Archive for January, 2012

American Exceptionalism #238: Opportunity (Not)

January 16th, 2012 5 comments

I don’t usually link to Paul Krugman because everyone reads him anyway, right? He doesn’t need my google juice.

But I have to make an exception here because he adds to my trove of graphs demonstrating how America today — after thirty years of Reaganomics policies that were supposed to be all about freedom, liberty, and economic opportunity for all (yeah, and I have a bridge for sale), is at the bottom of the heap when it comes to economic opportunity.

The shining city on the hill keeps getting smaller and richer, and the slopes leading up to it steeper, rougher, and slicker.

That opportunity is best displayed through intergenerational mobility — what my friend Steve calls “convection.” What are the odds that a child will be in a different economic stratum from his parents? It’s a darned good measure of “meritocracy.”

Here’s the key graphic:


On the vertical axis is the intergenerational elasticity of income — how much a 1 percent rise in your father’s income affects your expected income; the higher this number, the lower is social mobility.

As you can see, it’s only getting worse. My explanation is here.

The Great Gatsby Curve –

Cross-posted at Angry Bear.

John Galt, “Genocidal Prick”

January 16th, 2012 1 comment

John Scalzi:

…in Ayn Rand’s world, a man who self-righteously instigates the collapse of society, thereby inevitably killing millions if not billions of people, is portrayed as a messiah figure rather than as a genocidal prick, which is what he’d be anywhere else. Yes, he’s a genocidal prick with excellent engineering skills. Good for him. He’s still a genocidal prick.

What I Think About Atlas Shrugged – Whatever.

Cross-posted at Angry Bear.

An MMT Thought Experiment: The Arithmetic and Political Mechanics of Net Financial Assets

January 13th, 2012 63 comments

Imagine that over the next week (in a closed American economy — the rest of the world has never existed) everyone sold all their financial assets, paid off all their debts, and deposited the remaining money (and any currency they have) in their checking accounts. No money-market funds, even. Just banks with reserve accounts at the Fed, holding everybody’s money in “cash.”

All those other financial asset prices would dive to zero. Late sellers would sell for nothing.

Would the remaining money in all the bank accounts equal U.S. government debt? That seems to be the implication of MMT thinking, because the remaining money only exists because it got spent into existence by the government deficit spending — crediting bank accounts with that fiat, ex nihilo money in the first place.

Net financial assets = gross financial assets = government debt

(If the government had always just deficit-spent instead of borrowing to cover its deficits, “government debt” would be replaced by “cumulative to-date government deficit spending.”)

I ask not just for clarity, but because (as always), I’m struggling with the relationship between fixed assets and financial assets, between saving and investment.

It’s said that the true wealth of the nation — the “national savings” — consists of its real assets: stuff that can be consumed in the future through use and time/natural decay. The NIPAs only count “fixed assets” — hardware (equipment), software, and structures, so let’s pretend that those constitute all real assets (which they don’t in actuality — not by a long shot). Net investment — purchases/creation minus consumption of fixed assets — increases the stock of fixed assets/”savings.”

In theory, financial assets are just financialized, monetized representatives, proxies, for the real, fixed assets that underly them. And indeed over the (very?) long term, the quantity of fixed assets and net financial assets rise together. Both are much larger today in the U.S. than they are in Thailand, or the U.S. in 1910. Financial-asset values wander all over — even over decades — based on “animal spirits,” but again in the long term…

If that’s so, then in our thought experiment:

Net financial assets = gross financial assets = government debt = fixed assets

The quantity of fixed assets increases over time through net investment. But by MMT thinking, net financial assets can only increase through government deficit spending (or trade surpluses). What is the mechanism whereby government deficit spending is translated into more net financial assets that embody the increased stock of fixed assets?

I imagine a necessarily political mechanism something like the following:

1. People and businesses buy/create fixed assets, resulting in more economic activity — creating/consuming, buying/selling, spending/income.

2. Those increased quantities (both stocks and flows) create more demand for government services. Both individuals and businesses would be decidedly unhappy, I’m thinking, if today’s government were the same size it was, at least in absolute terms, in 1870. (Conservatives and libertarians may say otherwise, but they’re talking through their hats.)

