Thursday, December 17, 2015

Where Left and Right Agree on the Economy

Conventional economics these days suffers from two fundamental flaws:

  • Private and sovereign public debt are inappropriately lumped together in discussion of economic policy.
  • Monetary and fiscal policy are inappropriately lumped together as Keynesian or government-directed approaches to managing the economy.

I'm not a fan of the "Austrian" school of economics, but do agree with them on the folly of the current conventional economic wisdom.  Specifically, they point out that monetary policy doesn't work, and that this leads to excessive debt.  The Austrians feel strongly that periodic recessions are necessary and healthy in allowing the economy to recover from the periods of excess debt.  I agree with this to a point, but there is the further issue of the suffering resulting from recession in an economy such as ours.  Unlike the Austrians, I feel that government can and should take action to cushion the pain and limit the damage.

Here is a good short summary of the Austrian position:  The Important Role of Recessions, by Lance Roberts
Lawrence Summers correctly said the economy’s weakened ability to withstand higher interest rates is based on the fact that lower rates in the past have pulled forward demand for goods and services, thereby leaving less demand in the future... 
Today’s economy has a massive level of indebtedness from consumption of days past and a long history of misallocated capital that has tied up funds that could have otherwise been chasing the next great innovation and propelling our economy forward...   
The problem currently is that the Fed’s actions halted the “balance sheet” deleveraging process keeping consumers indebted and forcing more income to pay off the debt which detracts from their ability to consume. This is the one facet that Keynesian economics does not factor in.
Roberts unfortunately lumps monetary policy with fiscal policy and combines the mainstream view on these as Keynesian economics.   I think of the policies he describes as not Keynesian, but rather monetarist.  Monetarism is the school that advocates central bank tinkering with interest rates for the purpose of managing the economy.  In practice, this leads to the situation described by the Austrians.  After so many years of lowering interest rates to fight recessions by encouraging more borrowing, we end up with excessive private debt and zero interest rates.

To make matters worse, monetarism has no solution to unsustainable debt, and the result is that the central bank bails out the lending institutions.  As monetarism does not provide a fiscal safety net, the only way to avoid a crippling reception is engage in such bailouts.  The result is increased inequality and lack of fairness.  Austrians as well as liberal proponents of Modern Monetary Theory (MMT) are equally disgusted by this state of affairs.

The trap that many liberals fall into is to accept monetarism as a legitimate facet of Keynesianism.  Modern Monetary advocates (MMTers) fight against this.  Keynesianism is practical insofar as fiscal policy is predominant, and monetary policy is just part of the mechanics of implementing fiscal policy.   More broadly, we should use fiscal policy to achieve our explicit objectives (population has enough to eat, is educated, has access to medical care, etc.).  Monetary policy should be used to support these objectives, as opposed to serving as an all purpose tool to either revving up the economy by encouraging more debt or throttling down the economy by discouraging lending.  A currency-issuing government is only constrained by real resources, and not by monetary factors.

This perspective is discussed by John Cassidy in the New Yorker in a recent article entitled Printing Money.
Until recently, the textbook prescription for slow growth involved cutting interest rates and introducing a fiscal stimulus, with the Treasury issuing debt to pay for more government spending or for tax cuts (aimed to spur household spending). That was the recipe that the United States, Britain, and other countries followed after Lehman Brothers collapsed, and it helped prevent a deeper slump. Today, however, neither of the traditional policy responses is readily available. The short-term interest rate that the Federal Reserve controls has been close to zero since December, 2008. Janet Yellen, the Fed chair, and her colleagues can’t cut rates any further. And with over-all federal debt standing at more than eighteen trillion dollars Congress would strongly oppose the Treasury’s borrowing more money for another stimulus package. In the E.U., the situation is even more fraught. Growth has been negligible for years, interest rates are at very low levels, and a legal commitment to austerity policies rules out a fiscal stimulus.
 The highlighted passages are political, as opposed to economic, factors.  The point of the article is that these political factors may be based upon faulty economics, as MMTers would argue.  The author begins from the perspective of the conventional wisdom, lumping monetary and fiscal policy together, but sees that this leads nowhere.  He continues,
Lord Turner argues that countries facing the predicament of onerous debts, low interest rates, and slow growth should consider a radical but alluringly simple option: create more money and hand it out to people... It’s a deadly serious proposal, actually, and its author is a sixty-year-old English technocrat renowned for his intellect and his independence... My proposals will horrify many economists and policymakers, and in particular central bankers,” he writes. “ ‘Printing money’ to finance public deficits is a taboo policy. It has indeed almost the status of a mortal sin.” ... a number of liberal economists rallying under the banner of “Modern Monetary Theory” have urged the government to reverse budget cuts, financing the spending with money created by the Fed. In Britain, Jeremy Corbyn, the new leader of the Labour Party, has suggested that the Bank of England could pay for some infrastructure spending by printing money.
Unfortunately, Cassidy doesn't explain MMT very well, and perhaps does not clear up the conflations of public and private debt, and of monetary and fiscal policy.  Perhaps a clearer statement is that governments can and do create money at will to achieve objectives.  The size of the public debt is irrelevant, as is monetary policy.  Whether the government pays for things by printing money or by issuing debt is irrelevant.  The two are interchangeable as he points out with numerous examples.   His title "printing money" is only new as a way of thinking about how governments currently work, and thereby expanding the horizon as to what can and should be done.

Going back to the Austrians, who believe that recessions are healthy and necessary to extinguish bad debt, the MMTers would reply that the government can and should support the citizenry who had no role in the excess debt.  Punishing all for excessive debt incurred by some is neither fair nor efficient.  We can allow debts to fail, without allowing the overall economy to collapse.  Fiscal spending can accomplish this.  (Austrians are right to say that monetary policy cannot accomplish this.)  

This is socialism, and it is the way we operate.  We have a mixed capitalist-socialist economy, and that seems to be what works best.  Yet we pretend that the capitalist system, based upon private-style debt, is how our system works.  Austrians actually believe that it should work that way, but that is contrary to all evidence in my opinion.  Our modern monetary system is in fact largely socialist, yet provides considerable freedom and room for capitalist endeavor.  Governments create money by spending it into economies.  Capitalists leverage government money and work within the government run system to carve out powerful and efficient enterprises.  Each needs the other.

So both the left and the right are screaming that the current system, based upon the conventional wisdom, doesn't work.  And, in this case, the extremes are correct and the center is mistaken.

  1. Remove monetary policy from the discussion.  Both Austrians and MMTers agree this doesn't work as advertised.  +1 Austrians, +1 MMT
  2. Treat sovereign debt as money (not as something similar to private debt).  +1 MMT
    Gold and silver are not and should not be money.  -1 Austrians
  1. MMT +2
  2. Austrian 0
  3. Conventional 0