whom he is lending and for what purpose. If Central Banks set a very low interest rate, some entrepreneurs may borrow money (as it is so cheap); but others will conclude that 'times are bad' for investing and consequently will wait for better times. The Bank's one available signal of Bank Base Rate can have a damaging effect while trying to have a stimulatory effect.

How bad is debt?

Debt 6 —  How bad is debt?

"Neither a borrower nor a lender be; for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry." Hamlet 1.3

These words have found resonnance in puritan heads from Shakespeare till the last part of the 20^th century. Polonius could have said more against borrowing. A debtor who is unable to repay his debts finds himself at a considerable disadvantage; he may lose his liberty, or his house, or find himself tied to a tredmill, paying interest he can ill afford without hope of escape. Furthermore, Polonius mentioned none of the advantages of debt.

Is debt, in general, a good thing or a bad thing?

Well, it is a good thing for the lenders who can expect a return on their capital of 2 or more % above inflation, even if their loans are of the non productive sort.  And it is a good thing for the entrepreneur who is trying to expand a winning business model (productive borrowing). But it is a bad thing for the "over indebted". Citizens Advice Bureaux (CAB) estimate that keeping up with bills and other financial commitments is a burden (or worse) for nine per cent of the population [2].

But the 90% who can manage their affairs intelligently can freely choose to enjoy a house and a car while they are young and pay as they get older. Inflation will considerably mitigate the amount they lose in interest payments. If they come on hard times they could lose their house; but end where they started, little the worse.  Many young people nowadays will take thought, and borrow. The case will depend on: [a] rate of inflation, [b] stability of the jobs market; but can be skewed by governmental tamperings  such as [c] capital gains legislation, [d] income tax relief, etc. Another factor is [e] temperament; cautious individuals will overestimate the chance of losing their job while the reckless will underestimate that.

Since 1975 the household debt as a fraction of annual disposable income rose in most western countries; in the UK it almost trebled  from 0.64 in 1975 to a peak in 2008 of 1.80, from which it has sunk in 2012 to 1.55 [1] We are more deeply indebted than the US, but trail Denmark, Norway and Switzerland. Since 2000, Germany has almost halved its debt/income ratio, while most other countries have only reduced personal debt in the last 5 years. One suspects that these data reflect a spectrum of several underlying factors: caution, stability, cost of the housing stock, age distribution of the population.

 (Unscrupulous lending (offering money to someone unable to calculate the consequences) is a social evil, like drunkenness, and should be subject to social and even legal regulation. Predatory lending (where a secured loan is offered in the hope that it cannot be repaid so that the lender can acquire the security) would be criminal were it possible to prove.)

Though it goes against my gut feeling to let myself be beholden in that way, I conclude that there is little case against debt if it is entered into with due thought, but that it should not be encouraged by the state (to the benefit of the bankers and to the detriment of the economy and society generally. Furthermore, there should be closer scrutiny, and better means of regulation and redress.

Ref.1: http://www.zerohedge.com/news/2013-06-04/debt-nations

Ref.2: http://www.citizensadvice.org.uk/pdf_the_value_of_debt_advice.pdf

 

Ian West, 12 Longhirst Village, NE61 3LT

Payday Loans

Payday Loans

I believe that it would be socially beneficial if the rapacious activity of the payday loan industry could be reined in. Though it is possible to argue that these companies serve a useful, even a necessary, purpose, it is nevertheless clear that it is only the desperate (or the foolish) who use the loans. Meanwhile the general public wince at the extortionate rates of interest; it is painful to watch; it seem no less brutal than trussing a weak man and pulling out his toenails. But the evil goes further. The near indigent find themselves on a downward spiral of debt from which there is no (legal) escape.

My remedy is fair, logical, and (with a stroke of the legislative pen) could be made legal. It is not hyper-novel as it enshrines a principle accepted in most civilisations from Roman times till the modern barbarism of the capitalist era; the distinction between usury and capitalism.

As soon as the accumulated interest paid on a loan equals the amount borrowed, the loan should be regarded as discharged. A low interest rate (say,  inflation plus 1%) should then replace the original high rate, but calculated back to the beginning of the loan. 

It can be argued that a high rate of interest is justified if there is a high risk that the principal will not be repaid. That cannot be argued as soon as the borrowed sum has been repaid. Suppose I borrow £100 at 10% per month interest. If I pay the lender £10 a month and keep up the payments for 10 months, the loan company will say that I still owe £100, as I have only been paying the interest. But I will have paid £100, and to my way of looking at it I will have repaid the loan, but not yet the interest. It cannot be argued that I am a high risk, so the due interest should be a trivial £5 (if 5% p.a. Is appropriate).

Ian West, 12 Longhirst Village, NE61 3LT