3. Legislators and executives who don’t provide those increased services don’t get re-elected.

4. Taxation lags behind spending — resulting in deficits — because A) people hate taxes and vote against politicians who raise them, and B) if deficit spending is not sufficient to match the increases in fixed assets, depressions result, and the “fiscally responsible” leaders get voted out.

5. The new money from government deficit spending is used to purchase financial assets, driving their prices up to (roughly) match the value of fixed assets.

This is thinking of government and the Fed as one consolidated entity. If you think of them as separate, you can imagine a different mechanism, in which the Fed and the congress/president are engaged in a constant chicken game over inflation, unemployment, and GDP growth, to determine how and when to increase the amount of money/net financial assets (ultimately through deficit spending) to match the stock of fixed assets.

These mechanics would also explain how buying/creating a bunch of drill presses will — through a long, tangled, and messy political process, and in the long but not the short run — result in more “loanable funds.”

Cr0ss-posted at Angry Bear.

The Most Important Econoblog Post This Year: The Steve Keen/MMT Convergence

January 10th, 2012 1 comment

Neil Wilson has done yeoman’s duty to (perhaps) achieve a convergence that has been too-long delayed.

A Double Entry View on the Keen Circuit Model.

Steve Keen is, to my knowledge, the only person who is actually encoding a Godley-esque, MMT-style, accounting-based, stock-flow-consistent dynamic simulation model of how economies work. But many MMTers have been quite hostile or at least resistant to Steve’s work, based on some different concepts of endogenous/exogenous money, and — this may seem trivial but it isn’t, at least as it has played out over time — based on details of single- versus double-entry accounting.

The debate has been quite acrimonious at times, and that acrimony has greatly hindered a convergence that in my eyes would be the most salutary event possible in the development of economic thinking and practice.

You can read the details in Neil’s post, but in short he’s re-jiggered Steve’s accounts to make them conform better to (at least Neil’s view of) standard bank-accounting practices. I’m not qualified to evaluate his new formulation, but I am excited to read Neil’s comment on the post, replying to uber-MMTer Scott Fullwiler:

We need to get all this pulled together into a coherent overall model.

Steve’s up for it. I hope you are too.

I’ll just say: I’m very much up for watching it happen.

Also: run don’t walk to read Steve’s Debtwatch Manifesto, posted last week.

Cross-posted at Angry Bear.

The Upper Bound in the Fed’s Head: Inflation

January 10th, 2012 1 comment

Continuing with one of my current hobbyhorses:

Ryan Avent reports on the American Economic Association meeting, with special attention to a presentation by Robert Hall:

Monetary policy: The zero lower bound in our minds | The Economist.

Mr Hall argued that:

A little more inflation would have a hugely beneficial impact on labour markets,

And a reasonable central bank would therefore generate more inflation,

And the Federal Reserve as currently constituted is, in his estimation, very reasonable; therefore

The Federal Reserve must not be able to influence the inflation rate.

… Why is Mr Hall—why are so many economists—willing to conclude that the Fed is helpless rather than just excessively cautious? I don’t get it; it seems to me that very smart economists have all but concluded that the Fed’s unwillingness to allow inflation to rise is the primary cause of sustained, high unemployment. …a macro challenge that actually boils down to the political economy constraints (or intellectual constraints) facing the central bank.

Emphasis mine.

I, of course, am less charitable, and impute other motives.

Hat tip to David Beckworth, whose feelings I fully understand:

I found the whole affair so depressing that I wasn’t able to drag myself to many sessions.

Cross-posted at Angry Bear.

Answers: Taking IOR to Zero

January 7th, 2012 15 comments

I want to thank all the commenters on my last post — at Angry Bear, at Asymptosis, and at Mike Norman’s blog. You’ve provided me with exactly the education I hoped to achieve. Here’s hoping others benefited similarly.

I asked: what would happen if the the Fed cut the interest rate on reserves from its current .25% to zero. I was not suggesting it should be done. I simply wanted to understand what would happen if that one variable changed.

I want to summarize the conclusions I’ve come to based on all the discussion.

This is me speaking, based on sifting and considering all the responses. I won’t link to all the excellent comments that brought me to this. (Though I do want to highlight the Angry Bear comment by Bad Tux beginning “At 0% IOR”.  It arguably explains things better than I do here, and at significantly less length.)

First, the market monetarists responses. Scott Sumner said (in comments a while back on his blog, which I linked from my original post):

It could be slightly expansionary, or if accompanied by other moves, wildly expansionary.

I’m presuming he says “slightly expansionary” based on the theory Mark Thoma gives us in a November 17 post that Cameron was nice enough to link to on Angry Bear:

it would slightly lower the incentive for banks to hold cash rather than loaning it out, and more loans would help to spur the economy

So banks could lend a quarter point cheaper, or loosen their lending requirements slightly. Assuming there’s some decent amount of demand at lower rates (elasticity of demand is appreciably > 0), or that good borrowers are asking for loans but being turned down cause they’re too risky, this could have a small effect. Scott’s “other moves” presumably include NGDP level targeting by the Fed, but that’s all beyond the contained question I asked here.

James Oswald — who cites himself as a market monetarist but who seems to understand and adhere to much MMT thinking in his other comments and writings — said at Asymptosis:

There is no reason to think they [reserves] would not decrease back to the pre-IOR levels, at least over time, pushing around around 1.4 trillion dollars of high powered money into the economy and triggering significantly higher inflation.

This doesn’t seem to make any sense at all. (And I rather doubt that the Sumners and Beckworths of this world would agree with it.)

In (simplistic) theory, taking IOR nominally negative (the extreme case) would make banks want to instead hold physical currency, with its higher (zero) nominal return. Continuing the simplistic theory, that more-liquid money would be lent and spent more.


1. There are significant costs and management headaches associated with holding currency — trucks, warehouses, security guards, all that rot.

2. It’s completely unclear why banks holding warehouses full of currency would have any incentive effects on borrowing and lending — hence real-economy purchases/velocity. Lenders and real-economy borrowers do their thing because they see valuable risk/return opportunities in the real economy. Changing the form of banks’ holdings will not affect that real-economy reality. Recent history: the QE trades — giving banks reserves in return for bonds — doesn’t seem to have had such an effect, if the massive runup in excess reserves is any testament.

3. Explaining #2: For banks, currency is (see #1) less liquid than reserves. They’re not carrying it in their pockets so they can buy gum at the corner store. They want to make loans; are they going to make them in cash?

4. Even if they did make the move to currency:

A) They couldn’t all do it; there’s not enough currency around.

B) The effect would be to reduce the amount of currency “in circulation” (it’s stuffed under banks’ mattresses), presumably prompting exactly the opposite of what market monetarists suggest:

a. Less real-economy spending/circulation/velocity and

b. Deflation — dollar bills would be harder to come by, so they’d be more valuable relative to real goods

At least in the discussions I’ve been perusing, this “currency” theory of “pushing” “more-liquid” money into circulation doesn’t make any sense. At all.

Market monetarists do seem to at least loosely and implicitly adhere to the (questionable) theory that people and businesses spend more because they hold money in more-liquid form — and they might even confute bank’s incentives and behavior with people’s incentives and behavior at times — but still this currency thinking is probably not a good or widely held market-monetarist theory. In any case it deserves unequivocal debunking.

So: Numerous cogent and convincing commenters agree that taking IOR to zero would have negligible first-order effects on lending and spending. And (invoking authority here) Mark Thoma agrees, in the post cited above:

It probably wouldn’t do much

But — considering the practical, workaday effects on the financial system such as those depicted in the currency fantasy above — Thoma links to an article by Todd Keister from the NY Fed. In short, IOR of zero would break a whole lot of financial entities’ business models. The gang at Mike Norman’s blog point to the problems already facing primary dealers, which could be (greatly?) exacerbated by a drop to zero. StreetEye on Angry Bear says that it would trash the main-street banking model. And etc. Various institutions would die or just withdraw their services/trades from the financial system.

The second- and third-order effects of such eventualities could have profound negative impacts on the real economy.

Which perhaps explains another thing I’ve been wondering about: why did the Fed institute IOR in the first place, and why did it do so when it did?

We can at least give the Fed  credit for understanding the business models of various financial entities. When they saw interest rates heading toward zero, they instituted IOR to prevent the systemic lockup/breakdown described above.

IOW, nothing (much) to see here folks. Move along.

Sorry if I’m so dull that I had to go through all this to figure it out.

Make sense?

Cross-posted at Angry Bear.

Question for Market Monetarists and MMTers: What Happens if IOR Goes to Zero?

January 5th, 2012 21 comments

For the non-cognoscenti: “IOR” is interest on reserves. Banks keep money in their accounts at the Fed. In October, 2008 the Fed started paying .25% interest on those accounts.

The Fed’s also engaged in “quantitative easing,” a.k.a. open-market purchases on steroids, creating new money and using it to buy $1.6 trillion dollars worth of bonds from banks. The money is deposited in banks’ reserve accounts.

The result: banks have $1.6 trillion dollars in excess reserves (in excess of what they’re required to hold) sitting in their accounts at the Fed.

This is the heart of the “pushing on a string” argument — giving the banks more reserves (making their holdings more “liquid”) doesn’t (necessarily) increase real-economy transaction volumes (on consumption or investment), either directly through spending by the banks or via bank loans to people and businesses who will spend it. This $1.6 trillion in new money issued by the Fed is effectively stuffed in an electronic mattress.

So I’m curious what would happen if the Fed no longer paid IOR.

I asked Scott Sumner this a while back:

if tomorrow the Fed dropped IOR to zero or even negative, what would happen to:

o Excess reserves
o Inflation

He gave a somewhat less than satisfactory answer:

The IOR question is a good one, and at the risk of being annoying I’m going to slightly dodge the question. I do think it would be expansionary, but it’s hard to know how much, because it’s almost inconceivable to me that it would be done by itself, without any other policy changes. It could be slightly expansionary, or if accompanied by other moves, wildly expansionary.

Less than satisfactory (for me) because he often engages in these kind of simplified thought experiments. Change Variable X, ceteris paribus: what would happen?

I’m basically asking for a free education here (hoping others would appreciate such an education as well), but I’m also hoping to spur a discussion on a tightly focused question that has not been cogently discussed, as far as I can find. (I certainly could have missed it. Pointers welcome.)

Cross-posted at Angry Bear.

Menzie Chinn Explains it All for You: Demand Inflation Now!

January 3rd, 2012 2 comments

Whether it’s Market Monetarist NGDP targeting (a.k.a. Damn The Inflation Rate; We Need Growth!) or Menzie’s recommendation of Conditional Inflation Targeting with a notably higher target, everything tells us that somewhat higher inflation is the current path to greater and more widespread long-term prosperity.

Raising the expected inflation rate will lower real interest rates and spur investment and consumption. It will also make it difficult for the de facto dollar peggers, such as China, to sustain their policies. The resulting real depreciation of the dollar would stimulate production of U.S. exports and domestic goods that compete with imports, boosting American production. The United States would get faster growth, an accelerated process of deleveraging, a quicker recovery, and a firmer foundation upon which to address long-term fiscal problems.

Like the market monetarist approach, Chinn’s proposal is basically for an automatic stabilizer based on unemployment levels, that anchors expectations (emphasis mine, both above and below):

a policy that would keep the Fed funds rate near zero and supplemented with other quantitative measures as long as unemployment remained above 7 percent or inflation stayed below 3 percent. Making the unemployment target explicit would also serve to constrain inflationary expectations: As the unemployment rate fell, the inflation target would fall with it.

As I said a while back:

Automatic stabilizers are the key to effective 1) policy and 2) expectation-setting. Because 1) They happen, and 2) People know they’re gonna happen. Could be fiscal or monetary, largely a question of where you inject the money.

In other words:

Demand Inflation Now! Up the Real Economy

Full disclosure: as a wealth-holder/creditor, the policy proposed here is directly contrary to my own short-term best interests. I would much prefer to see a crash in financial asset prices resulting from deleveraging and slow-growth expectations, so I could buy those assets cheap with all the cash I’m sitting on. But for whatever crazy reasons, I’d rather that my (and your) children and grandchildren spend their lives in a thriving and widely prosperous country.

Cross-posted at Angry Bear.